BION ENVIRONMENTAL TECHNOLOGIES INC - Quarter Report: 2012 September (Form 10-Q)

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _________

Commission File No. 000-19333

Bion Environmental Technologies, Inc.

(Name of registrant in its charter)

Colorado		84-1176672
(State or other jurisdiction of incorporation or formation)		(I.R.S. employer identification number)

Box 566 / 1774 Summitview Way

Crestone, Colorado  81131

(Address of principal executive offices)

 

  (212) 758-6622

(Registrant’s telephone number, including area code) 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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.

 x  Yes   ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       x  Yes  ¨  No

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.

SEC 1296 (03-10) Potential persons who are to respond to the collection of information contained in this form are not required to respond unless the form displays a currently valid OMB control number.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨  Yes   x  No

 

1

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.   Not applicable.

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  On November 6, 2012, there were 17,025,704 Common Shares issued and 16,321,395 Common Shares outstanding.

2

BION ENVIRONMENTAL TECHNOLOGIES, INC.

FORM 10-Q

TABLE OF CONTENTS

3

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that involve substantial risks and uncertainties.  Forward-looking statements generally can be identified by the use of forward-looking terminology such as "may," "will," "expect," "intend," "estimate," "anticipate," "project," "predict," "plan," "believe" or "continue" or the negative thereof or variations thereon or similar terminology.  The expectations reflected in forward-looking statements may prove to be incorrect.

4

See notes to consolidated financial statements

5

See notes to consolidated financial statements

6

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (DEFICIT)
THREE MONTHS ENDED SEPTEMBER 30, 2012 (UNAUDITED)
		Bion’s Shareholders’
		Series C Preferred Stock			Common Stock
		Shares	Amount		Shares	Amount		Additional paid-in capital		Accumulated deficit		Noncontrolling interest		Total equity/(deficit)
Balances, July 1, 2012		300	$29,050		16,814,103	$         -		$91,177,978		$(92,065,095)		$83,887		$  (774,180)
Vesting of options for services		-	-		-	-		239,055		-		-		239,055
Issuance of common stock for services		-	-		17,081	-		1,156,493		-		-		1,156,493
Issuance of warrants for services		-	-		-	-		30,000		-		-		30,000
Sale of units		-	-		143,333	-		322,499		-		-		322,499
Dividends on Series B preferred stock		-	-		-	-		(917)		-		-		(917)
Dividends on Series C preferred stock		-	750		-	-		(750)		-		-		-
Net loss		-	-		-	-		-		(2,451,534)		(1,398)		(2,452,932)
Balances, September 30, 2012		300	$29,800		16,974,517	$         -		$92,924,358		$(94,516,629)		$82,489		$(1,479,982)

See notes to consolidated financial statements

7

See notes to consolidated financial statements

8

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

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 and has developed and continues to develop patented and proprietary technology that provides a comprehensive environmental solution to a significant source of pollution in United States agriculture, large scale livestock facilities known as Confined Animal Feeding Operations ("CAFO's"). Bion's technology produces substantial reductions of nutrient releases (primarily nitrogen and phosphorus) to both water and air (including ammonia, which is subsequently re-deposited to the ground) from livestock waste streams based upon our operations and research to date (and third party peer review thereof). 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 (thereby utilizing less land per animal) 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 Bion elected not to pursue near- term revenue opportunities such as retrofitting existing CAFO's with waste management solutions, because management believed such efforts would have diverted scarce management and financial resources and negatively impacted Bion’s ability to complete: 1) re-development of technology for environmentally sound treatment of CAFO waste streams and 2) development of an 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) installation of Bion systems to retrofit and environmentally remediate existing CAFO’s to reduce nutrient (nitrogen and phosphorus) releases, gaseous emissions (ammonia, greenhouse gases, volatile organic compounds, etc.), and pathogens, hormones and other compounds in order to clean the air and water in the surrounding areas (as described below) to ensure compliance with existing (and future) regulations and to permit herd expansion; and 2) development of "closed loop" Integrated Projects. Bion is pursuing these opportunities within the United States and internationally.

Management believes 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 fossil fuel replacement. The nutrient rich solids recovered from the livestock waste stream can be utilized as either high value fertilizer and/or the basis for high protein animal feed and the nutrient rich effluent can potentially be utilized in integrated hydroponic agriculture and/or field applied as fertilizer.  

9

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

1.

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

Organization and nature of business (continued):

Bion believes that its Integrated Projects will produce high quality, traceable animal protein at a lower cost than current industry practices while also maintaining  a far lower net environmental footprint per unit of protein produced due to water recycling (possible due to the removal of nutrients, etc.  from the water by Bion’s technology), production of renewable energy from the waste stream (reducing the use of fossil fuels), and multiple levels of economies of scale, co-location and integration savings in transportation and other logistics.

Bion is presently involved in the very early development and pre-development activities related to Integrated Projects in Pennsylvania.  The Company is also involved in pre-development evaluations and discussions regarding opportunities for Integrated Projects in New York and in Nebraska and elsewhere in the Midwest and the North Central United States (dairy and/or beef). All such discussions are still in preliminary stages.  Additionally, the Company is involved in very early stage discussions regarding development of Integrated Projects to meet specific needs of certain international markets (and regarding licensing our technology for use in overseas locations).

Additionally, Bion has recently commenced discussions that may lead to installation of Bion systems on existing and/or new dairies, beef facilities and swine farms in the Midwest.

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 (“PA-1”) a Bion system to treat the waste of 1,200 milking dairy cows (milkers, dry cows and heifers) at the Kreider Dairy, located in Manheim, 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 (referred to as “Kreider 1”)  together with the waste stream from Kreider’s poultry facilities for use at the facilities and/or for market sales. The Kreider projects are owned and operated by Bion through subsidiaries, in which Kreider has 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 continuing operations. 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.

The Company financed Kreider 1 through a $7.8 million loan from Pennsylvania Infrastructure Investment Authority (“Pennvest”).  Initial construction-related activities of Kreider 1, including bidding and ordering of equipment, commenced in October 2010 and was completed and a period of system ‘operation shakedown’ commenced in May 2011.  Kreider 1 reached full, stabilized operation by the end of the 2012 fiscal year.  During 2011 the Pennsylvania Department of Environmental Protection (“PADEP”) re-certified the nutrient credits for this project.  The PADEP issued final permits for Kreider 1 (including the credit verification plan) on August 1, 2012 on which date the Company deemed that Kreider 1 was ‘placed in service’. As a result, Bion can now commence generating and verifying nutrient reduction credits for sale during the 2013 fiscal year while continuing to utilize the system to test improvements and add-ons.  

10

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

1.

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

Organization and nature of business (continued):

Development work, including amended credit certification and negotiations with venture partners, continues related to the details of the second phase of the Kreider project. It is anticipated that agreements related to the second Kreider project will be executed during the current calendar year and that permitting and construction will be completed in 2013.

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 (including significant non-cash expenses) of approximately $6,465,000 and $6,998,000 during the years ended June 30, 2012 and 2011, respectively, and a net loss of approximately $2,453,000 for the three months ended September 30, 2012.  At September 30, 2012, the Company has a working capital deficit and a stockholders’ deficit of approximately $820,000 and $1,562,000, respectively.  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 years ended June 30, 2012 and 2011, the Company received total proceeds of $1,259,250, (including $200,000 of subscriptions receivable) and $2,649,250 (including $40,000 from the exercise of warrants into commons shares of the Company), respectively, from the sale of its equity securities.

During the three months ended September 30, 2012, the Company has sold 143,333 equity Units (Note 6) and received proceeds of approximately $322,500

The Company continues to explore sources of additional financing to satisfy its current operating requirements as it is not currently generating any revenues.

During fiscal year 2012 and through the three months ended September 30, 2012, the Company experienced greater difficulty in raising equity funding than in the prior year. As a result, the Company faced, and continues to face, significant cash flow management challenges due to material working capital constraints. To partially mitigate these working capital constraints, the Company’s core senior management and several key employees have been deferring all or part of their cash compensation (Note 4). The Company will need to obtain additional capital to fund its operations and technology development, to satisfy existing creditors, to develop Integrated Projects and CAFO waste remediation systems and to operate the Kreider 1 facilities. The Company anticipates that it will seek to raise from $7,500,000 to $50,000,000 or more (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 and projects.

11

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

1.

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

Going concern and management’s plans (continued):

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 ,  PA-1, and Bion PA 2 LLC; and its 58.9% owned subsidiary, Centerpoint Corporation (“Centerpoint”).  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 Securities and Exchange Commission (“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 September 30, 2012, the results of operations of the Company for the three months ended September 30, 2012 and 2011 and cash flows of the Company for the three months ended September 30, 2012 and 2011.  Operating results for the three months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending June 30, 2013.

Fair value measurements:

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal or most advantageous market.  The Company uses a fair value hierarchy that has three levels of inputs, both observable and unobservable, with use of the lowest possible level of input to determine fair value.

Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2 – observable inputs other than Level 1, quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and model-derived prices whose inputs are observable or whose significant value drivers are observable; and

Level 3 – assets and liabilities whose significant value drivers are unobservable.

12

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

2.

SIGNIFICANT ACCOUNTING POLICIES (continued):

Fair value measurements (continued):

Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on the Company’s market assumptions.  Unobservable inputs require significant management judgment or estimation.  In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy.  In those instances, the fair value measurement is required to be classified using the lowest level of input that is significant to the fair value measurement.  Such determination requires significant management judgment.  

The fair value of cash and accounts payable approximates their carrying amounts due to their short-term maturities.  The fair value of the loan payable approximates its carrying amount 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.  The fair value of deferred compensation is not practicable to estimate due to the related party nature of the underlying transactions.

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 months ended September 30, 2012 and 2011, the basic and diluted loss per share was the same, as the impact of potential dilutive common shares was anti-dilutive.

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

	September 30, 2012		September 30, 2011
Warrants	6,879,920		6,068,055
Options	5,261,145		2,620,833
Convertible debt	528,609		123,750
Convertible preferred stock	19,688		1,058,057

 

 

The following is a reconciliation of the denominators of the basic loss per share computations for the three months ended September 30, 2012 and 2011:

		Three months ended September 30, 2012		Three months ended September 30, 2011
Shares issued – beginning of period		16,814,103		13,730,291
Shares held by subsidiaries (Note 6)		(704,309)		(704,309)
Shares outstanding – beginning of period		16,109,794		13,025,982
Weighted average shares for fully vested stock   bonuses (Note 6)		766,630		323,478
Weighted average shares issued during the period		50,846		101,363
Basic weighted average shares – end of period		16,927,270		13,450,823

13

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

2.

SIGNIFICANT ACCOUNTING POLICIES (continued):

Recent Accounting Pronouncements:

The Company has evaluated all newly issued accounting pronouncements and believes such pronouncements do not have a material effect on the Company’s financial statements.

3.

PROPERTY AND EQUIPMENT:

Property and equipment consists of the following:

		September 30, 2012		June 30, 2012
Machinery and equipment		$5,432,947		$              -
Buildings and structures		2,574,010		-
Kreider 1		-		8,155,922
Leasehold improvements		31,336		31,336
Furniture		28,932		28,932
Computers and office equipment		246,900		34,240
		8,314,125		8,250,430
Less accumulated depreciation		(243,519)		(77,728)
		$8,070,606		$8,172,702

During the three months ended September 30, 2012, Kreider 1 was placed into service and the capitalized costs of $8,219,617 were allocated among its separately identifiable components.  Depreciation expense was $165,791 and $4,084 for the three months ended September 30, 2012 and 2011, respectively.  

4.

DEFERRED COMPENSATION:

Current:

The Company owes Edward Shafer, the Company’s Executive Vice Chairman, and three other key employees, aggregate deferred compensation of $138,833 as of September 30, 2012.

Non-current:

As of September 30, 2012, the Company owed Brightcap Capital Ltd. (“Brightcap”), for services provided by Dominic Bassani (“Bassani”), the Chief Executive Officer (“CEO”), deferred compensation of $662,845, including interest of $55,845, which is due and payable on January 15, 2014.  Of the $662,845, $202,125 of the deferred compensation accrues interest at 10% per annum and is convertible into the Company’s restricted common stock at $1.50 per share.  The remaining $460,720 of deferred compensation accrues interest at 8% per annum and is convertible into Units at $2.50 per Unit which consists of one share of the Company’s common stock and one warrant to purchase a share of the Company’s common stock. Conversion of this deferred compensation is at the sole discretion of Brightcap and Bassani.

14

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

4.

DEFERRED COMPENSATION (continued):

Non-current (continued)

As of September 30, 2012, the Company owes Mark A. Smith, the Company’s President, deferred compensation of $326,996, including interest of $12,792 which is due and payable on January 15, 2014.  The deferred compensation accrues interest at 8% per annum.  The deferred compensation plus accrued interest of $460,720 and $326,996 owed to Brightcap and Mr. Smith, respectively, may be converted, at the sole election of Brightcap and Mr. Smith, into Units consisting of one share of the Company’s common stock and one warrant to purchase a share of the Company’s common stock, at a price of $2.50 per Unit until December 31, 2016.  As the conversion price of $2.50 per Unit approximated the fair value of the Units at the date of the agreements, no beneficial conversion feature exists at September 30, 2012.  In addition, the conversion price of the deferred compensation plus accrued interest will be the lower of the $2.50 per Unit price or the lowest price at which the Company sells its common stock between April 1, 2012 and January 15, 2014. As of September 30, 2012, the lowest price at which the Company has sold its common stock during the relevant period is $2.00 per share.  Management evaluated the terms and conditions of the embedded conversion features based on the guidance of ASC 815-15-25-1 to determine if there was an embedded derivative requiring bifurcation. An embedded derivative instrument (such as a conversion option embedded in the deferred compensation) must be bifurcated from its host instruments and accounted for separately as a derivative instrument only if the “risks and rewards” of the embedded derivative instrument are not “clearly and closely related” to the risks and rewards of the host instrument in which it is embedded.  Management concluded that the embedded conversion feature of the deferred compensation was not required to be bifurcated because the conversion feature is clearly and closely related to the host instrument, and because of the Company’s limited trading volume that indicates the feature is not readily convertible to cash in accordance with ASC 815-10, “Derivatives and Hedging”.

5.

LOAN PAYABLE:

As of September 30, 2012, PA-1, the Company’s wholly-owned subsidiary, owes $7,754,000 under the terms of the Pennvest Loan related to the construction of the Kreider 1 System.  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 requires minimum annual principal payments of approximately $574,000 in fiscal year 2013, $704,000 in fiscal year 2014, $723,000 in fiscal year 2015, $741,000 in fiscal year 2016, $760,000 in fiscal year 2017 and $4,252,000 thereafter.  The Pennvest Loan is collateralized by a pledge of all revenues generated from Kreider 1 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 Kreider 1 calculated on a net cash flow basis, as defined.  For the three months ended September 30, 2012 and 2011, the Company has incurred interest expense related to the Pennvest Loan of $49,374 and $45,644, respectively, of which $15,793 and $43,650, respectively, has been capitalized as a cost of the Kreider 1 System.

In connection with the Pennvest Loan, the Company provided a ‘technology guaranty’ regarding nutrient reduction performance of Kreider 1 which was structured to expire when Kreider 1’s nutrient reduction performance had been demonstrated. On August 1, 2012 the Company informed Pennvest that the Kreider 1 System had surpassed the requisite performance criteria and that, as a result, the Company’s ‘technology guaranty’ had been met.

15

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

6.

STOCKHOLDERS' EQUITY:

Series B Preferred stock:

At July 1, 2012, the Company had 450 shares of Series B redeemable convertible Preferred stock outstanding with a par value of $0.01 per share, and are convertible at the option of the holder at $2.00 per share, with dividends accrued and payable at 2.5% per quarter.  The Series B Preferred stock is mandatorily redeemable at $2.00 per share by the Company three years after issuance and accordingly was classified outside of shareholders’ equity.

During the three months ended September 30, 2012 the Company redeemed 250 shares of its Series B Preferred stock plus accrued dividends of $2,500 for $27,500.  The remaining 200 shares have reached their maturity date, but due to the cash constraints of the Company have not been redeemed as of November 5, 2012.

During the years ended June 30, 2012 and 2011, the Company declared dividends of $72,550 and $281,700 respectively. During the three months ended September 30, 2012, the Company declared dividends of $500.  At September 30, 2012, dividends payable are $2,500.

Series C Preferred stock:

At July 1, 2012 the Company had 300 shares of Series C Preferred stock outstanding, which have a par value of $0.01 per share and are 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.

During the years ended June 30, 2012 and 2011, the Company declared dividends of $82,625 and $274,675 respectively. During the three months ended September 30, 2012, the Company declared dividends of $750.  At September 30, 2012 dividends payable are $3,750.

16

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

6.

STOCKHOLDERS' EQUITY (continued):

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 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 three months ended September 30, 2012, the Company issued 17,081 shares of the Company’s restricted common stock at prices ranging from $2.00 to $2.13 per share for consulting services valued at $35,243, in the aggregate, to a consultant and an employee.  

During the three months ended September 30, 2012, the Company granted Mr. Bassani and Mr. Smith shares of the Company’s common stock as bonuses for signing extensions to their employment agreements.  Mr. Bassani will be issued 300,000 shares of the Company’s common stock issuable in two tranches of 150,000 shares on each of January 15, 2015 and 2016, respectively.  Mr. Smith will be issued 150,000 shares of the Company’s common shares in two tranches of 75,000 shares on each of January 15, 2014 and 2015, respectively.  The Company recorded non-cash compensation of $585,000 and $292,500 related to the future stock issuances to Mr. Bassani and Mr. Smith, respectively, as the bonuses were fully vested upon grant date during the three months ended September 30, 2012.

During the three months ended September 30, 2012, the Company declared contingent stock bonuses of 25,000 and 100,000 shares to Mr. Schafer and Mr. Smith, respectively, and recognized $48,750 and $195,000 of non-cash compensation expense, respectively.  The stock bonuses are contingent upon the Company’s stock price exceeding $10.00 and do not require that Mr. Schafer or Mr. Smith remain employed by the Company.  

In August and September 2012, the Company entered into subscription agreements to sell 2012 B UNITS for $2.25 each, with each 2012 B UNIT consisting of one 2012 B share of the Company’s restricted common stock and one 2012 B warrant to purchase one half of a share of the Company’s restricted common stock for $3.10 per share until December 31, 2014 (the “2012 B UNITS”).  During the three months ended September 30, 2012, the Company issued 143,333 2012 B UNITS for total proceeds of approximately $322,500.  The Company allocated the proceeds from the 2012 B shares and the 2012 B warrants based upon their relative fair values, using the share price on the day each of the subscription agreements were entered into and the fair value of the 2012 B Warrants, which was determined to be $0.075 per 2012 B Warrant.  As a result, $5,469 was allocated to the 2012 B Warrants and $317,030 was allocated to the 2012 B Shares, and both were recorded as additional paid in capital.  

17

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

6.

STOCKHOLDERS' EQUITY (continued):

Warrants:

As of September 30, 2012, the Company had approximately 6.9 million warrants outstanding, with exercise prices from $0.75 to $4.25 and expiring on various dates through January 15, 2019.

The weighted-average exercise price for the outstanding warrants is $2.17, and the weighted-average remaining contractual life as of September 30, 2012 is 5.44 years.

In July 2012, warrants to purchase 50,000 and 250,000 shares of the Company’s common stock at $2.10 per share were issued pursuant to extension agreements with Mr. Bassani and Mr. Smith, respectively (Note 8).  These warrants were determined to have a fair value of $0.10 per warrant and expire on December 31, 2018.  The Company recorded non-cash compensation expense of $5,000 and $25,000, respectively, related to the warrant issuances.

During the three months ended September 30, 2012, the Company issued warrants to purchase 71,667 shares of the Company’s common stock in connection with the sale of 2012 B UNITS.  

Stock options:

The Company’s 2006 Consolidated Incentive Plan (the “2006 Plan”), as amended, provides for the issuance of options to purchase up to 8,000,000 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.

The Company recorded compensation expense related to employee stock options of $239,055 and $1,981,684 for the three months ended September 30, 2012 and 2011, respectively.  The Company granted 150,000 and 1,400,000 options during the three months ended September 30, 2012 and 2011, respectively.  The fair value of the options granted during the three months ended September 30, 2012 and 2011 were estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:

		Weighted average, June 30, 2012	Range, June 30, 2012		Weighted average, June 30, 2011	Range, June 30, 2011
Volatility		66%	60%-68%		84%	61%-88%
Dividend yield		-	-		-	-
Risk-free interest rate		0.32%	0.31%-0.34%		1.37%	0.25%-2.02%
Expected term (years)		3.05	2.66-3.25		4.1	2-4.5

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.

18

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

6.

STOCKHOLDERS' EQUITY (continued):

Stock options (continued):

A summary of option activity under the 2006 Plan for the three months ended September 30, 2012 is as follows:

	Options		Weighted- Average Exercise Price	Weighted- Average Remaining Contractual Life		Aggregate Intrinsic Value
Outstanding at July 1, 2012	5,111,145		2.86	4.6		274,200
Granted	150,000		2.10
Exercised	-		-
Forfeited	-		-
Expired	-		-
Outstanding at September 30, 2012	5,261,145		$2.84	4.4		$206,250
Exercisable at September 30, 2012	4,671,145		$2.85	4.2		$206,250

The following table presents information relating to nonvested stock options as of September 30, 2012:

	Options		Weighted Average Grant-Date Fair Value
Nonvested at July 1, 2011	590,000		$  1.83
Granted	150,000		0.83
Vested	(150,000)		(0.83)
Forfeited	-		-
Nonvested at June 30, 2012	590,000		$  1.83

The total fair value of stock options that vested during the three months ended September 30, 2012 and 2011 was $125,000 and $1,821,350, respectively.  As of September 30, 2012, the Company had $373,234 of unrecognized compensation cost related to stock options that will be recorded over a weighted average period of less than two years.

19

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

6.

STOCKHOLDERS' EQUITY (continued):

Stock options (continued):

Stock-based compensation charges in operating expenses in the Company’s financial statements for the three months ended September 30, 2012 and 2011 are as follows:  

		Three months ended September 30, 2012		Three months ended September 30, 2011
General and administrative:
Fair value of stock/warrant bonuses expensed		$   1,151,250		$   1,035,300
Fair value of stock issued to an employee		24,999		24,999
Change in fair value from modification of option terms		-		94,820
Fair value of stock options expensed		230,353		1,846,265
Total		$   1,406,602		$  3,001,384
Research and development:
Fair value of stock options expensed		$          8,702		$       40,598
Total		$          8,702		$       40,598

7.

OPERATING LEASE:

The Company entered into a non-cancellable operating lease commitment for office space in New York, effective August 1, 2006 and expiring November 30, 2013.  In conjunction with the signing of the lease, the Company provided the lessor with a secured letter of credit.  As of September 30, 2012, the Company has reflected $57,315 as restricted cash related to the secured letter of credit.  The Company’s obligations under the lease are partially guaranteed by Mr. Salvatore Zizza, a former officer and director of the Company.  The Company has entered into three separate agreements to sub-lease approximately 100% of the Company’s lease obligation, and the tenants have also agreed to reimburse the Company for leasehold improvements and furnishings.  Because the lease contains an escalation clause, the Company is recognizing rent under the straight-line method resulting in an average monthly rent expense of $15,820.  The Company is also recognizing the sub-lease rental income from its tenants under the straight-line method, with a monthly average of $17,242.  The difference between the straight-line method, and the actual lease payments has resulted in a deferred rent liability of $23,726 as of September 30, 2012.   Rent expense net of contractual and month-to-month sub-lease rental income, was nil for both of the three months ended September 30, 2012 and 2011, respectively.

20

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

7.

OPERATING LEASE (continued):

At September 30, 2012, future minimum rental payments due under non-cancelable leases and future minimum rental payments to be received under non-cancelable subleases are:

	Fiscal year ended June 30:	Operating lease payments		Sublease rentals		Net operating lease payments
	2013 (remainder of year)	169,834		169,834		-
	2014	97,219		97,219		-
	Total	$267,053		$267,053		$ -

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 term 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 of the restricted cash securing 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 restricted funds securing the letter of credit of approximately $57,000 if he fulfills his obligations pursuant to the Master Sublease.  

8.

COMMITMENTS AND CONTINGENCIES:

Employment and consulting agreements:

Mr. Smith has held the positions of Director, President and General Counsel of Company and its subsidiaries under various agreements and terms since March 2003 and since September 1, 2010 has been paid a monthly salary of $19,000.  During July 2011, the Company entered into an extension agreement whereby Mr. Smith will continue to hold his current position in the Company through a date no later than December 31, 2012.  Commencing January 1, 2012, Mr. Smith has been paid a monthly salary of $20,000.  In addition, Mr. Smith will be issued 90,000 shares of the Company’s common stock in two tranches of 45,000 shares on each of January 15, 2013 and 2014, respectively.  The Company recorded expense of $240,300 for the year ended June 30, 2012, related to the future stock issuances as the bonus was fully vested at the grant date.  As part of the extension agreement, Mr. Smith was also granted 200,000 options, which vested immediately, to purchase common shares of the Company at a price of $3.00 per share and which options expire on December 31, 2019.  The Company recorded expense of $334,000 during the year ended June 30, 2012 as the options were fully vested at the grant date. Effective July 15, 2012, the Company entered into an extension agreement whereby Mr. Smith will continue to hold his current positions in the Company through a date no later than June 30, 2014.  Effective September 2012, Mr. Smith will be paid a monthly salary of $21,000 (which is currently being deferred).  In addition, Mr. Smith will be issued 150,000 shares of the Company’s common stock in two tranches of 75,000 shares on each of January 15, 2014 and 2015, which shares vested immediately.  The Company recorded expense of $292,500 for the three months ended September 30, 2012, related to the future stock issuances as the bonus was fully vested at the grant date.  As part of the extension agreement, Mr. Smith was also granted a bonus of $25,000 paid in warrants, which vested immediately, to purchase 250,000 shares of the Company’s common stock at a price of $2.10 per share and which warrants expire on December 31, 2018 and a contingent stock bonus of 100,000 shares payable on the date on which the Company’s stock price first reaches $10.00 per share (regardless of whether Mr. Smith is still providing services to the Company on such date).

21

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

8.

COMMITMENTS AND CONTINGENCIES (continued):

Employment and consulting agreements (continued):

Since March 31, 2005, the Company has had various agreements with Brightcap, through which the services of Mr. Bassani are provided.  On September 30, 2009 the Company entered into an extension agreement with Brightcap pursuant to which Mr. Bassani will provide services to the Company through September 30, 2012 for $312,000 annually.  The Board appointed Mr. Bassani as the Company's CEO effective May 13, 2011.  On July 15, 2011, Mr. Bassani, Brightcap and the Company agreed to an extension/amendment of the existing agreement with Brightcap which provides that Mr. Bassani will continue to provide the services of CEO through June 30, 2013 and will continue to provide full-time services to the Company in other capacities through June 30, 2014 at a salary of $26,000 per month.  In addition Mr. Bassani will be issued 300,000 shares of the Company’s common stock issuable in three tranches of 100,000 shares on each of January 15, 2015, 2016 and 2017, respectively.  During the year ended June 30, 2012 the Company recorded expense of $795,000 related to the future stock issuances as the bonus was fully vested at the grant date.  Mr. Bassani was also granted 725,000 options, which vested immediately, to purchase shares of the Company’s common stock at $3.00 per share which options expire on December 31, 2019.   The Company recorded expense of $1,203,500 during the year ended June 30, 2012 as the options were fully vested at the grant date.  Effective July 15, 2012, Mr. Bassani, Brightcap and the Company agreed to a further extension/amendment of the existing agreement with Brightcap which provides that Mr. Bassani will continue to provide the services of CEO through June 30, 2014.  Mr. Bassani will continue to provide full-time services to the Company at a cash salary of $26,000 per month (which is currently being deferred) and Mr. Bassani will be issued 300,000 shares of the Company’s common stock issuable in two tranches of 150,000 shares on each of January 15, 2015 and 2016, respectively, which will be immediately vested.  The Company recorded expense of $585,000 for the three months ended September 30, 2012, related to the future stock issuances as the bonus was fully vested at the grant date.   As part of the extension agreement, Mr. Bassani was also granted a bonus of $5,000 paid in warrants, which vested immediately, to purchase 50,000 shares of the Company’s common stock at a price of $2.10 per share and which warrants expire on December 31, 2018.

Effective January 1, 2011, the Company entered into an employment agreement with Edward Schafer pursuant to which for a period of three years, Mr. Schafer will provide senior management services to the Company on an approximately 75% full time basis, initially as Executive Vice Chairman and as a director.  Compensation for Mr. Schafer’s services will initially be at an annual rate of $250,000, which will consist of $150,000 in cash compensation and $100,000 payable in the Company’s common stock.  Commencing the month following the first calendar month-end after the Company has completed an equity financing in excess of $3,000,000 (net of commissions and other offering expenses), Mr. Schafer’s compensation shall be at an annual rate of $225,000, all of which shall be payable in cash.  Effective July 15, 2012, the Company entered into a deferral/employment/ compensation agreement with Edward Schafer pursuant to which Mr. Schafer will continue to provide senior management services to the Company on an approximately 75% full time basis, initially as Executive Vice Chairman and as a director.  Basic compensation for Mr. Schafer’s services will remain unchanged and Mr. Schafer will be issued 100,000 options to purchase shares of the Company’s common stock at $2.10 per share until December 31, 2018, which are immediately vested and a contingent stock bonus of 25,000 shares payable on January 1 of the first year after the Company’s stock price first reaches $10.00 per share (regardless of whether Mr. Schafer is still providing services to the Company on such date).

22

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

8.

COMMITMENTS AND CONTINGENCIES (continued):

Employment and consulting agreements (continued):

Effective September 18, 2006, the Company entered into a four-year employment agreement with Jeremy Rowland whereby Mr. Rowland assumed the position of Chief Operating Officer of Projects at an annual salary of $150,000.  In June 2008, the employment agreement terms were extended through July 1, 2012. Mr. Rowland now serves as Chief Operating Officer of the Company’s Services Group subsidiary.

During January 2012, the Company approved an employment agreement contract extension effective January 1, 2012 with Craig Scott whereby he will continue to act as Vice President of Capital Markets and Shareholder Relations through December 31, 2012, at an annual salary of $144,000. In consideration for his extension agreement, Mr. Scott was granted 75,000 options to purchase shares of the Company’s common shares at $2.75 per share with an expiration date of December 31, 2016, 12,500 contingent stock options that will be issued if the Company’s stock price exceeds $10 and $20 per share, respectively, and an extension of the expiration dates all his existing warrants and options as of January 1, 2012 until December 31, 2016.

Effective February 1, 2011, the Company entered into an employment agreement with James Morris, pursuant to which Mr. Morris will act as Chief Technology Officer of the Company through January 31, 2015 at an annual salary of $150,000 until July 1, 2011, and $180,000 thereafter.  

Effective September 27, 2011, the Company entered into an employment agreement with George Bloom, pursuant to which Mr. Bloom, the Company’s Chief Engineering Officer, will act as Vice President-Engineering of the Company through January 31, 2016 at an annual salary of $180,000.

In May 2005 the Company declared contingent deferred stock bonuses of 690,000 shares to its key employees and consultants.  The stock bonuses of 492,500 and 197,500 shares are contingent upon the Company’s stock price exceeding $10.00 and $20.00 per share, respectively, and the grantees still being employed by or providing services to the Company at the time the target prices are reached.  As of September 30, 2012, 327,500 and 115,000 of these contingent bonus shares, respectively, remain outstanding, to be issued when and if the Company’s stock price exceeds $10.00 and $20.00 per share, respectively.  

Effective January 1, 2011 the Company declared a contingent stock bonus of 50,000 shares to Mr. Smith and effective July 15, 2012 the Company declared contingent stock bonuses of 100,000 and 25,000 shares to Mr. Smith and Mr. Schafer, respectively. The stock bonuses are contingent upon the Company’s stock price exceeding $10.00 and do not require that Mr. Smith or Mr. Schafer remain employed by the Company.  

23

BION ENVIRONMENTAL TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED SEPTEMBER 30, 2012

8.

COMMITMENTS AND CONTINGENCIES (continued):

Litigation:

The Company currently is not involved in any material litigation.

9.

SUBSEQUENT EVENTS:

The Company has evaluated events that occurred subsequent to September 30, 2012 for recognition and disclosure in the financial statements and notes to the financial statements.

From October 1, 2012 through November 6, 2012 the Company has issued 16,964 shares of the Company’s common shares to various consultants and an employee valued at approximately $33,700.

From October 1, 2012 through November 6, 2012 the Company has issued 34,223 Units (each consisting of one share of the Company’s common stock and a warrant to purchase ½ share of the Company’s common stock at $3.10 per share until December 31, 2014) for approximately $77,000 of proceeds.

As of November 6, 2012, the Company has accrued additional deferred compensation totaling approximately $59,500 of which $26,000 and $21,000, respectively, is owed to Mr. Bassani and Mr. Smith, and $12,500 is due to Mr. Shafer.

24

PART I - FINANCIAL INFORMATION

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes to Consolidated Financial Statements filed herein and with the Company's Form 10-K for the year ended June 30, 2012.

BUSINESS OVERVIEW

For several years, the Company focused on completion of the development of the next generation of its technology which provides a comprehensive environmental solution to a significant source of pollution in U.S. agriculture, large scale livestock facilities known as Confined Animal Feeding Operations ("CAFO's"). The re-development process is now substantially complete and the initial commercial system, based on our updated technology, has been constructed and placed in full commercial operation. Currently, Bion is focused on using applications of its patented waste management technology to pursue two main business opportunities: 1) installation of Bion systems to retrofit and environmentally remediate existing CAFOs in selected markets where: a) government policy supports such efforts (such as the Chesapeake Bay watershed and/or states and watersheds facing EPA ‘total maximum daily load’ (“TMDL’) issues, and/or b) where CAFO’s need our technology to obtain permits to expand or develop without negative environmental consequences; and 2) 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 recovering cellulosic biomass (to be utilized for renewable energy production) and nutrient rich solids (that can potentially to be marketed as feed and/or fertilizer), integrated with an ethanol plant capable of producing 40 million gallons (or more) of ethanol per year and/or with CAFO end product processors. The Company has been pursuing these opportunities within the United States during the later stages of technology re-development and has recently begun activities to pursue such opportunities internationally.

The Company has commenced actively pursuing the opportunity presented by environmental retrofit and remediation of the waste streams of existing CAFOs. The first commercial activity in this area is an agreement with Kreider Farms ("KF") in Pennsylvania to design, construct and operate a Bion system to treat KF's dairy and poultry waste streams to reduce nutrient releases to the environment while generating marketable nutrient credits and renewable energy. On January 26, 2009 the Board of the Pennsylvania Infrastructure Investment Authority (“Pennvest”) approved a $7.75 million loan to Bion PA 1, LLC (“PA-1”), a wholly-owned subsidiary of the Company, for the initial stage of Bion's Kreider Farms project. After substantial unanticipated delays, on August 12, 2010 the Company received a permit for construction of the Phase 1 Kreider system.  Construction activities commenced during November 2010.  The closing/settlement of the Pennvest Loan took place on November 3, 2010.   Bion finished the construction of the Phase 1 Kreider System and entered a period of system ‘operational shakedown’ during May 2011.  The Phase 1 Kreider System reached full, stabilized operation by the end of the 2012 fiscal year.  During 2011 the Pennsylvania Department of Environmental Protection (“PADEP”) re-certified the nutrient credits for this project.  The PADEP issued final permits for the Kreider System (including the credit verification plan) on August 1, 2012 on which date the Company deemed that the Kreider System was ‘placed in service’. As a result, Bion can now commence generating and verifying nutrient reduction credits for sale during the 2013 fiscal year while continuing to utilize the system to test improvements and add-ons.  Additionally, the Kreider System has met the ‘technology guaranty’ standards which were incorporated in the Pennvest financing documents and the Pennvest Loan is now solely an obligation of PA-1.

25

The Company continues its development work related to the second phase of the Kreider project (‘Phase 2 Kreider Project’) which involves production of renewable energy from the waste of KF’s poultry operations and the cellulosic solids recovered by the Phase 1 Kreider System. During May 2011 the PADEP certified the Phase 2 Kreider Project for 559,457 nutrient credits under the old EPA’s Chesapeake Bay model.  The Company anticipates that this project will be certified for between 1.5-2 million nutrient reduction credits pursuant to the recently amended EPA Chesapeake Bay model. The Company intends to have the Phase 2 Kreider Project operational during the 2013 calendar year, and hopes to enter into agreements related to sales of the credits for future delivery (under  long term contracts) during the 2013 fiscal year subject to verification by the PADEP.

The Company has commenced activities related to marketing and potential use of its technology in relation to expansion and/or development of CAFO’s in the Midwest (and elsewhere).  Bion considers this to be a large potential market for the Company’s growth over the next 18-36 months. It is anticipated that such activities will accelerate now that the Company has received final permits for the initial KF System (and as its credits are verified).  Now that final permitting and verification plan approval has been completed at the Kreider System, the Company intends to seek to advance commercial sales in additional areas which face deadlines to meet EPA TMDL requirements.

Additionally, we believe that Bion's technology platform will allow the integration of large-scale CAFO's and their end-product users, renewable energy production from the CAFO waste stream, and 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 and increasing revenue and profitability 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, will generate 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 CAFOs, and/or slaughter and/or processing facilities in the context of beef CAFOs) and/or other users as a  replacement for fossil fuel usage. In addition an integrated ethanol plant's main by-product, called distillers grain, can be added to the feed of the animals in wet form, thereby lowering the capital expenditures, operating, marketing and shipping costs and energy usage of the ethanol production process. In such cases, the ethanol plant would act as a feed mill for the integrated CAFO, thereby reducing the CAFO's feeding costs as well as generating revenue to the ethanol plant, and would also provide a market for the renewable energy that Bion's System produces from the CAFO waste stream. And, in some cases the nutrient rich liquid effluent from the Bion system modules may be directly utilized for greenhouse and/or hydroponic agriculture. Accordingly, such Bion Integrated Projects can be denominated "closed loop".  Bion, as developer of, and participant in, Integrated Projects, anticipates that it will share in the cost savings and the revenues generated from these activities.

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. The Company believes that its initial Integrated Project will most likely be located and developed (possibly in stages) in Pennsylvania and anticipates optioning land for such a Project during the current calendar year or soon thereafter.  Note that locations in other states are also under review and   the initial Integrated Project could be developed elsewhere. It is possible that the Company will develop one or more Integrated Projects as joint ventures specifically targeted to meet the growing animal protein demand outside of the United States (including without limitation Asia, Europe and/or the Middle East).  Bion intends to choose sites for additional Projects during the calendar years 2013-2015 to create a pipeline of Projects. Management has a 5-year development target (through calendar year 2019) of approximately 10-24 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 (or other locations), and the balance would be in various stages ranging from partial operation to early permitting stage. No Integrated Project has been developed to date.

26

The Company’s audited financial statements for the years ended June 30, 2012 and 2011 have been prepared assuming the Company will continue as a going concern.  The Company has incurred net losses of approximately $6,465,000 and $6,998,000 during the years ended June 30, 2012 and 2011, respectively.  At June 30, 2012, the Company had a working capital deficit and a stockholders’ deficit of approximately $345,000 and $858,000, respectively.  The Report of the Independent Registered Public Accounting Firm on the Company's consolidated financial statements as of and for the year ended June 30, 2012 includes a "going concern" explanatory paragraph which means that the accounting firm has expressed substantial doubt about the Company's ability to continue as a going concern.  The Company has incurred net losses of approximately $2,453,000 and $3,839,000 for the three months ended September 30, 2012 and 2011, respectively.  At September 30, 2012 the Company has a working capital deficit and a stockholder’s deficit of approximately $820,000 and $1,562,000, respectively.  Management's plans with respect to these matters are described in this section and in our consolidated financial statements (and notes thereto), and this material does not include any adjustments that might result from the outcome of this uncertainty.  However, there is no guarantee that we will be able to raise sufficient funds or further capital for the operations planned in the near future.  

CRITICAL ACCOUNTING POLICIES

Management has identified the following policies below as critical to our business and results of operations.  Our reported results are impacted by the application of the following accounting policies, certain of which require management to make subjective or complex judgments.  These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact quarterly or annual results of operations.  For all of these policies, management cautions that future events rarely develop exactly as expected, and the best estimates routinely require adjustment.  Specific risks associated with these critical accounting policies are described in the paragraphs below.

Revenue Recognition

While the Company has not recognized any operating revenues for the past two fiscal years, the Company anticipates that it will commence generation of revenues during the 2013 fiscal year.  Revenues will be generated from the sale of nutrient reduction credits, product sales, technology license fees, annual waste treatment fees and/or direct ownership interests in Integrated Projects.  The Company expects to recognize revenue from the sale of nutrient credits and products when there is persuasive evidence that an arrangement exists, when title has passed, the price is fixed or determinable, and collection is reasonably assured.  The Company expects that technology license fees will be generated from the licensing of Bion's systems.  The Company anticipates that it will charge its customers a non-refundable up-front technology license fee, which will be recognized over the estimated life of the customer relationship.  In addition, any on-going technology license fees will be recognized as earned based upon the performance requirements of the agreement. Annual waste treatment fees will be recognized upon receipt. Revenues, if any, from the Company's interest in Projects will be recognized when the entity in which the Project has been developed recognizes such revenue.

Stock-based compensation

The Company follows the provisions of Accounting Standards Codification 718, which generally requires that share-based compensation transactions be accounted and recognized in the statement of income based upon their grant date fair values.  

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Derivative Financial Instruments:

Pursuant to Accounting Standards Codification (“ASC”) Topic 815 “Derivatives and Hedging” (“Topic 815”), the Company reviews all financial instruments for the existence of features which may require  fair value accounting and a related mark-to-market adjustment at each reporting period end. Once determined, the Company assesses these instruments as derivative liabilities.  The fair value of these instruments is adjusted to reflect the fair value at each reporting period end, with any increase or decrease in the fair value being recorded in results of operations as an adjustment to fair value of derivatives.  

Warrants:

The Company has issued warrants to purchase common shares of the Company.  Warrants are valued using a fair value based method, whereby the fair value of the warrant is determined at the warrant issue date using a market-based option valuation model based on factors including an evaluation of the Company’s 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 valuations and purchases of the Company’s warrants.  When warrants are issued in combination with debt or equity securities, the warrants are valued and accounted for based on the relative fair value of the warrants in relation to the total value assigned to the debt or equity securities and warrants combined.

THREE MONTHS ENDED SEPTEMBER 30, 2012 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2011

General and Administrative

Total general and administrative expenses were $2,349,000 and $3,762,000 for the three months ended September 30, 2012 and 2011, respectively.

General and administrative expenses, excluding stock-based compensation charges of $1,407,000 and $3,001,000, were $942,000 and $761,000 for the three months ended September 30, 2012 and 2011, respectively, representing an $181,000 increase.  The primary reason for the increase is due to the increase in depreciation expense from $4,000 for the three months ended September 30, 2011 to $166,000 for the three months ended September 30, 2012. Kreider 1 was placed in service on August 1, 2012 and its components are being depreciated over their estimated useful lives.   Salaries and related payroll tax expenses increased to $300,000 for the three months ended September 30, 2012 from $230,000 for the three months ended September 30, 2011, primarily due to the fact that during the three months ended September 30, 2011, certain salaries were being capitalized as part of Kreider 1.  

General and administrative stock-based compensation for the three months ended September 30, 2012 and 2011 consists of the following:

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	Three months ended September 30, 2012		Three months ended September 30, 2011
General and administrative:
Fair value of stock/warrant bonuses expensed	$    1,151,000		$  1,035,000
Fair value of stock issued to an employee	25,000		25,000
Change in fair value from modification of option terms	-		95,000
Fair value of stock options expensed under ASC 718	231,000		1,846,000
Total	$1,407,000		$3,001,000

Stock-based compensation charges decreased to $1,407,000 from $3,001,000 for the three months ended September 30, 2012 and 2011, respectively.  Compensation expense relating to stock options was $231,000 and $1,846,000 during the three months ended September 30, 2012 and 2011, respectively, and the decrease is due to more options being vested upon grant date during the three months ended September 30, 2011.  The Company also recognized general and administrative non-cash compensation expenses of $1,151,000 and $1,035,000 during the three months ended September 30, 2012 and 2011, respectively, due to the granting and vesting of stock and warrant bonuses.  The non-cash compensation expense related to stock and warrant bonuses for both periods were primarily in connection with the extension of employment agreements of two key officers.  Compensation expense relating to the change in fair value from the modification of option terms was nil and $95,000 for the three months ended September 30, 2012 and 2011, respectively.  During the three months ended September 30, 2011 the options of a key employee were modified.  

Research and Development

Total research and development expenses were $49,000 and $70,000 for the three months ended September 30, 2012 and 2011, respectively.

Research and development expenses, excluding stock-based compensation charges of $9,000 and $41,000  were $40,000 and $29,000 for the three months ended September 30, 2012 and 2011, respectively.  The primary reason for the increase is due to some pilot program testing related to the enhancement of the Company’s technology.  

Research and development stock-based compensation for the three months ended September 30, 2012 and 2011 consists of the following: