UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K10-K/A

(Amendment No. 1)

(Mark One)

For the fiscal year ended December 31, 20072008

OR

For the transition period from            to        

Commission file number: 000-51991

Basin Water, Inc.

(Exact name of registrant as specified in its charter)

(909) 481-6800

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-knowwell-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x¨    No  ¨x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting and non votingnon-voting common equity held by non-affiliates of the registrant was approximately $131.8$93.4 million based upon the closing price of the Registrant’s common stock on the NASDAQ Global Market on June 29, 2007.30, 2008. On March 14, 2008,April 28, 2009, there were 21,948,70422,205,843 shares of common stock, par value $0.001, outstanding.

Documents Incorporated by Reference

Portions of the Proxy Statement to be delivered to stockholders in connection with the Registrant’s 2008 Annual Meeting of Stockholders to be filed on or before 120 days after the end of the Registrant’s fiscal year end are incorporated by reference into Part III of this Annual Report on Form 10-K. With the exception of those portions that are specifically incorporated in this Annual Report on Form 10-K, such Proxy Statement shall not be deemed filed as part of this Report or incorporated by reference herein.None.

TABLE OF CONTENTS

1

EXPLANATORY NOTE

This Amendment No. 1 to our Annual Report on Form 10-K/A (the Form 10-K/A) amends the Annual Report on Form 10-K for the year ended December 31, 2008, as originally filed with the Securities and Exchange Commission (the SEC) on March 31, 2009 (the “Original Form 10-K”). As permitted by General Instruction G(3) of Form 10-K, we did not include the information required by Part III of Form 10-K in the Original Form 10-K. In accordance with General Instruction G(3) of Form 10-K, this Form 10-K/A is being filed to include the information required by Part III of Form 10-K. We have also updated Item 1B of Part I to update the unresolved SEC Staff comments to our filings.

There are no changes to the disclosures in the Original Form 10-K, except that this Form 10-K/A amends and restates, in their entirety, Item 1B of Part I, Item 5 of Part II, Items 10-14 of Part III and Item 15 of Part IV of the Original Form 10-K. This Form 10-K/A continues to speak as of the date of the Original Form 10-K, and we have not updated the disclosure herein to reflect any events that occurred at a later date.

1

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K10-K/A contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “Safe harbor”Harbor” created by those sections. Any such forward-looking statements would be contained principally in “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities and the effects of regulation. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions.

Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in greater detail in “Item 1A. Risk Factors.”Factors”. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of thisthe Annual Report on Form 10-K filed on March 31, 2009.You should read this Annual Report on Form 10-K10-K/A completely and with the understanding that our actual future results may be materially different from what we expect.

We assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

PART I

Overview

Basin Water, Inc. is a providerOn October 23, 2008, we received comments from the Staff of reliable, long-term process solutions for a rangethe Division of customers, which include designing, building, implementing,Corporation Finance (the Staff) of the Securities and servicing systemsExchange Commission (the SEC) with respect to our Annual Report on Form 10-K for the treatmentyear ended December 31, 2007 (the 2007 Form 10-K), our Form NT 10-Q for the period ended June 30, 2008 and our Form 8-K dated August 11, 2008. We provided responses to these comments on November 6, 2008 and January 23, 2009. On February 10, 2009, we filed our Annual Report on Form 10-K/A for the year ended December 31, 2007 (the 2007 Form 10-K/A), our Quarterly Report on Form 10-Q/A for the period ended March 31, 2008, our Quarterly Report on Form 10-Q for the period ended June 30, 2008 and our Quarterly Report on Form 10-Q for the period ended September 30, 2008, which filings included disclosure to address the Staff’s comments in its October 23, 2008 letter.

On March 6, 2009, we received additional comments from the Staff with respect to our 2007 Form 10-K/A and our Quarterly Report on Form 10-Q/A for the period ended March 31, 2008. On March 30, 2009, we sent a letter to the Staff responding to these comments. On March 31, 2009, we filed our Annual Report on Form 10-K for the year ended December 31, 2008 (the 2008 Form 10-K), which included disclosures to address the Staff’s comments. On April 14, 2009, we received further comments from the Staff relating to our responses submitted on March 30, 2009 and our disclosures in the 2008 Form 10-K. The Staff’s unresolved comments relate primarily to the following:

Building on our success in the market for treating groundwaterThe Staff may have further comments to be used for drinking water, we are taking steps to become a next generation water services company that succeeds by combining the strengths of our existing businesses and employees with the offering of cutting edge technology and site-tailored solutions. We plan to employ this model across a broad range of treatment scenarios in municipal and industrial water markets.

We make available free of charge through our internet website our press releases, this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all10-K/A or our other required filings, with the Securities and Exchange Commission (SEC) and amendments thereto as soon as reasonably practical after they are electronically filed with, or furnishedwhich may require us to the SEC. Our internet website also contains our Code of Ethics. Our principal executive offices are located at 8731 Prestige Court, Rancho Cucamonga, California 91730, and our telephone number is (909) 481-6800. Our website address iswww.basinwater.com. The information on our website is neither part of nor incorporated by reference intofurther amend this Annual Report on Form 10-K.

Company History

Originally incorporated in California in 1999, Basin Water reincorporated in Delaware in connection with our initial public offering which was completed in May 2006. Our operations from 1999 until 2001 consisted

primarily of research and development activities, as we developed our proprietary ion-exchange process. Our proprietary process was conceived by Peter L. Jensen, our founder and former Chief Executive Officer, and the late Dr. Gerald Guter, who served as our Chief Scientific Officer. Also during this time, we developed a groundwater treatment system for commercialization of our proprietary process and increased our personnel to include additional engineers and sales and marketing personnel. We successfully completed a prototype for our groundwater treatment system in May 2002, and shortly thereafter, we assisted one of our customers in submitting an application with the California Department of Health Services (DHS) for a permit to operate our system for treatment of nitrate. In June 2002, our customer received the first permit from DHS for operation of our system to treat groundwater. We also received our first revenues in 2002 from sales of our groundwater treatment system and operations.

From 2002 through 2006, we focused on developing systems that could treat10-K/A or other contaminants, increasing our engineering workforce, developing our sales and marketing force, obtaining patents, and improving our internal finance and accounting capabilities.

Beginning in the last quarter of 2006, and continuing throughout 2007, we have focused on becoming a more diversified and predictable growth company by developing our technology+services business model and also implementing internal and external initiatives.

Our internal initiatives included:filings.

Our external initiatives included the Mobile Process Technology, Co. acquisition, and entering into a strategic alliance with Rohm and Haas Chemicals LLC, among others.

Market Opportunity

Demand for drinking water treatment technologies and services. Population growth has resulted in increased demand for drinking water in much of the United States. This is a problem throughout the United States but is particularly acute in California and other states in the southwest United States, which we refer to as the arid West, where population growth and chronic shortages of drinking water have resulted in rapidly increasing demand for drinking water.

Though we believe groundwater is a cost-effective and advantageous source of water supply, it is at substantial risk of contamination from a number of chemical contaminants; such as arsenic, nitrate, perchlorate, radium, chromium VI, uranium and radionuclides, as well as organic contaminants, such as methyl tertiary-butyl ether (MTBE), trichloroethylene (TCE) and perchloroethylene (PCE), which have been linked to various cancers, diseases, metabolic disorders and other health problems. Because of these health concerns, the Environmental Protection Agency, or EPA, and state regulatory agencies have been active in establishing and lowering2

maximum containment levels, or MCLs, for contaminants in drinking water to ensure that the public has access to a safe drinking water supply. In addition, improvements in water testing and treatment technologies have allowed the EPA and state regulatory agencies to lower the MCL for certain contaminants.

We believe that a large market opportunity exists in providing a solution for treatment of groundwater for drinking water. There are few economically attractive alternatives for treating groundwater at the wellhead. Customarily, water providers either shut down a contaminated well or blend the water with non-contaminated water to meet an MCL. Ion-exchange technology is acknowledged as a leading technology for groundwater treatment, including being designated by the DHS and EPA as a “best available technology” for treating groundwater for removal of contaminants. As compared to our ion-exchange technology, many existing contaminant treatment technologies are costly, produce large amounts of waste, or are generally designed for large industrial installations rather than for wellhead treatment. We believe there is significant demand for cost-effective groundwater treatment using our ion-exchange technology. We are actively pursuing opportunities to introduce our groundwater treatments systems across the United States where the opportunity exists to provide our technology+services offerings.

Demand for technology+services costs.We believe our technology+services offerings can be valuable to municipal and industrial customers. We believe there is demand by our customers for an offering that includes our technology combined with a long-term services agreement to provide services and maintenance with our performance guarantee for the life of the agreement.

Demand for wastewater treatment, water reuse and the recovery of valuable commodities. We also believe there is demand for industrial wastewater treatment, water reuse and metals and commodities recovery systems and services. Many industrial facilities face increasingly stringent discharge requirements for industrial wastewater, driving demand for technological solutions like ours for wastewater treatment. We also believe that demand exists for applications through which our customers can reuse and recycle wastewater for process water needed for manufacturing or other industrial uses. Furthermore, in light of the high cost of metals and other materials, we believe there is demand for technologies that are able to recover valuable commodities from wastewater streams.

Our Solution and Strengths

Basin Water onsite regenerable ion-exchange. Our proprietary onsite regenerable ion-exchange system is designed to treat groundwater contamination at the wellhead. We believe our multiple-bed system provides a safe, reliable and sustainable source of drinking water to our customers. Our system effectively treats water resulting in low waste rates, can be scaled to meet a customer’s requirements and has a small footprint. These systems are designed using the Basin Water IX Program and are installed with telemetry to allow independent functionality. Approximately 95% of our revenues in 2007 were derived from sales and service related to these systems.

Our expanded technologies. We have made concerted efforts to expand our technology portfolio beyond proprietary onsite regenerable ion-exchange technology. While our ion-exchange technology continues to have great potential in a variety of applications in the groundwater treatment market, we believe that additional opportunities exist for ion-exchange and absorptive media systems utilizing alternative methods of regeneration or media handling, and also technologies that can remove organic contaminants from water. Therefore, during 2007 we sought out and acquired the rights to ion-exchange technologies and other technologies that would enable us to address these opportunities through our September 2007 acquisition of Mobile Process Technology Co., which we refer to as MPT (see Note 3 to our consolidated financial statements), our November 2007 strategic alliance with a wholly owned subsidiary of Rohm and Haas Company named Rohm and Haas Chemicals, LLC, which we refer to as Rohm and Haas, and our 2007 agreement with Purifics ES Inc., which we refer to as Purifics, a licensed engineering firm headquartered in London, Ontario, Canada. In addition, we have developed a proprietary process, which we refer to as the BIONExchange^™ process, for biologically removing

and destroying the perchlorate loading from exhausted ion-exchange resins. This process can also be used to remove and destroy perchlorate from brine resulting from regeneration of the ion-exchange resins.

We believe these expanded technologies will enable us to address a large market of potential customers.

Our experienced management team. One of our developing strengths is our management team. Beginning in late 2006 and continuing throughout 2007, we bolstered our existing management team by hiring veterans from the water industry as well as other leading industries that have experience with technology and service offering business models. Most notably, our President and Chief Executive Officer joined Basin Water in October 2006 and brought the knowledge and experience to develop our business model. In addition, we hired four senior managers all of whom had past experience in the water, wastewater and other related industries. We believe the management team we have assembled has significantly strengthened our ability to achieve our goal to develop and implement our technology+services business model.

Our Strategy

Next generation water services company.In our view, water treatment companies who are able to profitably offer predictable, competitive life-cycle costs will become the “next generation” of water treatment companies.Our goal is to define, test and then implement the strategies necessary to become a “next generation” water services company. To do that we believe we must develop offerings and select opportunities that will generally involve pairing a proprietary or specialized technology with a service agreement to meet a defined set of customer needs. To date we have made significant progress as a leading provider of groundwater treatment systems and services to our customers throughout the United States, with an initial focus on the arid West. We expect to continue to expand our business and achieve these goals through the following strategies:

Develop and implement our technology+services model. We have developed and will now implement our technology+services business model that combines proprietary or specialized technologies with long-term relationships built through performance-based service agreements to meet groundwater treatment, industrial water and wastewater treatment, and resource recovery needs.

Extend our business and geographic reach throughout the United States. We intend to expand our business reach beyond the arid West into all areas of the United States. Our expansion plans include the creation of five regions (West, Southwest, Southeast, Great Lakes and Northeast) encompassing all of the continental United States to serve as our marketing, sales and technical services platforms for municipal customers within each of those regions. Marketing to municipal customers typically requires a local presence within the customer’s geographic region. In 2007, we began an internal organizational change and expansion through the assignment of dedicated management, sales, marketing, and technical support to certain of these regions. In addition to our West regional office in Rancho Cucamonga, we now have a footprint in the Southeast with our facility in Memphis, and will have a new Southwest regional office in Houston by mid-2008. We currently have a sales presence in the Great Lakes and the Northeast and are developing plans to open regional offices there in 2008 and 2009. We believe sales and marketing teams at the local level will be more effective because of their knowledge of and relationships with the municipalities within their region. We expect marketing to industrial customers to be more effective on a nationwide basis from one central location. Thus, for our industrial customers, we have a national sales and marketing team supported by our Memphis facility.

Expand our business by continuing to develop strategic relationships with companies serving and supplying the water industry on a national basis. We have identified and will continue to identify companies servicing and supplying the water industry on a national basis that can provide strategic benefits to the marketing of our groundwater treatment system. As part of this strategy, we have entered into a strategic alliance agreement with Rohm and Haas. We believe that by partnering with companies like Rohm and Haas, we can efficiently leverage their existing infrastructure to provide our technology+services offering in new markets.

Our Technology and Services

Our ion-exchange treatment systems. Our groundwater treatment services generally utilize our ion-exchange technology. To treat contaminated groundwater, the water is pumped from the wellhead into our system which contains a bed of ion-exchange resin. Through the ion-exchange process, the contaminants remain on the resin while the clean water exits the system and enters the drinking water distribution system. This process continues until the resin inside the bed is saturated with contaminants. We offer our customers three types of ion-exchange treatment systems—onsite regenerable systems, offsite regeneration systems, and disposable resin systems. The primary difference among these three types of system is how resin is used in the treatment process. For our onsite regenerable system, once the resin bed is saturated with contaminants, sometimes referred to as being spent or exhausted, a saturated salt brine solution is pumped into the tank which regenerates the resin onsite. For our offsite regeneration systems, we remove the spent resin to be regenerated offsite, and replenish the system with regenerated resin. The spent resin is transported for processing, such as at our Memphis central regeneration facility. There the resin is regenerated to be returned to service at the customer’s site. For some contaminants, such as radionuclides, regeneration is not feasible. In those situations we use a disposable resin system whereby we dispose of the resin in accordance with the particular regulation applicable to the contaminant being removed.

We manufacture our ion-exchange treatment systems on a build-to-order basis using raw materials from suppliers typically located in the United States and from predominantly “off-the-shelf” components for which there are generally multiple suppliers. We manufacture our onsite regenerable and disposable ion-exchange treatment systems at our facility in Rancho Cucamonga, California and our offsite regenerable systems at our facility in Memphis, Tennessee. As of December 31, 2007, eight onsite regenerable ion exchange treatment systems were in process at our Rancho Cucamonga location, and no systems were in process at our Memphis location.

Our customers must obtain a license and/or a permit from the applicable state regulatory agency in order to operate each system that we install at their wellheads. We work with our customers to secure required licenses and permits from state regulatory agencies, including assisting with the completion of the license or permit application and responding to inquiries or requests from these regulators regarding our system.

Our onsite regenerable, and certain disposable media treatment systems, use a multiple-bed system design, providing flexibility to meet different volume requirements. These systems allow resin beds to be sequenced in and out of service to optimize performance and offer users a wide range of production rates up to 12,000 gpm.

Typically our systems are installed adjacent to a wellhead. The systems use the well pump’s pressure to move water through the ion-exchange process. Our onsite regenerable systems require at least one waste brine tank to be placed onsite. The brine tank is connected to a waste line that allows for a contracted waste removal company to remove the brine without entering the well site. For our offsite regenerable systems, which service low flow wells, there is no onsite brine tank. Instead, we remove the resin vessel from the customer’s site for regeneration at our facility.

During the course of the groundwater treatment process, we do not take ownership of the water or title to the waste generated from the treatment of water, with the potential exception for recovery of valuable materials from the waste generated which we may then sell to third parties.

All of our onsite regenerable systems and some of our offsite regenerable systems and disposable resin systems are fully automatic and use a Program Logic Controller, or PLC, that runs advanced control programs to maximize treatment system performance and reliability while also minimizing waste products.

Our technology+services offering. The exact technology+services offering we use in a given situation is dependent upon the customer’s needs. Our most frequently offered technology to date is our onsite regenerable

ion-exchange system, which we incorporate into our offering by combining our treatment system with an ongoing services agreement. This agreement incorporates a variety of services requested by our customers. For our offsite regenerable systems and disposable resin systems, our service component might include such services as replacing media, conducting vessel exchanges on a periodic basis as the resin becomes exhausted, performing regeneration services at our central facility in Memphis, periodic testing of the system and ongoing support as required to optimize system operations.

We anticipate that service contracts for our expanded technology portfolio may include services similar to those listed above, and may also include the management of site-based operations involving a treatment system.

Customers

Historically, we have marketed our ion-exchange treatment systems and services to groundwater customers that included utilities, municipalities, cities and other organizations that supply drinking water. By enhancing our technology+services offerings to include smaller ion-exchange treatment systems, offsite regeneration and organic removal capabilities, we believe we have significantly expanded our potential customer base in the municipal market.

This expansion of our offerings also addresses industrial customers’ needs for wastewater treatment, water reuse and the recovery of valuable commodities from wastewater streams including for oil and gas, power, mining and chemical companies.

As of December 31, 2007, we had a total of 79 systems on order or under contract with 25 different customers (not including approximately 200 small customers from our Memphis facility), of which 48 systems are installed, permitted and can process water. Five systems are awaiting regulatory permits with the remaining 26 systems in various stages of contracting or manufacturing. These 79 systems on order or under contract nationwide represent an aggregate installed capacity of approximately 113,000 acre-feet per year, or approximately 36.9 billion gallons per year.

The following customers accounted for more than 10% of our revenues in the periods indicated:

As of December 31, 2007, our revenues backlog was $73.0 million, a decrease of $5.9 million, or 7%, compared to our revenues backlog of $78.9 million at December 31, 2006.

Competition

We believe successful competition in our industry and markets is dependent on the following factors: (1) superior technology and (2) customer relationships.

Superior technology is an important factor for competition in our industry. The EPA has reviewed and accepted certain well-established technologies for use in drinking water applications and designated them as “best available technology”. Ion-exchange technology has already been designated as a “best available technology” by the EPA and by many state regulatory agencies. Ion-exchange technology is also frequently sought for industrial applications. We believe our rights to proprietary technologies provide us a competitive advantage in the municipal and industrial markets.

There are significant competitive challenges even for companies relying on superior and cost-effective technologies. There are a large number of established and well-capitalized companies that already implement cost-effective technologies such as ion exchange in their solutions, and many of these large companies have strong and longstanding relationships with customers in the marketplace. We believe these relationships are critical in establishing credibility and in maintaining steady business. This is particularly true in the municipal market where a local presence and knowledge of the region contributes to a company’s ability to effectively market its services to municipalities. We are developing relationships with municipal customers on a local basis by implementing our regional structure.

We believe our geographic expansion plans, placing our marketing and sales force closer to our customer locations, coupled with the ongoing interactions between our field service force and customers, also provide us with a competitive advantage. Having regional offices will enable our marketing teams to develop closer ties with those existing and prospective customers within the region. For those existing customers, our field services staff is often our onsite ambassadors who are able to spot and kindle future opportunities to increase the number of systems, or expand on our existing services at an existing customer site.

Finally, many of our current and potential competitors have significantly stronger financial resources, larger marketing and service organizations and significantly greater market expertise than we have. However, we believe that we compete favorably based on the efficacy of our proprietary technology, our newly acquired technological expertise, our technology+services business model, and our significant relationships with our customers. In addition, we believe we also compete favorably based on lower operational costs, lower waste production, range of contaminants that can be treated, smaller system footprint and enhanced customer service.

Sales and Marketing

We market our technology+services offerings through a direct sales force, independent contractors and strategic relationships. In addition, members of our management team leverage their numerous business contacts to capitalize on opportunities to sell our technology+services offerings. Regulatory changes also trigger sales opportunities. For example, in 2006 and 2007, changes in MCLs, especially arsenic and radium, have caused customers to seek solutions such as ours to assist in their efforts to keep their groundwater supplies in compliance with regulatory standards. As a result, we periodically receive inquiries and are asked for referrals about our systems and services. Finally, our existing client base refers our services to other water providers. We also secure business through a procurement bid process in which we compete with others in qualification and proposal processes.

We are in the process of expanding our sales and marketing efforts beyond the arid West into all areas of the United States. Our expansion plans include the creation of five geographic regions (West, Southwest, Southeast, Great Lakes and Northeast) encompassing all of the continental United States to serve as our marketing, sales and technical services platforms for municipal customers within each of those regions. This expansion should assist our marketing efforts, because marketing to municipal customers typically requires a local presence within

the customer’s geographic region. In 2007, we made organizational changes to assign dedicated management, sales and service, marketing, and technical support to certain of these regions. In addition to our West regional office in Rancho Cucamonga, we now have a footprint in the Southeast with our facility in Memphis, and we expect to have a new Southwest regional office in Houston by mid 2008. We currently have a sales presence in the Great Lakes and the Northeast, and plan to open regional offices there in 2008 and 2009. We believe sales and marketing teams at the local level will be more effective because of their knowledge of and relationships with the municipalities within their region. We expect marketing to industrial customers to be more effective on a nationwide basis from one central location. Thus, for our industrial customers, we have a national sales and marketing team supported out of our Memphis facility.

We have expanded our sales and marketing efforts through strategic relationships, including the Rohm and Haas alliance and the agreement with Purifics. Our sales team plans to use Rohm and Haas’ expertise and contacts in the water treatment industry to develop and manage our relationships with customers and our strategic relationships.

Rohm and Haas Alliance

Rohm and Haas Company is a global company that develops advanced materials for customers around the world. Its business spans the world: North America, Latin America, Europe, Middle East, Africa, and Asia-Pacific, with more than 100 manufacturing, technical research and customer service sites in 27 countries. It had annual sales of approximately US $9 billion in 2007. It is a publicly owned company whose stock is traded under the “ROH” symbol on the New York Stock Exchange.

On November 14, 2007, we entered into an exclusive alliance with Rohm and Haas to provide technology solutions and service offerings in both the drinking water market and certain areas of the industrial market. We expect the alliance to also develop new technology to address other groundwater treatment issues, such as produced water from oil and gas operations and emerging water recovery applications. Each member of the alliance will contribute its respective core strengths to the alliance: Rohm and Haas its research and development capabilities, global infrastructure and ion exchange resins and our company its systems designs, channels to market and service capabilities. We expect the alliance to initially market offerings in the United States and Canada using our technology+services business model to provide guaranteed performance and guaranteed costs over the lifetime of a project. As part of the alliance, we have exclusive access to Rohm and Haas ion-exchange resin technology for certain selected markets.

The initial term of the alliance is five years. The parties agreed to renew the alliance agreement if at the end of the initial term the alliance has met projected budget, earnings and growth projections.

Shaw Agreement

Our agreement with Shaw Environmental Inc., or Shaw, expired on December 9, 2007. We continue to work with Shaw on various projects on a case-by-case basis, but as a result of the expiration of the agreement with Shaw we have now reacquired rights to market our arsenic treating systems in all territories to which Shaw had previously been granted exclusive rights.

Government Regulation

Our customers are subject to extensive environmental laws and regulations concerning emissions to the air, discharges to waterways and the generation, handling, storage, transportation, treatment and disposal of waste materials and also are subject to other federal and state laws regarding health and safety matters. Under the contracts with our customers, we assist them in meeting these regulations and obtaining any required permits and/or licenses in order to implement our system. These laws and regulations are constantly evolving, and it is difficult to predict the effect these laws and regulations may have on us or our customers in the future.

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. Changes in such laws and regulations could have a material adverse effect on our business. The increased interest in the treatment of contaminated groundwater due to increased attention on the adverse health effects from contaminated drinking water may result in intervention by governmental regulatory agencies in the United States or elsewhere 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. Conversely, the failure of the EPA or state regulatory agencies to act on a timely basis to set interim or permanent standards for pollutants, 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 system and services and thus harm our business significantly.

Each groundwater treatment solution, including our contaminant treatment systems, must be permitted by applicable state regulatory agencies prior to use of such systems by our customers. Typically, our customers apply for a permit from the applicable state regulatory agency to use our system, and we assist our customers in completion of the permit application process. The application process for our system is time consuming and often involves several information requests to our customers by the regulatory agencies with respect to our system.

Furthermore, we cannot predict the impact of changing drinking water standards on the approval of our technology for groundwater treatment. The MCLs for contaminants are subject to review and revision by the EPA and applicable state regulatory agencies. The MCLs may be changed to levels below that which our system can treat on a cost-effective basis, and if we are unable to design a system that removes contaminants below the designated MCL, then the state regulatory agencies will fail to approve our system. Without regulatory approval, our system could not be used by our customers, and we would be required to develop technology that meets any revised MCLs.

Although our customers retain title to the brine waste generated by our systems, we facilitate the removal of the waste with a licensed waste disposal service and in some cases contract directly with the waste transporter on behalf of our customers. As such, we may become subject to the provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or CERCLA. CERCLA, which is also known as Superfund, addresses problems created by the release or threatened release of hazardous substances (as defined in CERCLA) into the environment. CERCLA imposes strict, joint and several liability for remediation of certain disposal sites on: current owners and operators of the site, on former site owners and operators at the time of disposal, on parties who arranged for disposal or treatment or arranged for transportation for disposal or treatment of hazardous substances at the site, and on parties that transport hazardous substances to a site. Because CERCLA liability is joint and several, the costs of a CERCLA cleanup can be substantial. Because liability under CERCLA is strict, it is not premised upon the violation of any law, statute, rule or regulation but is rather based upon a party’s status as an owner, operator, transporter or arranger (as those terms are described above). Such liability can therefore be based upon the release or threatened release, even as a result of lawful, unintentional and non-negligent action, of any one of the more than 700 “hazardous substances” listed by the EPA, even in small amounts.

Our Memphis Facility. Our facility in Memphis supports services that include catalyst recovery, service exchange programs for containers of spent filtration media, and media processing and regeneration of ion-exchange media for other water service providers and end users that have applied the media to capture or recover various metals, organics, or inorganic compounds. Because our facility does not accept or receive materials that have been profiled as hazardous wastes, it does not maintain environmental permits as a treatment, storage, and disposal facility for hazardous wastes as defined by the EPA and the State of Tennessee. The Memphis facility performs its own independent waste stream profiling and acceptance criteria review to ensure that all materials received for processing and regeneration are applicable to the Memphis facility processes and are in accordance with the facility’s environmental permits.

The Memphis facility’s environmental permits include a National Pollution Discharge Elimination System (NPDES) wastewater discharge permit to discharge process wastewater to the City of Memphis, Tennessee’s

publicly owned treatment works (POTW), an NPDES Stormwater Discharge permit issued by the State of Tennessee, and Special Solid Waste Disposal Permits issued by the facility’s solid waste disposal contractor for the land disposal of certain non-hazardous special waste streams.

Since the Memphis facility is also a Small Quantity Generator (SQG) of hazardous waste, we maintain an EPA generator registration and identification number for their hazardous waste disposal activities.

We are also pursuing business opportunities involving the removal of radionuclides from groundwater and/or industrial wastewater streams. Our plans are to sell or lease the removal systems to third party customers, with an associated service contract for removal and disposal of the resin material upon exhaustion. We would use a licensed subcontractor for transportation and disposal of the media. These activities would fall under regulations governed by the Nuclear Regulatory Commission (NRC). All subcontractors, transporters, and disposal facilities would be required to possess the required NRC permits and licenses to engage in these roles. However, should any of the spent radionuclide-containing resins also contain characteristic or listed hazardous wastes, the resins would be classified as “mixed wastes” and would no longer be regulated by the NRC, but, would be subject to the EPA’s Resource Conservation and Recovery Act (RCRA) hazardous waste regulations.

Given our Memphis facility’s onsite chemical inventory and disposal and/or release of chemical substances / wastes / residues as a part of doing business, the Memphis facility is subject to annual reporting requirements as specified by the EPA Superfund Amendment and Reauthorization Act (SARA) (specifically the SARA 312, Tier II Hazardous Chemical Inventory, and SARA 313, Toxic Release Inventory, regulations).

To the extent we do not comply with the various laws and regulations applicable to our activities, we may be subject to fines, regulatory action or private litigation that may adversely affect our business.

Research and Development

Product development activities include 1) the design and evaluation of experimental ion-exchange processes and groundwater treatment systems for the removal of various contaminants, 2) development of “green” processes for recycle and regeneration of spent medias being conducted at the University of Nevada, Las Vegas, or UNLV, and the University of Maryland Biotechnology Institute, or UMBI, and 3) development of processes involving an array of technologies useful in our expansion from an ion-exchange company to a commercial water treatment company. These development activities include extensive piloting efforts on applications related to the removal of nitrate, arsenic and radionuclides from groundwater.

As part of our research and development, we have developed a technology for biologically removing and destroying perchlorate load from spent ion-exchange resins. This technology combines biological and ion-exchange treatment in an innovative method which to our knowledge has not been used in the past. We have patents granted in five European countries directed to the BIONExchange™ process as well as one patent granted by the USPTO, which is directed to a process for the removal of perchlorate. We have also contracted with the East Valley Water District to install a full-scale perchlorate removal system which will utilize this technology pending permitting by DHS.

We have a sponsored research arrangement with UNLV under which they are researching and testing certain aspects related to the regeneration of exchange resins that may be useful in the BIONExchange™ process. Any intellectual property developed by us under the agreement will be owned by us, any intellectual property developed by UNLV under the agreement will be owned by UNLV and intellectual property developed jointly will be jointly owned by the parties. We have an option to acquire intellectual property from UNLV not solely owned by us, and we paid $0.3 million to UNLV from 2005 to 2007.

In 2007, we sponsored research and testing at the UMBI. This research involves the biological destruction of nitrates from residual brine solutions resulting from ion exchange processes to remove nitrates from

groundwater. In our view, management of residual brines accounts for approximately 75 percent of the costs associated with treatment processes to remove nitrates from groundwater. The biological destruction of nitrates to nitrogen gas reduces waste costs from these treatment processes, thus potentially resulting in more economical solutions to deliver nitrate-free water to our customers. We paid $5,000 to UMBI in the year ended December 31, 2007.

Our total research and development expenses were $0.6 million, $0.6 million and $0.7 million in 2007, 2006 and 2005, respectively.

We intend to continue our active research and development efforts internally and through selective strategic alliances to strengthen the position of our groundwater and other treatment technologies through the development of new and improved processes and the filing of additional patent applications. The principal goals of our research program are maintaining our position as a technological leader in solving customers’ problems with technology+services, and acquiring access to and developing new products and services. We may also continue to pursue expanding our expertise into other water treatment technologies through acquisition of, or strategic alliances with other companies.

Intellectual Property

Our intellectual property is the result of many years of research and development efforts as well as strategic acquisitions and contract relationships. We have pursued a broad strategy of protecting our developed and owned intellectual property, including seeking patent protection, safeguarding trade secrets, registering trademarks and using non-disclosure and other contractual agreements to protect other intellectual property rights.

We have developed what we believe to be an innovative process design that significantly improves the economics of using ion exchange for groundwater treatment. As of December 31, 2007, we have two issued United States patents directed to a system and process for the removal of arsenic, one issued United States patent directed to a process for the removal of nitrate and two issued United States patents directed to processes for the removal of perchlorate. We also have one issued patent in the United States and in five European countries directed to our BIONExchange™ process, a proprietary process for biologically removing and destroying perchlorate load from used ion-exchange resins and alternatively from perchlorate-laden ion-exchange resin regeneration brines. We currently are developing technology related to the removal of chromium VI and radium, for which we plan to seek patent protection.

In addition, we hold eight pending United States patent applications and eleven pending foreign patent applications on various aspects of our treatment processes. Our patents and patent applications as a group are related to ion exchange and the treatment of one or more of the following contaminants:

We employ the Basin Water IX™ software program for the operation of our system. We also use this software program for the design of our system to determine the most efficient operating parameters for our system based upon the contaminant profile of the water source being treated.

We have pending trademark applications in the United States for Basin Water^® and Basin Water IX™.

As part of our business procedures, we typically enter into confidentiality and invention assignment agreements, or have confidentiality provisions in agreements with our employees, independent contractors and consultants, and non-disclosure agreements with our customers, partners, independent contractors and consultants.

MPT, which was acquired by us in September 2007, holds five United States patents and twelve foreign patents related to various chemical manufacturing processes. These patents relate to 1) an improved process for the recovery of ethylene glycol from spent glycol generated in the manufacture of polyethylene terephthalate, 2) an improved separation process for the continuous catalytic oxidation of aromatic alkyls for the production of aromatic carboxylic acids in a liquid solvent medium, 3) an apparatus and method for the purification of waste wash water derived from the production of aromatic acids, 4) a method of polyester manufacturing using cross flow membrane filtration, and 5) a process for the recovery of molybdenum catalyst from the epoxidation reaction product of olefins with organic hydroperoxides.

MPT also has three pending United States patent applications related to processes for the treatment of the following contaminants: nitrate, ammonia and radium.

The pending patent application related to the treatment of radium has been assigned to us pursuant to our acquisition of MPT. In 2008, we plan to have the other patents and pending patent applications assigned to us.

MPT also holds trademark registrations for Hypersorb^®, Hyperflux^® and Chromasep^®.

Employees

As of December 31, 2007, we employed 107 full-time and 5 part-time employees. None of our employees are represented by a collective bargaining agreement. There are no pending labor-related legal actions against us filed with any state or federal agency. We believe our employee relations are good.

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

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:

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.

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:

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:

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,

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

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:

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

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

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

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 captionedPoulos v. Basin Water, et al., Case No. CV 07-8359 GW (FFMx) andNofer 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:

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

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

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

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

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.

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.

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

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.

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:

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.

None.

ITEM 2.

PROPERTIES

Facilities

Our corporate headquarters, finance and administration offices are located in Rancho Cucamonga, California where we occupy approximately 10,000 square feet under a lease expiring on February 14, 2013 at an initial annual cost of approximately $256,000 with annual escalations. We also occupy approximately 35,000 square feet under an additional lease expiring on March 31, 2011 comprising our engineering and manufacturing facilities. We have an option to extend the lease for an additional three years. Our rental expense in 2007 was approximately $226,000 for this facility.

We lease our Memphis facility from a limited liability company owned by the former stockholders of MPT. The facility is approximately 55,000 square feet. The lease provides for an annual base rent of $81,900 and an initial lease term of five years, with three 5 year options to extend the lease term. We also lease warehouse and office space in Pasadena, California and outside Phoenix, Arizona, respectively.

In addition, in March 2008 we leased approximately 6,400 square feet for our Southwest Region office under a lease expiring on April 30, 2012 at an initial annual cost of approximately $130,000 with periodic escalators.

We believe that our existing office space will not be adequate for our needs through the end of the term of the lease agreements. We intend to lease additional office space to accommodate our growth. When our leases expire, we may exercise our renewal options or seek additional or alternate space for our operations, and we believe that suitable additional or alternative space will be readily available in the future at commercially reasonable terms.

Property, Plant and Equipment

Property, plant and equipment, net of accumulated depreciation, consisted of the following as of December 31, 2007 (in thousands):

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 captionedPoulos v. Basin Water, et al., Case No. CV 07-8359 GW (FFMx) andNofer 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.

No matters were submitted to a vote of security holders during the fourth quarter of 2007.

PART II

Market Information

The following table shows the range of market prices of Basin Water’s common stock since its initial public offering in May 2006.for the last two fiscal years. Our common stock is traded on the Nasdaq Global Market under the symbol “BWTR”. There were 8,6015,479 stockholders of record as of March 12, 2008.11, 2009.

Performance Graph

The following graph compares the cumulative total return to holders of Basin Water’s common stock during the period from May 12, 2006 (the date of our initial public offering) through December 31, 2008 to the cumulative total return during that same period achieved by the 35 companies listed in the PowerShares Water Resources Portfolio Fund (PHO:AMEX) (based on the Palisades Water Index^™) and that achieved by the Standard & Poor’s 500 Stock Index. The comparison assumes an initial investment of $100 made on May 12, 2006 in each of Basin Water common stock, the PowerShares Water Resources Portfolio Fund and the Standard & Poor’s 500 Stock Index. The cumulative total returns assume the reinvestment of all dividends. The historical performance reflected in the graph is not necessarily indicative of future price performance.

BWTR – Basin Water, Inc. common stock

SP 500 – S&P 500 Composite Stock Index

PHO – Power Shares Water Resources Portfolio Fund, which includes VMI, LAYN, URS, IEX, WTS, FELE, DHR, INSU, PNR, ITT, BMI, PLL, LNN, ROP, PWEI, FLS, EMR, SE, GE, GRC, AMN, NLC, CCC, ASH, VE, UU, WTR, SBS, CWT, SWWC, SJW, CWCO and SZE

3

Dividend Policy

We have never declared or paid any cash dividend on our capital stock. We currently intend to retain all future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Consequently, stockholders will need to sell shares of our common stock to realize a return on their investments, if any. Any future determination related to dividend policy will be made at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements, contractual restrictions and such other factors as our board of directors deems relevant.

Repurchases of Securities

In May 2007, our Board of Directors authorized management to repurchase up to $10.0 million of shares of our common stock in the market from time to time. The shares could be repurchased at times and prices as determined by management, and may be completed through open market or privately negotiated transactions. The repurchase program provides that repurchases must be made in accordance with the terms and subject to the restrictions of Rule 10b-18 under the Securities Exchange Act of 1934, as amended.

Equity Compensation Plans

In November 2007, we repurchased 85,000For an analysis of the shares of our common stock at a priceauthorized for issuance under our equity compensation plans, see Item 11. – “Executive Compensation – Equity Compensation Plan Information”. A description of $6.45 per share. These repurchased shares have been classified as treasury stockour equity compensation plans appears in the December 31, 2007 balance sheet.

ISSUER PURCHASES OF EQUITY SECURITIESItem 11. – “Executive Compensation – Retirement and Other Benefit Plans”.

ITEM 6.

SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. See “Forward-Looking Statements” elsewhere in this Annual Report on Form 10-K. As a result of many factors, such as those set forth under “Item 1A. Risk Factors”, our actual results may differ materially from those anticipated in such forward-looking statements.

Overview

We are providers of reliable, long-term process solutions for a range of customers which include designing, building, implementing and servicing systems for the treatment of contaminated groundwater, the treatment of wastewater, waste reduction and resource recovery. We were initially incorporated in December 1999 and during our first two years of operations primarily focused on the development of our ion-exchange regenerable, onsite treatment system. The first permit to be issued by the California Department of Health Services, or DHS, to one of our customers for the operation of our system was issued in 2002. We currently have 79 systems on order or under contract in California, Arizona, North Carolina and New Jersey with an aggregate installed capacity of approximately 113,000 acre-feet per year, or approximately 36.9 billion gallons per year.

In 2007, we marketed our treatment systems and services primarily to utilities, cities, municipalities, special districts, real estate developers and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of chemical contaminants. We marketed our treatment systems and services through our direct sales force, independent contractors and strategic relationships. Our customers include Arizona American Water, Aqua America, California Water Service Group and American States Water Company, four of the largest investor-owned water utilities in the United States based on population served.

As a manufacturer of treatment systems, our operations necessitate a significant investment in receivables and property and require significant working capital. In the case of sales of ion-exchange regenerable, onsite treatment systems, we must expend all of the costs to build and deliver our system to the customer, and we receive payment for the system primarily when the delivery is completed and the system has been placed into service. For systems that we deliver to customers under our long-term contract arrangements, we must incur the costs to build and deliver our treatment systems, and we receive payment over a typical period of five or more years.

In May 2006, we completed our initial public offering which resulted in the issuance of 6,900,000 shares of our common stock at a price of $12.00 per share for net proceeds of approximately $75.2 million.

On September 14, 2007, we completed the acquisition of Mobile Process Technology Co. (MPT), a provider of technology and services to the water treatment and industrial process markets. This acquisition provides additional capabilities including expanded technological solutions, geographic presence and expanded customer base. The new company provides the ability to service and treat smaller capacity water systems than our product offering.

Outlook

We believe that the following trends and uncertainties, among others, may impact our revenues, income, liquidity and cash flows:

Financial Operations Review

We evaluate our business using a variety of key financial measures:

Revenues

Our revenues tend to vary from period to period, because customers can choose between purchasing our groundwater treatment systems and entering into long-term contract arrangements for our treatment systems. If a customer chooses to purchase a system, we recognize revenues over a much shorter period of time, generally within one or two quarters, than we would recognize for the same system if the customer chose a long-term contract arrangement for the system. Thus, our revenues will tend to be higher in periods in which we sell rather than place our systems under long-term contracts. For any customers selecting a long-term capital arrangement, we may enter into third-party financing arrangements.

Sales

For treatment systems sold to customers which are sold under fixed-price contracts, or that we enter into a sale under a third-party financing arrangement, we recognize revenues using the percentage-of-completion method. This method takes into account the cost, estimated earnings and revenues to date on systems not yet completed. This method is used because management considers total cost to be the best available method of measuring progress on systems sold to customers. In general, financial statements based on the percentage-of-completion method present the economic substance of production-type activities more clearly than the completed-contract method, and present the relationships between sales, cost of sales and related period costs more accurately. Because of inherent uncertainties in estimating costs, estimates used may change in the near term. Such estimates are adjusted under the cumulative-catch-up method. Unless contractually agreed to otherwise, the sales contract is deemed to be substantially complete when the treatment system has been physically completed and a performance test has been passed. Historically, our sales consisted of large system4

sales and standard system sales. Our large systems consisted of large site regenerable treatment systems that we constructed at our customer’s site as opposed to standard systems which are fabricated at our facilities.

Contract Revenues

Our recurring contract revenues are generated from three sources. The first source of recurring contract revenues is from long-term fixed contracts under which we install our system at the customer’s site and treat the customer’s water. We retain ownership of the installed system. Under this contract we recognize monthly revenues on a straight-line basis over the life of the contract, which represents a return of the capital value of the installed system. The amount of this fixed monthly revenue is based on both the capacity of the system and the type of contaminant(s) being treated. The straight-line method best reflects the value of having the system’s capacity available to the customer at all times and is similar to the method used for calculating depreciation.

The second source of recurring revenues is from long-term contracts for the treatment of the water produced from installed treatment systems, which we also refer to as service revenues. Service revenues are recognized based on the actual volume of water treated each month. Such water-treatment revenues bear a direct relationship to the variable costs for the purchase and delivery of salt, chemicals and resin used in the system, the removal of waste and the cost to maintain and service the system. This revenue stream is generated both by systems that were purchased by our customers and by systems in which we retain ownership and recognize revenue for the monthly capital component.

The third source of contract revenues relates to providing other services for the processing of water, replacement of resins or equipment parts and other water treatment related services.

Under each of the long-term contracts, the customer is typically obligated to pay us for the treatment of its water—not for specific hours worked, supplies purchased or waste-hauls provided. Our newer long-term contracts allow us to recover increased operating costs, including costs for salt, chemicals, resin and removal of waste. Most of our contracts entered into prior to 2005 do not have such provisions.

Under the criteria set forth in EITF 00-21, we have determined that the multiple deliverables of each of our long-term contracts specifically, the capital component and the volume related service charge, qualify for separate accounting treatment. The three criteria required for separate accounting treatment are: 1) that each deliverable has a standalone value to the customer, 2) that there is objective and reliable evidence of fair value of each deliverable and 3) that there are no general refund rights for the deliverables.

In the case of contracts under which we own the system, the customer is obligated to pay us the fixed capital component of the system on a monthly basis. These arrangements are classified and treated as operating leases under Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases, because they meet the four criteria of an operating lease: 1) there is no transfer of title; 2) there is not a bargain purchase option; 3) the lease term is substantially shorter than the economic life of the system; and 4) the present value of the capital component payments is less than 90% of the fair value of the water treatment system at the inception of the contract.

In connection with long-term contracts, we may receive payments from our customers prior to the system being placed in service. Such payments are recorded as deferred revenues. In addition, we may receive payments from our customers in excess of that which can be recognized on a straight-line basis. These payments are also recorded as deferred revenues. All deferred revenues amounts are recognized as revenues in the periods in which services are rendered to the customer.

In each of these arrangements, the contract term is typically five or more years, provided our customers may elect to terminate their contract with us prior to the expiration upon the occurrence of certain circumstances. In the case of the long-term water treatment contracts, they generally contain a purchase option at the end of the agreement.

Cost of Revenues

Our cost of revenues varies based on the type of revenues as follows:

During the latter half of 2006 and 2007, improvements to our management controls and accounting systems enabled us to more thoroughly analyze operating results for each service contract and determine that certain, generally older contracts were operating at net cash flow losses. These contracts have sustained increasing operating costs such as waste disposal and salt purchase costs as the direct result of higher fuel, salt and other third-party costs. However, unlike our more recent contracts, these older contracts did not allow management to renegotiate terms to recover such increased costs. Management determined that these contracts would continue to generate net operating cash flow losses through the end of the contract period. Accordingly, we recorded a reserve for future contract losses in the amount of $3.7 million in the fourth quarter of 2006. This amount represented the losses which we expect to incur during the remaining term of these contracts. Actual losses on the underlying contracts are being charged against the reserve as incurred.

During 2007, additional older legacy contracts became operational and were operated during the busy, higher volume summer months. Based on the new operating history, especially during the third quarter, it became apparent that the original reserve was not adequate. Management reviewed each contract’s financial performance and identified the future expected losses for these contracts, resulting in a $4.7 million increase to the reserve (net of third quarter charges against the reserve) for future contract losses, which was charged to cost of contract revenues during the third quarter of 2007. These reserve amounts are being reversed as actual losses are incurred on the underlying contracts. The net reserve for future contract losses included on our balance sheet, both short and long term, as of December 31, 2007 was approximately $7.3 million.

The cost of revenues for a system also varies by the contaminant(s) that the system is designed to address. We purchase components and raw materials from third party vendors which are then assembled into our treatment systems in our manufacturing facilities or assembled at our customers’ site. We are not dependent on any sole source suppliers and generally have multiple vendors for each of our components and raw materials, all of which are located within the United States.

Research and Development Expense

Research and development expense consists primarily of research material costs, payroll and payroll related costs for our research and development personnel and outside sponsored research and consulting expenses associated with the design, development and testing of new and existing technologies and systems.

Selling, General and Administrative Expense

Selling, general and administrative expense consists primarily of payroll and payroll related costs for our corporate management, finance, accounting, sales, marketing and administrative personnel, including

commissions for our sales and marketing personnel. Also included in selling, general and administrative expense are overhead costs associated with these activities, marketing and promotion expenses, recruiting fees, public company costs, director fees, and audit and legal expenses.

Other Income

Other income included in the statements of operations consists primarily of interest income and income from affiliate, partially offset by interest and other expense.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our audited financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, long-lived assets, accrued liabilities, and income taxes. These estimates are based on historical experience, information received from third parties and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Predicting future events is inherently an imprecise activity and, as such, requires the use of assumptions. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be based on assumptions about matters that are highly uncertain at the time the estimate is made, and different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements.

We believe the following critical accounting policies affect the significant judgments and estimates used in the preparation of our financial statements:

assets are affected by factors such as changes in operating performance and fluctuations in economic conditions. If our assumptions change in the future, we may be required to record impairment charges for these assets.

Results of Operations

The following table sets forth key components of our results of operations for the years indicated, both in dollars and as a percentage of revenues.

Years Ended December 31, 2007 and 2006

Revenues, Cost of Revenues and Gross Profit (Loss)

The following table summarizes the significant components of revenues, cost of revenues and gross profit (loss) for the year ended December 31, 2007 compared to the prior year.

Revenues

Revenues increased by $1.7 million, or 10%, to $18.8 million in 2007 from $17.1 million in 2006. This increase occurred primarily as a result of (i) our acquisition of MPT in September 2007 and (ii) growth in our contract revenues, offset in part by a decrease in our revenues from system sales. Revenues recognized for sales of groundwater treatment systems decreased from $13.9 million in 2006 to $13.5 million in 2007, a decrease of $0.4 million, or 3%, primarily due to decreased groundwater treatment systems sales volume. Revenues from system sales represented 72% and 81% of our total revenues during 2007 and 2006, respectively. Contract revenues increased to $5.3 million in 2007 from $3.2 million in 2006, an increase of $2.1 million, or 66%, as the number of systems placed in service with customers increased in 2007 compared to 2006. We anticipate that our annual revenues will continue to increase in the future as we sell more systems and enter into more contracts with our customers. However, the percentage of increase from year to year will likely fluctuate as our base of revenues increases.

Cost of Revenues

Cost of revenues increased by $4.8 million, or 24% to $24.9 million in 2007 from $20.1 million in 2006. This increase was partially due to an increase in the cost of systems sold of $1.6 million, or 13%, to $13.8 million in 2007 compared to $12.2 million in 2006. This increase was primarily due to significantly higher than anticipated costs on our largest project, as well as lower than normal margins on the sale of existing systems. Operating costs for our contract revenues increased by $3.4 million, or 89%, to $7.2 million in 2007 from $3.8 million in 2006. The increase in operating costs was primarily due to higher costs of waste disposal, salt, chemicals and increased field service labor expense, as well as higher depreciation expense, all as a result of having more systems placed in service with customers in 2007 compared to 2006. During 2007 we recorded a

$3.6 million reserve for future contract losses (net of approximately $1.4 million of charges against the reserve for actual contract losses during 2007) as a result of management’s evaluations of certain loss contracts, compared to a $3.7 million reserve for future contract losses recorded in 2006 (see “Management’s Discussion and Analysis of Financial Condition—Financial Operations Review” for a further discussion of this reserve). We expect that our cost of revenues will increase in absolute dollars in future periods due to both an increase in the number of systems sold and higher costs of salt, waste disposal and increased field service labor expense, as well as higher depreciation expense, as a result of having more systems placed in service in future periods.

Gross Loss

Our gross loss increased to $6.1 million in 2007 from $3.0 million in 2006. Our gross profit percentage in 2007 was negative 33% compared to negative 17% in 2006. This increase in gross loss was primarily the result of (i) an increase of $1.3 million in our negative margins from contract operations, (ii) a decrease of $1.2 million in our gross margins on standard system sales and (iii) an increase in our negative gross margin on large system sales of $0.8 million.

As noted above, in both 2006 and 2007 we recorded a reserve for future contract losses (net of $1.4 million of charges against the reserve for actual contract losses during 2007) of $3.7 million and $3.6 million, respectively, which severely impacted our operating profit. In addition to this reserve, the gross loss on our contract operations was $2.3 million prior to applying any charges against the contract loss reserve; this compared to $1.0 million gross loss in the prior year. The increased gross loss was due primarily to the certain legacy contracts booked in prior periods that became operational in 2007 that included, among other things, poor pricing and inadequate contract terms.

Research and Development Expense

Research and development expense was approximately $0.6 million in both 2007 and 2006. We incurred research and development costs for outside consultant expense, research material costs and personnel costs. We expect our research and development expense to increase in absolute dollars in subsequent periods as we develop additional groundwater treatment systems and expand our research and development personnel, but to decrease as a percentage of revenues as our revenues grow. We anticipate that our research and development expense will fluctuate significantly from period to period based upon the timing of our internal and sponsored research projects.

Selling, General and Administrative Expense

The following table summarizes the significant changes in selling, general and administrative expense for the year ended December 31, 2007 compared to the prior year.

Selling, general and administrative expense increased by $6.9 million, or 101%, to $13.7 million in 2007 from $6.8 million in 2006. The increase was primarily due to an increase in compensation expense and related employee benefits of $2.6 million due to additional executive and management personnel and related costs to support our overall growth (including approximately $0.8 million added expense as a result of the September 2007 acquisition of MPT), an increase in professional fees of $1.3 million, primarily due to higher legal fees incurred in connection with various litigation; an increase in restricted stock expense of $0.5 million, primarily for restricted stock granted in October 2006; approximately $0.5 million of expense incurred in connection with the development and implementation of internal controls over financial reporting to comply with Section 404 of the Sarbanes Oxley Act of 2002; an increase of $0.4 million in directors fees and public company costs (as 2007 was our first full year as a public company); and an increase of $0.4 million in outside selling, marketing and promotion. We expect our selling expense to continue to increase in future periods as we expand our sales and marketing force. We also anticipate that our general and administrative expense will continue to increase in future periods as we incur additional costs associated with operating as a public company, and expand our administrative organization to support our overall growth.

Other Income (Expense)

The following table summarizes the significant changes in other expense for the year ended December 31, 2007 compared to the prior year.

We recorded other income of $5.1 million in 2007 compared to other expense of $0.7 million in 2006. The overall increase in other income is primarily due to (i) a gain on sale to an affiliate of $2.5 million recorded in the fourth quarter of 2007 as the result of the assignment to Empire of our contract to purchase certain water assets (see Note 15 to our consolidated financial statements) and (ii) an increase in interest income of $0.6 million, or 29%, to $2.7 million in 2007 from $2.1 million in 2006.

In addition, during 2006, the write off of approximately $1.5 million in unamortized fair value of warrants and the write off of approximately $0.4 million in unamortized loan costs in connection with the repayment of amounts outstanding under our loan, and our Notes, respectively, both of which are more fully discussed below under “Liquidity and Capital Resources,” resulted in higher interest expense. We expect that we would have net interest income for 2008 due to our large cash balance.

In addition, Empire plans to sell up to an additional 8,000,000 shares of its common stock at a price of $2.00 per share in a private placement during the first half of 2008. If Empire is successful in raising additional capital of at least $10.0 million on or before June 30, 2008, then we will receive an additional 6,000,000 shares of Empire common stock. We anticipate that, if we receive such additional consideration and Empire sells 8,000,000 shares in its private placement, then we will have an ownership interest of approximately 37% in Empire.

Years Ended December 31, 2006 and 2005

Revenues, Cost of Revenues and Gross Profit (Loss)

The following table summarizes the significant components of revenues, cost of revenues and gross profit (loss) for the year ended December 31, 2006 compared to the prior year.

Revenues

Revenues increased by $4.9 million, or 40%, from $12.2 million in 2005 to $17.1 million in 2006. This increase occurred primarily as a result of growth in sales of our groundwater treatment systems. Revenues recognized for sales of groundwater treatment systems increased from $10.0 million in 2005 to $13.9 million in 2006, an increase of $3.9 million, or 39%, primarily due to increased groundwater treatment systems sales volume. Revenues from system sales represented 81% and 82% of our total revenues during 2006 and 2005, respectively. Contract revenues increased from $2.2 million in 2005 to $3.2 million in 2006, an increase of $1.0 million, or 45%, as the number of systems placed in service with customers increased in 2006 compared to 2005. We anticipate that our annual revenues will continue to increase in the future as we sell more systems and enter into more contracts with our customers. However, the percentage of increase from year to year will likely fluctuate as our base of revenues increases.

Cost of Revenues

Cost of revenues increased by $13.0 million, or 183% from $7.1 million in 2005 to $20.1 million in 2006. This increase was primarily due to an increase in the cost of systems sold of $7.7 million, or 171%, from $4.5 million in 2005 to $12.2 million in 2006. This was primarily due to the significantly higher than anticipated costs on our largest project, including a $1.3 million reserve. Operating costs for our contract revenues also increased by $1.5 million, or 65%, from $2.3 million in 2005 to $3.8 million in 2006. The increase in operating costs was primarily due to higher costs of waste disposal, salt, and increased field service labor expense, as well as higher depreciation expense, all as a result of having more systems placed in service with customers in 2006

compared 2005. In addition, we recorded a $3.7 million reserve for future contract losses as a result of management’s evaluations of certain loss contracts (see “Management’s Discussion and Analysis of Financial Condition—Financial Operations Review” for a further discussion of this reserve). We expect that our cost of revenues will increase in absolute dollars in future periods due to both an increase in the number of systems sold and higher costs of salt, waste disposal and increased field service labor expense, as well as higher depreciation expense, as a result of having more systems placed in service in future periods. As a percentage of revenues, we expect that our cost of revenues will vary from year to year, depending upon the percentage of our revenues recognized from systems sold as opposed to revenues recognized from long-term contracts.

Gross Profit (Loss)

We recorded a gross loss of $3.0 million in 2006 compared to gross profit of $5.1 million in 2005. Our gross profit percentage in 2006 was negative 17% compared to a 42% profit in 2005. This decrease in gross profit was primarily the result of (i) a 2006 reserve for future contract losses in the amount of $3.7 million as discussed above, and (ii) higher than anticipated costs on our largest system sale project. Additionally, the 2006 system sales gross loss reflects the low margins on two projects with special requirements for the construction of buildings through the use of subcontractors during 2006. Excluding this largest system sale project and the two projects involving the construction of buildings (large system sales), our standard system sales gross profit percentages were in the normal mid 40% range during 2006.

Our contract operations gross profit was impacted by higher volume-related contract operating costs, particularly waste hauling charges and increased field service labor and engineering expense, especially on certain older contracts. In general, our gross profit percentage is higher on systems we sell than on systems we place with customers under long-term contracts. We expect our gross profit and gross margin to fluctuate based on the portion of our revenues derived from system sales as opposed to long-term contracts. As noted above, we recorded a $3.7 million reserve for future losses primarily on older contracts which severely impacted our operating profit.

Research and Development Expense

Research and development expense was approximately $0.6 million in both 2006 and 2005. We incurred research and development costs for outside consultant expense, research material costs, and personnel costs. We expect our research and development expense to increase in absolute dollars in subsequent periods as we develop additional groundwater treatment systems and expand our research and development personnel, but to decrease as a percentage of revenues as our revenues grow. Our research and development expense constituted a higher percentage of our revenues in prior periods when we were selling our first systems. We anticipate that our research and development expense will fluctuate significantly from period to period based upon the timing of our internal and sponsored research projects.

Selling, General and Administrative Expense

The following table summarizes the significant changes in selling, general and administrative expense for the year ended December 31, 2006 compared to the prior year.

Selling, general and administrative expense increased by $3.5 million, or 106%, from $3.3 million in 2005 to $6.8 million in 2006. The increase was primarily due to stock-based compensation of $0.7 million recorded in 2006 in accordance with the provisions of SFAS No. 123(R); bad debt expense in the amount of $0.5 million primarily due to a default under one contract; and an increase in compensation expense and related employee benefits of $1.1 million due to increased personnel and related costs to support our overall growth. In addition, we incurred approximately $0.4 million in higher liability insurance costs and certain professional fees directly related to our becoming a publicly traded company in 2006. We expect our selling expense to continue to increase in future periods as we expand our sales and marketing force. We also expect our general and administrative expense to continue to increase in future periods as we incur additional costs associated with operating as a public company, and expand our administrative organization to support our overall growth.

Other Expense

The following table summarizes the significant changes in other expense for the year ended December 31, 2006 compared to the prior year.

Other expense increased by $0.2 million, or 40%, from $0.5 million in 2005 to $0.7 million in 2006. The overall increase in other expense is primarily due to the write off of approximately $1.5 million in unamortized

fair value of warrants and the write off of approximately $0.4 million in unamortized loan costs in connection with the repayment of amounts outstanding under our BWCA loan, and our XACP Notes, both of which are more fully discussed below under “Liquidity and Capital Resources,” resulting in higher interest expense. These increases in interest expense were partially offset by an increase of approximately $2.0 million in interest income earned on net proceeds from our initial public offering in mid-May 2006. We expect that we will have net interest income for 2007.

Liquidity and Capital Resources

From our inception until our initial public offering in May 2006, we financed our growth and operations primarily with proceeds from the issuance of preferred stock and common stock, as well as the incurrence of indebtedness under the BWCA loan, our subordinated notes payable to The Co-Investment 2000 Fund, LP, Cross Atlantic Technology Fund II, LP and Catalyst Basin Water, LLC (the “XACP Notes”), and our $2.0 million subordinated note to Aqua America, Inc. (the “Aqua Note”).

In connection with our initial public offering in May 2006, we received net cash proceeds of approximately $75.2 million, of which $11.0 million was used to repay the $4.0 million BWCA loan, $5.0 million in XACP Notes and the $2.0 million Aqua Note.

Our long-term future capital requirements will depend on many factors, including our level of revenues, the expansion of our sales and marketing activities, the success of our strategic relationships in the marketing of our treatment systems, our ability to place our systems under long-term contracts and provide service under our long-term contracts, our need to make capital expenditures to increase our resin regeneration capacity including through building new or expanding existing facilities and the continuing market acceptance of our systems and services.

We anticipate continued revenue growth. Our revenue growth impacts our liquidity and places increased demands on our capital resources. For example, as our system sales to customers increase, we require an increased investment in accounts receivable, as system sales accounts receivable may have repayment terms from several months to one year or beyond. Additionally, as our long-term contract revenues increase, we will experience much higher capital expenditure requirements.

We expect that our current cash and cash equivalents will be sufficient to fund our anticipated future growth and operations for at least the next 12 months. We anticipate that we may need additional capital to finance our growth and operations after such 12-month period or to accelerate our expected growth during such 12-month period. In such an event, we anticipate that we would be able to raise additional capital through a combination of bank credit facilities, issuance of long-term debt and private or public equity offerings. If we were unable to obtain additional capital through one or more of these sources, our investment in groundwater treatment systems and our revenue growth would be delayed, or we would focus our sales and marketing on the sales of systems as opposed to placing such systems under long-term contracts. We also expect to use third-party financing with respect to systems placed through long-term contracts, resulting in the sale of the systems.

We also expect to consider opportunities to acquire or make investments in other technologies, products and businesses that could enhance our technical capabilities, complement our current products and services or expand the breadth of our customer base. These activities would require additional capital resources.

At December 31, 2007, we had $35.5 million in cash and cash equivalents. We have invested substantially all of our available cash funds in money market funds placed with reputable institutions for which credit loss is not anticipated.

The following table summarizes our primary sources of cash in the periods presented:

Operating Activities

Net cash used by operating activities was $13.3 million during 2007 compared to net cash used in operating activities of $12.4 million during 2006. This increase in net cash used by operating activities was due primarily to (i) an increase in our net loss of $4.1 million to $15.3 million in 2007 from $11.2 million in 2006, (ii) an increase in gain on sale to affiliate of $2.5 million, (iii) the issuance of $3.3 million in notes receivable in 2007 and (iv) a $3.5 million decrease in accrued expenses compared to the prior year (excluding accrued expenses arising from our acquisition of MPT in September 2007). The foregoing increases in net cash used by operating activities were offset in part by (i) an increase of $3.4 million in net book value of systems sold, (ii) a $2.7 million decrease in accounts receivable arising from more timely collection of accounts receivable from our customers, (iii) a $2.2 million increase in accounts payable as a result of increased operating activity and increases in construction in process and (iv) a $3.2 million decrease in other assets and liabilities during 2007.

Net cash used by operating activities was $12.4 million during 2006 compared to net cash used in operating activities of $6.4 million during 2005. In addition to our net loss of $11.2 million, the increase in net cash used by operating activities was due primarily to a $2.1 million decrease in accounts payable reflecting expedited settlements of obligations to our vendors when compared to the prior year. In addition, as noted above, our prepaid expenses increased due to much higher insurance premiums incurred for our corporate liability coverage, most notably directors’ and officers’ liability insurance. Accounts receivable balances were higher in 2006 when compared to 2005, resulting in approximately $4.5 million use of cash for operating activities. The increase in accounts receivable was offset by the $3.7 million contract loss reserve recorded in 2006.

In general, accounts receivable arising from systems sales to customers are due in accordance with the provisions of the sales contract, which may provide for extended payment terms ranging from several months to one year or more for a significant portion of the contract price. In contrast, accounts receivable from systems placed under long-term contracts with customers are usually due within a much shorter period, generally within one month after the date services have been performed and the customer has been billed. Accordingly, in periods in which our revenues from system sales are higher, our collection of accounts receivable will be much slower due to the nature of the sales contracts, and we will require additional cash to fund these system sales accounts receivable.

Investing Activities

Net cash used in investing activities was $11.6 million in 2007 compared to $3.9 million in 2006. The increase in cash used in investing activities was due primarily to $6.2 million in cash paid as partial consideration for the acquisition of MPT, net of cash acquired. In addition, we experienced a $1.4 million increase in capital expenditures in 2007 compared to 2006. This increase in capital expenditures was the result of more systems placed with customers under long-term contracts during 2006 than during 2005 since more customers chose to purchase systems from us rather than pay us under long-term contracts.

Net cash used in investing activities was $3.9 million in 2006 compared to $1.7 million in 2005. This increase was due primarily to a $2.0 million increase in capital expenditures in 2006 compared to 2005. This increase in capital expenditures was the result of more systems placed with customers under long-term contracts during 2006 than during 2005, since more customers chose to pay us under long-term contracts rather than purchase systems from us.

Financing Activities

Net cash provided by financing activities was $5.7 million in 2007 compared to $68.1 million in 2006. This decrease was due primarily to $75.2 million in net proceeds from sales of common stock (attributable to our initial public offering) and $2.0 million in net proceeds received from notes payable receipt. These decreases in net cash provided by financing activities were offset in part by $8.1 million in net proceeds from exercise of common stock warrants and a decrease of $6.8 million in repayments of notes payable and capital lease obligations during 2007 compared to the prior year.

Net cash provided by financing activities was $68.1 million in 2006 compared to $9.1 million in 2005. The increase was due primarily to an increase of $71.6 million in net proceeds from sales of common stock (attributable to our initial public offering in May 2006), offset in part by a $3.2 million decrease in net proceeds from notes payable and an $8.9 million increase in principal payments on notes payable and capital leases.

Capital Expenditures

Our capital expenditures are primarily for groundwater treatment systems that we build and then contract to customers under long-term contracts. Capital expenditures totaled $5.3 million, $3.9 million and $1.9 million during the years ended December 31, 2007, 2006 and 2005, respectively. Our future capital expenditures will fluctuate depending on the number of our systems we place with customers under long-term contracts.

We anticipate that our capital expenditures will continue to increase in future years. We anticipate the use of cash of approximately $5.0 million to $7.0 million for capital expenditures during 2008 for increases in our resin regeneration capacity, development of certain pilot plants for treatment technologies and improving or expanding our existing facilities. In addition, capital expenditures could increase further relative to any increases in the number of treatment systems delivered to customers under long-term contract arrangements, though it is our intent to sell these arrangements to a third party financing company, thus reducing the use of cash for that customer system.

Outstanding Indebtedness

At December 31, 2007, we had no outstanding indebtedness.

Warrants Issued in connection with Indebtedness and other Transactions

In connection with the BWCA loan (which was repaid in full in May 2006), we issued to the lender warrants to purchase an aggregate of 717,450 shares of our common stock at an exercise price of $4.00 per share. These warrants are immediately exercisable and expire in November, 2008, provided, that the warrant shall no longer be exercisable on the date of a change in control of our company.

On August 13, 2007, we entered into an Omnibus Amendment to Business Loan Agreement and Warrants dated October 3, 2003, April 30, 2004 and February 10, 2006 (Omnibus Amendment) with BWCA I, LLC. Pursuant to the terms of the Omnibus Amendment, the prepayment penalty associated with the May 2006 repayment of the loans previously outstanding and owed to BWCA I, LLC was reduced from 5.0% to 2.5%, and each of the warrants previously issued to BWCA I, LLC was amended to allow the holder thereof to effect a “net” or “cashless” exercise of the warrant.

The number of shares of common stock that will be issued to BWCA I, LLC upon cashless exercise will be reduced from the 767,450 shares originally issuable under the warrants. These warrants have an aggregate exercise price of $3.3 million, which the warrant holder would normally pay in cash to us. Instead, upon exercise the warrant holder will receive a reduced number of shares of our common stock, effectively foregoing shares equal to $3.3 million in market value at the time of exercise.

Subsequent to the Omnibus Agreement, during the last two quarters of 2007, holders of 56,066 warrants exercised such warrants through cashless exercises, and received 38,995 shares of our common stock.

In connection with the XACP Notes (which were repaid in full in May 2006), we issued to the purchasers warrants to purchase an aggregate of 750,000 shares of our common stock at an exercise price of $5.50 per share and warrants to purchase an aggregate of 250,000 shares of our common stock at an exercise price of $7.00 per share. These warrants are immediately exercisable and expire on the earliest of November 11, 2008 and immediately prior to a change in control of our company. During the third and fourth quarters of 2007, the holders of the XACP warrants exercised 725,000 warrants at an exercise price of $5.50 per share and 225,000 warrants at an exercise price of $7.00 per share, resulting in the issuance of 950,000 shares of our common stock and net proceeds to us of approximately $5.6 million.

In connection with our nationwide strategic relationship with Aqua America and issuance of the Aqua Note (which was repaid in full in May 2007), we granted to Aqua America a warrant to purchase 300,000 shares of our common stock at an exercise price of $6.00 per share and a warrant to purchase 100,000 shares of our common stock at an exercise price of $7.00 per share. During the fourth quarter of 2007, the holders of the Aqua warrants exercised all of their warrants, resulting in the issuance of 400,000 shares of our common stock and net proceeds to us of $2.5 million.

In addition, in connection with the consent granted by BWCA I, LLC with respect to our issuance of the Aqua Note, we granted to BWCA I, LLC a warrant to purchase 50,000 shares of our common stock at an exercise price of $8.00 per share.

Pursuant to our December 2005 binding commitment letter with Shaw, Shaw committed to purchase a total of $5.0 million of our groundwater treatment systems prior to December 31, 2006. We granted to Shaw a warrant to purchase 300,000 shares of our common stock at an exercise price of $7.00 per share in connection with its purchase of our groundwater treatment systems. One-fifth of the shares subject to this warrant vest upon each $1.0 million of our groundwater treatment systems paid for by Shaw. As of December 31, 2007, no shares had vested under the Shaw warrant. The warrant may be exercised for five years after the date of grant. In 2005, we recognized revenues of approximately $1.6 million from Shaw’s purchase of our systems, which was offset by approximately $0.2 million attributable to the warrant that we granted to Shaw pursuant to the transaction. During 2006, we recognized revenues in the amount of $2.9 of the remaining $3.4 million pursuant to this commitment which was offset by approximately $0.3 million attributable to the warrants we granted to Shaw.

We have applied the provisions of SFAS No. 123 and SFAS No. 123(R) to the warrants issued in connection with these transactions. Accordingly, the total fair value of the warrants issued has been calculated using the Black-Scholes method. In accordance with the provisions of SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, the fair values of those warrants primarily related to indebtedness have been or will be recorded as a discount to notes payable, with a corresponding increase in common stock. The fair value of such warrants is being amortized through the end of each respective loan term under the interest method.

Off Balance Sheet Arrangements

Through December 31, 2007, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have

been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships. We do not have relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties.

Contractual Obligations

The following table summarizes our significant contractual obligations as of December 31, 2007:

Effect of Inflation and Seasonality

We do not believe that inflation will have a material impact on our financial condition or results of operations. We believe current contracts and pricing policies will allow for these costs to be appropriately passed on to our customers. We identified certain older contracts where we did not provide for the ability to offset cost increases and have recorded a $3.7 million reserve in 2006 for these future losses.

During 2007, additional older legacy contracts became operational and were operated during the busy, higher volume summer months. Based on the new operating history, especially during the third quarter, it became apparent that the original reserve was not adequate. Management reviewed each contract’s financial performance and identified the future expected losses for these contracts, resulting in a $4.7 million increase to the reserve for future contract losses, which was charged to cost of contract revenues during the third quarter of 2007. The net reserve for future contract losses included on our balance sheet, both short and long term, as of December 31, 2007 was approximately $7.3 million.

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 must increase the utilization of their groundwater resources resulting in a higher volume of groundwater treated during these periods and thus higher revenues from our long-term contracts. Our net sales and net income have historically been lowest in the three-month periods ending December 31 and March 31, when the Arid West generally faces cooler weather that reduces the utilization of groundwater sources which in turn reduces the processing fees we receive from our long-term contracts. Historically, the impact of seasonality has been mitigated through the impact of the sales of our systems in certain periods. We also expect sales of our systems to continue to mitigate the impact of seasonality in future periods in the near-term.

Recently Issued Accounting Standards

In June 2006, the FASB issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement standard for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 became effective for the Company on January 1, 2007. The provisions of FIN 48 are to be applied to all tax positions upon initial application of this standard. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption. The cumulative effect of applying the provisions of FIN 48, if any, must be reported as an adjustment to the opening balance of retained earnings or other appropriate components of equity for the fiscal year of adoption. The adoption of FIN 48 had no material impact on our financial statements.

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. This statement establishes a single authoritative definition of fair value, sets out framework for establishing fair value, and requires additional disclosures about fair value measurements. This statement applies only to fair value measurements that are already required or permitted by other accounting standards and is expected to increase the consistency of those measurements. Adoption of SFAS 157 is required for our fiscal year beginning January 1, 2008, and will be applied prospectively under most circumstances. We do not expect adoption of SFAS No. 157 to have a material impact on our financial statements.

In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115. This statement permits companies to choose to measure many financial instruments and other specified items at fair value. This statement is effective for our fiscal year beginning January 1, 2008 and will be applied prospectively. We do not expect adoption of SFAS No. 159 to have a material impact on our financial statements.

In December 2007, the FASB issued SFAS No. 141(R),Business Combinations (SFAS No. 141R(R)). This statement replaces SFAS No. 141in its entirety and retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combination, including business combinations achieved in states (step acquisition), to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first reporting period beginning on or after December 15, 2008, and may not be applied before that date. We are currently evaluating the impact SFAS 141(R) could have on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (SFAS No. 160), which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective for the fiscal year beginning January 1, 2009 and will be applied prospectively. We do not expect adoption of SFAS No. 160 to have a material impact on our consolidated financial statements.

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. At December 31, 2007, we had no outstanding indebtedness. The amount of our outstanding debt at any time may fluctuate and we may from time to time be subject to refinancing risk. A hypothetical 100 basis point increase in interest rates would not have a material effect on our annual interest expense, our results of operations or financial condition. We derive substantially all of our revenues from sales within the United States. Since transactions in foreign currencies are immaterial to us as a whole because we do not currently have any significant foreign customers nor do we enter into contracts with foreign entities except contracts denominated in United States currency, we do not consider it necessary to hedge against currency risk.

Our financial statements, supplementary financial data and financial statement schedules are included in a separate section at the end of this Report. The financial statements, supplementary data and schedules are listed in the index on page F-1 of this Report and are incorporated herein by reference.

None.

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC and that such information is accumulated and communicated to management, including our chief executive officer (CEO) and chief financial officer (CFO), as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Management, with participation by our CEO and CFO, has designed the Company’s disclosure controls and procedures to provide reasonable assurance of achieving the desired objectives. As required by SEC Rule 13a-15(b), in connection with filing this Annual Report on Form 10-K, management conducted an evaluation, with the participation of our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as of December 31, 2007, the end of the period covered by this report.

Based upon the evaluation conducted by management in connection with the audit of the Company’s financial statements for the years ended December 31, 2007 and 2006, we identified a material weakness in our internal control over financial reporting. A material weakness is “a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected by us in a timely manner.” As a result of this material weakness, our CEO and CFO concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of December 31, 2007.

(b) Management’s Evaluation of Internal Control over Financial Reporting.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. This system is designed to provide

reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of (US GAAP) records that, in reasonable detail, accurately and fairly reflect our transactions and disposition of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.

Our management performed an assessment of the effectiveness of our internal controls over financial reporting as of December 31, 2007 based upon the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was not effective as of December 31, 2007.

Our independent registered public accounting firm has issued an attestation report on our internal control over financial reporting, which is included in Item 8 of this Report.

The ineffectiveness of internal controls as of December 31, 2007 stemmed in large part from several significant changes within the Company. The organization structure was changing as we hired additional management, and we were establishing the new accounting information system. This placed additional stress on the organization and our internal controls as these new structures were being instituted within the company. Additionally, the acquisition of MPT in the third quarter of 2007 caused additional changes to our organization structure and accounting systems. While we believe the new organization and the accounting information system will strengthen our internal control functions into the future, during the transition, these changes caused control deficiencies, which in the aggregate resulted in a material weakness.

These control deficiencies could result in a misstatement of account balances that would result in a reasonable possibility that a material misstatement to our financial statements may not be prevented or detected on a timely basis. Accordingly, we have determined that these control deficiencies as described above together constitute a material weakness.

In light of this material weakness, we performed additional analyses and procedures in order to conclude that our consolidated financial statements for the year ended December 31, 2007 included in this Annual Report on Form 10-K were fairly stated in accordance with US GAAP. Accordingly, management believes that despite our material weaknesses, our financial statements for the year ended December 31, 2007 are fairly stated, in all material respects, in accordance with US GAAP.

We may in the future identify further material weaknesses or significant deficiencies in our internal control over financial reporting that we have not discovered to date. We plan to refine our internal control over financial reporting to meet the internal control reporting requirements included in Section 404 of the Sarbanes-Oxley Act (SOX 404) to have effective internal controls by December 31, 2008. The effectiveness of the measures we implement in this regard will be subject to ongoing management review supported by confirmation and testing by management and by our internal auditors, as well as audit committee oversight. As a result, we expect that additional changes could be made to our internal control over financial reporting and disclosure controls and procedures.

(c) Plan for Remediation of Material Weaknesses

We have implemented a number of changes designed to improve our internal control over financial reporting such as:

During 2008, we intend to take the following remediation efforts:

We believe these remediation efforts will contribute towards an effective internal control environment for financial reporting.

(d) Changes in Internal Control over Financial Reporting

Other than as described above, there were no changes in our internal control over financial reporting during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

None.

PART III

Board of Directors

Information relating to the officers andAt March 31, 2009, our board of directors consisted of the Company, other corporate governance mattersfollowing members:

Scott A. Katzmannhas served as a director since August 2001 and other information required under this Item 10 is set forthas Chairman of the Board since March 6, 2008. Since 1993, he has served as Managing Director at Paramount BioCapital, Inc., an investment banking firm. Prior to joining Paramount, from 1982 to 1993, Mr. Katzmann worked in our Proxy Statement for our 2008 Annual Meetingthe investment banking department of Stockholders (Proxy Statement)Credit Suisse First Boston where he specialized in the placement of a wide variety of private equity-oriented securities. From 1997 to 1999, Mr. Katzmann served as a director of Western Water Company. Mr. Katzmann received his B.A. in economics from Tulane University and is incorporated herein by reference.

Executive Officersan MBA in finance from the Wharton School at the University of Pennsylvania.

Michael M. Starkjoined the board as a director in May 2008, and has served as our President and Chief Executive Officer since February 2008 and as our President and Chief Operating Officer from October 2006 to February 2008. Mr. Stark served from 1997 to 2005 as President of Veolia Water North America, previously known as USFilter, a water services company. From 2005 to 2006, Mr. Stark has beenwas an independent consultant to companies in the water industry. From 1992 to 1997, Mr. Stark served as President and Chief Executive Officer of Mobley Environmental Services, a company specializing in non-hazardous hydrocarbon recycling. Prior to that time, Mr. Stark has held executive positions at a variety of companies, and has been in the water, environmental and specialty chemical industry since 1965. Mr. Stark holds a B.S. in Biology from Marietta College.

ThomasVictory J. Frylinghas served as a director since April 2003. Since December 2000, Mr. Fryling has served as a consultant and principal of Integrum Energy Ventures LLC, a management consulting firm. From 1990 to 2000, Mr. Fryling served as a director of CMS Energy Corporation, a provider of natural gas and electricity service. At CMS Energy Corporation, Mr. Fryling also served as its President from 1990 to 2000, as its Chief Financial Officer from 1988 to 1990 and as its Chief Operating Officer from 1990 to 2000. Mr. Fryling currently serves on the Board of Directors of Renewable Energy Systems Americas and Renewal Power and Light. Mr. Fryling received his B.A. in accounting and finance from Wayne State University.

Keith R. Solarhas served as a director since February 2000 and our Secretary from November 2002 until January 2006. Since June 2007, he has been the Managing Partner of the San Diego office of Buchanan Ingersoll & Rooney LLP. From February 2000 until June 2007, he was a partner at the law firm of Alhadeff & Solar, LLP. From 1991 to 2000, he was a partner at the law firm of Alhadeff Cannon Rose Solar & Parks, LLP. Mr. Solar received his A.B. in journalism from Indiana University and his J.D. from the University of the Pacific, McGeorge School of Law.

Roger S. Faubel joined Basin Water as a director in April 2007. In 1997, Mr. Faubel established Faubel Public Affairs and has served as its President and CEO for the last twelve years. Prior to that, he served as the Director of Public Affairs for Southern California Edison until his retirement in 1997. He was re-elected in 2002 to the Santa Margarita Water District Board of Directors and is a founding board member of the Urban Water Institute. Mr. Faubel received his B.A. in English literature from the California State University, Fullerton.

Stephen A. Sharpe joined Basin Water as a director in April 2007. Since 2002, Mr. Sharpe has been a consultant in the energy, infrastructure and real estate industries. Prior to that, Mr. Sharpe held executive positions with Peter Kiewit, a construction company, U.S. Generating, an energy company, and several banks including Shearson Lehman, Lloyds and Chemical. Mr. Sharpe received his B.A. in Economics from Rhodes College and an MBA in finance from Emory University.

5

Susan H. Snowjoined the board as a director in May 2008. From 2002 to 2007, she served as Chief Financial Officer, Chief Administrative Officer and on the Board of Directors of Maxim Systems, Inc. Prior to this, she held Chief Financial Officer positions at Network Insight, LLC and AP Labs, Inc. Earlier in her career, Ms. Snow served in CFO and executive positions at water systems companies including Desalination Systems, Inc. and Nimbus Water Systems, Inc. Ms. Snow serves as a Board Director and Board Advisor for a number of organizations including PRI, Inc., Red Horse, Inc., CONNECT and the Corporate Directors Forum. She is also a member of the University of San Diego Business School Advisory Board. Ms. Snow received her M.S. in Accounting from Northeastern University.

There is no family relationship between any director and any of our other directors or executive officers.

Nominating and Governance Committee

The members of the Nominating and Governance Committee are Messrs. Solar (Chair) and Faubel and Ms. Snow. Ms. Snow replaced Mr. Ball on the Nominating and Governance Committee in May 2008. The Board has determined that all members meet the criteria required under applicable SEC and NASDAQ listing standards for independence. The Nominating and Governance Committee’s written charter can be found in the Investor Relations section of our website atwww.basinwater.com. On behalf of the Board, the Nominating and Governance Committee assists the Board by identifying individuals qualified to become directors consistent with criteria established by the Board. Among other matters, the committee’s responsibilities include the following:

Selection of Board Nominees

Prior to our initial public offering, as a privately held company, we informally identified potential candidates for nomination as directors. Generally, Board members have been our officers or persons who have had significant industry or other relevant experience, and have been known to one or more of our Board members or officers. Following the establishment of our Nominating and Governance Committee, the Nominating and Governance Committee has reviewed the qualifications of potential director candidates in accordance with its charter and our Corporate Governance Guidelines.

The Nominating and Governance Committee’s consideration of a candidate as a director includes assessment of the individual’s understanding of our business, the individual’s professional and educational background, skills, and abilities and potential time commitment and whether such characteristics are consistent with our Corporate Governance Guidelines and other criteria established by the Nominating and Governance Committee from time to time. To provide such a contribution to the Company, a director must generally possess one or more of the following, in addition to personal and professional integrity:

The Nominating and Governance Committee may also adopt such procedures and criteria not inconsistent with our Corporate Governance Guidelines as it considers advisable for the assessment of director candidates. The Nominating and Governance Committee retains the services of an executive search or other firm to conduct background checks on each director nominee. Other than the foregoing, there are no stated minimum criteria for director nominees. The Nominating and Governance Committee does however recognize that at least one member of the Board should meet the criteria for an “audit committee financial expert” as defined by SEC rules, and that at least a majority of the members of the Board must meet the definition of “independent director” under the Nasdaq Marketplace rules.

6

Stockholder Nominations

Pursuant to our Bylaws, only persons who are nominated in accordance with the following procedures are eligible for election as directors. Nominations of persons for election to the Board may be made at a meeting of stockholders only (1) by or at the direction of the Board or (2) by a stockholder who is a stockholder of record at the time of the giving of the required notice described below, who is entitled to vote for the election of directors at the meeting, and who complies with the following notice procedures. All nominations, other than those made by or at the direction of the Board, must be made pursuant to timely notice in writing to our Secretary.

Our Bylaws provide that to be timely, a stockholder’s notice must be delivered to our Secretary at our principal executive offices not less than 90 days nor more than 120 days prior to the first anniversary of the preceding year’s annual meeting. However, if the date of the 2010 Annual Meeting of Stockholders is advanced by more than 30 days prior to or more than 60 days after the anniversary of this year’s annual meeting, notice of nominations by a stockholder for the 2010 Annual Meeting of Stockholders to be timely must be delivered not earlier than the close of business on the 120^th calendar day prior to such annual meeting nor later than the close of business on the later of the 90^th calendar day prior to such annual meeting or the 10^th calendar day following the earlier of (1) the day on which notice of the meeting was mailed or (2) on which public announcement of the date of such meeting is first made by us.

A stockholder’s notice to our Secretary with respect to persons that the stockholder proposes to directly nominate as a director must set forth (a) as to each individual whom the stockholder proposes to nominate, all information relating to the person that is required to be disclosed in solicitations of proxies for the election of directors or is otherwise required, pursuant to Regulation 14A (or any successor provisions) under the Exchange Act (including their name, age, business address, residence address, principal occupation or employment, the number of shares beneficially owned by such candidate, and the written consent of such person to be named in the proxy statement as a nominee and to serve as a director if elected) and (b) as to the stockholder proposing to make such nomination, the same information as is described above with respect to proposals to be made by a stockholder.

The Nominating and Governance Committee will consider all stockholder recommendations for candidates for the Board, which should be sent to the Nominating and Governance Committee, c/o Secretary, Basin Water, Inc., 9302 Pittsburgh Avenue, Suite 210, Rancho Cucamonga, California 91730.

The Nominating and Governance Committee will evaluate recommendations for director nominees submitted by directors, management or qualifying stockholders in the same manner, using the criteria stated above. All directors and director nominees will be required to submit a completed directors’ and officers’ questionnaire as part of the nominating process. The process may also include interviews and additional background and reference checks for non-incumbent nominees, at the discretion of the Nominating and Governance Committee.

Corporate Governance Guidelines

Our Company has adopted Corporate Governance Guidelines that we believe reflect our Board’s commitment to a system of governance that enhances corporate responsibility and accountability. The Nominating and Governance Committee is responsible for implementing the guidelines and making recommendations to the Board concerning corporate governance matters. The guidelines are available on the Investor Relations section of our website atwww.basinwater.com. We will also furnish copies of the guidelines to any person who requests them. Requests for copies should be directed to the Basin Water, Inc., 9302 Pittsburgh Avenue, Suite 210, Rancho Cucamonga, California 91730, Attention: Secretary.

Among other matters, the guidelines include the following:

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Audit Committee

The members of the Audit Committee are Messrs. Fryling (Chair), Sharpe and Ms. Snow. On May 6, 2008, Ms. Snow replaced Russell C. TekulveBall, who resigned as a director in May 2008. The Board has determined that members of the Audit Committee satisfy the criteria required under applicable SEC and Nasdaq listing standards for financial literacy and the SEC and Nasdaq standards for independence. The Audit Committee’s written charter can be found in the Investor Relations section of our website atwww.basinwater.com.

The Audit Committee oversees our accounting and financial reporting processes, internal control systems, independent auditor relationships and the audits of our financial statements. Among other matters, the Audit Committee’s responsibilities include the following:

Audit Committee Financial Expert. The Board has determined that Mr. Fryling is the “audit committee financial expert” as defined under SEC rules and regulations implementing Section 407 of The Sarbanes-Oxley Act of 2002. The Board has also determined that Mr. Sharpe and Ms. Snow qualify as audit committee financial experts.

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Audit Committee Report

The following report of our audit committee does not constitute soliciting material and shall not be deemed filed or incorporated by reference into any other Company filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate this report by reference.

The Audit Committee is comprised of three non-employee directors – Victor J. Fryling, Stephen A. Sharpe and Susan H. Snow – and operates under a written charter, adopted by the Board, which is posted on the Investor Relations section of the Company’s website atwww.basinwater.com. We believe the charter is in compliance with SEC regulations and the NASDAQ listing standards.

The primary purposes of the Audit Committee are to assist the Board in fulfilling its responsibility to oversee (i) the integrity of the financial statements of Basin Water, (ii) the independent registered public accounting firm’s qualifications, independence and performance and (iii) the audit of Basin Water’s financial statements. The Audit Committee is directly responsible for the appointment, compensation, and oversight of the work of the independent registered public accounting firm. The independent registered public accounting firm reports directly to the Audit Committee.

Management has the primary responsibility for the preparation of the financial statements and the reporting process. The Company’s management has represented to the Audit Committee that the consolidated financial statements for the fiscal year ended December 31, 2008 were prepared in accordance with generally accepted accounting principles. The Company’s independent registered public accounting firm is responsible for auditing these consolidated financial statements. In the performance of its oversight function, the Audit Committee reviewed and discussed the audited consolidated financial statements with management and the independent registered public accounting firm. The Audit Committee discussed with management the critical accounting policies applied by the Company in the preparation of its consolidated financial statements. The Audit Committee also discussed with the Company’s management the process for certifications by the Chief Executive Officer and Chief Financial Officer. The Audit Committee discussed with the independent registered public accounting firm the matters required to be discussed by Statement on Auditing Standards No. 61 (Communication with Audit Committees), as amended by Statement on Auditing Standards No. 90 (Audit Committee Communications).

In addition, the Audit Committee received from the independent registered public accounting firm the written disclosures required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees) and discussed with them their independence from the Company and its management. The Audit Committee also evaluated whether the independent registered public accounting firm’s provision of non-audit services to the Company was compatible with the auditor’s independence and determined it was compatible.

In May 2008, Ms. Snow was appointed to the Audit Committee to replace Russell C. Ball, who resigned as a director. The Board determined that Messrs. Fryling, Sharpe and Snow meet the independence requirements of Rule 10A-3 of the Exchange Act and applicable NASDAQ independence rules.

In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors, and the Board approved, that the audited consolidated financial statements be included in Basin Water, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2008, and any amendments thereto, for filing with the SEC.

Victor J. Fryling (Chair)

Stephen A. Sharpe

Susan H. Snow

April 30, 2009

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Executive Officers

At March 31, 2009, our executive officers consisted of the following:

See “Board of Directors” for the biography of Mr. Stark.

W. Christopher Chisholm has served as our Vice President and Chief Financial Officer Treasurersince June 2008. From 2003 to 2008, Mr. Chisholm served as Executive Vice President, Finance & Administration and Chief AdministrativeFinancial Officer since October 2004.of Veolia Water North America. Subsequent to the 1999 acquisition of USFilter by Veolia Environment, Mr. Tekulve alsoChisholm served as our Secretary from February 2006Executive Vice President, Finance of US Filter until August 2007. From January 19992003. In 1997, Mr. Chisholm joined US Filter (prior to September 2004, Mr. Tekulveit becoming part of Veolia Water) as its Vice President and Group Controller for North American operations and later served as Vice President of Finance and Treasurer of Southwest Water Company, a company engaged in the business of water production and distribution, wastewater collection and treatment, public works services and utility submetering. From 1995 to 1998, he served as Chief Financial Officer of SafeGuard Health Enterprises, a providerUSFilter’s Water & Wastewater Group until 1999. From 1991 to 1997, Mr. Chisholm served as Vice President and Chief Financial Officer of dentalMobley Environmental Services, which was acquired in 1997 by USFilter. Prior to his career in the environmental services and vision care benefit programs. From 1984 to 1994,water industries, Mr. Tekulve servedChisholm spent 11 years in the audit practice of KPMG, an international public accounting firm, serving clients in a wide variety of executive positions at Beckman Coulter, Inc., including as Directorindustries. Mr. Chisholm is an accounting graduate of International Finance. Mr. Tekulve is a certified public accountant and holds an MBA from Portland State University and a B.S. in accounting from California State University, Northridge.

Scott B. Hamilton has served as the Company’s General Counsel since July 2007 and as the Company’s Secretary since August 2007. From 2005 to 2007, Mr. Hamilton served as Associate General Counsel of Veolia Water North America Operating Services, LLC, previously known as USFilter Operating Services, Inc., a water services company, and from 1999 to 2004, served as Senior Counsel of the same company. From 1998 to 1999, Mr. Hamilton served as the Vice President, General Counsel and Assistant Secretary of US Filter Operating Services, Inc., and Regional Counsel of United States Filter Corporation, before its acquisition by Veolia Water North America. From 1992 to 1998, Mr. Hamilton served in the enforcement division of the Securities and Exchange Commission, and prior to that was involved in the private practice of law for several years. Mr. Hamilton holds a B.A. in Comparative Area Studies and History from Duke University and a J.D. from the University of Illinois College of Law.Louisiana at Monroe and obtained his certification as a Certified Public Accountant in 1981.

Richard A. Reese joined Basin Water in September of 2007 as the Marketingour Vice President of Marketing, and was named an Executive Officer in January of 2008. From 1997 to 2008, Mr. Reese served in management roles within Siemens Water Technologies, Inc., previously known as United States Filter Corporation (USFilter).USFilter. These roles includeincluded Vice President, General Manager of Aftermarket within the Services & Products segment (2003 – 2007), Senior Vice President, Marketing within the Services Group of USFilter/Veolia Water (2002 – 2003), Vice President, Customer Service & Satisfaction (2000 – 2002) for USFilter, and Vice President, General Manager of the Recovery Services Southwest business unit of USFilter (1997 – 2000). Prior to joining USFilter, Mr. Reese served in Regional Vice President and Business Development roles with Mobley Environmental Services, Inc., as an Operations manager for Browning Ferris Waste Management Systems Inc., and as an engineer for R.J. Brown and Associates of America and J.P. Kenny Offshore Engineering. Mr. Reese holds a B.S. in Ocean Engineering from Texas A&M University and an MBA from the University of Texas.

Scott B. Hamilton has served as our General Counsel since July 2007 and as our Secretary since August 2007. From 2005 to 2007, Mr. Hamilton served as Associate General Counsel of Veolia Water North America Operating Services, LLC, previously known as USFilter Operating Services, Inc., a water services company, and from 1999 to 2004, served as Senior Counsel of the same company. From 1998 to 1999, Mr. Hamilton served as the Vice President, General Counsel and Assistant Secretary of USFilter Operating Services, Inc., and Regional Counsel of USFilter, before its acquisition by Veolia Water North America. From 1992 to 1998, Mr. Hamilton served in the enforcement division of the Securities and Exchange Commission, and prior to that was involved in the private practice of law for several years. Mr. Hamilton holds a B.A. in Comparative Area Studies and History from Duke University and a J.D. from the University of Illinois College of Law.

There is no family relationship between any executive officer and any of our other executive officers or directors.

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Code ofBusiness Conduct and Ethics

We have adopted the Basin Water, Inc. Code of Business Conduct and Ethics (Code of Ethics). The Code of Ethics applies that complies with the SEC and NASDAQ listing standards and is applicable to all of our directors, officers and employees, including our chief executive officer and chief financial officer (who is also our principal accounting officer),. On November 8, 2007, the Board adopted a revised Code of Business Conduct and Ethics. The revised Code of Business Conduct and Ethics is available to the public in the Investor Relations section of our website atwww.basinwater.com.www.basinwater.com. We intend to post amendments to or waivers, if any, from our Code of Business Conduct and Ethics (to the extent applicable to our directors or our chief executive officer, principal financial officer, or principal accounting officer) at this location on our website.

Among other matters, this Code of Business Conduct and Ethics is designed to promote:

16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers and directors, and persons who own more than ten percent (10%) of a registered class of our equity securities, to file reports of securities ownership and changes in such ownership with the SEC. Officers, directors and greater than ten percent stockholders also are required by rules promulgated by the SEC to furnish us with copies of all Section 16(a) forms they file.

Based solely on our review of these forms and written representations from the executive officers and directors, we believe that all Section 16(a) filing requirements were met during fiscal year 2008, other than (a) the late filing of the Forms 4 on May 12, 2008 on behalf of Messrs. Faubel, Fryling, Katzmann, Sharpe and Solar and the Form 4 filed on May 13, 2008 on behalf of Ms. Snow, with respect to the annual grant of stock options and restricted stock made to our directors, and (b) the late filing of the Form 4 filed on June 23, 2008 on behalf of Mr. Chisholm, with respect to the grant of stock options and restricted stock in connection with the commencement of his employment.

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Information relatingCompensation Discussion and Analysis

Overview

This Compensation Discussion and Analysis describes the material elements of compensation awarded to, earned by, or paid to our Chief Executive Officer, Chief Financial Officer, and the two other executive officers of the Company (collectively the Named Executive Officers) during the last completed fiscal year. This Compensation Discussion and Analysis focuses on the information contained in the following tables and related footnotes and narrative for primarily the last completed fiscal year. However, we also describe compensation actions taken before and after the last completed fiscal year to the extent it enhances the understanding of our executive compensation disclosure. The Compensation Committee of the Board of Directors (the Committee) oversees the design and administration of our executive compensation program in accordance with the processes and procedures discussed in the section entitled “Compensation Committee” presented elsewhere in this Annual Report on Form 10-K/A.

Compensation Philosophy

We believe executive compensation programs impact all employees by setting general levels of compensation and helping to create an environment of goals, rewards and expectations. We also believe that the compensation cost for our employees is an investment in human capital to secure certain knowledge and performance capabilities necessary for our business. To this end, our compensation programs for all employees, including our Named Executive Officers, are designed to: (1) provide a competitive total compensation package, sufficient to attract, motivate and retain high caliber, proven performers, (2) support and recognize attainment of tactical and strategic goals of our organization, (3) align employee compensation with the interests of stockholders, and (4) provide retention incentives, securing the services of key contributors to our business over an extended period of time.

The Committee will take into account several factors in determining compensation, including: (1) current market value of a particular position, based on the skills, knowledge, experience and competencies required for the position (including taking into consideration the broader labor market depending on the nature of the position), (2) internal comparability of a position as compared to other similar positions within the organization, (3) our ability to pay, based on current economic and business factors, (4) individual performance within the position, and (5) contribution to the financial performance of the employee’s division, or our entire Company, as applicable.

Compensation Methodology

During 2008, the Committee retained Strategic Compensation Planning, Inc. (SCP), a Philadelphia-based consulting firm that provides total compensation plan design and program management support, to make recommendations regarding our compensation philosophy and policies. The Committee conducted discussions with SCP specifically related to (1) annual cash incentive plan design and (2) intermediate and long-term incentive awards. SCP provides no other services to, and receives no other compensation from, the Company or its executives.

Role of Chief Executive Officer in Compensation Decisions.During 2008, Mr. Stark, in his role as President and Chief Executive Officer, offered his opinions and assessment of the performance for the other Named Executive Officers to the Committee regarding compensation changes affecting the other Named Executive Officers, including with respect to (1) changes in base salaries, (2) option grants and (3) bonus awards. The Committee took into account Mr. Stark’s opinions and recommendations, but the Committee makes its own independent assessment of any compensation decision affecting officers of the Company (with the input of its compensation consultant). Mr. Stark did not play any role with respect to any matter impacting his own compensation. The Committee met in executive session when considering Mr. Stark’s compensation.

Components of Named Executive Officers Compensation

The executive compensation program for our Named Executive Officers is intended to be composed of four basic components tied to performance standards (both objective and subjective) and market practice: (1) base salary, (2) annual cash incentive opportunity, (3) intermediate-term incentive awards in the form of restricted stock and (4) long-term incentive awards in the form of stock options.

Base Salary

Base salary compensation for our Named Executive Officers is generally established by the terms of employment agreements between us and the Named Executive Officer. The level of base salary is intended to provide appropriate base pay to each of our Named Executive Officers taking into account their responsibilities, level of experience, individual performance and internal equity considerations. In addition, the Committee takes into account both Company and individual performance in setting compensation. We have recognized that to attract talented employees from secure positions at other more stable growth companies, we must be able to pay competitive base salaries, while also supplementing the salaries with equity compensation. Each of the employment agreements

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for our Named Executive Officers provides for annual salary reviews by the Committee. The Committee believes in relatively median level salaries and significant equity appreciation opportunities. The amount of a Named Executive Officer’s base salary is the reference point for much of the other compensation received by the executive. For example, the potential annual incentive award for each executive is a percentage of the executive’s base salary.

When hiring Mr. Chisholm, the Committee determined an appropriate salary for the chief financial officer position based on the factors detailed above, its review of his qualifications and experience, the scope of the responsibilities of that position and the input and recommendation of SCP.

There were no changes to the base compensation of our Named Executive Officers during 2008.

Annual Cash Incentive Opportunity

All of the employment agreements for our Named Executive Officers provide that each officer is eligible to receive an annual cash bonus equal to between 15% and 75% of his base salary depending on whether we meet certain annual targeted revenue and net income targets set by the Committee. In April 2008, the Committee approved the 2008 Annual Incentive Plan, under which the Named Executive Officers were eligible to receive a cash bonus equal to 50% of their respective base salaries depending on the achievement in fiscal year 2008 of (a) corporate performance goals measured by certain financial metrics, including revenues, gross margins, cash flow, operating income and earnings per share, (b) business unit or functional performance goals and (c) personal performance goals, in each case, as determined by the Committee. Participants are not entitled to any bonus payment if corporate performance is below 80% of the target; provided that, the Committee may in its discretion award bonuses at corporate performance below 80% of the target. Participants are eligible for a maximum of 120% of the target bonus for performance above the target. Corporate performance relative to the objectives approved by the Committee was below 80% of the target levels and, accordingly, no cash bonuses were paid under the 2008 Annual Incentive Plan.

In addition, all of the employment agreements for our Named Executive Officers provide that each officer may receive a discretionary bonus of up to 25% of his salary based on factors not related to the achievement of performance targets. In December 2008, the Committee reviewed our financial performance along with our other achievements in 2008, including the development of our infrastructure and business processes, our integration of Mobile Process Technology Company, our acquisition of Envirogen from Shaw Environmental and Infrastructure, Inc. and two of its affiliates (Shaw), our alliance with Rohm and Haas Company, and our effort in the restatement of financial statements for 2007 and 2006. The Committee also discussed management’s recommendation for 2008 cash incentive, stock and option awards for each Named Executive Officer and assessed each Named Executive Officer’s accomplishments and contributions to our Company in 2008, each Named Executive Officer’s total compensation (base, bonus and option awards) under various possible award scenarios, and the recommendations of SCP. Based on these various factors, in February 2009, the Committee awarded discretionary bonuses to the following Named Executive Officers, in the amounts indicated: Mr. Chisholm—$30,000, Mr. Reese—$25,000, and Mr. Hamilton—$30,000. Mr. Stark did not receive a discretionary bonus as the Committee believes his incentive compensation should be tied solely to corporate financial performance.

In October 2008, the Committee also awarded a one-time cash bonus of $20,000 to Mr. Hamilton in recognition of the significant efforts he made during 2008 in connection with our litigation and other legal matters.

Intermediate-Term Incentive Awards. An important component of our executive compensation has been the use of intermediate-term incentive awards in the form of restricted stock. The 2006 Plan authorizes us to grant restricted stock to employees, directors and consultants. In October 2006, Mr. Stark was granted a restricted stock award of 200,000 shares of our common stock, as to which one-third of the shares vested on the first anniversary date and one-third of the shares will vest on each of the second and third anniversaries of the grant date. In July 2007, Mr. Hamilton was granted a restricted stock award of 25,000 shares of our common stock, as to which one-third of the shares vested on the first anniversary date and one-third of the shares will vest on each of the second and third anniversaries of the grant date. In September 2007, Mr. Reese was granted a restricted stock award of 10,000 shares of our common stock, as to which one-third of the shares vested on the first anniversary date and one-third of the shares will vest on each of the second and third anniversaries of the grant date.

In June 2008, Mr. Chisholm was granted a restricted stock award of 150,000 shares of our common stock in connection with his commencement of employment, as to which 25,000 shares vested on December 31, 2008, while 50,000 shares will vest on December 31, 2009 and 75,000 shares will vest on December 31, 2010. The size of the award to Mr. Chisholm was determined based on the Committee’s review of his qualifications and experience and the scope of the responsibilities of his position.

There were no other awards of restricted stock to Named Executive Officers during 2008.

The Committee considers the use of restricted stock as particularly important for the hiring of our key executives as these grants (1) provide an incentive for our executives to remain in our employ without the need for a short-term significant increase in our stock price and (2) retain value despite short-term decreases in our stock price, unlike stock options which lose significant value if our stock price falls below the exercise price. For our Named Executive Officers, the restricted stock grants made to them at the time of hire were a part of their initial compensation package, similar to a “sign-on bonus,” for accepting the risk of joining a development stage company and for assisting in our Company’s growth at an early stage.

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The Committee determines the restricted stock awards to the Named Executive Officers, and takes into account the recommendations of the Chief Executive Officer in making such awards to the other Named Executive Officers and to other employees. In determining the number of shares and vesting schedule of restricted stock awards granted to Named Executive Officers and to other employees, the Committee generally takes into account the individual’s position, scope of responsibilities, value of the award in relation to the other elements of the individual’s total compensation and, where applicable, the need to attract the individual from their current position.

Long-Term Incentive Awards. Stock options have been the primary vehicle for payment of long-term compensation to our Named Executive Officers and non-Named Executive Officer management employees. Our 2006 Plan authorizes us to grant stock options to employees, directors and consultants. The Committee believes that stock options are a necessary part of compensation packages granted to employees because: (1) they help attract and retain employees, (2) the value received by the recipient of a stock option is based on the growth of our stock price – thereby creating and enhancing incentives to increase our stock price and maximize stockholder value, and (3) they create a balance with shorter term incentives such as base salary and bonuses and intermediate-term incentives such as restricted stock. The Committee determines the stock option awards to the Named Executive Officers, and takes into account the recommendations of the Chief Executive Officer in making decisions on the other Named Executive Officers.

In determining the number and vesting schedule of stock options granted to Named Executive Officers and other employees, the Committee generally takes into account the individual’s position, scope of responsibility, value of stock options in relation to the other elements of the individual’s total compensation and, where applicable, the need to attract the individual from their current position. The Committee assesses the appropriate vesting schedule for these stock options, based not only on time but also on achievement of significant Company milestones.

On December 28, 2007, the Committee approved option grants for each Named Executive Officer based on an evaluation of each executive officer’s performance during 2007 and the achievement of certain corporate objectives, including the consummation of several significant transactions during 2007. The option grants were also made to the Named Executive Officers to provide incentives for performance in the coming fiscal year. Each option has an exercise price per share of $7.31, the closing price of the Company’s common stock on the Nasdaq Global Market on January 4, 2008, the date of grant, has a term of ten years, and will vest in three substantially equal annual tranches the first of which vested on December 28, 2008, and the next two tranches vesting on December 31, 2009 and 2010. The Named Executive Officers were granted stock options to purchase the following number of shares: Mr. Jensen – 55,000 shares; Mr. Stark – 50,000 shares; Mr. Tekulve – 35,088 shares; Mr. Reese – 17,000 shares; and Mr. Hamilton – 23,000 shares.

The 2008 Incentive Plan described above also provided for the grant of stock options by the Committee to the Named Executive Officers. The number of shares under such grants that each Named Executive Officer was eligible to receive was equal to 70% of his base salary divided by the closing price of our common stock on the Nasdaq Global Market as of the grant date. These stock options have a term of ten years, and one-third of the shares subject to the options will vest on each of the first, second and third anniversaries of the grant date. On May 5, 2008, the Committee approved the grant of stock options to our Named Executive Officers and certain other employees under the 2006 Plan, with a grant date of May 15, 2008 and an exercise price of $5.00 per share, which was equal to the closing price of our stock on the Nasdaq Global Market on such grant date. The Named Executive Officers were granted stock options to purchase the following number of shares: Mr. Stark – 57,018 shares; Mr. Tekulve – 35,088 shares; Mr. Reese – 35,088 shares; and Mr. Hamilton – 30,702 shares. Each of these options vests one-third on each of the first, second, and third anniversaries of the grant date. In connection with his resignation from our Company in October 2008, all of Mr. Tekulve’s stock options vested on October 13, 2008 and expire on July 1, 2011 – see “Former Chief Financial Officer Resignation” below.

On May 29, 2008, the Committee approved the grant of a stock option to purchase 43,240 shares to Mr. Chisholm, effective upon the date of his employment with us, which was June 17, 2008, with an exercise price of $4.29 per share, which was equal to the closing price of our stock on the Nasdaq Global Market on such grant date. The number of shares subject to this stock option grant to Mr. Chisholm was based on 70% of his base salary divided by the closing price of our common stock on the Nasdaq Global Market on the grant date.

No other stock options were awarded to executive officers in 2008 or with respect to services performed during 2008.

All stock option grants are required to be approved by the Committee. We have not timed the award of stock options or other equity-based compensation to coincide with the release of favorable or unfavorable information about our Company. We have no intention of timing the award of stock options or other equity-based compensation to coincide with the release of favorable or unfavorable information about our Company in the future.

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Severance Arrangements and Change in Control Payments

We have entered into employment agreements with Messrs. Stark, Chisholm, Reese and Hamilton. The terms of the employment agreements with each of our Named Executive Officers provide each of them with certain severance benefits in the event his employment is terminated by us other than for cause or if he resigns with good reason.

The employment agreements for our Named Executive Officers provide severance and change in control protection under market-competitive terms. The specific provisions are summarized in the narrative accompanying the tables under “Potential Payments Upon Termination or Change in Control.”

Our outlook with respect to these severance and change-in-control provisions is that they are appropriate because they make it easier for the executives to focus on the best interests of Basin Water and our stockholders rather than the implications for them personally in the event we face the possibility of a change in control. These provisions were designed to:

Severance payments are only made under the employment agreements if the Named Executive Officer complies with the confidentiality, non-compete and non-solicitation provisions of the agreements. We believe that these severance and change in control payment provisions in our Named Executive Officers’ employment agreements are necessary in order for us to provide competitive compensation within our industry and to encourage our Named Executive Officers to remain in our employ.

Compensation Differences Among the Named Executive Officers

Differences in compensation among the Named Executive Officers are based on experience in the industry, longevity with our Company and relative level of responsibility. Our President and CEO earns more in base salary than our Chief Financial Officer. Our Chief Financial Officer earns more in base salary than our Vice President of Marketing, and our Vice President of Marketing earns more than our General Counsel. Although each Named Executive Officer’s contributions to our Company are important, the Committee believes that the responsibilities and contributions of the President and Chief Executive Officer and the Chief Financial Officer are the most significant. As stated above, base salary is the one of the bases for annual incentive awards of cash bonus and equity awards.

Perquisites, Personal Benefits and Other Compensation

In 2008, Mr. Jensen received reimbursement for Company vehicle use, office lease payments, accrued vacation, severance and consulting payments and other expenses in the amount of $628,401. In 2008, Mr. Tekulve received severance payments, accrued vacation and other expenses in the amount of $143,385 in connection with his resignation from Basin Water.

Under their employment agreements, each of Messrs. Stark and Chisholm is entitled to (1) long-term disability insurance in an amount equal to 75% of his base salary, up to a maximum of $30,000 per month, (2) life insurance in a face amount equal to three times his annual base salary, and (3) reimbursement of out-of-pocket expenses up to a maximum of $3,000 for a biennial physical examination.

Under his employment agreement, Mr. Chisholm is also entitled to reimbursement of certain out-of pocket expenses related to the maintenance of his Certified Public Accountant license, continuing education required to maintain that license and his membership in up to two professional organizations of which he is a member.

Under their employment agreements, each of Messrs. Reese and Hamilton is entitled to long-term disability insurance in an amount equal to 70% of his base salary, up to a maximum of $12,500 per month. Under his employment agreement, Mr. Hamilton is also entitled to reimbursement of certain out-of-pocket expenses related to bar and/or registration dues and fees, continuing legal education and membership in certain legal associations.

All of our Named Executive Officers also receive supplemental life insurance coverage of $250,000, as well as supplemental long-term disability insurance coverage.

Our Named Executive Officers are eligible to participate in all of our employee benefit plans, including medical, dental, vision, long- and short-term disability and life insurance coverage of $50,000, in each case on the same basis as our other employees.

We have no outstanding loans of any kind to any of our Named Executive Officers, and federal law prohibits us from making any new loans to our Named Executive Officers. We have no pension plans or other defined benefit retirement plans. We have no non-qualified deferred compensation plans or supplemental executive retirement plans.

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We reimburse travel expenses between home and our corporate headquarters, including expenses for hotel rooms and meals, to Messrs. Stark, Chisholm and Reese, all of whom reside in Houston, Texas, and to Mr. Hamilton, who resides in Chicago, Illinois.

Former Chief Executive Officer Employment Transition

On February 19, 2008, we announced the resignation of Mr. Jensen as our Chief Executive Officer and Chairman of the Board. At that time, Mr. Jensen remained on our Board of Directors. In connection with his resignation, we entered into an Employment Transition and Consulting Agreement dated February 19, 2008 (the Separation Date) with Mr. Jensen (the Transition Agreement).

On March 11, 2008, Mr. Jensen resigned from our Board of Directors.

The Transition Agreement provided Mr. Jensen with the following benefits: (1) he received a cash lump sum payment of $422,797, (2) we agreed to pay for his healthcare insurance for 18 months following the Separation Date (or until he accepts employment with another employer providing comparable benefits), (3) he was retained as our consultant for two years after the Separation Date, for which he will receive $200,000 per year (payable each year in 12 equal monthly installments), (4) he received compensation for his services as a director in accordance with our Amended and Restated Director Compensation Policy for non-employee directors (for the applicable period until his resignation from our Board of Directors) and (5) he retained all Basin Water personal property, including computer equipment, printers, cameras and a used Company truck, that was in his possession as of the Separation Date. Mr. Jensen will not be entitled to any further benefits under his employment agreement in effect prior to the Separation Date except as provided in the Transition Agreement. The Transition Agreement contained other customary terms and conditions, including mutual releases and indemnification obligations (including with respect to Mr. Jensen’s wife).

Mr. Jensen’s consulting services pursuant to the Termination Agreement were terminated in November 2008.

Former Chief Financial Officer Resignation

On June 23, 2008, we announced the resignation of Mr. Tekulve as our Chief Financial Officer. At that time, he was appointed as Vice President of Finance – Business Development. On October 8, 2008 (the Separation Date), Mr. Tekulve resigned as an employee. In connection with his resignation, we entered into a Confidential Resignation Agreement dated October 13, 2008 with Mr. Tekulve (the Separation Agreement) which provided him with the following benefits: (1) he received a cash lump sum payment of $115,000, (2) we paid for his healthcare insurance for six months following the Separation Date and (3) all restricted stock awards and stock option grants previously granted to him became 100% vested on October 13, 2008. All of Mr. Tekulve’s outstanding stock options will remain exercisable until July 1, 2011.

Tax and Accounting Information

Section 162(m) of the Code and the Omnibus Budget Reconciliation Act of 1993 and regulations adopted thereunder, place limits on deductibility of compensation in excess of $1.0 million paid in any one year to the our chief executive officer and our three other most highly compensated executive officers (other than our chief financial officer), employed at year end, unless this compensation qualifies as “performance based.” The non-performance based compensation paid in cash to each of our Named Executive Officers did not exceed the $1.0 million limit per officer in 2008, and the Committee does not anticipate that the non-performance based compensation to be paid in cash to our Named Executive Officers will exceed that limit in 2009. Although it will consider the tax implications of its compensation decisions, the Committee believes its primary focus should be to attract, retain, and motivate high caliber executives and to align the executives’ interests with those of our stockholders.

For 2006 and continuing thereafter, the Committee has considered and will continue to consider the impact of the requirement under Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 123(R),Share-Based Payment(SFAS 123(R)), that we record in our financial statements the expense incurred when stock options are granted to employees. In addition, the Committee will examine the tax impact on employees and the potential tax deductions to Basin Water with respect to the exercise of stock option grants. We do not pay or reimburse any Named Executive Officer for any taxes due upon exercise of a stock option.

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Compensation Committee

The members of the Compensation Committee of the Board (the Committee) are Messrs. Solar (Chair), Faubel and Fryling. The Committee is comprised of a majority of independent, outside directors within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended (the Code) and independent non-employee directors within the meaning of Rule 16b-3 under the Exchange Act. All members of the Committee meet the independence requirements of Nasdaq listing standards. The Committee’s written charter can be found in the Investor Relations section of our website atwww.basinwater.com. The Committee has responsibility for the review, evaluation and approval of executive compensation, including the compensation philosophy, policies and plans for our executive officers.

On behalf of our Board, the Committee monitors and assists our Board in determining compensation for our senior management, directors and employees. Among other matters, the Committee’s responsibilities include the following: