BION ENVIRONMENTAL TECHNOLOGIES INC - Quarter Report: 2011 March (Form 10-Q)

See notes to unaudited consolidated financial statements.

F-4

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED MARCH 31, 2011

1.

ORGANIZATION, NATURE OF BUSINESS, GOING CONCERN AND MANAGEMENT’S PLANS:

Organization and nature of business:

Bion Environmental Technologies, Inc. (“Bion” or “We” or the "Company") was incorporated in 1987 in the State of Colorado.

Bion’s patented and proprietary technology provides a comprehensive environmental solution to a significant source of pollution in US agriculture, Confined Animal Feeding Operations ("CAFO's"). Bion's technology produces substantial reductions of both nutrient releases to water and air emissions including ammonia (which is subsequently re-deposited to the ground) from livestock waste streams based upon our research to date. Because Bion's technology reduces the harmful releases and emissions from a CAFO on which it is utilized, the CAFO can potentially increase its herd concentration while lowering or maintaining its level of nutrient releases and atmospheric emissions.

From 2003 through early 2008, the Company primarily focused on completing re-development of its technology platform and business model. As such, during that period we elected not to pursue near- term revenue opportunities such as retrofitting existing CAFO's with our waste management solutions, because such efforts would have diverted scarce management and financial resources and negatively impacted our ability to complete: 1) re-development of our technology for environmentally sound treatment of CAFO waste streams and 2) development of our integrated technology platform in support of large-scale sustainable Integrated Projects (defined below) including renewable energy production.

Bion is now actively pursuing business opportunities in two broad areas 1) retrofit and environmental remediation of existing CAFO’s to reduce nutrient (nitrogen and phosphorus) releases and gaseous emissions (ammonia, greenhouse gases, volatile organic compounds, etc.) in order to clean the air and water in the surrounding areas (as described below)  and 2) development of "closed loop" Integrated Projects.

We believe that Bion's technology platform allows the integration of large-scale CAFO's and their end-product users, renewable energy production from the CAFO waste stream, on site utilization of the renewable energy generated and biofuel/ethanol production in an environmentally and economically sustainable manner while reducing the aggregate capital expense and operating costs for the entire integrated complex ("Integrated Projects" or "Projects"). In the context of Integrated Projects, Bion's waste treatment process, in addition to mitigating polluting releases, generates renewable energy from cellulosic portions of the CAFO waste stream which renewable energy can be utilized by integrated facilities including ethanol plants, CAFO end-product processors (including cheese, ice cream and/or bottling plants in the case of dairy CAFO’s and/or slaughter and/or processing facilities in the context of beef CAFO’s) and/or other users as a natural gas replacement. Bion is presently involved in the very early development stage regarding a beef-based Integrated Projects in New York and Pennsylvania and is involved in pre-development evaluations regarding opportunities for Integrated Projects in Nebraska and elsewhere in the Midwest and the North Central United States (dairy and/or beef).

F-5

On September 27, 2008, the Company executed an agreement with Kreider Farms (and its affiliated entities) (collectively "Kreider") to design, construct and operate (through its wholly-owned subsidiaries, Bion Services Group, Inc. (“Bion Services”) and Bion PA-1 LLC (“LLC”) a Bion system to treat the waste of 1,200 milking dairy cows (milkers, dry cows and heifers) at the Kreider Dairy, located in Mannheim, Pennsylvania. In addition, the agreement provides for a second phase which will treat the wastes from the rest of Kreider’s herd and includes  renewable energy production from the cellulosic solid wastes from the Phase 1 system together with the waste stream from Kreider’s poultry facilities for use at the facilities and/or for market sales. The Kreider projects will be owned and operated by Bion through subsidiaries, in which Kreider will have the option to purchase a noncontrolling interest. To complete these projects substantial capital (equity and/or debt) has been and will continue to be expended.  Additional funds will be expended for construction. Upon successful construction and operation of these systems, the Company anticipates that it will earn revenue from the sale of nutrient (and other) environmental credits related to the Kreider system and through sales of renewable energy generated by the Kreider systems.

During January 2009, the Board of Pennsylvania Infrastructure Investment Authority (“Pennvest”) approved a loan up to $7.8 million (“Pennvest Loan”) to LLC for development and construction of the Phase 1 System at Kreider.  After substantial unanticipated delays over the previous year, on August 12, 2010 the Company received its permit for construction of the Phase I Kreider System.  Initial construction-related activities, including bidding and ordering of equipment, commenced during October 2010.  The closing/settlement of the Pennvest Loan took place on November 3, 2010, and LLC received the initial drawdown/reimbursement from Pennvest pursuant to the Pennvest Loan on January 6, 2011(see note 7).  Bion is in the process of finalizing the construction of the Phase 1 Kreider System and will enter a period of system ‘operation shakedown’ during May 2011.  It is anticipated that the Phase 1 Kreider System will be in full, stabilized operation by mid to late summer 2011.  The Pennsylvania Department of Environmental Protection recently re-certified the nutrient credits for this project.  Work continues related to the details of the second phase of the Kreider project.

Going concern and management’s plans:

The consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company has not generated revenues and has incurred net losses of approximately $2,976,000 and $1,318,000 during the years ended June 30, 2010 and 2009, respectively, and a net loss of approximately $5,982,000 for the nine months ended March 31, 2011.  These factors raise substantial doubt about the Company's ability to continue as a going concern.  The accompanying consolidated financial statements do not include any adjustments relating to the recoverability or classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.  The following paragraphs describe management’s plans with regard to these conditions.

During the year ended June 30, 2010, the Company sold 18,000 shares of the Company’s Series C Preferred shares at $100 per share, which resulted in net proceeds to the Company of $1,566,000 after commissions.  During the nine months ended March 31, 2011, the Company sold an additional 14,150 shares of the Company’s Series C Preferred shares at $100 per share, which resulted in net proceeds to the Company of $1,231,050.  Also during the nine months ended March 31, 2011, the Company sold 311,746 shares of its common stock for net proceeds of $813,200.  

F-6

At March 31, 2011, the Company has a working capital surplus and a total deficit of approximately $491,000 and $1,655,000, respectively.  

The Company continues to explore sources of additional financing to satisfy its current operating requirements. While the Company currently does not face a severe working capital shortage, it is not currently generating any revenues. The Company will need to obtain additional capital to fund its operations and technology development, to satisfy existing creditors, to develop Projects and to construct and operate the Kreider Farm facilities. The Company anticipates that it will seek to raise from $5,000,000 to $50,000,000 (debt and equity) during the next twelve months.  There is no assurance, especially in the extremely unsettled capital markets that presently exist, that the Company will be able to obtain the funds that it needs to stay in business, complete its technology development or to successfully develop its business.

There can be no assurance that funds required during the next twelve months or thereafter will be generated from operations or that those funds will be available from external sources such as debt or equity financings or other potential sources. The lack of additional capital resulting from the inability to generate cash flow from operations or to raise capital from external sources would force the Company to substantially curtail or cease operations and would, therefore, have a material adverse effect on its business. Further, there can be no assurance that any such required funds, if available, will be available on attractive terms or that they will not have a significantly dilutive effect on the Company's existing shareholders.   All of these factors have been exacerbated by the extremely unsettled credit and capital markets presently existing.  

2.

SIGNIFICANT ACCOUNTING POLICIES:

Principles of consolidation:

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Bion Integrated Projects Group, Inc. (formerly Bion Dairy Corporation) (“Projects Group”), Bion Technologies, Inc., BionSoil, Inc., Bion Services, Bion PA-1 LLC, and Bion PA-2 LLC; and its majority owned subsidiary, Centerpoint Corporation (“Centerpoint”) (Note 3).  All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements have been prepared without audit pursuant to the rules and regulations of the SEC.  The consolidated financial statements reflect all adjustments (consisting of only normal recurring entries) that, in the opinion of management, are necessary to present fairly the financial position at March 31, 2011 and the results of operations and cash flows of the Company for the three and nine months ended March 31, 2011 and 2010.  Operating results for the three and nine months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending June 30, 2011.

The unaudited consolidated financial statements should be read in conjunction with the Company’s audited financial statements and footnotes thereto included in its Annual Report on Form 10-K for the year ended June 30, 2010.  

F-7

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED MARCH 31, 2011

Loss per share:

Basic loss per share amounts are calculated using the weighted average number of shares of common stock outstanding during the period.  Diluted loss per share assumes the conversion, exercise or issuance of all potential common stock instruments, such as options or warrants, unless the effect is to reduce the loss per share.  During the three and nine months ended March 31, 2011 and 2010, the basic and diluted loss per share is the same, as the impact of potential dilutive common shares is anti-dilutive.

The following table represents the warrants, options and convertible securities excluded from the calculation of diluted loss per share:

The following is a reconciliation of the denominators of the basic loss per share computations for the three and nine months ended March 31, 2011 and 2010:

Fair value measurements:

The fair value of cash, line of credit and accounts payable approximates their carrying amounts due to their short-term maturities.  The fair value of the loan payable approximates its carrying value as it bears interest at rates commensurate with market rates.  The fair value of the redeemable preferred stock approximates its carrying value due to the dividends accrued on the preferred stock which are reflected as part of the redemption value.

F-8

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED MARCH 31, 2011

3.

NONCONTROLLING INTEREST OF CENTERPOINT CORPORATION:

The Company owns a 58.9% interest in Centerpoint.  During the three and nine months ended March 31, 2011 and 2010, Centerpoint had losses of approximately $3,200 and $2,900 and $10,800 and $7,900, respectively.  The noncontrolling interest as of March 31, 2011 was $102,243.

4.

PROPERTY AND EQUIPMENT:

Property and equipment consists of the following:

Depreciation expense was $4,165 and $4,333 for the three months ended March 31, 2011 and 2010, respectively, and $12,589 and $12,531 for the nine months ended March 31, 2011 and 2010, respectively.  

5.

LINE OF CREDIT:

In December 2010, the Company entered into a loan and security agreement with a lender whereby the lender extended a credit facility of up to $1,500,000 in interim financing for the purchase of equipment and payment of construction costs of its Phase 1 System at the Kreider Dairy covered under the Pennvest Loan.  As of March 31, 2011, the amount owed under the line of credit is $183,530.  The credit facility bears interest at the prime rate published in the Wall Street Journal plus 2% and requires a $25,000 interest reserve account.  The credit facility is collateralized by the Pennvest loan proceeds and is subject to many standard debt covenants and conditions regarding payment and representation.  Should the Company default on the line of credit and not remedy the default within 10 days of notice from the lender, the principal and interest shall be payable immediately.  The maturity date of the line of credit is January 5, 2012.  For the three and nine months ended March 31, 2011 the Company capitalized interest expense of $6,668 related to the line of credit.  

6.

DEFERRED COMPENSATION:

As of March 31, 2010, the Company owed Brightcap Capital Ltd. (“Brightcap”) for services provided by Mr. Bassani, deferred compensation of $150,000.  The Company entered into an agreement with Brightcap in June 2009, whereby the deferred compensation earned by Brightcap from January 1, 2009 through June 30, 2009, totaling $150,000, was made due July 1, 2010 and convertible until July 1, 2010 into the Company’s restricted common stock, at Brightcap’s option, at a price of $1.50 per share, the fair value of the shares at the date of the agreement.  As the conversion price of $1.50 per share approximated the fair value of the shares at the time the conversion agreement was entered into, no beneficial conversion feature existed.  During June 2010, the Company entered into an extension agreement with Brightcap pursuant to which the maturity date and the conversion date of the deferred compensation were extended to July 1, 2011.  As consideration for the extension, an additional $15,000 principal was added to the obligation and the deferred compensation accrues interest commencing July 1, 2010 at 10% per annum.  As of March 31, 2011, the deferred compensation and accrued interest total $177,375.  Interest expense for the three and nine months ended March 31, 2011 was $4,125 and $12,375, respectively.

F-9

7.

LOAN PAYABLE:

As of March 31, 2011, LLC, the Company’s wholly owned subsidiary, owes $5,694,857 under the terms of the Pennvest Loan related to the construction of the Phase 1 System at Kreider Farms.  The Pennvest Loan is structured in phases (pre and post-completion of permitting/commencement of construction) and Pennvest’s disbursements take the form of reimbursements of qualified sums expended by LLC.  In connection with the Pennvest Loan, the Company has provided a ‘technology guaranty’ regarding nutrient reduction performance of the Kreider System which will expire when the Kreider System’s nutrient reduction performance has been demonstrated.  The closing/settlement of the Pennvest Loan took place on November 3, 2010, and as of March 31, 2011, LLC has submitted four requests for drawdowns/reimbursements from Pennvest totaling $5,994,587 of which Pennvest has held $299,730 as retainage pending completion of the project and has loaned LLC $5,694,857.   LLC has been using the proceeds from the Pennvest Loan to reduce its current obligations related to the Kreider project.  The terms of the Pennvest Loan provide for funding of up to $7,754,000 which is  to be repaid by interest-only payments for three years, followed by an additional ten-year amortization of principal.  The Pennvest Loan accrues interest at 2.547% for years 1 through 5 and 3.184% for years 6 through maturity.  The Pennvest Loan is collateralized by a pledge of all revenues generated from the project including, but not limited to, revenues generated from nutrient reduction credit sales and by-product sales. In addition, in consideration for the excess credit risk associated with the project, Pennvest is entitled to participate in the profits from the project calculated on a net cash flow basis, as defined.  Bion is in the process of finalizing construction of the Phase 1 Kreider System.  For the three and nine months ended March 31, 2011, the Company has incurred interest expense related to the Pennvest Loan of $18,912, of which $16,963 has been capitalized as a cost of the Phase 1 System.  

8.

STOCKHOLDERS' EQUITY:

Series B Preferred stock:

In March 2009, the Company authorized the issuance of 50,000 shares of Series B Preferred stock; which have a par value of $0.01 per share and are issuable at a price of $100 per share.  The Series B Preferred stock is convertible for three years from the date of issuance at the option of the holder into shares of the Company’s common stock calculated by dividing the sum of the $100 per share purchase price plus any accrued and unpaid dividends by $2.00 (the Conversion Rate).  The Series B Preferred stock shall be automatically and mandatorily converted into shares of the Company’s common stock at the Conversion Rate upon each occasion (at least 30 calendar days apart) after a date of six months subsequent to the initial issuance of the Series B Preferred stock on which the closing price of the Company’s common stock has been equal to or greater than 150% of the Conversion Rate (initially $3.00) for twenty consecutive trading days with a reported average daily trading volume of 10,000 shares or more.  The Series B Preferred stock may be redeemable at the option of the Company after one year from the issuance with 10 days written notice, at a price equal to $100 per share plus any accrued unpaid dividends.  During the 10 day period, the holder may elect to convert the Series B Preferred stock to the Company’s common stock at the Conversion Rate.  On the third anniversary of issuance, the Company shall redeem the outstanding Series B Preferred stock at the price of $100 per share plus any accrued unpaid dividends.  The Series B Preferred stock accrues dividends at a rate of 2.5% per quarter (10% per year) and shall be earned and accrued or paid quarterly.  

F-10

Because the Series B Preferred stock is redeemable in cash at a fixed price ($100 per share plus accrued unpaid dividends) on a fixed date (the third anniversary of issuance), the Company has classified the Series B Preferred stock outside of stockholders' equity.  Therefore, the Series B Preferred stock has been recorded at its redemption value as “temporary equity” in the accompanying consolidated balance sheet.  Dividends on the Series B Preferred stock are reflected as part of the redemption value with an offset to reduce additional paid-in capital, and are included in the determination of net loss applicable to common stockholders.

The Company declared dividends on July 31, 2010 for the Series B Preferred stockholders with a record date of June 30, 2010, totaling $70,425; which were paid on August 16, 2010.  

The Company declared dividends on November 12, 2010 for the Series B Preferred stockholders with a record date of September 30, 2010, totaling $70,425; which were paid on November 16, 2010.  

The Company declared dividends on January 1, 2011 for the Series B Preferred stockholders with a record date of December 31, 2010, totaling $70,425; which were paid on February 15, 2011.    

The Company declared dividends on April 22, 2011 for the Series B Preferred stockholders with a record date of March 31, 2011, totaling $70,425, which are expected to be paid on or about May 17, 2011.  

Series C Preferred stock:

During December 2009, the Company authorized the issuance of 60,000 shares of Series C Preferred stock, which have a par value of $0.01 per share and are issuable at a price of $100 per share.  The Series C Preferred stock is convertible at the option of the holder at any time from the date of issuance, into shares of the Company’s common stock calculated by dividing the sum of the $100 per share purchase price plus any accrued and unpaid dividends by $4.00 (the Conversion Rate), provided the shares have not been redeemed into common shares by the Company at is sole election.  A portion (up to 100% as calculated below) of each share of Series C Preferred stock shall be automatically and mandatorily converted into shares of the Company’s common stock at the Conversion Rate  upon each occasion (at least 30 calendar days apart) after a date of six months subsequent to the initial issuance of the Series C Preferred stock on which the closing price of the Company’s common stock has been equal or greater than 150% of the Conversion Rate (initially $6.00) for twenty consecutive trading days with a reported average daily trading volume of 10,000 shares or more.   On each occasion for mandatory conversion as set forth above, a sufficient portion of the outstanding shares of Series C Preferred stock shall be prorata converted so that the holders of the Series C Preferred stock receive an aggregate number of shares of the Company’s restricted common stock equal to 7.5 times the average reported daily volume of trading in the Company’s publicly traded common stock for the applicable twenty day period and each outstanding share shall thereafter be proportionately reduced in its rights to represent the effect of the partial conversions.  The Series C Preferred stock accrues dividends at a rate of 2.5% per quarter (10% per year) and shall be earned and accrued or paid quarterly.  

Dividends on the Series C Preferred stock are reflected as part of the redemption value with an offset to reduce additional paid-in capital, and are included in the determination of net loss applicable to common stockholders.

F-11

During the nine months ended March 31, 2011, the Company issued 14,150 shares of Series C Preferred stock for cash proceeds of $1,415,000 (net proceeds of $1,231,050 after commissions).  

The Company declared dividends on July 31, 2010 for the Series C Preferred stockholders with a record date of June 30, 2010 totaling $39,592; which were paid on August 16, 2010.

The Company declared dividends on November 12, 2010 for the Series C Preferred stockholders with a record date of September 30, 2010 totaling $47,712; which were paid on November 16, 2010.

The Company declared dividends on January 1, 2011 for the Series C Preferred stockholders with a record date of December 31, 2010 totaling $66,212; which were paid on February 15, 2011.

The Company declared dividends on April 22, 2011 for the Series C Preferred stockholders with a record date of March 31, 2011 totaling $80,375, which are expected to be paid on or about May 17, 2011.

Common stock:

Holders of common stock are entitled to one vote per share on all matters to be voted on by common stockholders.  In the event of liquidation, dissolution or winding up of the Company, the holders of common stock are entitled to share in all assets remaining after liabilities have been paid in full or set aside and the rights of any outstanding preferred stock holders have been satisfied. Common stock has no preemptive, redemption or conversion rights.  The rights of holders of common stock are subject to, and may be adversely affected by, the rights of the holders of any outstanding series of preferred stock or any series of preferred stock the Company may designate in the future.  

Centerpoint holds 704,309 shares of the Company’s common stock.  These shares of the Company’s common stock held by Centerpoint are for the benefit of its shareholders without any beneficial interest.  The Company accounts for these shares similar to treasury stock.

During the nine months ended March 31, 2011, the Company issued 113,721 shares of the Company’s restricted common stock at prices ranging from $1.50 to $3.19 per share for consulting services valued at $271,940, in aggregate, to various consultants and an employee.

During the nine months ended March 31, 2011, the Company sold 311,746 of the Company’s common stock for net proceeds of $813,200.

On December 31, 2010, the Company declared stock bonuses to certain key employees and a consultant at $2.90 per share, the approximate market value on the date of the grant totaling $536,500 for services performed through December 31, 2010.  The Company issued 185,000 shares of its common stock and recorded non-cash compensation expense of $536,500 during the nine months ended March 31, 2011.

On January 1, 2011 the Company declared a deferred stock bonus of 50,000 shares to Mr. Smith and recognized $145,000 of non-cash compensation expense.  The stock bonus is contingent upon the Company’s stock price exceeding $10.00 and does not require that Mr. Smith remains employed by the Company.  

F-12

In July 2009, the Company issued 130,000 common shares of the Company as stock bonuses to certain key employees and a consultant at $1.01 per share, the approximate market value on the date of grant, totaling $131,300.  The stock bonuses are subject to vesting and during the nine months ended March 31, 2011, $3,367 was recorded as compensation expense and $13,467 was capitalized as project construction in progress as it directly related to construction services provided by employees and consultants.  As of March 31, 2011 the stock bonuses are fully vested.

During the nine months ended March 31, 2011, 20,000 warrants were exercised at $2.00 per share for the purchase of 20,000 shares of the Company’s common stock for proceeds of $40,000.

Warrants:

As of March 31, 2011, the Company had the following common stock warrants outstanding:

F-13

In July 2010, warrants to purchase 200,000 shares of the Company’s common stock at $2.00 per share were issued pursuant to an extension agreement with Mr. Smith (Note 10).  These warrants were determined to have a fair value of $0.10 per warrant and expire on January 15, 2019.  The fair value of these warrants was determined to be $0.10 per warrant based on factors including the evaluation of the Company’s fair value as of the date of the issuance, consideration of the Company’s limited liquid resources and business prospects, the market price of the Company’s stock in its mostly inactive public market, and the historical valuation and purchases of the Company’s warrants.  The Company recorded non-cash compensation expense of $20,000 related to the warrant issuance.

From July 1, 2010 through March 31, 2011, warrants to purchase 135,000 shares of the Company’s common stock at $2.25 per share were issued pursuant to an agreement with two consultants.  The warrants were determined to have a fair value of $0.25 per warrant and expire on December 31, 2015.  The fair value of these warrants was determined to be $0.25 per warrant based on factors including the evaluation of the Company’s fair value as of the date of the Company’s agreement to issue the warrants, consideration of the Company’s limited liquid resources and business prospects, the market price of the Company’s stock in its mostly inactive public market and the historical valuation and purchases of the Company’s warrants.  The Company recorded non-cash compensation expense of $33,750 related to the warrant issuances.

During the nine months ended March 31, 2011, 20,000 warrants were exercised to purchase 40,000 shares of the Company’s common stock.

The weighted-average exercise price for the outstanding warrants is $2.04, and the weighted-average remaining contractual life as of March 31, 2011 is 7.23 years.

Stock options:

The Company’s 2006 Consolidated Incentive Plan (the “2006 Plan”), as amended, provides for the issuance of options to purchase up 6,000,000 shares of the Company’s common stock. Terms of exercise and expiration of options granted under the 2006 Plan may be established at the discretion of the Board of Directors, but no option may be exercisable for more than ten years.

In December 2010, the Board of Directors, in an effort to retain key employees and consultants, approved the modification of certain options to certain employees and consultants resulting in the extension of certain expiry dates.  As a result of the modifications, the Company recorded incremental non-cash compensation expense of $891,203 for the nine months ended March 31, 2011 and approximately $13,000 of additional non-cash compensation will be recognized over a weighted average period of approximately 1 year.  

In January and March 2011, the Company entered into new employment agreements with two employees which vested stock options previously granted to the employees during May 2008, with issuance and vesting contingent upon the signing of new employment agreements.  The new employment agreements also entitled the employees to modifications of stock options resulting in the extension of certain expiry dates which resulted in incremental non-cash compensation expense of $263,700 being recorded for the nine months ended March 31, 2011.  

F-14

The Company recorded compensation expense related to employee stock options of $979,499 and $40,899 for the three months ended March 31, 2011 and 2010, respectively, and $3,011,535 and $208,976 for the nine months ended March 31, 2011 and 2010, respectively.  The Company granted 2,045,000 and 195,000 options during the nine months ended March 31, 2011 and 2010, respectively.  The fair value of the options granted during the nine months ended March 31, 2011 and 2010 were estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:

The expected volatility was based on the historical price volatility of the Company’s common stock.  The dividend yield represents the Company’s anticipated cash dividend on common stock over the expected term of the stock options.  The U.S. Treasury bill rate for the expected term of the stock options was utilized to determine the risk-free interest rate.  The expected term of stock options represents the period of time the stock options granted are expected to be outstanding based upon management’s estimates.

A summary of option activity under the 2006 Plan for the nine months ended March 31, 2011 is as follows:

Stock-based compensation expense increased from $17,000 for the nine months ended March 31, 2010 to $438,000 for the same period in fiscal year 2011.  The increase is due to the signing in March 2011 of a new employment agreement with a research and development employee which vested stock options previously granted to the employee during May 2008, with issuance and vesting contingent upon the signing of new employment agreement.  The new employment agreement also entitled the employee to modifications of stock options resulting in the extension of certain expiry dates which resulted in incremental non-cash compensation expense of $200,000 being recorded for the nine months ended March 31, 2011.  

Loss from Operations

As a result of the factors described above, the loss from operations was $5,972,000 and $2,235,000 for the nine months ended March 31, 2011 and 2010, respectively.

Other Expense and (Income)

Other expense and (income) was $10,000 and $(8,000) for the nine months ended March 31, 2011 and 2010, respectively.  Interest expense increased to $14,000 for the nine months ended March 31, 2011 from $2,000 for the nine months ended March 31, 2010.  Interest expense increased due to the interest accrued on the deferred compensation balance as of March 31, 2011 and the non-capitalized interest associated with the Company’s loan payable.  Interest income was $4,000 and $9,000 for the nine months ended March 31, 2011 and 2010, respectively and the difference is primarily due to lower average invested cash balances.  

11

Net Loss Attributable to the Noncontrolling Interest

The net loss attributable to the noncontrolling interest was $4,000 and $3,000 for the nine months ended March 31, 2011 and 2010, respectively.  

Net Loss Attributable to Bion’s Stockholders

            As a result of the factors described above, the net loss attributable to Bion’s stockholders was $6,383,000 and $2,448,000 for the nine months ended March 31, 2011 and 2010, respectively, representing a $0.31 increase in the net loss per basic and diluted common share to $0.52 from $.21.

LIQUIDITY AND CAPITAL RESOURCES

The Company's financial statements for the nine months ended March 31, 2011 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business.  The Report of our Independent Registered Public Accounting Firm on the Company's financial statements as of and for the year ended June 30, 2010 includes a "going concern" explanatory paragraph which means that the auditors stated that conditions exist that raise substantial doubt about the Company's ability to continue as a going concern.

Operating Activities

As of March 31, 2011, the Company had cash and cash equivalents of approximately $3,370,000. Approximately $1,804,000 of the cash balance represented cash from a Pennvest loan draw/reimbursement received during the final days of March 2011 which funds had not yet been dispersed to pay invoices related to construction of the Kreider system. The Company’s payables were elevated in a similar amount. During the nine months ended March 31, 2011, net cash used in operating activities was $82,000, primarily consisting of cash operating expenses.  As previously noted, the Company is currently not generating revenue and accordingly has not generated cash flows from operations.  The Company does not anticipate generating sufficient revenues to offset operating and capital costs for a minimum of two to five years.  While there are no assurances that the Company will be successful in its efforts to develop and construct its Projects and market its Systems, it is certain that the Company will require significant funding from external sources. Given the unsettled state of the current credit and capital markets, there is no assurance the Company will be able to raise the funds it needs on reasonable terms.

Investing Activities

During the nine months ended March 31, 2011 the Company used $5,147,000 for the design, permitting and the majority of the construction of the KF Project which has been capitalized as property and equipment.  Also during the nine months ended March 31, 2011, the Company was required to maintain an interest reserve bank account of $25,000 associated with its line of credit.  

Financing Activities

During the nine months ended March 31, 2011, $1,231,000 and $853,000 of cash was provided from the sale of the Company's Series C preferred stock and the Company’s common stock, respectively.  Cash of $1,136,000 and $5,695,000 was provided from a line of credit and loan payable the Company utilized during the nine months ended March 31, 2011 for the construction of the KF Project.  The Company used $211,000 and $154,000 for Series B and Series C preferred dividends payments, respectively and $953,000 for repayments on the line of credit.

12

As of March 31, 2011 the Company has debt obligations consisting of deferred compensation of $177,000, a line of credit of $184,000 and a loan payable of $5,695,000. In addition, the Company entered into an 88-month operating lease for office space in New York City in August 2006, with an average monthly lease expense of $15,820. The Company has entered into sub-lease agreements with three separate parties which fully covers the lease expense.  As of March 31, 2011, the Company has 32 months remaining on the lease.

Plan of Operations and Outlook

As of March 31, 2011 the Company had cash and cash equivalents of approximately $3,370,000.  Approximately $1,804,000 of the cash balance represented cash from a Pennvest loan draw/reimbursement received during the final days of March 2011 which funds had not yet been dispersed to pay invoices related to construction of the Kreider system. The Company’s payables were elevated in a similar amount. While the Company currently does not face a severe working capital shortage, it is not currently generating any revenues.  The Company will need to obtain additional capital to fund its operations and technology development, to satisfy existing creditors, to develop Projects and to finish construction and sustain operations at the KF facilities.  In January 2009, the Board of Pennsylvania Infrastructure Investment Authority approved a $7.75 million loan to the Company for the initial stage of the KF Project.  The Company received a permit for construction of the KF Project on August 12, 2010. Initial construction commenced during November 2010. The settlement/closing of the Pennvest loan took place on November 3, 2010 and the Company received the initial drawdown/reimbursement from Pennvest on January 6, 2011.  From January 1, 2011 through May 10, 2011, the Company has received reimbursements of approximately $6,412,000 pursuant to the Pennvest Loan.  

The Company anticipates that it will seek to raise from $5,000,000 to $50,000,000 (debt and equity) during the next twelve months.  There is no assurance, especially in the extremely unsettled capital markets that presently exist, that the Company will be able to obtain the funds that it needs to stay in business, finance its Projects and other activities, continue its technology development and/or to successfully develop its business.

There can be no assurance that funds required during the next twelve months or thereafter will be generated from operations or that those funds will be available from external sources such as debt or equity financings or other potential sources. The lack of additional capital resulting from the inability to generate cash flow from operations or to raise capital from external sources would force the Company to substantially curtail or cease operations and would, therefore, have a material adverse effect on its business. Further, there can be no assurance that any such required funds, if available, will be available on attractive terms or that they will not have a significantly dilutive effect on the Company's existing shareholders.   All of these factors have been exacerbated by the extremely unsettled credit and capital markets presently existing.  

Currently, Bion is focused on using applications of its patented waste management technology to pursue two main business opportunities: 1) development of Integrated Projects which will include large CAFOs, such as large dairies, beef cattle feed lots and hog farms, with Bion waste treatment System modules processing the aggregate CAFO waste stream from the equivalent of 40,000 or more beef and/or dairy cows (or the waste stream equivalent of other species) while producing solids to be utilized for renewable energy production (and potentially to be marketed as feed and/or fertilizer), integrated with an ethanol plant capable of producing 40 (or more) million gallons of ethanol per year and/or integrated with CAFO end product processors, and 2) environmental retrofit and remediation of the waste streams of existing CAFOs in selected markets.

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Bion is currently working with local, state and federal officials with regard to regulatory and legislative initiatives and with such parties and potential industry participants to evaluate sites in multiple states and anticipates selecting a site for its initial Integrated Project during the 2010 fiscal year. The Company anticipates that its initial Integrated Project will be developed in Pennsylvania or upstate New York and anticipates optioning land for the first Integrated Project during the 2011 fiscal year or soon thereafter (although  locations other states are also under review). In addition, Bion intends to choose sites for additional Projects during the calendar years 2011-2012 to create a pipeline of Projects. Management has a 5-year development target (through calendar year 2017) of approximately 12-24 Integrated Projects.  At the end of that period, Bion projects that 5 or more of these Integrated Projects will be in full operation in 3-5 states, and the balance would be in various stages ranging from partial operation to early permitting stage. No Integrated Project has been developed to date.

The Company has also commenced actively pursuing the opportunity presented by environmental retrofit and remediation of the waste streams of existing CAFOs in selected markets. The first commercial activities in this area are the Kreider projects in Pennsylvania.

CONTRACTUAL OBLIGATIONS

We have the following material contractual obligations (in addition to employment and consulting agreements with management and employees):

1)   The Company executed a non-cancelable operating lease for office space in New York City effective August 1, 2006 and extending to November 30, 2013. The average monthly rent expense under the lease is $15,820.  The Company has provided the lessor with a letter of credit in the amount of $57,315 in connection with the lease as of December 31, 2010.  The Company's obligations under the lease are partially guaranteed by Salvatore Zizza, former Chairman of Bion Projects.  The Company has entered into sub-leases with non-affiliated parties for approximately 100% of the obligations under the lease.  Effective January 1, 2009, Mr. Zizza entered into a Master Sublease with the Company pursuant to which Mr. Zizza became a sublessee and for a one year initial period, made all payments pursuant to the lease and managed the lease premises.  Rental payments from existing sub-tenants are being deposited into a Company bank account such that Mr.  Zizza utilizes those funds towards the monthly lease payment.  During November 2009, Mr. Zizza exercised his option to continue the Master Sublease for the entire period of the lease.  Mr. Zizza fulfilled his obligations under the Master Sublease during the one year initial period and in January 2010; he received the funds from the release from the Company's letter of credit of $28,658.  Since Mr. Zizza exercised the option to continue the Master Sublease for the entire term of the lease, Mr. Zizza will be entitled to the balance of funds held under the letter of credit of approximately $57,000 if he fulfills his obligations pursuant to the Master Sublease.  

2)   On September 27, 2008, the Company executed an agreement with Kreider Farms (and its affiliated entities) (collectively "Kreider") to design, construct and operate, through its wholly-owned subsidiaries, Bion Services Group, Inc. ("Bion Services") and Bion PA-1 LLC ("LLC"), a Bion system to treat the waste of the dairy cows (milkers, dry cows and heifers) at the Kreider Dairy, located in Mannheim, Pennsylvania. In addition, the agreement provides for a second phase which will include treatment of the cellulosic solid wastes from the Phase 1 together with the waste stream from Kreider's poultry facilities to produce renewable energy for Bion's waste treatment facility and/or for market sales. The system will be owned and operated by Bion through LLC, in which Kreider has the option to

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purchase a minority interest. Funds were expended over the  last year to complete final design work and all building, zoning and other related pre-construction matters, and for construction of the Phase 1 Kreider System and  substantial capital and operating funds (equity and/or debt) has been and will continue to be expended.  Upon successful completion of construction and ‘shakedown’ operations of the Phase 1 system, the Company anticipates that it will receive revenue from the sale of nutrient (and other) environmental credits related to the Kreider system and through sales of renewable energy generated in connection with the second phase (largely poultry manure) of the Kreider project. On January 26, 2009 the Board of the Pennsylvania Infrastructure Investment Authority approved a $7.75 million loan to Bion for "the construction of a livestock waste treatment facility at Kreider Farms..." for the Phase 1 dairy portion of the Kreider Farms projects.  After substantial unanticipated delays, on August 12, 2010 the Company received a permit for construction of the Phase 1 Kreider System.  Initial construction commenced during November 2010.  The initial settlement/closing of the Pennvest loan took place on November 3, 2010 and the Company received the initial drawdown/re-imbursement from Pennvest pursuant to the Pennvest Loan on January 6, 2011.  The Company believes the $7.75 million loan from Pennvest will be sufficient to fund the anticipated construction costs and that the construction will be completed and the project will be operational by early summer 2011.  The Pennsylvania Department of Environmental Protection recently re-certified the nutrient credits for this project.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.

Not applicable.

(a)  Evaluation of Disclosure Controls and Procedures.

The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). This term refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized, and reported within the required time periods. Our Chief Executive Officer and Principal Financial Officer has evaluated the effectiveness of the design and operations of our disclosure controls and procedures as of the end of the period covered by this quarterly report, and has concluded that, as of that date, our disclosure controls and procedures were not effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act, as a result of the material weakness in internal control over financial reporting discussed in Item 9(A) of our Form 10-K for the year ended June 30, 2010.

(b)  Changes in Internal Control over Financial Reporting.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

The Company is not involved in any material legal proceedings at this time.e

Not applicable.

During the quarter ended March 31, 2010 the Company sold 236,000 shares of restricted common stock for net proceeds of $590,000 (not including: a) 196,066 shares issued pursuant to our 2006 Consolidated Incentive Plan (‘Plan’), valued at $570,619, in aggregate, to certain consultants and/or employees for services; b) 20,000 shares issued to consultants outside the Plan, valued at $60,000,for services which shares were issued in reliance on the exemption in Section 4(2) of the Securities Act of 1933 and c)20,000 shares issued pursuant to exercise of an outstanding warrant at $2.00 per share which shares were issued in reliance on the exemption in Section 4(2) of the Securities Act of 1933). These shares were issued in reliance on the exemptions provided by Regulation D of the Securities Act of 1933.

The proceeds were utilized for general corporate purposes.

Not applicable.

Not applicable.

(a)  Exhibits required by Item 601 of Regulation S-K.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.