BWTR Basin Water (MM)

Risks Related to Our Business

We have a limited operating history, have incurred significant operating losses in our first few years of operation and have not consistently achieved profitability on an annual basis.

We have a limited operating history and limited revenues derived from our operations. We began our business operations in December 1999 and did not generate our first revenues until 2002. Our revenues grew from $12.2 million in 2005 to $17.1 million in 2006 and $18.8 million in 2007. We have incurred significant net losses attributable to common stockholders since our inception, including net losses of $1.3 million in 2003, $0.6 million in 2004, $11.2 million in 2006 and $15.3 million in 2007. Our net loss in 2006 resulted in part from reserves we recorded in connection with certain of our contracts which have ongoing operating costs in excess of our contract revenues. In addition, our net loss in 2007 resulted in part from additional reserves we recorded in the third quarter of 2007. We took these reserves in connection with certain older legacy projects when it became apparent that most of these projects would be operating at a loss for some period of time. In addition, we may find that additional contracts have ongoing operating costs in excess of revenues, which could have an adverse effect on future results of operations. Though we have taken steps to improve our business processes, we cannot assure you that these improved processes will positively impact our results of operations. At December 31, 2007, we had an accumulated deficit of approximately $30.5 million.

Our operations prior to 2006 primarily focused on development of our technology and onsite regenerable ion exchange treatment system, building our sales and marketing capabilities, commencing the commercial

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launch of these systems and developing and maintaining customer relationships. In late 2006 and throughout 2007, we implemented several initiatives to improve our business model, but we cannot assure you that any of these initiatives will result in increased revenues or positively impact our financial results. In addition, our ability to successfully sell our systems and services depends on, among other things, the level of demand for contaminated groundwater treatment, which is an evolving market, and the demand for our technology and services in those geographic areas and markets into which we are expanding. Even if we do achieve significant revenues from our business operations, increased operating expenses associated with any expansion of our business may result in future operating losses in the near term as we, among other things:

As a result of these and other factors, we may not achieve, sustain or increase our profitability on an ongoing basis.

Our future operating results will likely fluctuate significantly from reporting period to reporting period.

We expect our future revenues and operating results to fluctuate significantly from period to period due to a number of factors, including:

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Any of the foregoing factors, some of which are not within our control, may cause our operating expenses to be disproportionately high or cause our revenues and operating results to fluctuate, which could prevent us from maintaining or increasing our business or could harm our results of operations. In addition, our future revenues or our future operating expenses may not be consistent with our past results, which could adversely affect our stock price.

If we do not manage our anticipated growth effectively, we may not be able to develop or implement the infrastructure to support our operations, market our services, manage our relationships with customers and our relationships with strategic partners which could place significant strain on our management and significantly harm our business and operating results.

We have grown rapidly, with our revenues increasing from $4.3 million in 2004 to $12.2 million in 2005, $17.1 million in 2006 and $18.8 million in 2007, and the number of our employees increasing from 44 as of December 31, 2005 to 65 as of December 31, 2006 and 107 full time and 5 part time employees as of December 31, 2007. We expect to continue to expand significantly our management, sales and marketing, engineering functions, field services, research and development, testing, quality control, customer service and support operations as well as financial and accounting controls. For instance, we recently expanded our operations to the Southeast U.S. with our acquisition of MPT. This expansion has placed, and will continue to place, significant strain on our management and administrative, operational, technical and financial infrastructure. If our management is unable to manage growth effectively, the quality of our field services, our ability to attract and retain key personnel, the success of our strategic alliance and relationships, and our business or prospects could be harmed significantly. To manage growth effectively, we must:

We may not be able to effectively manage any expansion in one or more of these areas, and any failure to do so could harm our ability to maintain or increase revenues and operating results. In addition, our growth may require us to make significant capital expenditures or to incur other significant expenses, and may divert the attention of our personnel from our core business operations, any of which could affect our financial performance adversely.

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Our financial success will depend in part on the efforts of strategic relationships we may work with in the future.

In November 2007, we announced the formation of an exclusive, service-based alliance with Rohm and Haas. This alliance provides us with exclusive access in selected markets to the Rohm and Haas ion-exchange resin technology which we intend to deploy as part of our business model. Our alliance also provides us access to technology for the removal of organic contaminants from water, support for our business model through access to the Rohm and Haas scientific and laboratory resources and Rohm and Haas’ developed channels to the specified markets. In late 2007, we entered into an agreement with Purifics to provide us with unique engineered systems, solutions and products effective in removing organic contaminants from groundwater. Under this agreement, we can exclusively market the Purifics photocatalysis technology in certain areas of the United States, and we have access to the technology on a non-exclusive basis in a larger market area. We may enter into other such strategic relationships with other companies focused on the water, wastewater, waste reduction and resource recovery industries on a national basis. Our financial success and our anticipated growth will depend in part on the efforts of these strategic relationships as we market and sell our treatment systems and solutions. If Rohm and Haas, Purifics or any other strategic relationships fail to perform satisfactorily under their respective agreements with us, or if we fail to maintain these relationships, or establish new relationships as required, then we may lose our access to their technologies, and our ability to market our treatment systems and our technology+services offering will likely suffer. In addition, our revenues resulting from these strategic relationships may not grow as anticipated, and we could be subject to additional costs which could negatively impact our operating results and financial condition significantly.

Our long sales cycles make predicting our financial results difficult.

Many of our service contracts have a term of five or more years, and some contain an option either to purchase the system or to renew the contract at the end of the initial contract term. Since most of our sales are based on long-term contracts, our customers generally take a longer time to decide to purchase our system and/or services, thus creating a lengthy sales cycle. Other reasons for our long sales cycle include:

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In addition, to the extent we expand our service to international markets, we may face additional factors that contribute to long sales cycles, including additional time required for travel to foreign locations as well as potential problems caused by language barriers, cultural differences, differing business practices, differing contracting practices, and varying regulatory requirements. Our long sales cycles, as well as the placement of large orders with short lead times on an irregular and unpredictable basis, may cause our revenues and operating results to vary significantly and unexpectedly from period to period. Since our operating expenses are largely based on anticipated revenue trends and a significant portion of our expenses are, and will continue to be, fixed, any delay in generating or recognizing revenues could harm our operating results or financial condition significantly.

Our ion-exchange treatment systems and the technologies upon which they are based may not achieve widespread market acceptance among our customers which may impact demand for our system and services.

We have developed our proprietary ion-exchange technology and processes for groundwater treatment based on ion-exchange technology that competes with other forms of groundwater treatment technologies that currently are in operation throughout the United States. This proprietary technology is used in our onsite regenerable and disposable resin treatment systems. Through our acquisition of MPT, we have expanded our capabilities into central regeneration for ion exchange, smaller ion-exchange systems and technologies to serve customers in the industrial markets. These treatment systems and the technologies on which they are based may not achieve widespread market acceptance. Our success will depend on our ability to market our systems and services to businesses and customers on terms and conditions acceptable to us and to establish and maintain successful relationships with municipal and industrial customers.

We believe that market acceptance of our systems and technology and our related success will depend on many factors including:

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If our systems or technologies fail to achieve or maintain market acceptance or if new technologies are introduced by others that are more favorably received than our technology, are more cost effective or otherwise render our technologies obsolete, we may experience a decline in demand for our systems and services. If we are unable to market and sell our systems and services successfully, our revenues would decline and our operating results and prospects would suffer.

We may be unable to attract and retain qualified personnel which could harm our business, operating results, financial condition and prospects significantly.

Our future success also will depend, in large part, on our ability to identify, attract and retain sufficient numbers of highly skilled employees, particularly qualified sales, marketing and engineering personnel. As of December 31, 2007, we had 107 full-time and 5 part-time employees. Although we have expanded our sales force somewhat, we have a limited number of sales and marketing employees and consultants, as well as service employees who provide field and other services to our treatment systems. We may not succeed in identifying, attracting and retaining individuals who qualify for these positions. Further, competitors and other companies may attempt to recruit our employees. If we are unable to hire and retain adequate staffing levels, it may be difficult to increase sales of our systems or services or adequately support our installed systems, which could harm our business and prospects.

Our future success also depends on the experience and expertise of our President and CEO, whose talents, efforts and relationships within the water industry have been, and continue to be, critical to our success. We have an employment agreement with our CEO that provides for “at will” employment. However, we cannot prevent our CEO from leaving our employ if he chooses to do so. We do not currently carry “key man” insurance upon the life of our CEO or the lives of any of our employees or officers. The loss of our CEO’s services and access to his abilities and relationships could adversely affect our ability to maintain or increase our customer base and could harm our operating results and prospects significantly.

The current geographic concentration of our customers in California and Arizona and the location of our headquarters in California make our business particularly vulnerable to adverse conditions affecting these markets.

Currently, our customers are concentrated geographically, primarily in the states of California and Arizona. Our revenues and operating results are therefore subject to local regulatory, economic, demographic and weather conditions in those areas. A change in any of these conditions could make it more costly or difficult for us to conduct our business. In addition, we are subject to greater risk of loss from earthquakes and wildfires because our headquarters, where we assemble our onsite regenerable systems, and most of the well locations that utilize our system are concentrated in California. Any of these occurrences could result in increased costs and a disruption in our operations, which would harm our operating results and financial condition significantly.

Due to our current client concentration, a loss of one of our significant customers could harm our business, operating results, financial condition and prospects.

As of December 31, 2007, we had 25 customers, not including approximately 200 small customers we added as a result of our acquisition of MPT. Our top three customers collectively accounted for 53% of our revenues during 2007 and typically have more than one contract with us for services provided to different wells. Our customers, including these top three customers,

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may, upon the occurrence of certain circumstances, elect to terminate their contracts with us prior to their contractual expiration date and seek services from our competitors. In addition, upon the expiration of these contracts, our customers may decide not to renew such contracts with us. If we were to lose one or more of these significant customers for any reason, our revenues would decline significantly and our business, operating results and prospects would suffer.

We may face risks associated with our geographic expansion.

We are implementing a regional structure in which we plan to open offices in five regions throughout the United States to support our municipal customers and one office to support our industrial customers. Our ability to expand our offering geographically will depend on our ability to recruit, hire, train and motivate sales, operations and field services personnel. If we are unsuccessful in gathering a critical mass of projects in a regional office, we may find it additionally difficult to recruit and hire sales, operations and field services personnel or leverage our overhead costs or to maintain the profitability of such regional office. Our operations in these regional offices, including our industrial operations office, will be far from our executive offices in Southern California and will require additional management time and attention. Failure to properly supervise the personnel in these offices could result in loss of new business and potentially harm future sales prospects. In addition, as our systems and services for industrial customers become accepted in North America, these customers may require us to support their international activities which will require additional time and resources. Supporting the marketing, development, process design, and operations of potentially distant operations will further challenge our management team and operations and could cause harm to our business or operating results.

Most of our operations are conducted in our facilities in Southern California and our facility in Memphis, Tennessee. Disruptions at these facilities could increase our expenses.

A significant portion of our fabricating operations for our onsite regenerable and disposable resin treatment systems are conducted in one facility in Southern California. In addition, our executive offices are also located in Southern California. Our central resin regeneration operations for our offsite regenerable treatment systems and our base of our operations servicing the industrial markets are located at our facility in Memphis, Tennessee. We take precautions to safeguard our facilities, including obtaining insurance, maintaining health and safety protocols, and using off-site storage of computer data. However, a natural disaster, such as an earthquake, fire or flood in Southern California or a tornado, flood or earthquake in Memphis, could cause substantial delays in our operations, damage or destroy our fabricating equipment, resin regeneration facility or inventory and cause us to incur additional expenses. The insurance we maintain against natural disasters may not be adequate to cover our losses in any particular case, which would require us to expend significant resources to replace any destroyed assets, thereby harming our financial condition and prospects significantly.

We face risks associated with the historical and current operations at our Memphis facility.

We acquired our Memphis facility in September 2007 and have limited operating experience with this facility. From our Memphis facility, we regenerate the ion-exchange resins associated with our offsite regenerable treatment systems and for other customers that have not purchased one of our systems but who require resin. Any problems we face in shipping or transporting resins to our Memphis facility for regeneration, the inability to regenerate certain resins, or any other problems at our Memphis facility that would prevent us from timely providing regeneration services on a cost-effective basis would adversely affect our relationships with our customers, our business and our results of operations.

In connection with our acquisition of MPT, we obtained indemnification from the MPT stockholders for any violations of environmental laws that occurred prior to the acquisition date. We cannot assure you that there are no environmental risks associated with the Memphis facility or that indemnification obligations of the MPT stockholders with respect to any such problems will adequately protect us from any liability we may face. In

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addition, we cannot be certain that the materials characterization procedures at our Memphis facility are adequate to properly identify and dispose of hazardous waste. If these procedures are deficient, then we may be in violation of certain environmental laws which could result in potential liability or disruptions in our operations.

Our Memphis facility is over 50 years old and may also contain latent defects or other damage of which we are unaware. In the future, this facility may also lack the capacity to meet our needs for central regeneration of resins or for conducting our industrial market operations. Any of these occurrences could require us to make substantial investment in this facility so that it meets our needs, or require us to relocate our operations from this facility, which would result in significant disruptions in our operations at this facility.

Also in connection with our acquisition of MPT, we assumed certain legacy contracts and other arrangements to which MPT was a party. Some of these contracts may have terms that we do not find to be favorable or compatible with our business plans, including our ability to expand and/or penetrate markets. We may be unable to renegotiate these contracts on more favorable terms or at all, which may adversely impact our business and results of operations.

Because our Memphis facility serves as the base for our marketing efforts in the industrial markets, a disruption at our Memphis facility would significantly impair our ability to market to industrial customers, which could adversely affect the growth of our business. In addition, we may face difficulties in attracting, recruiting, and retaining employees with the requisite technical or operating talent to Memphis for our expansion into industrial markets.

Because our Memphis facility serves as the base for our geographic expansion into the Southeast, a disruption at our Memphis facility could significantly impair our ability to expand our marketing and field services into this region.

We face risks associated with the design and operation of our systems which may prevent us from increasing our revenues.

We take responsibility for the design, construction, initial maintenance and installation of our ion exchange systems. However, we cannot predict whether we will be able to design our systems for every particular contaminant. Thus, we may be required to turn away customers that require treatment of chemical contaminants that our systems do not treat. We also cannot guarantee that once constructed, our systems will operate according to their design or be free from defects. Because many of our systems treat groundwater for dangerous contaminants, if our systems fail to operate properly, it could cause significant public harm, especially for drinking water applications.

Following installation, testing and regulatory certification of a system, actual day-to-day operation of our groundwater treatment systems is transitioned to our customer’s personnel. Though we retain ownership of many of our systems, our customers take responsibility for operation of some of these systems. We, however, continue to be responsible for the maintenance of the installed systems in most cases. We may not be able to provide sufficient employees for the maintenance of those systems. In addition, because our systems are located at our customers’ sites, we will not always be physically present should problems arise.

If there are defects in our system or if significant reliability, quality or performance problems develop with respect to our system or services, this may have a number of negative effects on our business, operating results, financial condition and prospects, including:

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In order to operate our business successfully, we must meet evolving municipal customer requirements for groundwater treatment and invest in the development of our technology.

If we fail to develop or enhance our system and services to satisfy evolving municipal customer demands, our business, operating results, financial condition and prospects may be harmed significantly. The market for groundwater treatment in the municipal markets is characterized by changing technologies, periodic new product introductions and evolving customer and industry standards. For instance, competitors in the groundwater treatment industry are continuously searching for methods of groundwater treatment that are more cost-effective and more efficient. Our current and prospective municipal customers may choose future groundwater treatment solutions and/or services that might be offered at a lower price than our system and/or services. To achieve market acceptance for our system and services, we must effectively and timely anticipate and adapt to customer requirements and offer products and services that meet customer demands. Our municipal customers may require us to provide water treatment solutions for new contaminants or higher volumes of water or to decrease the presence of contaminants well below an applicable MCL which may increase our operating costs for those systems and harm our results of operations. We also may experience design, engineering and other difficulties that could delay or prevent the development, introduction or marketing of any modifications to our system or our new services. Our failure to successfully develop and offer systems or services that satisfy customer requirements would likely cause a decrease in our financial performance. In addition, if our competitors introduce solutions and/or services based on new or alternative water treatment technologies, our existing and future systems and/or services could become obsolete, which would also weaken demand for our systems or services, thereby decreasing our revenues and harming our operating results.

Serving customers in industrial markets presents numerous risks.

We face numerous risks as we expand our services to customers in the industrial markets. We have limited experience in serving industrial market customers and have never provided systems or services to customers in the oil, gas or mining industries. Industrial customers may have different requirements and goals than our municipal customers. Our industrial customers may choose treatment solutions and/or services that are offered on a low life-cycle cost basis or that give them an advantage from a technological standpoint. They may also require us to tailor our systems to meet their specific business needs, which may result in additional development and design costs. We may have difficulty in developing technologies and services that address the needs of these customers and in hiring the appropriate engineering or other talent that can develop such technologies. In some cases, we may be required to conduct a pilot project to address an industrial market customer’s needs. We may expend significant time and resources in building and conducting the pilot project, and there can be no assurance that the pilot will successfully uncover all key process variables required to successfully scale up a particular process or meet the customer’s requirements. Since these processes have not been successfully commercialized, more extensive or other pilot testing may be required.

Even if we meet the customer’s treatment requirements at the pilot stage, when we build the full-scale treatment system, positive results from a pilot test might not provide an accurate indication of the treatment capabilities of and the cost of operation of a full-scale treatment system, and thus, we may have problems meeting the relevant treatment requirements on an economically feasible basis or at all. Additionally, startup of new industrial process facilities could cause increased safety risks until processes and procedures for normal operation, upset conditions and emergency conditions are established and well understood by our employees. To

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the extent we are unable to meet these customers’ demands and requirements, our expansion into these markets may not be successful which would adversely affect our business, operating results, financial condition and prospects. The economics of the systems for some of our industrial customers may rely on the recovery of a valuable resource from waste streams. Should the underlying economics of the resource deteriorate significantly, demand for these types of our systems and services may decline which could have an adverse effect on our business and operating results.

Industrial market customers may pose credit risks that we do not necessarily face to the same degree with our municipal market customers. Our industrial market customers may not be economically viable, might be newly formed without adequate capitalization and/or may be highly dependent on commodity prices, such as companies in the oil, gas and mining industries. Changes in commodity prices will particularly impact the viability of our business in recovery of valuable materials. Finally, when we install our treatment system onsite for an industrial customer, we must take into account the location which our customer provides us for the installation. We, our systems or the hazardous chemicals we use in our systems may damage the property or harm our customer’s personnel that may be in proximity to our systems, or we may adversely impact our customer’s operations while we install, service and/or repair our systems. In addition, our employees may be injured by hazardous chemicals, machinery or other dangers at our customer’s site during the installation, operation and/or servicing of our systems. Because of our unfamiliarity with building systems for the industrial markets, we may not understand all of the safety and other risks associated with these systems until we have more experience servicing this industry. Any of these risks could have an adverse effect on our ability to address the industrial market.

Our reliance on third party suppliers and manufacturers poses significant risks to our business and prospects.

We contract for all of the components in our system and for all of the commodities necessary to fulfill our service obligations, including salt, chemicals and replacement resin, with third-party suppliers. We plan to rely on third party suppliers and manufacturers for systems we market to industrial customers. We are subject to substantial risks because of our reliance on these suppliers and manufacturers. For example:

As a result of any of these factors, we may be required to find alternative suppliers for the components of our system or alternative manufacturers for our systems marketed to industrial customers. It may take considerable amounts of time to identify and qualify such alternative suppliers. In addition, we may be required to redesign our system to conform to the components provided by these alternative suppliers. As a result of these factors, we may experience delays in obtaining raw materials and components on a timely basis and in sufficient

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quantities from our suppliers, which could result in delays in the production and installation of our system. We may also face delays in the manufacture and assembly of our industrial market systems from third party manufacturers. These delays could impact our ability to sell our systems, enter into recurring revenue contracts or profitably execute our service agreements, which would cause our revenues and operating results to decline. In addition, we have lacked the leverage or have otherwise been unable able to negotiate consistently long-term contracts for the supply of components and commodities necessary to build our systems and fulfill our service obligations. As a result, rising component or commodity prices could increase our expenses and adversely affect our results of operations.

We often place our systems through a party other than the party with whom we enter into a long-term contract which may cause difficulties in selling our systems and offering our services.

When we sell a system to a municipal or industrial customer, we often contract with a general contractor as opposed to our actual customer. We often enter into a separate long-term contract for servicing the system directly with our municipal or industrial customer. Contracting with different parties can create difficulties for us, including having inconsistent terms between the two contracts which makes it more difficult to successfully close the transaction and could harm our relationships with our customers. These difficulties may adversely affect our business and results of operations.

As part of our growth, we intend to increase our ability to provide service to our customers under recurring revenue contracts and develop new technologies internally. Our failure in these endeavors could negatively impact our stock price and cause our business, operating results, financial condition and prospects to suffer.

We plan to continue to grow rapidly for the foreseeable future. As part of this growth, we intend to make significant capital expenditures to support our operations focused on our recurring revenue contracts. In addition, we plan to continue developing new technologies through our research and development efforts. The capital expenditures we incur or the technologies we develop internally may not result in the financial results that we expect. In addition, developing new technologies may cause diversion of management’s attention from our existing business. Any or all of these factors could prevent us from maintaining or increasing our customer base and business and cause the price of our common stock to decline.

The revenues from certain of our long-term contracts for onsite regenerable treatment systems are moderately seasonal, with higher processing fees received in the summer months and lower processing fees received in the winter months.

Our business, particularly the revenues we receive from our long-term contracts, is moderately seasonal due to the impact of summer and hot weather conditions on the water requirements of our customers. In the summer and warmer months, our customers have a higher demand for water and generally increase the utilization of their groundwater resources resulting in a higher volume of groundwater treated during a period and thus higher revenues from our long-term contracts. However, this increased utilization results in increased operating costs for us, which could adversely affect our profit margins and results of operations. Conversely, our customers experience lower demand in cooler months in the first and fourth calendar quarters, resulting in lower revenues from our long-term contracts during those periods. This seasonality in processing fees has resulted in fluctuations in our revenues and operating results. These moderate seasonal trends can cause some reductions in our profit margin and variations in our financial condition.

We own a large stake in Empire Water Corporation, and to the extent that it does not succeed, the value of our investment in Empire Water Corporation may decline.

We recently disposed of our rights to purchase certain water assets to Empire Water Corporation, or Empire, in exchange for approximately 32% of the outstanding stock of Empire. After the closing of an anticipated

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second financing, we expect to own approximately 37% of the outstanding stock of Empire. To the extent that Empire does not succeed in its operations or business, the value of Empire’s common stock will likely decline, which would cause the value of our investment in Empire to decline. Such a decline in the value of our investment would have an adverse effect on our financial position and results of operations.

We have been named as a party to lawsuits, including class action and derivative action lawsuits, and we may be named in additional litigation, all of which could require time and attention from certain members of management and result in significant legal expenses. An unfavorable outcome in one or more of these lawsuits could have a material adverse effect on our business, financial condition, results of operations and cash flows.

On October 26, 2007, Veolia Water North America Operating Services, LLC and certain other related parties filed a lawsuit in the United States District Court of the Middle District of Florida, Tampa Division, naming as defendants Basin Water-MPT, Inc. (a wholly owned subsidiary of Basin Water, Inc.) and two of its employees, one of whom is the son of Basin Water, Inc.’s President and Chief Executive Officer. The lawsuit alleges, among other things, certain claims related to trade secrets and unfair trade practices relating to treatment of by-products produced as a result of the phosphate mining industry. The lawsuit does not claim a specific amount of damages.

On December 27, 2007 and January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against Basin Water, Inc., Peter L. Jensen, Michael M. Stark and Thomas C. Tekulve (collectively referred to as the “Basin defendants”) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned Poulos v. Basin Water, et al ., Case No. CV 07-8359 GW (FFMx) and Nofer v. Basin Water, et al ., Case No. CV 08-0002 SGL (JCRx). The lawsuits, among other things, allege that the Basin defendants “issued materially false and misleading statements regarding the Company’s business and financial results” because the Company “had not adequately accounted for reserves in connection with its legacy system contracts.” Plaintiffs allege a putative class period between May 14, 2007 and November 13, 2007, and do not claim a specific amount of damages.

On January 23, 2008, we received a letter dated January 17, 2008, from attorneys representing a purported shareholder demanding that we investigate and remedy alleged breaches of fiduciary duty by certain unnamed officers and directors of the Company. In the demand letter, the attorneys allege that the unnamed officers and directors violated their duties to the Company by, among other things, participating in or permitting the company to issue false and misleading statements regarding our business and financial results giving rise to the above named lawsuits.

On January 31, 2008, Loren Charif, a purported stockholder of our company, filed a shareholder derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of our executive officers and our current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to allegations of improper selling.

From time to time, we are involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which we believe are not material to the conduct of our business.

We are subject to risks related to our international operations.

We currently serve some international customers from our Memphis facility. We may serve additional international customers or expand our operations internationally. As we expand our international operations, we will be increasingly susceptible to the following risks associated with international operations:

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In addition, we may develop formal and informal relationships with existing and new local business partners who can provide local expertise and sales and distribution infrastructure to support our expansion in our target international markets, which will be time-consuming and costly. Several of the risks associated with our international business may be within the control (in whole or in part) of these local business partners with whom we have established relationships or may be affected by the acts or omissions of these local business partners. No assurances can be provided that these local business partners will effectively help us in their respective markets and the inability to do so would adversely affect our business, prospects, financial condition and results of operations.

Risks Related to Our Intellectual Property

Failure to protect, or uncertainty regarding the validity, enforceability or scope of, our intellectual property rights could impair our competitive position.

Our treatment systems and services utilize a variety of proprietary rights that are important to our competitive position and success. Because the intellectual property associated with our technology is evolving and rapidly changing, our current intellectual property rights may not protect us adequately. We rely on a combination of patents, trademarks, trade secrets and contractual restrictions to protect the intellectual property we use in our business. In addition, we generally enter into confidentiality or license agreements, or have confidentiality provisions in agreements, with our employees, consultants, strategic relationships and customers and control access to, and distribution of, our technology, documentation and other proprietary information. Our pending patent applications may not be granted or, if granted, the resulting patent may be challenged or invalidated by our competitors or by other third parties. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our intellectual property. In addition, monitoring unauthorized use of our intellectual property is difficult, and we cannot be certain the steps we have taken to protect our intellectual property will prevent unauthorized use of it.

Because legal standards relating to the validity, enforceability and scope of protection of patent and intellectual property rights in new technologies are uncertain and still evolving, the future viability or value of our intellectual property rights is uncertain. Furthermore, our competitors independently may develop similar technologies that limit the value of our intellectual property or design around patents issued to us. If competitors or third parties are able to use our intellectual property or are able to successfully challenge, circumvent, invalidate or render unenforceable our intellectual property, we likely would lose a significant portion of our competitive advantage in the market. We may not be successful in securing or maintaining proprietary or patent

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protection for the technology used in our systems or services, and protection that is secured may be challenged and possibly lost. We may have to prosecute unauthorized uses of our intellectual property and the expense, time, delay and burden on management of such litigation could prevent us from maintaining or increasing our business. Our inability to protect our intellectual property adequately for these and other reasons could result in weakened demand for our systems or services, which would result in a decline in our revenues.

In addition, we have entered into an alliance agreement with Rohm and Haas and an agreement with Purifics, pursuant to which we have access to certain of their technologies. To the extent that each of these parties faces a challenge to its intellectual property rights in those technologies, it could have an adverse effect on our ability to market our systems and/or services that incorporate those technologies which would result in a decline in our revenues.

We could become subject to litigation regarding intellectual property rights, which could harm our business significantly.

Our commercial success will continue to depend in part on our ability to make and sell our systems or provide our services without infringing the patents or proprietary rights of third parties. We face these risks with respect to intellectual property that we have developed internally, as well as with respect to intellectual property rights we have acquired from third parties. For example, pursuant to our alliance agreement with Rohm and Haas and our agreement with Purifics, we have access to the technologies owned by each of these companies. To the extent either of these parties has failed to adequately protect the technologies upon which we rely or if these technologies infringe upon the patents or proprietary rights of third parties, we may be unable to continue using such technologies or we may face lawsuits related to our past use of these technologies. In addition, our competitors, many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make or sell our systems or provide our services.

If we are unsuccessful in any challenge to our rights to market and sell our systems, our rights to use third party technologies or to provide our services, we may, among other things, be required to:

Even if we successfully defend any infringement claims, the expense, time, delay and burden on management of litigation could prevent us from maintaining or increasing our business. Further, negative publicity could decrease demand for our systems and services and cause our revenues to decline, thus harming our operating results significantly.

If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology, systems and services could be harmed significantly.

We also rely on trade secrets, know-how and other proprietary information in operating our business. We seek to protect this information, in part, through the use of confidentiality agreements with employees, consultants, advisors and others upon commencement of their relationships with us. These agreements require

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that all confidential information developed by the individual or made known to the individual by us during the course of the individual’s relationship with us be kept confidential and not disclosed to third parties. Our agreements with employees also provide that any inventions conceived by the individual in the course of rendering services to us are our exclusive property. Nonetheless, those agreements may not provide adequate protection for our trade secrets, know-how or other proprietary information and prevent their unauthorized use or disclosure. In the event of unauthorized use or disclosure of our trade secrets or proprietary information, these agreements may not provide meaningful protection, particularly for our trade secrets or other confidential information.

To the extent that consultants, key employees or other third parties apply technological information independently developed by them or by others to our proposed products, disputes may arise as to the proprietary rights to such information which may not be resolved in our favor. The risk that other parties may breach confidentiality agreements or that our trade secrets become known or independently discovered by competitors, could harm us by enabling our competitors, who may have greater experience and financial resources, to copy or use our trade secrets and other proprietary information in the advancement of their products, methods or technologies. The disclosure of our trade secrets would impair our competitive position, thereby weakening demand for our systems or services and harming our ability to maintain or increase our customer base.

In addition, to the extent that we do not fulfill our contractual or other obligations to adequately protect the technologies to which we have been granted access by Rohm and Haas or Purifics, we could be liable to either of them for any resulting harm to their businesses or could lose further access to those technologies, which could harm our business, operating results or financial condition.

Risks Related to Our Industry

We are subject to environmental risks that may prevent us from selling our systems and, if such risks are realized, may subject us to clean-up costs or litigation that could adversely affect our business, operating results, financial condition and prospects.

We are subject to a number of governmental regulations with respect to our business activities and operations. See “Business—Government Regulation.” For example, our onsite regenerable ion-exchange technology generates a byproduct known as brine waste. Our customers are required to dispose of any waste materials or byproducts from our treatment process in a manner mandated by the EPA or state regulatory agencies. The EPA or state regulatory agencies may consider these or other byproducts of the ion-exchange process to be hazardous, and in such cases, our customers will be subject to additional requirements relating to the treatment, storage, disposal and transportation of hazardous substances. With respect to our onsite regenerable treatment systems, though our customers take title to all brine waste, together with all other byproducts of the ion-exchange technology process, we generally contract with third parties to secure waste disposal services on our customers’ behalf. We cannot predict whether any new laws, statutes, ordinances, rules or regulations will be enacted that may require significant modification to our system or our services, which may weaken demand for our system or services and harm our business significantly.

In addition, we cannot predict whether any third party will assert against us any claims for violations of any federal, state or local statute, ordinance, law, rule or regulation relating to hazardous or toxic substances in connection with the brine waste or groundwater treatment process or as a result of any actions of the third-party waste disposal services with whom we contract on behalf of our customers who use our onsite regenerable treatment systems. We face similar risks with respect to resins containing contaminants that we transport to our Memphis facility for regeneration, as these resins may contain hazardous substances with our knowledge. CERCLA and analogous state laws provide for the remediation of certain contaminated facilities and impose strict, joint and several liability for remediation costs on current and former owners or operators of a facility at which there has been a release or a threatened release of a “hazardous substance.” This liability is also imposed on persons who arrange for the disposal or transportation of such substances, and on those who transport such substances to the facility. Hundreds of substances are defined as “hazardous” under CERCLA and analogous

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state laws and their presence, even in small amounts, can result in substantial liability. The expense of conducting a cleanup can be significant. The actual costs for these liabilities could be significantly greater than the amounts that we might be required to accrue on our financial statements from time to time. In addition to the costs of complying with environmental regulations, we may incur costs to defend against litigation brought by government agencies and private parties. As a result, we may be required to pay fines to governmental agencies if we are found to have violated these environmental laws. In addition, we may in the future be a defendant in lawsuits brought by private parties who assert claims alleging environmental damage, natural resource damages, personal injury, property damage and/or violations of permits and licenses by us. If such claims are asserted against us, and if we do not prevail in defending such claims, we may be required to pay significant damages, causing our financial condition to suffer. Even if we successfully defend against such claims, we may devote significant time and resources to litigation, which would likely prevent us from maintaining or increasing our customer base and business.

We face additional environmental risks related to the parties with whom we do business, particularly those parties that send resin to our Memphis facility for regeneration. Our customers may not be in compliance with federal, state or local statutes, ordinances, laws, rules or regulations relating to hazardous or toxic substances and to the extent we assist them with water and wastewater treatment services offsite regeneration of resins or waste reduction or resource recovery services, we could be subject to liability under these various laws and regulations. In addition, our contracts with these customers may not adequately protect us from these liabilities, and even if our contracts provide these legal protections, these customers may not have the financial resources to provide us with the protection to which we are legally entitled such as the ability to pay indemnity obligations to which they are contractually obligated.

We also face environmental risks associated with our operations targeted to serve industrial customers. These operations involve wastewater treatment, water reuse and the recovery of valuable commodities and often require the discharge of wastewater and other materials. We plan for these activities to take place at our Memphis facility. These activities subject us to numerous stringent permitting requirements as well as numerous federal, state or local statutes, ordinances, laws, rules or regulations relating to hazardous or toxic substances. For example, our Memphis facility’s environmental permits include a NPDES wastewater discharge permit and Special Solid Waste Disposal Permits. In addition, this facility is required to maintain an EPA generator registration and identification number for its hazardous waste disposal activities. Additionally, to the extent these activities involve radionuclides, they would be subject to regulations governed by the NRC. If we do not comply with the applicable environmental laws and regulations applicable to our activities or obtain and maintain the appropriate permits necessary to conduct these activities, we would be subject to numerous

Changes in governmental regulation and other legal uncertainties could adversely affect our customers or decrease demand for our systems, and thus harm our business, operating results and prospects.

In the United States, many different federal, state and local laws and regulations govern the treatment and distribution of contaminated groundwater and disposal of attendant wastes. The increased interest in the treatment of contaminated groundwater due to increased media attention on the adverse health effects from contaminated drinking water may result in intervention by the EPA or state regulatory agencies under existing or newly enacted legislation and in the imposition of restrictions, fees or charges on users and providers of products and services in this area. These restrictions, fees or charges could adversely affect our customers, which could negatively affect our revenues. Conversely, the failure of the EPA or state regulatory agencies to act on a timely basis to set interim or permanent standards for pollutants such as MCLs, or to delay effective dates for standards for pollutants, grant waivers of compliance with such standards or take other discretionary actions not to enforce these standards, may decrease demand for our systems and services because our customers would not be required to bring their water into compliance with such regulatory standards. Changes in regulations affecting our industrial customers, such as with respect to wastewater treatment or water reuse processes, could also impact their need for our systems and/or services. While we are not aware of any currently proposed federal regulation directly affecting our business, we cannot predict whether there will be future legislation regarding the treatment

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and distribution of contaminated groundwater, the disposal of attendant wastes, wastewater treatment or water reuse processes. If there are significant changes in such laws and regulations, particularly if such laws and regulations become less stringent, such changes could weaken demand for our systems or services and cause our revenues to decline, thus harming our operating results and prospects.

Each groundwater treatment solution must be permitted by a regulatory agency prior to its use by our customers, and changing drinking water standards and other factors could affect the approval process with respect to our system by such regulatory agencies.

Each groundwater treatment solution, including our groundwater treatment system and those of our competitors, must be permitted by applicable state regulatory agencies prior to use of such systems by our customers. We cannot assure you when or whether the various regulatory agencies will approve our system for use by our customers. The application process for our system is time consuming and often involves several information requests by the regulatory agencies with respect to our system. Any long waiting periods or difficulties faced by our customers in the application process could cause some of our customers to use competing technologies, products, services or sources of drinking water, rather than use our technology.

Also, we cannot predict the impact of changing drinking water standards on the approval of our technology for groundwater treatment. Our system currently treats groundwater so that it meets the MCL for several different contaminants. MCLs are set by the EPA and/or state regulatory agencies that regulate drinking water contaminants. However, the MCL for any contaminant is subject to review and revision by the EPA or state regulatory agencies. MCLs may be changed to levels below that which our system can treat, resulting in state regulatory agencies failing to approve our system. Without regulatory approval, our system could not be used by our customers, and we may be required to develop technology that meets any revised MCLs, and to the extent we cannot do so, sales of our system will suffer. The development of such technology may require increased expenditures, and during this development, we could be delayed in selling our system, which would cause our revenues to decline, thus harming our operating results significantly.

Demand for our groundwater treatment systems would be adversely affected by a downturn in government spending related to groundwater treatment solutions, or in the cyclical residential or non-residential building markets.

Our municipal market business is dependent upon spending on groundwater treatment solutions by utilities, municipalities and other organizations that supply water, which in turn is often dependent upon residential construction, population growth, continued contamination of groundwater sources and regulatory responses to this contamination. As a result, demand for our water treatment systems could be impacted adversely by general budgetary constraints on our governmental or regulated customers, including government spending cuts, the inability of government entities to issue debt to finance any necessary groundwater treatment projects, difficulty of our customers in obtaining necessary permits or changes in regulatory limits associated with the chemical contaminants we seek to address with our groundwater treatment system. It is not unusual for the implementation of water treatment solutions to be delayed and rescheduled for a number of reasons, including changes in project priorities and difficulties in complying with environmental and other government regulations. We cannot assure you that economic conditions will continue such that state and local governments will address groundwater contaminant needs and consider purchasing or entering into long-term contracts for our systems. In addition, although our target markets have experienced population growth in recent years along with related residential building market growth, we have recently witnessed a significant slowdown in the residential building industry, particularly in the arid West. A slowdown of growth in residential and non-residential building would reduce demand for drinking water and for groundwater treatment solutions such as our systems. The residential and non-residential building markets are generally cyclical, and, historically, down cycles have typically lasted a number of years. Any significant decline in the governmental spending on groundwater treatment solutions or residential or non-residential building markets could weaken demand for our systems or services, thus harming our operating results and prospects significantly.

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We operate in a competitive market, and if we are unable to compete effectively, our business, operating results and prospects could suffer.

The market environment in which we operate is very dynamic and is characterized by evolving standards, the development of new technology, regulations which continually reduce the acceptable levels for contaminants and affect the means, methods and costs of disposing of wastes derived from groundwater treatment. Though barriers to entry in this market are arguably high, we expect that competition will intensify in the future. We believe that in such a rapidly changing market, key competitive factors include:

We compete with large groundwater treatment companies, such as Severn Trent PLC, GE Water and Siemens AG, in our business aimed at the municipal markets. We compete with large industrial market companies, such as GE Water and Layne Christensen, in our business aimed at the industrial markets. Many of our current and potential competitors have technical and financial resources, marketing and service organizations and market expertise significantly greater than ours. Many of our competitors also have longer operating histories, greater name recognition and larger customer bases. Moreover, our competitors may forecast the course of market developments more accurately and could in the future develop new technologies that compete with our systems and/or services or even render our system and/or services obsolete. Due to the evolving markets in which we compete, additional competitors with significant market presence and financial resources may enter those markets, thereby further increasing competition. These competitors may be able to reduce our market share by adopting more aggressive pricing policies than we can or by developing technology and services that gain wider market acceptance than our system and/or services. Existing and potential competitors also may develop relationships with distributors of our systems and services or third parties with whom we have strategic relationships in a manner that could harm our ability to sell, market and develop our systems and services significantly. If we do not compete successfully we may never achieve significant market penetration and we may be unable to maintain or increase our business or revenues, causing our operating results and prospects to suffer.

We could become subject to litigation as a result of claims brought against our customers, which could harm our operating results and financial condition significantly.

Our municipal customers are water providers that supply drinking water treated by our system to the general public. If our customers faced claims from consumers related to the quality of the drinking water, such consumers also may bring claims against any other party with whom the customer contracted in the groundwater treatment process. Even if our system treated the groundwater successfully for the contaminants it was designed to remove, we still may be subject to claims from such consumers. Our industrial customers may also face liability from consumers or regulatory agencies with respect to their wastewater treatment or waste reduction activities. These parties may also bring claims or actions against us because our systems and services were utilized in our customer’s activities. Despite any success in defending such claims, the expense, time, delay and burden on management of litigation would likely prevent us from maintaining or increasing our business and negative publicity could weaken demand for our services, cause our revenues to decline and harm our operating results and financial condition significantly.

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Risks Related to our Finances and Capital Requirements

We will need additional capital to sustain and grow our business and we cannot provide any assurances that additional financing will be available to us on favorable terms when required, or at all.

We expect that our current cash and cash equivalents will be sufficient to fund our anticipated future growth and operations for the foreseeable future. We cannot guarantee you that we will not need additional capital to finance our growth and operations or to accelerate our expected growth over the next 12-month period. We have based our estimate of liquidity needs on assumptions that may prove to be incorrect, and we may spend our available financial resources much faster than we currently anticipate.

Adequate funds, whether obtained through financial markets or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available when needed or on terms acceptable to us. We also may need to raise additional funds in order to fund more rapid expansion, to develop new and enhanced technologies, to develop and implement our technology+services model, to respond to competitive pressures or to acquire complementary technologies or assets. If additional funds are raised through the issuance of additional common stock, other equity securities or indebtedness, the percentage ownership of our then-current shareholders may be diluted substantially and the equity or debt securities issued to new investors may have rights, preferences or privileges senior to those of the holders of our then-existing capital stock. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of unanticipated opportunities, develop new products or services or otherwise respond to competitive pressures. Such inability could prevent us from maintaining or increasing our business, result in significant harm to our financial condition and prospects and negatively affect our stock price.

We may incur indebtedness that contains terms that place restrictions on the operation of our business; our failure to comply with these terms could put us in default, which would harm our business and operations.

We may incur indebtedness in the future that contains a number of significant covenants. These covenants may limit our ability to, among other things, do the following:

If we were to incur such indebtedness, a material breach of any of these covenants would result in a default under this indebtedness which could result in significant harm to our business and operations.

Our customers may need financing to purchase our systems, which exposes us to additional business and credit risks.

Availability and cost of financing are significant factors that affect demand for our systems and services. Many of our customers can purchase our systems only when financing is available at a reasonable cost. Some customers seek to acquire our systems and services through a long-term contract. We often rely on third parties to purchase the systems that are then subject to long-term contracts with our customers. In certain cases, we will indemnify the third party for any financial damages caused by our default under our long-term services

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agreement with our customer. This exposes us to potential additional costs in the event of our failure to perform. In addition, if we are unable to identify third parties that will purchase our systems in connection with the placement of our systems with municipal or industrial customers, we would be faced with either keeping these systems on our balance sheet or requiring our customers to purchase the equipment outright. In the latter case, this may delay or terminate the sale to our customer, which could adversely affect our business and operating results.

We have recorded and will record non-cash expense in future periods that result in a decrease in our net income for a given period.

As required by the Financial Accounting Standards Board, or FASB, we record expense for the fair value of stock options and restricted stock granted and this expense is reflected in our operating results. We rely on stock options to motivate current employees and attract new employees. As a result of the requirement to expense stock options, we may choose to reduce our reliance on stock options as a motivation tool. If we reduce our use of stock options, it may be more difficult for us to attract and retain qualified employees. However, if we do not reduce our reliance on stock options, our reported net loss may increase or our reported net income may decrease.

We have also applied the provisions of SFAS No. 123(R), Share-Based Payment , to warrants issued to lenders and other third parties including Cross Atlantic Partners, Aqua America and BWCA. The fair value of these warrants is expensed over the period of the related agreements, as appropriate. As a result, we recognized expense in 2005 and 2006 which affected our interest expense or selling, general and administrative expense, depending upon the nature of the underlying transaction. In May 2006, we repaid our indebtedness. The remaining fair value of the associated warrants attributed to the debt was charged to interest expense during that period. In future periods, we will recognize expense for the fair value of the warrants issued to third parties other than the lenders. Early completion of the third party agreements under which the warrants were issued will accelerate the recognition of this expense.

We have identified a material weakness in our internal control over financial reporting and may not be able to report financial results accurately.

We have identified a material weakness in our internal control over financial reporting and have determined that our internal control over financial reporting was not effective as of December 31, 2007 (see Item 9A.—“Controls and Procedures”). We cannot assure you that additional material weaknesses, significant deficiencies and control deficiencies in our internal control over financial reporting will not be identified in the future.

We have incurred and expect to incur substantial expenses relating to the remediation of the material weaknesses in our internal control over financial reporting. The effectiveness of our internal control over financial reporting may in the future be limited by a variety of factors including without limitation:

If we fail to achieve and maintain effective controls and procedures for financial reporting, we could be unable to provide timely and accurate financial information which may have an adverse effect on our company and the trading price of our common stock.

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We intend to pursue, but may not be able to identify, finance or successfully complete, strategic acquisitions.

Our growth strategy includes the pursuit of acquisitions. We may not be able to identify acceptable opportunities or complete acquisitions of targets identified in a timely manner or on acceptable terms. Acquisitions involve a number of risks, including the following:

We recently acquired MPT, which is located in Tennessee, for approximately $12.2 million, consisting of $6.9 million in cash and 462,746 shares of our common stock with a fair value of $5.3 million. There can be no assurance that we will achieve higher revenues or benefit from any synergies as a result of the acquisition.

In addition, we may require additional debt or equity financing for future acquisitions, and such financing may not be available or on favorable terms, if available at all. We may not be able to successfully integrate or profitably operate any new business we acquire, and we cannot assure you that any such acquisition will meet our expectations. Finally, in the event we decide to discontinue pursuit of a potential acquisition, we will be required to immediately expense all costs incurred in pursuit of the possible acquisition which may have an adverse effect on our results of operations in the period in which the expense is recognized.

Risks Related to Our Common Stock

We expect that the price of our common stock will fluctuate substantially.

The price of our common stock may decline, and the price of our common stock that prevails in the market may be higher or lower than the price you pay, depending on many factors, some of which are beyond our control. Factors that could cause fluctuations in the trading price of our common stock include:

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In addition, the equity markets in general, and the Nasdaq Global Market in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of water-related companies have been particularly volatile. These broad market and industry factors may affect the market price of our common stock adversely, regardless of our operating performance.

Anti-takeover provisions in our charter documents, as amended and restated, and under Delaware law could delay or discourage a takeover that stockholders may consider favorable.

Provisions in our amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. Some of these provisions include:

In addition, because we are a Delaware corporation, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including to delay or impede a merger, tender offer, or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.