**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**x  QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934****for thequarterly period ended March 31, 2008**

 

**or**

 

**o  Transition Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

**(Forthe transition period from        to      ).**

** **

**Commission File Number: 000-31973**

 

**Beacon Power Corporation**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                    | **04-3372365**      |
|---------------------------------|---------------------|
| (State or other jurisdiction of | (I.R.S. Employer    |
| incorporation or organization)  | Identification No.) |

 

| **65 Middlesex road**                    |       |
|------------------------------------------|------------|
| **Tyngsboro, Massachusetts**             | **01879**  |
| (Address of principal executive offices) | (Zip code) |

 

**(978) 694-9121**

(Registrant’s telephone number, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15 (d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  xYes o No

 

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

 

| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in rule 12b-2 of theExchange Act.) o Yes x No

 

The number of shares ofthe Registrant’s common stock, par value $.01 per share, outstanding as of May 1,2008 was 88,682,707.

 

 

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**BEACON POWER CORPORATION ANDSUBSIDIARY(A Development Stage Company)Table of Contents**

 
| ** **    | **Page**                                                                                                                                                                                             |
|---------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **    | ** **                                                                                                                                                                                           |
| PART I.  | Financial  Information                                                                                                                                                                               |   |
|          |                                                                                                                                                                                                 |
| Item 1.       | Financial Statements                                                                                                                                                                                 |   |
|          |                                                                                                                                                                                                 |   |
|          | Consolidated Balance Sheets at March 31, 2008  (unaudited) and December 31, 2007 (audited).                                                                                                | 1 |
|          |                                                                                                                                                                                                 |   |
|          | Unaudited Consolidated Statements of Operations for  the three months ended March 31, 2008 and 2007, and for the period from  May 8, 1997 (date of inception) through March 31, 2008. | 2 |
|          |                                                                                                                                                                                                 |   |
|          | Unaudited Consolidated Statements of Cash Flows for  the three months ended March 31, 2008 and 2007 and for the period from  May 8, 1997 (date of inception) through March 31, 2008.  | 3 |
|          |                                                                                                                                                                                                 |   |
|          | Notes to Unaudited Consolidated Financial Statements.                                                                                                                                                | 5 |
|          |                                                                                                                                                                                                 |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.                                                                                                         | 15 |
|          |                                                                                                                                                                                                 |   |
| Item 3.       | Quantitative  and Qualitative Disclosures about Market Risk.                                                                                                                                         | 31 |
|          |                                                                                                                                                                                                 |   |
| Item 4.       | Controls and Procedures.                                                                                                                                                                             | 32 |
|          |                                                                                                                                                                                                 |   |
| PART II. | Other Information                                                                                                                                                                                    |   |
|          |                                                                                                                                                                                                 |   |
| Item 1.       | Legal Proceedings.                                                                                                                                                                                   | 33 |
|          |                                                                                                                                                                                                 |   |
| Item 1A.      | Risk Factors.                                                                                                                                                                                        | 33 |
|          |                                                                                                                                                                                                 |   |
| Item 2.       | Unregistered  Sales of Equity Securities and Use of Proceeds.                                                                                                                                        | 33 |
|          |                                                                                                                                                                                                 |   |
| Item 3.       | Defaults  Upon Senior Securities.                                                                                                                                                                    | 33 |
|          |                                                                                                                                                                                                 |   |
| Item 4.       | Submission  of Matters to a Vote of Security Holders.                                                                                                                                                | 33 |
|          |                                                                                                                                                                                                 |   |
| Item 5.       | Other Information.                                                                                                                                                                                   | 33 |
|          |                                                                                                                                                                                                 |   |
| Item 6.       | Exhibits.                                                                                                                                                                                            | 33 |
|          |                                                                                                                                                                                                 |   |
| Signatures    |                                                                                                                                                                                                 | 34 |
|               |                                                                                                                                                                                                      |  |  |

 

ii

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**PART 1 — FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**BEACON POWER CORPORATION ANDSUBSIDIARY(A Development Stage Company)Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                             | ** ** | **(unaudited)**    | ** ** | **(audited)**         | ** ** |
| **Assets**                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                              |       | $                  | 25,037,320 |                  | $          | 30,417,095 |   |
| Accounts receivable, trade, net                                                                                                                                                        |       | 71,915             |       | 424,788               |       |
| Unbilled costs on contracts in progress                                                                                                                                                |       | 82,139             |       | 82,195                |       |
| Prepaid expenses and other current assets                                                                                                                                              |       | 1,610,454          |       | 1,475,084             |       |
| Total current assets                                                                                                                                                                   |       | 26,801,828         |       | 32,399,162            |       |
| Property and equipment,  net                                                                                                                                                           |       | 9,333,734          |       | 7,004,021             |       |
| Restricted cash                                                                                                                                                                        |       | 200,000            |       | 374,346               |       |
| Total assets                                                                                                                                                                           |       | $                  | 36,335,562 |                  | $          | 39,777,529 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                                         | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                                   |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                       |       | $                  | 673,222    |                  | $          | 296,463 |   |
| Accrued compensation and benefits                                                                                                                                                      |       | 804,022            |       | 1,024,874             |       |
| Other accrued expenses                                                                                                                                                                 |       | 2,124,904          |       | 2,183,217             |       |
| Advance billings on contracts                                                                                                                                                          |       | 7,166              |       | 7,222                 |       |
| Accrued contract loss                                                                                                                                                                  |       | 66,921             |       | 67,419                |       |
| Lease liability - current                                                                                                                                                              |       | 7,370              |       | —                |       |
| Total current liabilities                                                                                                                                                              |       | 3,683,605          |       | 3,579,195             |       |
| Commitments and  contingencies (Note 5)                                                                                                                                                |       |               |       |                  |       |
| Lease liability - long  term                                                                                                                                                           |       | 971,292            |       | —                |       |
| Stockholders’ equity:                                                                                                                                                             |       |               |       |                  |       |
| Preferred Stock, $.01 par value; 10,000,000 shares authorized; no  shares issued or outstanding                                                                                        |       | —             |       | —                |       |
| Common stock, $.01 par value; 200,000,000 shares authorized; 88,668,448  and 88,658,967 shares issued and outstanding at March 31, 2008 and  December 31, 2007, respectively |       | 886,685            |       | 886,590               |       |
| Additional paid-in-capital                                                                                                                                                             |       | 200,120,999        |       | 199,351,427           |       |
| Deficit accumulated during the development stage                                                                                                                                       |       | (168,614,180       | )          | (163,326,844          | )          |
| Treasury stock, 421,692 shares at cost                                                                                                                                                 |       | (712,839           | )          | (712,839              | )          |
| Total  stockholders’ equity                                                                                                                                                       |       | 31,680,665         |       | 36,198,334            |       |
| Total liabilities and  stockholders’ equity                                                                                                                                       |       | $                  | 36,335,562 |                  | $          | 39,777,529 |   |

 

See notes to unaudited consolidated financial statements.

 

1

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**BEACONPOWER CORPORATION AND SUBSIDIARY**

**(A Development Stage Company)Consolidated Statements of Operations (Unaudited)**

 
| ** **                                  | ** ** | ** **                             | ** ** | ** **                  | ** ** | **Cumulative  from**     | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | ** **                             | ** ** | ** **                  | ** ** | **May 8,  1997**    | ** ** |
| ** **                                  | ** ** | ** **                             | ** ** | ** **                  | ** ** | **(date  of inception)** | ** ** |
| ** **                                  | ** ** | **Three  months ended March 31,** | ** ** | **through  March 31,** | ** ** |
|                                        | ** ** | **2008**                               | ** ** | **2007**                    | ** ** | **2008**                 | ** ** |
| Revenue                                     |       | $                                      | 20,203     |                        | $          | 392,706                  |       | $ | 4,740,750 |   |
| Cost of goods sold                          |       | 57                                     |       | 392,246                     |       | 5,126,316                |       |
| Gross profit                                |       | 20,146                                 |       | 460                         |       | (385,566                 | )          |
| Operating expenses:                         |       |                                   |       |                        |       |                     |       |
| Selling, general and administrative         |       | 2,175,661                              |       | 1,414,359                   |       | 53,150,056               |       |
| Research and development                    |       | 3,032,342                              |       | 1,659,558                   |       | 71,450,830               |       |
| Loss on contract commitments                |       | —                                 |       | —                      |       | 2,717,461                |       |
| Depreciation and amortization               |       | 279,741                                |       | 25,968                      |       | 4,740,831                |       |
| Casualty loss (recovery)                    |       | —                                 |       | 107,943                     |       | —                   |       |
| Restructuring charges                       |       | —                                 |       | —                      |       | 2,159,280                |       |
| Loss on impairment of assets                |       | —                                 |       | —                      |       | 4,663,916                |       |
| Total operating expenses                    |       | 5,487,744                              |       | 3,207,828                   |       | 138,882,374              |       |
| Loss from operations                        |       | (5,467,598                             | )          | (3,207,368                  | )          | (139,267,940             | )          |
| Other income (expense):                     |       |                                   |       |                        |       |                     |       |
| Interest income                             |       | 180,394                                |       | 113,885                     |       | 5,414,402                |       |
| Interest expense                            |       | —                                 |       | —                      |       | (1,093,703               | )          |
| Gain on sale of investment                  |       | —                                 |       | —                      |       | 3,562,582                |       |
| Other income (expense)                      |       | (132                                   | )          | 3,865                       |       | (223,327                 | )          |
| Total other income, net                     |       | 180,262                                |       | 117,750                     |       | 7,659,954                |       |
| Net loss                                    |       | (5,287,336                             | )          | (3,089,618                  | )          | (131,607,986             | )          |
| Preferred stock dividends                   |       | —                                 |       | —                      |       | (36,825,680              | )          |
| Accretion of convertible  preferred stock   |       | —                                 |       | —                      |       | (113,014                 | )          |
| Loss to common  shareholders                |       | $                                      | (5,287,336 | )                           | $          | (3,089,618               | )          | $ | (168,546,680 | ) |
| Loss per share, basic and  diluted          |       | $                                      | (0.06      | )                           | $          | (0.05                    | )          |   |   |
| Weighted-average common  shares outstanding |       | 88,668,383                             |       | 65,432,694                  |       |                     |       |

 

See notes to unaudited consolidated financial statements.

 

2

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**BEACON POWER CORPORATION ANDSUBSIDIARY(A Development Stage Company)Consolidated Statements of Cash Flows (Unaudited)**

 
| ** **                                                                   | ** ** | ** **                             | ** ** | ** **         | ** ** | **Cumulative  from**     | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|--------------------------|------------|
| ** **                                                                   | ** ** | ** **                             | ** ** | ** **         | ** ** | **May 8,  1997**    | ** ** |
| ** **                                                                   | ** ** | ** **                             | ** ** | ** **         | ** ** | **(date  of inception)** | ** ** |
| ** **                                                                   | ** ** | ** **                             | ** ** | **through**        | ** ** |
| ** **                                                                   | ** ** | **Three  months ended March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                                                   | ** ** | **2008**                               | ** ** | **2007**           | ** ** | **2008**                 | ** ** |
| Cash flows from operating  activities:                                       |       |                                   |       |               |       |                     |       |
| Net loss                                                                     |       | $                                      | (5,287,336 | )                  | $          | (3,089,618               | )          | $ | (131,607,986 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities: |       |                                   |       |               |       |                     |       |
| Depreciation and amortization                                                |       | 279,741                                |       | 25,968             |       | 4,740,832                |       |
| Loss (gain) on sale or disposal of fixed assets                              |       | 132                                    |       | (3,865             | )          | 193,078                  |       |
| Impairment of assets, net                                                    |       | —                                 |       | 7,263              |       | 4,551,147                |       |
| (Expenses paid) restructuring charge                                         |       | —                                 |       | (91,515            | )          | —                   |       |
| Interest expense relating to issuance of warrants                            |       | —                                 |       | —             |       | 371,000                  |       |
| Non-cash charge for change in option terms                                   |       | —                                 |       | —             |       | 346,591                  |       |
| Non-cash charge for settlement of lawsuit                                    |       | —                                 |       | —             |       | 303,160                  |       |
| Amortization of deferred consulting expense, net                             |       | —                                 |       | —             |       | 1,160,784                |       |
| Amortization of deferred stock compensation                                  |       | —                                 |       | —             |       | 3,699,721                |       |
| Options and warrants issued for consulting services                          |       | —                                 |       | —             |       | 1,585,654                |       |
| Services and interest expense paid in preferred stock                        |       | —                                 |       | —             |       | 11,485                   |       |
| Gain on sale of investments                                                  |       | —                                 |       | —             |       | (3,562,582               | )          |
| Stock-based compensation                                                     |       | 751,310                                |       | 580,257            |       | 3,859,984                |       |
| Deferred rent                                                                |       | 65,972                                 |       | —             |       | (451,338                 | )          |
| Cash received from landlord for build-out credit                             |       | 1,430,000                              |       | —             |       | 1,430,000                |       |
| Changes in operating assets and liabilities:                                 |       |                                   |       |               |       |                     |       |
| Accounts receivable                                                          |       | 352,873                                |       | 377,547            |       | (71,915                  | )          |
| Unbilled costs on government contracts                                       |       | 56                                     |       | (78,555            | )          | (82,139                  | )          |
| Prepaid expenses and other current assets                                    |       | (652,680                               | )          | 89,004             |       | (1,710,114               | )          |
| Accounts payable                                                             |       | 376,759                                |       | (247,497           | )          | 673,222                  |       |
| Accrued compensation and benefits                                            |       | (220,852                               | )          | 38,854             |       | 804,022                  |       |
| Advance billings on contracts                                                |       | (56                                    | )          | (225,333           | )          | 7,166                    |       |
| Accrued interest                                                             |       | —                                 |       | —             |       | 275,560                  |       |
| Accrued loss on contract commitments                                         |       | (498                                   | )          | (254,117           | )          | 66,921                   |       |
| Other accrued expenses and current liabilities                               |       | (58,313                                | )          | 80,859             |       | 2,133,574                |       |
| Net cash used in operating activities                                        |       | (2,962,892                             | )          | (2,790,748         | )          | (111,272,173             | )          |
| Cash flows from investing  activities:                                       |       |                                   |       |               |       |                     |       |
| Purchase of investments                                                      |       | —                                 |       | —             |       | (1,190,352               | )          |
| Sale of investments                                                          |       | —                                 |       | —             |       | 4,752,934                |       |
| Restricted cash                                                              |       | 174,346                                |       | —             |       | (200,000                 | )          |
| Increase in other assets                                                     |       | —                                 |       | —             |       | (412,072                 | )          |
| Purchases of property and equipment                                          |       | (2,609,586                             | )          | (45,606            | )          | (18,155,782              | )          |
| Sale of property and equipment                                               |       | —                                 |       | 4,077              |       | 202,674                  |       |
| Net cash used in investing activities                                        |       | (2,435,240                             | )          | (41,529            | )          | (15,002,598              | )          |
| Cash flows from financing  activities:                                       |       |                                   |       |               |       |                     |       |
| Initial public stock offering, net of expenses                               |       | —                                 |       | —             |       | 49,341,537               |       |
| Stock offerings, net of expenses                                             |       | 18,357                                 |       | 9,717,095          |       | 59,677,195               |       |
|                                                                              |            |                                        |            |                    |            |                          |            |  |  |  |

 

3

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| ** **                                          | ** ** | ** **                             | ** ** | ** **         | ** ** | **Cumulative  from**     | ** ** |
|-----------------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|--------------------------|------------|
| ** **                                          | ** ** | ** **                             | ** ** | ** **         | ** ** | **May 8,  1997**    | ** ** |
| ** **                                          | ** ** | ** **                             | ** ** | ** **         | ** ** | **(date  of inception)** | ** ** |
| ** **                                          | ** ** | ** **                             | ** ** | **through**        | ** ** |
| ** **                                          | ** ** | **Three  months ended March 31,** | ** ** | **March 31,** | ** ** |
| ** **                                          | ** ** | **2008**                               | ** ** | **2007**           | ** ** | **2008**                 | ** ** |
| Payment of dividends                                |       | —                                 |       | —             |       | (1,159,373               | )          |
| Shares issued under employee stock purchase plan    |       | —                                 |       | —             |       | 177,904                  |       |
| Exercise of employee stock options                  |       | —                                 |       | —             |       | 2,288,909                |       |
| Stock and warrants issued to landlord               |       | —                                 |       | —             |       | 716,614                  |       |
| Issuance of preferred stock                         |       | —                                 |       | —             |       | 32,868,028               |       |
| Repayment of subscription receivable                |       | —                                 |       | —             |       | 5,000,000                |       |
| Proceeds from capital leases                        |       | —                                 |       | —             |       | 495,851                  |       |
| Repayment of capital leases                         |       | —                                 |       | —             |       | (1,031,395               | )          |
| Repurchase company stock                            |       | —                                 |       | —             |       | (613,179                 | )          |
| Proceeds from notes payable issued to investors     |       | —                                 |       | —             |       | 3,550,000                |       |
| Net cash provided by (used in) financing activities |       | 18,357                                 |       | 9,717,095          |       | 151,312,091              |       |
| (Decrease) increase in  cash and cash equivalents   |       | (5,379,775                             | )          | 6,884,818          |       | 25,037,320               |       |
| Cash and cash equivalents,  beginning of period     |       | 30,417,095                             |       | 5,251,337          |       | —                   |       |
| Cash and cash equivalents,  end of period           |       | $                                      | 25,037,320 |               | $          | 12,136,155               |       | $ | 25,037,320 |   |
| Supplemental disclosure of  cash flow information:  |       |                                   |       |               |       |                     |       |
| Cash paid for interest                              |       | $                                      | —     |               | $          | —                   |       | $ | 488,126 |   |
| Cash paid for taxes                                 |       | $                                      | —     |               | $          | —                   |       | $ | 32,750 |   |
| Assets acquired through capital lease               |       | $                                      | —     |               | $          | —                   |       | $ | 535,445 |   |

 

See notes to unaudited consolidated financial statements.

 

4

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**BEACON POWER CORPORATION ANDSUBSIDIARY(A Development Stage Company)Notes to Unaudited Consolidated Financial Statements**

 

**Note1.  Nature of Business and Operations**

 

*Natureof Business*

 

Beacon PowerCorporation (the “Company”, “Beacon”, “we”, “our”, or “us”) (a developmentstage company) was incorporated on May 8, 1997.  Since our inception,we have been primarily engaged in the development of flywheel devices forstoring and transmitting kinetic energy.  During 2000 we completed aninitial public offering of our common stock and raised approximately $49.3million net of offering expenses. Since 2000, we have raised approximately$59.7 million through the sale of common stock and warrants. We expect togenerate revenues in the future from the commercialization of our flywheelenergy storage systems to supply frequency regulation services to theelectricity grid.  We believe that our sustainable energy storage andpower conversion solutions can help provide reliable electric power for theutility, renewable energy, and distributed generation markets. In addition, webelieve as the commercialization of our technologies continues, we will developother cost-effective applications for our flywheel systems that will provideadditional revenue opportunities. Because we have not yet generated asignificant amount of revenue from our principal operations, we are accountedfor as a development stage company under Statement of Financial AccountingStandards No. 7.

 

*Operations*

 

We haveexperienced net losses since our inception and, as of March 31, 2008, hadan accumulated deficit of approximately $168.6 million.  We do not expect to become profitable or cashflow positive until at least 2010. We will need to raise additional capital toexecute our business plan and continue as a going concern.  Based on our current cash usage rates andadditional expenditures expected in support of our business plan, we haveenough cash to fund operations into approximately the fourth quarter of2008.  We will require substantial funds to construct and deploy flywheel-basedfrequency regulation facilities, continue research and development activitiesand further market our products and services. We anticipate that such funds will be obtained from external sources andwe intend to seek additional equity or debt to fund future operations. Weestimate that we will need to raise an additional $20 million during 2008through the issuance of equity securities in order to complete development ofthe Smart Energy MatrixTM flywheel system, and to build, operate and receivefees for frequency regulation services, and have sufficient working capital tocontinue to execute our business plan. Our short-term business plan includesmanufacturing the flywheel systems and beginning construction of frequencyregulation facilities in at least two of our initial target markets which arethe New York ISO, New England ISO, Midwest ISO or PJM.  Beyond 2008 we will continue tohave capital needs that will require additional equity or debt to fund theongoing deployment of frequency regulation facilities.

 

**Note2.  Basis of Presentation and Summary of Significant Accounting Policies**

 

**Basis ofPresentation**

 

The accompanyingunaudited consolidated financial statements have been prepared using accountingprinciples generally accepted in the United States of America except thatcertain information and footnote disclosures normally included in consolidatedfinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted in this Form 10-Q.  Wesuggest that the consolidated financial statements presented herein be read inconjunction with our consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2007.  In our management’s opinion, all adjustments consisting of normalrecurring accruals considered necessary for a fair presentation have beenincluded in the accompanying unaudited financial statements.  Operatingresults for the three months ended March 31, 2008 are not necessarilyindicative of the results that may be expected for the full year ending December 31,2008.

 

5

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*GoingConcern*

 

The accompanyingconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business.  As shown in ourconsolidated financial statements, we have had minimal revenues and incurredlosses of approximately $168.6 million since our inception, including lossesduring the three months ending March 31, 2008 of approximately $5.3million.  We have approximately $25 million of cash and cash equivalentson hand at March 31, 2008.  Since our operating cash requirements farexceed any cash generated from operations, we may be unable to continue as agoing concern.  The consolidated financial statements contained herein donot include any adjustments relating to the recoverability and classificationof liabilities that might be necessary should we be unable to continue as agoing concern.

 

We recognize thatour continuation as a going concern is dependent upon our ability to generatesufficient cash flow to allow us to satisfy our obligations on a timelybasis.  The generation of sufficient cash flow is dependent in theshort-term on our ability to obtain additional equity and debt financing, andin the long-term, on our ability to successfully establish a share of thefrequency regulation market based on deploying our Smart Energy MatrixTMflywheel systems that are now entering production and obtain debt financing todevelop frequency regulation facilities.

 

*Consolidation*

 

The accompanyingconsolidated financial statements include the accounts of Beacon PowerCorporation and our subsidiary, Beacon Power Securities Corporation.  Allsignificant inter-company accounts and transactions have been eliminated inconsolidation.

 

*Lossper Share — Basic and Diluted*

 

Basic and dilutedlosses per share have been computed using the weighted-average number of sharesof common stock outstanding during each period. Warrants, options and othersecurities exercisable for common shares are used in the calculation offully-diluted EPS only if their conversion to common shares would decreaseincome or increase loss per share from continuing operations.  Since thequarters ended March 31, 2008 and 2007 reflect losses, including thepotential conversion of warrants and options in the diluted EPS calculationwould decrease loss per share. Thus, they are considered anti-dilutive and arenot included in the calculation of earnings per share.

 

**Summaryof Significant Accounting Policies**

 

*Use ofEstimates*

 

The preparation ofconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period.  Actual results could differ fromthose estimates.

 

*Lease Obligation and DeferredRent*

 

During July 2007,we signed a seven-year operating lease with escalating payments on a 103,000square foot facility in Tyngsboro, Massachusetts. As part of this lease agreement,we issued to the landlord 150,000 shares of our common stock and a warrantexercisable for 500,000 shares of our common stock in return for lower cashpayments under the lease. (See Note 5: Commitments and Contingencies.)  Additionally, the landlord has reimbursed theCompany for certain leasehold improvements. These reimbursements have beencredited to our lease liability.  We haverecorded rent expense on a straight line basis in accordance with SFAS No. 13,“*Accounting for Leases*.”  The current portion of the deferred rent isincluded in current liabilities, and the remainder is shown on the balancesheet as “Lease payable – long term.” Prior to the receipt of the landlord leasehold improvementreimbursements during the first quarter of 2008, Deferred Rent had a debitbalance and was included in “Prepaid expenses and other current assets.”  The amount included in prepaid expenses as ofDecember 31, 2007 was approximately $517,000.

 

6

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*Property and Equipment*

 

Propertyand equipment, including leasehold improvements, are stated at cost anddepreciated using the straight-line method over the estimated useful lives ofthe assets. The cost of the item is defined as the purchase price of the itemas well as all of the costs necessary to bring it to the condition and locationnecessary for its intended use. Repair and maintenance costs are expensed asincurred.  Capital assets are classifiedas “Construction in Progress” (CIP) when initially acquired, and reclassifiedto the appropriate asset account after being placed into service. Depreciationexpense is not recorded on assets not yet placed into service. Materialspurchased to build flywheels for use in our frequency regulation facilities areclassified as CIP, along with related labor and overhead costs.  No overhead is generally applied for otherinternally-constructed projects not directly related to our core business(e.g., leasehold improvements.)

 

*Stock-BasedCompensation*

 

We account forstock-based compensation in accordance with the Financial Accounting StandardsBoard’s Statement of Financial Accounting Standards No. 123R (“SFAS 123R”),“Share-Based Payment”. Under the fair value recognition provisions of SFAS123R, stock-based compensation cost is measured at the grant date based on thefair value of the award and is recognized as an expense as it is earned overthe requisite service period, which is the vesting period. We implemented thisstandard using the modified-prospective transition method, under which priorperiods were not revised for comparative purposes. The valuation provisions ofSFAS 123R apply to new grants and to grants that were outstanding as of theeffective date and are subsequently modified. Estimated compensation expensefor grants that were outstanding as of the effective date will be recognizedover the remaining vesting period using the compensation cost estimated for theSFAS 123R pro forma disclosures.

 

The adoption ofSFAS 123R had a material impact on our consolidated financial position andresults of operations.

 

*Restructuring and Asset Impairment Charges*

 

We periodicallyevaluate all of our property and equipment as required by Statement ofFinancial Accounting Standards No. 144 “*Accountingfor the Impairment or Disposal of Long-Lived Assets*,” and recordimpairment charges as appropriate.

 

**Note3.  Accounts Receivable**

 

Our trade accountsreceivable include amounts due from customers and are reported net of a reservefor uncollectible accounts as follows:

 
| ** **                 | ** ** | **As of:**         | ** ** |
|----------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                 | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Accounts receivable, trade |       | $                  | 74,483     |   | $ | 427,356 |   |
| Reserve                    |       | (2,568             | )          | (2,568 | ) |
| Accounts receivable, net   |       | $                  | 71,915     |   | $ | 424,788 |   |

 

Two of ourresearch and development contracts contain holdback provisions that allow ourcustomers to withhold 10% from each invoice payment. At March 31, 2008 andDecember 31, 2007 we had approximately $69,000 and $68,000 of holdbacks,respectively, in our accounts receivable balance.  These holdbacks arepayable once work has been satisfactorily completed and the final reports havebeen delivered and approved.

 

7

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**Note4.  Property and Equipment**

 

Details of our propertyand equipment follow:

 
| ** **                                      | ** ** | **Estimated** | ** ** | **As of:**         | ** ** |
|-------------------------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                                      | ** ** | **Useful**    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                      | ** ** | **Lives**     | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Construction in Progress                        |       | Varied        |       | $                  | 2,012,929  |   | $ | 5,782,127 |   |
| Machinery and equipment                         |       | 5  - 10 years |       | 1,372,048          |       | 1,137,946 |   |
| Service vehicles                                |       | 5  years      |       | 16,763             |       | 16,763 |   |
| Furniture and fixtures                          |       | 7  years      |       | 730,460            |       | 603,382 |   |
| Office equipment                                |       | 3  years      |       | 912,670            |       | 828,918 |   |
| Leasehold improvements                          |       | Lease  term   |       | 5,932,884          |       | — |   |
| Equipment under capital  lease obligations      |       | Lease  term   |       | 700,517            |       | 700,516 |   |
| Total                                           |       |          |       | $                  | 11,678,271 |   | $ | 9,069,652 |   |
| Less accumulated  depreciation and amortization |       |          |       | (2,344,537         | )          | (2,065,631 | ) |
| Property and equipment, net                     |       |          |       | $                  | 9,333,734  |   | $ | 7,004,021 |   |

 

The components ofconstruction in progress, which represents costs related to assets that havenot yet been placed into service and for which no depreciation expense has beentaken, were as follows:

 
| ** **                                                                                  | ** ** | **As of:**         | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                  | ** ** | **2008**           | ** ** | **2007** | ** ** |
| Materials to build production flywheels                                                     |       | $                  | 1,277,716  |   | $ | 453,192 |   |
| Frequency regulation facilities                                                             |       | 222,393            |       | 9,527 |   |
| Deposits and other costs related to the acquisition of land for frequency  regulation plant |       | 95,754             |       | 17,123 |   |
| Machinery and equipment                                                                     |       | 123,204            |       | 85,725 |   |
| Office equipment                                                                            |       | 63,862             |       | 115,647 |   |
| Leasehold improvements                                                                      |       | 230,000            |       | 5,100,913 |   |
| Construction in progress                                                                    |       | $                  | 2,012,929  |   | $ | 5,782,127 |   |

 

**Note5.  Commitments and Contingencies**

 

The followingtable summarizes our commitments at March 31, 2008:

 
| ** **             | ** ** | **Description  of Commitment** | ** ** |
|------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **Operating  leases**          | ** ** | **Purchase    Obligations** | ** ** | **Total** | ** ** |
| Period ending:         |       |                           |       |   |   |   |   |
| March 31, 2008    |       | $                              | —     |   | $ | 7,132,240 |   | $ | 7,132,240 |   |
| December 31, 2008 |       | 422,438                        |       |   |   | 422,438 |   |
| December 31, 2009 |       | 701,687                        |       |   |   | 701,687 |   |
| December 31, 2010 |       | 727,437                        |       |   |   | 727,437 |   |
| December 31, 2011 |       | 753,188                        |       |   |   | 753,188 |   |
| December 31, 2012 |       | 778,937                        |       |   |   | 778,937 |   |
| Thereafter             |       | 1,422,689                      |       |   |   | 1,422,689 |   |
| Total Commitments      |       | $                              | 4,806,376  |   | $ | 7,132,240 |   | $ | 11,938,616 |   |

 

8

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At March 31,2008, we had firm purchase commitments with our suppliers to acquire componentsfor needed to manufacture commercial flywheel units, complete the build-out ofthe Tyngsboro facility, begin development of our initial frequency regulationfacilities and to satisfy contractual obligations for our research anddevelopment programs in the amount of approximately $7.1 million.

 

In July 2007,we signed a seven-year lease on a new corporate headquarters that significantlyexpands our manufacturing capacity and provides sufficient space to continueour research and development activities. Our new facility is located at 65Middlesex Road, Tyngsboro, MA.  The103,000 square foot facility, which has manufacturing capacity for theproduction of more than 1,000 flywheels per year, has been renovated andbuilt-out to our specifications, and we relocated all operations to our newcorporate headquarters in January 2008.

 

We have providedthe Tyngsboro lessor with an irrevocable letter of credit securing ourperformance under the lease with a balance at March 31, 2008 of $200,000,which is reduced periodically during the lease term.  This letter ofcredit is secured by a cash deposit, which is included in restricted cash inthe accompanying consolidated balance sheets. In addition to our rent payments, we are responsible for real estatetaxes and all operating expenses of the Tyngsboro facility.

 

Additional capitalexpenditures will be required in the future to optimize the plant for maximummanufacturing capacity.  The amount andtiming of these expenditures are dependent on requirements for equipment neededto meet production schedules as well as having sufficient funding.

 

*LegalProceedings*

 

We may from timeto time be subject to legal proceedings, often likely to involve routinelitigation incidental to our business.  The outcome of any legalproceeding is not within our complete control, may often be difficult topredict and may be resolved over a very long period of time.  Estimatingprobable losses associated with any legal proceedings or other loss contingencyis very complex and requires the analysis of many factors including assumptionsabout potential actions by third parties.  A loss contingency is recordedas a liability in the consolidated financial statements when it is both (i) probableand known that a liability has been incurred and (ii) the amount of theloss is reasonably estimable.  If the reasonable estimate of the loss is arange and no amount within the range is a better estimate, the minimum amountof the range is recorded as a liability.  If a loss contingency is notprobable or not reasonably estimable, a liability is not recorded in theconsolidated financial statements.

 

OnOctober 9, 2007, Arete Power, Inc. filed a complaint against usclaiming damages from alleged willful infringement of U.S. Patent No. 6,710,489,entitled “Axially Free Flywheel System.” On November 30, 2007, we filed an Answer denying infringement and aCounterclaim seeking a declaratory judgment that the ‘489 patent isinvalid.  At the same time, we filed amotion to transfer the lawsuit from the Northern District of California to theDistrict of Massachusetts.  On February 22,2008, the Court granted our motion to transfer the lawsuit to the District ofMassachusetts.  We believe that thislawsuit is without merit and we plan to vigorously defend the Company againstthe lawsuit.

 

9

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**Note6.  Stock Warrants**

 

The followingschedule shows warrants outstanding as of March 31, 2008:

 
| **Description**                                        | ** ** | **Grant Date** | ** ** | **Expiration  Date** | ** ** | **Strike  Price** | ** ** | **Issued and  Outstanding** | ** ** |
|--------------------------------------------------------|------------|---------------------|------------|----------------------|------------|-------------------|------------|----------------------------------|------------|
| May 24, 2005 Financing                            |       | 5/24/2005           |       | 5/24/2010            |       | $                 | 1.008      |                             | 800,000    |   |
| November 8, 2005 Financing (Investors)            |       | 11/8/2005           |       | 11/8/2010            |       | $                 | 1.99       |                             | 3,287,821  |   |
| November 8, 2005 Financing (Placement Agents)     |       | 11/8/2005           |       | 11/8/2010            |       | $                 | 2.21       |                             | 450,000    |   |
| February 15, 2007 Shelf Issue                     |       | 2/15/2007           |       | 2/15/0012            |       | $                 | 1.33       |                             | 6,261,786  |   |
| GFI Tyngsboro Lease                                    |       | 7/23/2007           |       | 7/22/2014            |       | $                 | 1.77       |                             | 500,000    |   |
| September 10, 2007 Shelf Issue (Investors)        |       | 9/10/2007           |       | 3/10/2013            |       | $                 | 1.99       |                             | 6,122,449  |   |
| September 10, 2007 Shelf Issue (Placement Agents) |       | 9/10/2007           |       | 3/10/2013            |       | $                 | 1.99       |                             | 153,061    |   |
| October 31, 2007 Shelf Issue                      |       | 10/31/2007          |       | 5/1/2013             |       | $                 | 2.97       |                             | 11,316,260 |   |
| Total warrants outstanding                             |       |                |       |                 |       |              |       | 28,891,377                       |       |

 

We haveoutstanding various series of warrants to purchase our common stock. Holders ofthe warrants are not entitled to receive dividends, vote, receive notice of anymeetings of stockholders or otherwise have any right as stockholders withrespect to their warrant shares.

 

*May 2005 Financing Warrant*

 

In connection withthe investment by Perseus 2000 Expansion, L.L.C., we issued a warrant for 800,000shares of our common stock at an exercise price of $1.008.

 

*November 2005Financing Warrants*

 

Aspart of a financing transaction in November 2005, we issued warrants topurchase an aggregate of 2,960,527 shares of our common stock to ten “accreditedinvestors.” In addition, 450,000 warrants were issued to the placementagents.  Each warrant was exercisable fora period of five years and the per-share exercise price for the warrant shareswas $2.21.  The terms of the investorwarrants included anti-dilution provisions which required us to adjust theexercise price and the number of shares of our common stock to be issued uponexercise of the warrants under certain circumstances, which include:

 

·                        Subdivisions, stock dividends orcombinations of our common stock

·                        Reclassifications, exchanges,substitutions, or in-kind distributions that result in a change in the numberand/or class of the securities issuable upon exercise of the warrants

·                        Reorganizations, mergers and similartransactions; and

·                        Issuance of additional shares of ourcommon stock, or securities convertible into our common stock, at a price pershare lower than the closing stock price on the date of this transaction, whichwas $1.85.

 

In February 2007,we issued stock at a price per share below the $1.85 threshold notedabove.  Based on the warrants’anti-dilution provisions, the exercise price of these warrants was adjustedfrom $2.21 to $1.99 and 327,294 additional warrants were issued to theinvestors.  Warrants issued to theplacement agent were not subject to adjustment.

 

10

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*February 2007Shelf Warrants*

 

In February 2007,we sold 11,814,687 units of the Company at a purchase price of $0.90 perunit.  Each unit consisted of one shareof our common stock, par value $0.01 per share, and a warrant to purchase 0.5shares of common stock at an exercise price of $1.33 per share, for a total of5,907,345 warrants. In addition, we issued 354,441 warrants to the placementagents at the same price per share. These warrants became exercisable as of August 16, 2007, and expirefive years from date of issue. The units were issued pursuant to a prospectussupplement filed with the Securities and Exchange Commission in connection withour registration statement on Form S-3 filed on September 1, 2006,which became effective on December 14, 2006.  We filed a request with the Securities andExchange Commission on August 1, 2007 that this registration statement on Form S-3be withdrawn and the unsold securities deregistered, and filed a new shelfregistration statement on Form S-3 for $50 million on August 6, 2007,which we amended on August 14, 2007 and became effective on August 15,2007.

 

*July 2007Warrants*

 

In July 2007we entered into a lease for a new facility in Tyngsboro, MA.  We agreed under the terms of the lease toissue to the landlord pursuant to an exemption from registration under theSecurities Act of 1933, as amended, a warrant exercisable for 500,000 shares ofour common stock at an exercise price of $1.77 per share.  This warrant became exercisable as of July 23,2007, may be exercised at any time over the term of the lease and expires on July 22,2014.  The warrant and the sharesissuable upon exercise of the warrant are restricted securities and may not besold without registration under the Securities Act of 1933, as amended, andapplicable state securities laws or an exemption there-from.

 

*September 2007Shelf Warrants*

 

In September 2007,we sold 5,102,041 units of the Company at a purchase price of $1.96 perunit.  Each unit consisted of one shareof our common stock, par value $0.01 per share, and a warrant to purchase 1.2shares of common stock at an exercise price of $1.99 per share, for a total of6,122,449 warrants. In addition, 153,061 warrants were issued to the placementagents at the same price per share. The warrants become exercisable as of March 10,2008, and expire on March 11, 2013. The units were issued pursuant to aprospectus supplement filed with the Securities and Exchange Commission inconnection with our registration statement on Form S-3 for $50 millionfiled on August 6, 2007, which we amended on August 14, 2007 andbecame effective on August 15, 2007.

 

*October 2007Shelf Warrants*

 

In October 2007,we sold 11,911,852 units of the Company at a purchase price of $2.10 perunit.  Each unit consisted of one shareof our common stock, par value $0.01 per share, and a warrant to purchase 0.95shares of common stock at an exercise price of $2.97 per share, for atotal of 11,316,260 warrants. The warrants become exercisable six months andone day after their issuance, and expire five and one half years after theirissuance. The units were issued pursuant to a prospectus supplement filed withthe Securities and Exchange Commission in connection with our registrationstatement on Form S-3 for $50 million filed on August 6, 2007, whichwe amended on August 14, 2007 and became effective on August 15,2007.

 

**Note7.  Stock Based Compensation**

 

**Descriptionof Plans**

 

*StockOption Plan*

 

Our Third Amendedand Restated 1998 Stock Incentive Plan allows for the granting of stock optionsto purchase up to 23,000,000 shares of our common stock.  Options may begranted to our employees, officers, directors, consultants and advisors. Underthe terms of the option plan, incentive stock options (“ISOs”) are to begranted at the fair market value of our common stock at the date of grant, andnonqualified stock options (“NSOs”) are to be granted at a price determined bythe Board of Directors.  In general, the Board has authorized vestingperiods of one to three years and terms of varying length but in no case morethan 10 years.  Our stock option program is a long-term retention programthat is intended to attract, retain and provide incentives for talentedemployees, officers and directors, and to align stockholder and employeeinterests.  We consider our option program critical to our operation andproductivity; essentially all of our employees participate.  At March 31,2008, we had 12,151,275 shares reserved for issuance under this plan, net ofoutstanding options and RSUs.

 

11

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*EmployeeStock Purchase Plan*

 

Our Employee StockPurchase Plan (the “ESPP”) allows substantially all of our employees to purchaseshares of our common stock at a discount through payroll deductions. Participating employees may purchase our common stock at a purchase price equalto 85% of the lower of the fair market value of the common stock at thebeginning of an offering period or on the exercise date.  Employees maydesignate up to 10% of their base compensation for the purchase of common stockunder this plan.  The ESPP provides for the purchase of up to 2,000,000shares of our common stock.  At March 31, 2008, we had 1,830,738shares reserved for issuance under this plan.

 

*RestrictedStock Unit Arrangements*

 

Our Third Amendedand Restated 1998 Stock Incentive Plan permits the grant of restricted stockunits (“RSUs”) to our employees, officers, directors and other service providers.  We use RSUs to (i) align our employees’interests with those of the Company, (ii) motivate our employees toachieve key product development milestones and thus create stockholder value, (iii) retainkey employees by providing equity to such employees and (iv) conservecash, by paying bonuses in the form of RSUs, rather than in cash, but with thenumber of such RSUs calculated on a discounted basis to compensate for thereduced liquidity as compared to cash.  With respect to the RSUs that aregranted in lieu of cash bonuses, the number of RSUs granted are based onperformance, and are automatically converted into shares of common stock infour equal tranches in the fiscal year following the year of performance.Certain other RSUs are granted to our officers as a form of equity incentive,are not tied to performance, and vest over a three-year period in equalquarterly installments.  There are also other performance-based restrictedstock units (PSUs) granted to our officers that cliff-vest upon the achievementof certain earnings-based milestones and upon the Company achieving a level ofrevenue such that it is no longer treated as a development stage company foraccounting purposes, both such vesting events subject to the recipient officerbeing employed by us during the period ending with the milestones. The unvestedportion of any RSU or PSU grant is subject to forfeiture upon the holder’sresignation or termination for cause.  Asof December 31, 2007, certain RSUs granted under the officer employmentagreements were vested but stock was not issued because the vesting date, December 31,fell during our holiday shut-down period.

 

Restricted stockactivity as of December 31, 2007 and for the three months ended March 31,2008 is as follows:

 
| ** **                                          | ** ** | **Three months ended  March 31,** | ** ** | **Year ended  December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                         | ** ** | **2007**                               | ** ** |
| ** **                                          | ** ** | **(number of shares)**                 | ** ** |
| Shares issued related to vested RSUs:               |       |                                             |       |                                   |       |
| Based on prior year grants                          |       | 9,521                                            |       | 14,044                                 |       |
| Based upon current year executive officer agreement |       | —                                           |       | 18,030                                 |       |
|                                                |       |                                             |       |                                   |       |
| Vested RSUs not yet converted to stock              |       | 14,219                                           |       | 9,521                                  |       |
|                                                |       |                                             |       |                                   |       |
| RSU’s granted but not vested:                  |       |                                             |       |                                   |       |
| Related to 2006 executive officer agreement         |       | 10,542                                           |       | 14,053                                 |       |
| Related to 2007 executive officer agreement         |       | 42,098                                           |       | 48,108                                 |       |
| Related to 2008 executive officer agreement         |       | 51,696                                           |       | —                                 |       |
| Related to performance-based executive plan*        |       | 1,265,823                                        |       | 1,265,823                              |       |

 

----

*Subject to achievement of performance requirements.

 

12

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**StockOption Plan Schedules**

 

Stock option activityfor the first three months of 2008 was as follows:

 
| ** **                          | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** |
|-------------------------------------|------------|--------------------|------------|---------------|------------|---------------|------------|
| ** **                          | ** ** | ** **         | ** ** | **Average**   | ** ** | **Average**   | ** ** |
| ** **                          | ** ** | **Number of** | ** ** | **Exercise**  | ** ** | **Fair**      | ** ** |
| ** **                          | ** ** | **Shares**         | ** ** | **Price**     | ** ** | **Value**     | ** ** |
| Outstanding, December 31, 2007 |       | 8,712,488          |       | $             | 1.18       |          |       |   |
| Granted                             |       | 2,110,803          |       | $             | 1.27       |          | $          | 0.78 |   |
| Exercised                           |       | —             |       | $             | —     |          |       |   |
| Canceled, forfeited or expired      |       | —             |       | $             | —     |          |       |   |
| Outstanding, March 31, 2008    |       | 10,823,291         |       | $             | 1.20       |          |       |   |
|                                     |            |                    |            |               |            |               |            |  |  |

 

The following tablesummarizes information about stock options outstanding at March 31, 2008:

 
| ** **    | ** ** | ** **          | ** ** | **Weighted-**         | ** ** | ** **    | ** ** | ** **          | ** ** | **Vested**    | ** ** |
|---------------|------------|---------------------|------------|-----------------------|------------|---------------|------------|---------------------|------------|---------------|------------|
| ** **    | ** ** | ** **          | ** ** | **Average**           | ** ** | **Weighted-** | ** ** | ** **          | ** ** | **Weighted-** | ** ** |
| ** **    | ** ** | **Number**          | ** ** | **Remaining**         | ** ** | **Average**   | ** ** | **Vested**          | ** ** | **Average**   | ** ** |
| **Exercise**  | ** ** | **of Options** | ** ** | **Contractual**       | ** ** | **Exercise**  | ** ** | **Number**          | ** ** | **Exercise**  | ** ** |
| **Price**     | ** ** | **Outstanding**     | ** ** | **Life (Years)** | ** ** | **Price**     | ** ** | **of Options** | ** ** | **Price**     | ** ** |
| $0.26 - $0.74 |       | 3,194,138           |       | 6.28                  |       | $             | 0.70       |                | 3,194,138  |          | $          | 0.70 |   |
| $0.82 - $1.46 |       | 5,663,433           |       | 8.05                  |       | $             | 1.06       |                | 2,440,824  |          | $          | 0.95 |   |
| $1.51 - $2.19 |       | 1,508,470           |       | 7.48                  |       | $             | 1.82       |                | 1,112,516  |          | $          | 1.87 |   |
| $2.50 - $3.10 |       | 130,000             |       | 2.10                  |       | $             | 2.64       |                | 130,000    |          | $          | 2.64 |   |
| $4.10 - $5.27 |       | 222,250             |       | 2.91                  |       | $             | 4.40       |                | 222,250    |          | $          | 4.40 |   |
| $6.00 - $9.31 |       | 105,000             |       | 2.56                  |       | $             | 6.40       |                | 105,000    |          | $          | 6.40 |   |
| Total         |       | 10,823,291          |       |                  |       |          |       | 7,204,728           |       |          |       |

 

**StockCompensation**

 

We account for ourstock compensation in accordance with SFAS 123R. We use the Black-Scholesoption pricing model to determine the fair value of stock options and employeestock purchase plan shares. The valuations determined using this model areaffected by our stock price as well as assumptions we make regarding a numberof complex and subjective variables, including our stock price volatility,expected life of the option, risk-free interest rate and expected dividends, ifany.

 

We estimate thevolatility of our common stock by using historical volatility.  Weestimate the expected term of the option grant, and determine a risk-freeinterest rate based on U.S. Treasury issues with remaining terms similar to theexpected term of the stock or options. We do not anticipate paying any cashdividends in the foreseeable future and therefore use an expected dividendyield of zero in our valuation model. We are required to estimate forfeituresat the time of grant and revise those estimates in subsequent periods. Allstock-based payment awards are amortized as they are earned over the requisiteservice periods of the awards, which are generally the vesting periods.

 

Restricted stockunits (RSUs) are valued at the stock price at date of grant, and expensedratably over the performance period or vesting period, as appropriate. The number of PSUs for which stock compensation expense is calculated is basedupon management’s assessment of the likelihood of achieving the performancetargets.

 

The assumptionsused to value stock option grants for the three months ended March 31,2008 and 2007, respectively, are as follows:

 

13

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| ** **                                                                               | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Risk-free interest rate                                                                  |       | 2.15%  - 2.89%                                       |       | 4.48%  - 4.90% |   |
| Expected life of option                                                                  |       | 3.5  years                                           |       | 3  years |   |
| Expected dividend payment rate, as a percentage of the stock price on  the date of grant |       | 0%                                                   |       | 0% |   |
| Assumed volatility                                                                       |       | 87%  - 98%                                           |       | 95%  - 97% |   |
| Expected forfeitures                                                                     |       | 10%                                                  |       | 10% |   |

 

Stock-basedcompensation expense recognized on our consolidated statement of operations forthe three months ended March 31, 2008 and 2007 are as follows:

 
| ** **                                    | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Selling, general and administrative           |       | $                                                    | 388,401    |   | $ | 363,208 |   |
| Research and development                      |       | 362,909                                              |       | 217,049 |   |
| Total stock compensation expense              |       | $                                                    | 751,310    |   | $ | 580,257 |   |
|                                          |       |                                                 |       |   |   |
| Components of stock compensation expense:     |       |                                                 |       |   |   |
| Compensation expense related to RSUs and PSUs |       | $                                                    | 162,147    |   | $ | 158,520 |   |
| Compensation expense related to stock options |       | 589,163                                              |       | 421,737 |   |
| Total stock compensation expense              |       | $                                                    | 751,310    |   | $ | 580,257 |   |

 

As of March 31,2008, there was approximately $2,581,000 of unrecognized compensation cost,adjusted for estimated forfeitures, related to unvested stock-based paymentsgranted to our employees and directors. Total unrecognized compensation costwill be adjusted for future changes in estimated forfeitures and recognizedover the remaining vesting periods of the stock option grants.

 

**Note8.  Subsequent Event**

 

In April 2008 we were awarded a subcontract to provide a flywheelenergy storage system in support of a wind integration research and development(R&D) project sponsored by the California Energy Commission.  We will receive approximately $250,000 tooffset R&D expenses and will contribute an additional $90,000 ofengineering resources for the project, bringing the R&D total to approximately$340,000.  In addition to the CaliforniaEnergy Commission, which is funding the project, other leading stakeholdersinclude Southern California Edison and the California ISO.  The flywheel system will be installed inTehachapi, California, a high-potential wind resource area where, according toa report from the California ISO, up to 4,200 megawatts of wind power may beadded in the coming years.  Our flywheelenergy storage systems may also have the potential to address shortages intransmission line capacity, which this wind power integration project isintended to prove.  The primary goal ofthe project is to demonstrate that advanced control technology with energystorage can help expand the delivery of renewable wind energy by effectively increasingthe capacity of constrained transmission facilities in the Tehachapi area.  This project supports California’s goal toupgrade and expand its electricity transmission and distribution infrastructureper the state’s Energy Action Plan of 2003.

 

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**Item 2. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**NoteRegarding Forward Looking Statements:**

 

This QuarterlyReport on Form 10-Q contains forward-looking statements concerning, amongother things, our expected future revenues, operations and expenditures, andestimates of the potential markets for our products and services.  Suchstatements made may fall within the meaning of the Private Securities LitigationReform Act of 1995, as amended.  All such forward-looking statements arenecessarily only estimates of future results and the actual results we achievemay differ materially from these projections due to a number of factors asdiscussed in the section entitled “Risk Factors” of this Form 10-Q. Newrisks can arise and it is not possible for management to predict all suchrisks, nor can management assess the impact of all such risks on our businessor the extent to which any factor, or combination of factors, may cause actualresults to differ materially from those contained in any forward-lookingstatement.  Given these risks and uncertainties, investors should notplace undue reliance on forward-looking statements as a prediction of actualresults.  All forward-looking statements speak only as of the date of thisQuarterly Report on Form 10-Q.  We undertake no obligation to reviseor update publicly any forward-looking statement in order to reflect any eventor circumstance that may arise after the date of this Quarterly Report on Form 10-Q,other than as required by law.

 

**CriticalAccounting Policies and Estimates**

 

The preparation offinancial statements requires management to make estimates and judgments thatmay significantly affect the reported amounts of assets, liabilities, revenues,expenses and related disclosures. On an ongoing basis, management evaluates ourestimates and assumptions including, but not limited to, those related torevenue recognition, asset impairments, inventory valuation, warranty reservesand other assets and liabilities.  Management bases its estimates onhistorical experience and various other assumptions that it believes to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources.  Actual results may differ fromthese estimates under different assumptions or conditions.

 

*RevenueRecognition*

 

Although we havesold photovoltaic inverters and recorded revenues for flywheel developmentcontracts, our operations have not yet reached a level that would qualify us toemerge from the development stage.  Therefore we continue to be accountedfor as a development stage company under Statement of Financial AccountingStandards No. 7 “Accounting and Reporting by Development StageEnterprises.”

 

*InverterSales*

 

We recognizerevenue in accordance with accounting principles generally accepted in theUnited States of America.  Generally, revenue is recognized on transfer oftitle, typically when products are shipped and all related costs areestimable.  For sales to distributors, we make an adjustment to deferrevenue until our products are subsequently sold by distributors to theircustomers.

 

*GovernmentContract Revenue Recognized on the Percentage-of-Completion Method*

 

We recognizecontract revenue using the percentage-of-completion method. We use labor hoursas the basis for the percentage of completion calculation, which is measuredprincipally by the percentage of labor hours incurred to date for each contractto the estimated total labor hours for each contract at completion. Changes tototal estimated contract costs or losses, if any, are recognized in the periodin which they are determined.  Revenues recognized in excess of amountsbilled are classified as current assets, and included in “Unbilled costs oncontracts in process” in our balance sheets.  Amounts billed to clients inexcess of revenues recognized to date are classified as current liabilitiesunder “Advance billings on contracts.”  Changes in project performance andconditions, estimated profitability, and final contract settlements may resultin future revisions to construction contract costs and revenue.

 

Some of ourresearch and development contracts are subject to cost review by governmentagencies. Our reported results from these contracts could change adversely as aresult of these reviews.

 

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*Loss onContract Commitments*

 

Our contracts havebeen primarily for the development of demonstration units of new products andthe design of a frequency regulation plant. As such, the work has supported our core research and developmentefforts.  We establish reserves foranticipated losses on contract commitments if, based on our cost estimates tocomplete the commitment, we determine that the cost to complete the contractwill exceed the total expected contract revenue.  Most of our contracts have been granted on acost-share basis, for which the expected cost-share is recorded as a contractloss. Additionally, each quarter we perform an evaluation of expected costs tocomplete our in-progress contracts and adjust the contract loss reserveaccordingly.

 

*WarrantyReserves*

 

The solarinverters we have sold carry warranties that require us to repair or replacedefective products returned to us during the applicable warranty period at nocost to the customer. We record an estimate for warranty-related costs based onactual historical return rates, anticipated return rates and repair costs atthe time of sale.

 

*IncomeTaxes*

 

Deferred taxassets and liabilities are determined based on differences between thefinancial reporting and income tax basis of assets and liabilities as well asnet operating loss and tax credit carryforwards, and are measured using theenacted tax rates and laws that will be in effect when the differencesreverse.  Deferred tax assets are reduced by a 100% valuation allowance toreflect the uncertainty associated with their ultimate realization.

 

Significantmanagement judgment is required in determining the provision for income taxes,the deferred tax assets and liabilities and any valuation allowance recordedagainst deferred tax assets.  The valuation allowance is based on ourestimates of taxable income and the period over which our deferred tax assetswill be recoverable.  In the event that actual results differ from theseestimates or we adjust these estimates in future periods, we may need toestablish an additional valuation allowance or reduce our current valuationallowance, which could materially impact our tax provision.  We classify interest and penalties relatingto uncertain tax position in income tax expense.

 

*Impairmentof Long-Lived Assets*

 

In accordance withStatement of Financial Accounting Standards No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets” long-lived assets we hold and useare reviewed to determine whether any events or changes in circumstancesindicate that the carrying value of the asset may not be recoverable.  The conditions to be considered includewhether or not the asset is in service, has become obsolete, is damaged, orwhether external market circumstances indicate that the carrying amount may notbe recoverable.  When appropriate we recognizea loss for the difference between the estimated fair value of the asset and thecarrying amount.  The fair value of theasset is measured using either available market prices or estimated discountedcash flows.

 

**Overview**

 

We design, develop, configureand expect to begin operating flywheel-based frequency regulation facilitiesthat will provide services to support more reliable and cost-effectiveelectricity grid operation. The focus of our research and development has beento establish commercially viable flywheel-based energy storage technologiesthat can provide highly reliable energy solutions for the worldwide electricitygrid at competitive costs. Initially, we expect to generate revenues from thecommercialization of our flywheel energy storage systems to supply frequencyregulation services to the electricity grid in North America. We believe thatas we expand our production capabilities we can become a provider of frequencyregulation services to grid operators on a global basis. In addition we believethat as the commercialization of our technologies continues, we will developother cost-effective applications for our flywheel systems that will provideadditional revenue opportunities.

 

Our market focus is onthe geographic regions of the domestic grid that provide open bid markets forregulation services. These regions and their Independent System Operator (ISO)or Regional Transmission Operator (RTO) designations are: New England (ISO NewEngland or ISONE); California (California ISO or CAISO); New York (New York ISOor NYISO); Mid-Atlantic (PJM Interconnect) and Texas (ERCOT). In addition,during 2008 Midwest Independent Transmission System Operator, Inc.(Midwest ISO or MISO) is expected to begin operating its open-bid ancillaryservices market for frequency regulation. We have been proactive in thisemerging market and have added it to our initial target markets.

 

These regional ISOs/RTOsor grid operators purchase frequency regulation services from independentproviders in open bid markets that they manage and maintain. We are seeking tobecome one such provider. We believe our technology will offer grid 

 

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operatorsthe benefits of greater reliability; faster response time; cleaner operation,including zero direct emissions of carbon dioxide (CO2), nitrogenoxide, sulfur dioxide and mercury; and lower maintenance costs compared toconventional power generation facilities that also provide frequency regulationservices.  We believe that we will havelower operating costs and faster response time than the majority of otherentities that provide frequency regulation services, which we believe willallow us to have sufficient margins to make the company economically viable.

 

InNorth America, the frequency regulation market in areas that were accessiblevia open-bid auction mechanisms was valued at approximately $800 million in2007.  Before the end of 2008 (by whichtime Midwest ISO’s regulation market is expected to be in operation) the addressableopen-bid regulation market on an annualized basis is expected to exceed $1billion per year.  Based on globalelectrical production, we believe that the worldwide frequency regulationmarket is several times this amount. Significant growth in the US open-bidmarket is expected due to a combination of factors, including:

 

·                  Greater useof renewable energy sources – especially wind generation and solar

·                  Anticipatedexpansion of open-bid grid operating regions such as the Midwest ISO

·                  Increaseddemand for electricity

·                  Increasednatural gas prices.

 

Underthe open-bid market, grid operators forecast the need for frequency regulationas a percentage of expected power demand, and approved suppliers submit bidsfor these services. Bids are stacked from lowest to highest prices until thecumulative amount of bids is sufficient to meet the calculated need. The pricesubmitted by the highest selected bidder determines what every bidder is paid.

 

Tofully exploit this regulatory-driven open-bid market, we are finalizing ourdesign and expect to build, own and operate a number of frequency regulationfacilities. Our business model, which is a sale-of-services model, is similarto that of independent power producers who also design, build, own and operatetheir own power plants. Each Smart Energy MatrixTM frequency regulation facilitywill be up to 20 megawatts (MW) in size. A Smart Energy MatrixTM is amulti-flywheel energy storage system designed to provide reliable andsustainable frequency regulation services for utility grids.  A Smart Energy MatrixTM can be scaled to anysize to provide one or more megawatts of frequency regulation capacity.  Smart Energy MatrixTM frequency regulationplants that are 20 MW or less in size offer the advantage of being eligible touse fast-track interconnection regulations that allow plants of this capacityor smaller to be approved more quickly in accordance with streamlinedregulatory rules. A key aspect of our business model is that we are notdependant on the lengthy procurement cycles typically associated with themarketing and sale of capital equipment to the utility sector.  Instead, our business model is to become amerchant provider of frequency regulation services to the deregulated open bidmarkets.  We will be bidding the outputof our plants into multiple open-bid markets for regulation services on a dailybasis.

 

Akey qualification for our participation in these markets is the ability todemonstrate that our technology can deliver the regulation services required byeach grid operator. To attain this qualification and accelerate market entry weinstalled two scale-power 100-kilowatt (kWh) demonstration models of our SmartEnergy MatrixTM for evaluation by two large grid operators. Both of ourscale-power systems were comprised of multiple flywheels.  In 2005, we were awarded contracts for thesesystems by the California Energy Commission (CEC) and the New York State EnergyResearch and Development Authority (NYSERDA), in cooperation with the U.S.Department of Energy (DOE), to test the viability of our flywheel technologiesfor frequency regulation by these grid operators.  The demonstration systems were scale-powerprototypes of the Smart Energy Matrix TM multi-flywheel system.  As a result of the success of the pilotprograms, we have focused on the design of the full scale Smart Energy Matrix TMsystems.

 

Boththe California and New York systems were installed and evaluated in formalfield trials. The demonstration units contained fully-functional control,communication and interconnection elements similar or identical to the elementsof our design for 20 MW frequency regulation facilities. The purpose of thesepilot systems was twofold: 1) to demonstrate the ability of our flywheeltechnology to provide frequency regulation services consistent with thetechnical requirements of the grid operators, including the California ISO andNew York ISO, and 2) to obtain certification or other approval from thesesystem operators that, from a technical perspective, our technology is approvedto provide commercial frequency regulation services in their respective statesand territories.

 

TheCalifornia system completed its field trial on January 31, 2007, earning apositive evaluation from both the CEC and the CAISO.  On December 26, 2006, the California ISOcertified our flywheel technology for use as a frequency regulation resource inCalifornia.

 

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The New York demonstration unit incorporatedtechnology improvements as a result of field testing in California and thesystem contained additional voltage support and power quality capabilities. Theadded capabilities were designed to demonstrate the technical efficacy of twoentirely new applications for our core technology.

 

On March 22, 2007, the New York State EnergyResearch and Development Authority (NYSERDA) and the U.S. DOE confirmed thesuccessful outcome of technical field trial testing of our scale-power flywheelfrequency regulation system in New York. At the same time, the New York ISOdetermined that our technology is a viable technology for frequency regulationon its grid and is acceptable for provision of commercial frequency regulation inthe State of New York. Our New York-based flywheel system field trial reachedthis significant milestone after the U.S. DOE (through Sandia NationalLaboratories, which co-monitored the demonstration with NYSERDA) concluded thatthe unit’s performance had been successfully demonstrated and that additionaltesting of the technology was not required. However, current market rules ofNYISO might expose us to unwarranted costs and potentially reduce our revenues.As explained below, we are seeking to have these market rules amended. Duringthe first quarter of 2008, the New York demonstration unit was retrieved forpotential future use in supporting other demonstration programs and/or R&Dactivities.

 

Thelocation of our regulation plants and the sequence in which they will beconstructed depend on a number of factors, including but not limited to theavailability and cost of land, the cost of power plant construction, technicalgrid interconnection requirements, comparative market pricing available forfrequency regulation in the various regional markets, and our ability toreceive appropriate revenues and payments within the market rules of eachregional market.

 

Wehave an option to purchase approximately seven acres of land at theStephentown, New York site.  This site isserved by two transmission companies: National Grid and New York StateElectric and Gas (NYSEG). National Grid owns a 115 KVA transmission line thatabuts the site, and NYSEG owns a substation that also abuts the site. Ourinterconnection request for a 20 MW plant includes National Grid as thetransmission provider. We also recently submitted a separate interconnectionapplication for a 1 MW facility with NYSEG that would connect directly to itssubstation.

 

Pendingthe approval of a land-use permit we have requested from the town ofStephentown, New York, approval of our active interconnection request to NYISO,and any other implementation requirements of the NYISO, the location of ourfirst 20 megawatt frequency regulation plant will likely be inStephentown.  With respect to land-usepermit approval, there have been hearings in the local community regarding thenecessary zoning and environmental permits, and that process is ongoing. We areaggressively pursuing completion of the required interconnection processes forthe Stephentown plant. This includes completion by NYISO of a System ImpactStudy, currently underway, whose purpose is to insure that our plant can safelyinterface with the grid, and to identify any utility upgrades or other equipmentthat may be needed before operation of the plant can be approved.

 

Ourapplication to the DOE for a loan guarantee identifies Stephentown, New York,as the planned location for our first 20 MW plant. The timing, success orfailure of efforts to obtain the land-use permit, as well as the need forsatisfactory completion of NYISO’s System Impact Study and clear resolution ofmarket rule issues that impact our ability to enter and operate in the NYISOmarket could impact the timing or success of our DOE loan guaranteeapplication. Lengthy delays or negative outcomes in any of the factorsidentified above could potentially require us to select another location forthe first 20 MW plant. While we are working to bring matters related to the 20MW plant in Stephentown to the earliest possible successful conclusion, we arealso actively developing alternate plant sites in multiple ISOs as acontingency against these location-based risks.

 

Weexpect to have a minimum of five megawatts of capacity in place by the end of2008.  Our revised schedule forecastsrevenue from the Stephentown site in New York, as well as revenues from asecond plant in New England or the PJM Interconnection, by the end of 2008.   Tothat end, we have initiated the process of establishing up to five megawatts offrequency regulation capacity on our Tyngsboro site, and potential locationsare being actively pursued in the PJM Interconnection.

 

Ourdeployment schedule is conditional upon the following additional factors andactivities:

 

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·                  Component development and quality:

 

·                  Complete development of certain components toensure highly durable operation at commercial operating speeds.

 

·                  Development of multiple sources for our keycomponents. We are working to expand our supplier base to qualify theircomponents to our designs and specifications so that we may complete theinitial production run of Smart Energy 25 flywheel units.

 

·                  Continuing to work closely with our suppliersto refine their manufacturing processes and ensure quality results.

 

·                  Market rules and participation:

 

·                  To participate in and be paid for regulationservices in our target markets, certain conditions must be met. The technologymust be demonstrated and accepted by the Independent System Operators (ISOs).We accomplished this through our successful demonstration projects inCalifornia and New York.  Prior to plantconstruction, we must also file an interconnection application with theISO.  Our interconnect application forthe Stephentown NY site was filed at the end of 2007.  New York ISO is currently in the process ofcompleting a System Impact Study for our 20MW plant.  The purpose of the impact study is to ensurethe seamless integration of our plant to the grid.  Following the completion of this study weexpect to be granted an interconnection agreement (although there can be noassurance that we will receive the agreement).

 

·                  We must become a member of each ISO andconfirm that market rules specific to each ISO are compatible with ourtechnology.  We have been a member of thePJM Interconnection since 2004 and we have found no restrictions to marketparticipation there.  More recently, wehave been accepted as a member of ISO New England and approved as a customer ofNew York ISO.

 

·                  The need to conform some market rules tobe compatible with our technology within our target markets is requiring moretime to complete than we had previously thought, and in some cases market rule changesare required which also require time to complete.  Some ISOs (other than PJM) have not yetupdated their market rules to comply with the Federal Energy RegulatoryCommission’s 2007 mandate that non-generation resources (such as ours) beallowed equal access to enter the market for regulation services.  It is believed that these ISOs will require anumber of months to come into compliance, and we have added more resources toaccelerate the process.

 

**Regulatoryand Market Affairs**

 

Withineach ISO there is a market tariff and set of market rules that determinewho is allowed to bid into regulation markets, how much regulation providersare paid for their services, and what costs providers must pay to participatein markets. While three ISO’s have certified or otherwise approved our flywheeltechnology for commercial deployment, each ISO has its own market rules thatwill govern the pace at which markets are opened and the degree to which ourtechnology is allowed to participate. Historically, the market rules forregulation were written to conform to traditional generators’ abilities toprovide regulation. This is understandable, because until the advent of ourtechnology, the capabilities and limitations of traditional generators definedhow regulation could be technically implemented. In the markets in which weintend to compete, most of the ISO market rules still contain legacyterms, performance characteristics and other requirements that do not match ournew technology. The impact of this mismatch varies from market to market, andour ability to foster beneficial changes to ISO market rules willdetermine our timing for entering these markets and building regulationfacilities, as well as the revenues and costs associated with each market.

 

Ofconsiderable importance and benefit to us, on February 16, 2007, theFederal Energy Regulation Commission (FERC) issued a landmark ruling, Order890, *Preventing Undue Discrimination and Preference inTransmission Service*. This FERC ruling seeks to promote greatercompetition in electricity markets and strengthen the reliability of the grid.Included in Order 890 was a mandate by FERC that all ISOs must change theirmarket tariffs to allow non-generation resources (such as ours) capable ofproviding frequency regulation the ability to bid and sell into these markets.The ruling also stated that market rule changes must be implemented in acompletely non-discriminatory manner.

 

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Webelieve that FERC Order 890 will accelerate the pace of market rule changesand we have already made progress with several of the ISOs by working with themdirectly to implement changes to market rules. We are already experiencing positive effects of Order 890 in the form ofheightened commitments by ISOs to work collaboratively with us to integrate ourtechnology to their grids. To insure that we have the right resources toproperly address the timely opportunity represented by FERC Order 890, weobtained expert regulatory and legal counsel and have put a vigorous regulatoryaffairs program in place.

 

Asa result of FERC Order 890, all ISO’s were required to submit a compliancefiling with the FERC in October 2007 to define their degree of compliancewith this mandate. Once the ISO compliance filings were published, we became anactive participant in reviewing these ISO filings and providing input to FERC.We determined that most of the ISOs were deficient in some way with respect tofull Order 890 compliance. In November 2007 we intervened with FERC andsubmitted comments on each of the ISOs’ Order 890 compliance filings in aneffort to ensure that our technology is allowed to fairly participate in eachof the markets, earn revenues in proportion to the true value of servicesprovided and incur no more than a fair share of costs for market participation.

 

TheseFERC regulatory proceedings are ongoing. The current status of each ISO marketis as follows:

 

·                  Midwest ISOhas implemented a new Ancillary Services Market (ASM) to meet its compliancerequirements with Order 890. We are actively engaged with MISO in thedevelopment of this market. This new ASM is in a testing phase and is expectedto start on September 9th, 2008.  Our analysis of MISO’s ASM tariff disclosedfeatures that would have increased our costs and/or decreased revenues in whatwe believe would be a discriminatory manner. In response to our FERC filing todraw attention to these issues, on February 25, 2008, the FERC issued itsdecision with respect to MISO’s ASM tariff. FERC responded positively to the issues we raised in our Initial andReply Comments.  Specifically, FERCcommented: “We require the Midwest ISO to evaluate, through stakeholderdiscussions (we consider discussions between the Midwest ISO and Beacon Powerto be the most appropriate venue for determining whether new technologiesqualify as generation resources) adjustments to operating requirements and ASMprocedures that will remove barriers to comparable treatment of DRRs and newtechnologies in the regulating reserve markets and to provide a report on itsefforts to incorporate these resources into its markets within 60 days of thedate of this order.  We also require the Midwest ISO to submit revisedtariff sheets, if adjustments are proposed, in a compliance filing to besubmitted concurrently with the 60-day informational filing.”   After working in good faith with Beacon forthat period, on April 25, 2008 MISO fully complied with FERC’s 60-daydirectives by filing a request for an entirely new regulation resource categoryspecifically designed for Stored Energy Resources (“SER”), including ourflywheel technology. This is the first such tariff in the United Statesdesigned specifically to accommodate energy storage-based regulation resourcesand it contains features that are expected to maximize our revenues in the MISOmarket.  We expect that FERC will approvethis tariff request. Given the landmark nature of this specific proposed tariffand its potential to facilitate our market entry and profitable operation, weintend to pursue the creation of similar stored energy tariffs applicable tothe provision of frequency regulation services in all of our open-bid markets.

 

·                  PJM amendedits tariff language to comply with Order 890 and stated that its current rules allownon-generation resources like ours to fully participate in its Regulation andFrequency Response market. We believe PJM’s market rules allow us to enterthe market any time we choose to do so, subject to normal arrangements forinterconnection, financing, zoning and so forth.  We are currently working with PJM to clarifycertain aspects of PJM’s settlement methods in order to maximize our potentialrevenues in the PJM market.

 

·                  NYISOpostponed submitting a new tariff and market rules to allow non-generationresources and instead stated that we can qualify under the existing tariff as agenerator. While we can enter the market within the generator category, webelieve this category might expose us to unwarranted costs and potentiallyreduce our revenues. In its November 19, 2007 response to our comments toNYISO’s Order 890 Compliance Filing, NYISO noted that: “The NYISO is currentlyworking with Beacon to ensure that software and metering arrangements are inplace to support its participation in the markets as a generator when itsfacility actually comes on line, which is expected to occur sometime this year2008. There is, however, no tariff obstacle to Beacon’s provision of regulationservice.” Our regulatory focus includes working with NYISO to remedy certainlimitations we see within the generator category. NYISO has been very slow toengage in constructive interaction; consequently we must continue to seekrecourse through FERC in an effort to accelerate NYISO’s delivery on its pastcommitment to work with us to remedy limitations to market participation withrespect to qualifying under the generator category.

 

·                  ISONEmodified its tariff language but stated that it needed to make changes tomarket rules in order to fully comply with Order 890. Since acknowledgingthe need for market changes ISONE has worked with us in good faith. On March 11,

 

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2008,ISONE announced its plan to create a 13 MW Non-Generation Regulation Pilotprogram to comply with Order 890.  Thepilot program is designed to begin in November 2008 and run forapproximately 18 months. The purpose of the Non-Generation Regulation Pilotprogram will be to: evaluate the performance of new energy storage-basedtechnologies like ours that are unable to participate in ISONE’s currentregulation market, determine how these technologies can best be used to meetNew England’s regulation requirements, allow program participants to operate ina realistic market environment where they can evaluate their market viability,and provide operating experience that ISONE can use to formulate permanentmarket rules. We plan to participate in this pilot program and expect togenerate revenues under this program as early as November, 2008. ISONEtypically uses such pilot programs to launch major and permanent changes to itsmarket rules, so we see this program as a direct and appropriate response toFERC’s Order 890 directives.

 

·                  CAISOoriginally did not submit changes to its tariff to comply with Order 890, butclearly acknowledged to FERC its need to do so. CAISO has been stronglysupportive of the evolution and value of our technology with respect to itsability to integrate renewable energy sources, especially wind, and we believethat CASIO will ultimately make market rule changes that result in aperformance-based tariff that rewards fast-response regulation resources,including our flywheel technology.  Mostrecently, on April 15th 2008, CAISO filed a revised tariff withFERC to comply with Order 890. We are currently evaluating CAISO’s filing toassess how responsive it is to FERC’s earlier directives. We will seek furtherrelief if we find that CAISO’s most recent filing does not fully meet theintent of FERC’s Order 890 directive.

 

·                  ERCOT’smarket prices for regulation currently do not support market entry. Since ERCOTis not regulated by the Federal Energy Regulatory Commission, our ability toseek beneficial market rule changes that hold the potential to supporthigher pricing in consideration of our technology’s superior performance islimited at this time. As the performance of our technology is fullydemonstrated at a system-wide level in other ISOs, and as wind penetration inTexas increases and the demand for fast regulation resources rises, we willre-evaluate the feasibility of encouraging beneficial market rule changesand the potential of entering this market on a more profitable basis.

 

Wecompleted the move to our new facility in January 2008, and we havecompleted the first phase build-out of our manufacturing facility. We now havea facility capable of producing up to 600 flywheels per year, which is being rampedup to commence all aspects of production.  We have a second phase manufacturing build-outplanned which will increase annual manufacturing capacity to more than 1,000flywheels.

 

Becauseour business model is based on being a service provider that owns and operatesplants and equipment as opposed to selling equipment, we will need to obtainsignificant additional funding to further expand our manufacturing capacity, procureflywheel components for manufacture as well as ancillary equipment andconstruct frequency regulation facilities. We expect to raise additional capital in 2008 through the sale of stockin the Company. In the future, we will need to raise additional capital eitherfrom project finance or additional equity transactions in order to buildadditional regulation facilities.

 

As our business develops, we may from time to time evaluate possibleacquisitions of enterprises or technologies that we would consider synergisticfrom a market, technology or product perspective.

 

From inception through March 31, 2008, we have incurred losses ofapproximately $168.6 million. We expect to continue to incur losses as weexpand our product development and begin to increase our manufacturing andassembly capacity.

 

*Revenues*

 

Inthe past, we were awarded fixed price research and development contracts fromgovernment agencies and are pursuing similar contracts from other governmentagencies.  We have recognized revenues onour existing contracts using the percentage of completion method.  We are continuing to evaluate markets for ourflywheel systems but we have not recognized revenues from these products.

 

*Cost of Goods Sold*

 

Cost of goods sold on fixed price research and development contractsare predominantly being recorded on the percentage of completion method andconsist of direct labor and material, subcontracting, and associated overheadcosts.

 

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*Selling, General and Administrative Expenses*

 

Oursales and marketing expenses consist primarily of compensation and benefits forsales and marketing personnel and related business development expenses. During the first quarter of 2008, we added a Director of Regulatory Affairs towork directly with the ISOs to implement changes to their market rules toallow non-generation resources (such as ours) capable of providing frequencyregulation the ability to bid and sell into these markets. We also added aDirector of Human Resources to assist us in hiring and maintaining qualifiedstaff as we transition from development into full production.  We expectsales and marketing expenses to continue to increase as we expand efforts todefine new markets for our products, expand our marketing efforts forgovernment sales and government-backed loans for new facilities, as well asincreased efforts to modify market rules to insure our ability to competein these markets. General and administrative expenses consist primarily ofcompensation and benefits related to our corporate staff, professional fees,insurance and travel. We expect our selling, general and administrativeexpenses to increase in 2008 over 2007 due primarily to additional staffing tosupport the move to production.

 

*Research and Development*

 

Our cost of research and development consists primarily of the cost ofcompensation and benefits for research and development and support staff, aswell as materials and supplies used in the engineering design and developmentprocess. We expect research and development expenses to increase during 2008 aswe finalize our designs and focus on our cost reduction objectives.

 

*Loss on Contract Commitments*

 

Weestablish reserves for anticipated losses on contract commitments if, based oncost estimates to complete the commitment, we determine that a loss will beincurred.  We recorded a $1.4 millioncharge during 2006 and $1.5 million in 2005 for anticipated losses on ourresearch and development contracts.  In2007, we completed all but one of our existing contracts.  These contracts were completed at costs thatwere lower than previously anticipated, and we recorded a reduction ofapproximately $0.6 million to the contract loss reserve. We evaluate our estimatedcosts to complete our government contracts on a quarterly basis and establishreserves when appropriate.

 

*Depreciation and Amortization*

 

Ourdepreciation and amortization is primarily related to depreciation on capitalexpenditures and the amortization of lease and leasehold costs related to ourfacilities.  We have intellectualproperty in the form of patents on our flywheel vacuum system, our heat pipecooling systems, DC output paralleling, metal hub, low-loss motor, co-mingledrims, crash management system and earthquake-tolerant bearings on our flywheelproducts, anti-islanding software, drawings, source code and productionknow-how on our Smart Power M5inverter system, and expect to obtain other patents during 2008 andbeyond.  Due to the uncertainty ofrealizing any future value and lack of substantial revenues to date, all costsrelated to the development of intellectual property have been expensed asincurred.

 

*Interest and Other Income/Expense, net*

 

Our non-operating income and expenses are primarily attributable tointerest income resulting from cash on hand and funds received in settlement ofa class action suit relating to unfair practices engaged in by certaininsurance brokerage firms.

 

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**Results of Operations**

 

***Comparison of Three Months ended March 31, 2008and 2007***

 
| ** **                             | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(in thousands)**                              | ** ** |
| Revenue                                |       | $                                                    | 20         |   | $ | 393 |   | $ | (373 | ) | (95)% |   |
| Cost of goods sold                     |       | —                                               |       | 393 |   | 393 |   | 100% |   |
| Gross margin                           |       | 20                                                   |       | — |   | 20 |   | 0% |   |
| Selling, general and administrative    |       | 2,176                                                |       | 1,414 |   | (762 | ) | (54)% |   |
| Research and development               |       | 3,032                                                |       | 1,660 |   | (1,372 | ) | (83)% |   |
| Loss on sales and contract commitments |       | (1                                                   | )          | — |   | 1 |   | 0% |   |
| Depreciation and amortization          |       | 280                                                  |       | 26 |   | (254 | ) | (977)% |   |
| Casualty loss (recovery)               |       | —                                               |       | 108 |   | 108 |   | 100% |   |
| Interest and other income, net         |       | 180                                                  |       | 118 |   | 62 |   | 53% |   |
| Net loss                               |       | $                                                    | (5,287     | ) | $ | (3,090 | ) | $ | (2,197 | ) | (71)% |   |

 

*Revenue*

 

The following table provides details of our revenues for the threemonths ended March 31, 2008 and 2007:

 
| ** **                    | ** ** | ** **   | ** ** | **Three months ended** | ** ** | **Cumulative  Contract  Value** | ** ** | **Total**    | ** ** |
|-------------------------------|------------|--------------|------------|----------------------------------|------------|---------------------------------|------------|--------------|------------|
| ** **                    | ** ** | **Percent**  | ** ** | **March 31,**               | ** ** | **Earned as of**      | ** ** | **Contract** | ** ** |
| ** **                    | ** ** | **complete** | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008**     | ** ** | **Value** | ** ** |
| ** **                    | ** ** | ** **   | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** **   | ** ** | ** ** | ** ** |
| CEC                           |       | 100          | %          | $                                | —     |                            | $          | 21           |       | $ | 1,233 |   | $ | 1,233 |   |
| NYSERDA PON 846               |       | 100          | %          | —                           |       | 47                              |       | 646          |       | 646 |   |
| NYSERDA PON 800               |       | 82           | %          | —                           |       | 4                               |       | 51           |       | 63 |   |
| Air Force Research Laboratory |       | 100          | %          | —                           |       | 191                             |       | 750          |       | 750 |   |
| Sandia DOE Earmark            |       | 100          | %          | —                           |       | 131                             |       | 752          |       | 752 |   |
| Total Contract Revenue        |       |         |       | $                                | —     |                            | $          | 394          |       | $ | 3,432 |   | $ | 3,444 |   |
| M5 and accessories            |       |         |       | 20                               |       | (1                              | )          |         |       |   |   |
| Total                         |       |         |       | $                                | 20         |                            | $          | 393          |       | $ | 3,432 |   | $ | 3,444 |   |

 

Inthe three months ended March 31, 2008, we did not record any revenue fromflywheel-related research and development contracts because all but one smallcontract was completed during 2007. In the same period for 2007, we recordedrevenue from flywheel-related research and development contracts calculatedusing the percentage of completion method of approximately $394,000.

 

23

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*Cost of Goods Sold*

 

No costs were incurred in the performance of our research anddevelopment contracts during the three months ending March 31, 2008. Weincurred approximately $393,000 for cost of goods sold related to our researchand development contracts during the first quarter of 2007.  The change incost of goods sold is consistent with the change in revenue for the relatedperiods.

 

*Selling, General and Administrative Expense*

 
| ** **                       | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**                          | ** ** |
| Period Ended March 31, 2007 |       | $                                                | 1,414      |   |
| Increases (decreases):           |       |                                             |       |
| Salaries and benefits            |       | 239                                              |       |
| Subcontractors and consultants   |       | 212                                              |       |
| Legal and professional           |       | 191                                              |       |
| Materials and office expenses    |       | 25                                               |       |
| Stock compensation expense       |       | 25                                               |       |
| Other                            |       | 24                                               |       |
| Audit fees                       |       | 18                                               |       |
| Travel                           |       | 17                                               |       |
| Facility costs                   |       | 14                                               |       |
| Dues and subscriptions           |       | 14                                               |       |
| Reduction of bad debt reserve    |       | 12                                               |       |
| Public company expenses          |       | (29                                              | )          |
| Period Ended March 31, 2008 |       | $                                                | 2,176      |   |

 

Selling, general and administrative expenses totaled approximately$2,176,000 and $1,414,000 for the three months ended March 31, 2008 and 2007,respectively. The increase of approximately $762,000 or 54% was primarily theresult of higher salaries and benefits due to additional staffing ofapproximately $239,000, increased use of subcontractors and consultants ofapproximately $212,000 related primarily to our efforts to work with the ISOsto modify their market rules and perform market studies, higher legal andprofessional fees of approximately $191,000, and increases in various otherselling, general and administrative expense related to the maintenance of alarger facility and staff and our transition from research and development toproduction activities.  In the firstquarter of 2007, we had a bad debt recovery of approximately $12,000; therewere no bad debt write-offs or recoveries during the first quarter of 2008. Weexpect our selling, general and administrative expenses to be somewhat higherin 2008 than 2007 due primarily to increases in staffing needed to support ourtransition to a production facility, increased marketing and sales expensesassociated with flywheel products and increased efforts to work with the ISOsto modify market rules and fund-raising efforts.

 

24

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*Research and Development Expense*

 
| ** **                          | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **(in thousands)**                          | ** ** |
| Period Ended March 31, 2007    |       | $                                                | 1,660      |   |
| Increases (decreases):              |       |                                             |       |
| Allocation of overhead to contracts |       | 475                                              |       |
| Legal                               |       | 296                                              |       |
| Salaries and benefits               |       | 268                                              |       |
| Facility costs                      |       | 217                                              |       |
| Stock compensation expense          |       | 146                                              |       |
| Software maintenance                |       | 18                                               |       |
| Other                               |       | 9                                                |       |
| Consultants and subcontractors      |       | 6                                                |       |
| Travel                              |       | 6                                                |       |
| Outside testing                     |       | (9                                               | )          |
| Expense materials                   |       | (60                                              | )          |
| Period Ended March 31, 2008    |       | $                                                | 3,032      |   |

 

For the three months ended March 31, 2008, research anddevelopment expense increased by approximately $1,372,000 or 83%, in comparisonto the equivalent period in 2007.  Thisincrease is primarily due to a reduction in the overhead allocated to ourgovernment contracts of approximately $475,000, as those contracts were mostlycompleted during 2007, increased legal costs of approximately $296,000 relatedto the Arete lawsuit, increased headcount-related expenses resulting fromhiring of engineering and support staff to support our flywheel development andmove to production of approximately $268,000, increased facility costs due toour larger facility of approximately $217,000, and increased stock compensationexpense of approximately $146,000, and increases in various other costs ofapproximately $39,000.  These increaseswere partially offset by reductions in development materials and outsidetesting of approximately $60,000 and $9,000 each.We expect research and development costsduring 2008 to be higher than in 2007. Although critical testing of the Smart Energy 25 flywheel is complete,we continue to perform various operational tests and other development workaimed at achieving manufacturing cost reductions.  Additionally, we expect occupancy costs inour new, larger facility in Tyngsboro to be higher than those at our Wilmingtonfacility.

 

*Loss on Contract Commitments*

 

Ourcontracts have been primarily for the development of demonstration units of newproducts and the design of a frequency regulation plant. As such, the work hassupported our core research and development efforts.  Most of these contracts have been structuredon a cost-share basis, for which the expected cost-share has been recorded as acontract loss.  We recorded contractcommitment losses on our research and development contracts in 2005 of$1,535,000 based on expected cost overruns related to material, labor andoverhead required to complete the contracts. During 2006, we recorded additional charges totaling approximately$1,385,000 to the contract loss reserve. This amount consisted of net increases in estimated material, labor,overhead and travel costs expected to complete existing contracts along withour expected cost share portion of the Sandia contract. By the end of 2007, allbut one smaller government contract was complete. We recorded a reduction tothe losses on contract commitments of approximately $578,000, based on theactual cost to complete these contracts, which was less than previouslyestimated. This amount consisted of net decreases in material, labor, overheadand travel costs required to complete existing contracts of approximately$465,000.  In addition, since our actualoverhead rate was lower than forecasted at the beginning of the fiscal year, wereduced the overhead applied to the contracts and our contract loss reserve byan additional $113,000.  Based on ourassessments of the estimated costs to complete our contracts as ofMarch 31, 2007, no additional charges to the contract loss reserve wererequired.

 

25

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*Depreciation and Amortization*

 

The increase in depreciation expense for the first three months of 2008as compared to the first three months of 2007 of approximately $254,000, or977%, is primarily due to capital expenditures relating to leaseholdimprovements at our new manufacturing and office facility in Tyngsboro as wellas the purchase of machinery and equipment required to begin commercialproduction. We expect depreciation expense to continue to increase during 2008as we build and place our frequency regulation facilities into commercial operation.

 

*Interest and Other Income/(Expense), net*

 

The increase in interest income for the first three months of 2008 ascompared to the same period during 2007 of approximately $62,000, or 53%, isattributable to higher cash balances available for investing, primarily as aresult of the cash obtained through the sale of stock and warrants at varioustimes during 2007.

 

*Net Loss*

 

As a result of the changes discussed above, the net loss for the threemonths ended March 31, 2008 was approximately $5,287,000 which compares toa net loss during the same period in 2007 of approximately $3,090,000, anincrease in net loss of approximately $2,197,000 or 71%.

 

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**Liquidityand Capital Resources**

 
| ** **                                | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                              | ** ** |
| Cash and cash equivalents                 |       | $                                                    | 25,037     |   | $ | 12,136 |   |
| Working capital                           |       | 23,118                                               |       | 10,506 |   |
| Cash provided by (used in)                |       |                                                 |       |   |   |
| Operating activities                      |       | (2,963                                               | )          | (2,791 | ) |
| Investing activities                      |       | (2,435                                               | )          | (41 | ) |
| Financing activities                      |       | 18                                                   |       | 9,717 |   |
| Net decrease in cash and cash equivalents |       | $                                                    | (5,380     | ) | $ | 6,885 |   |
| Current ratio                             |       | 7.3                                                  |       | 5.0 |   |

 

Our cash requirements depend on many factorsincluding, but not limited to, cost to build our flywheels and frequencyregulation facilities, research and development activities, facility costs aswell as general and administrative expenses. Since we are still in the development stage and have not yet begun ourprincipal operations, we do not generate enough cash from operations to satisfyour working capital requirements.  Weexpect to make significant expenditures to fund our operations, developtechnologies and explore opportunities to find and develop additional marketsto sell our products. In previous years, we took significant actions to reduceour cash expenditures for product development, infrastructure and productionreadiness by significantly reducing headcount, development spending and capitalexpenditures.  However, as we enterproduction of the Smart Energy MatrixTM aimed at revenue generation in 2008, wehave begun to increase our headcount, and have spent additional funds onproduction materials, capital equipment, market analyses and the pursuit ofregulatory relief to modify market rules in a way that ensures our abilityto enter markets on a timely basis and to profitably compete.  We expect to require significant cashresources during 2008 as we increase capacity to manufacture our Smart Energy25 flywheels and begin commercial deployment of megawatts of frequencyregulation in service at two ISOs during the fourth quarter of 2008.

 

We must raise additional equity and/or project financing to execute ourbusiness plan.  Based on our rate ofexpenditure of cash and the additional expenditures expected to support ourbusiness plan, we have sufficient cash to fund operations into approximatelythe fourth quarter of 2008. We need to obtain additional cash during 2008 tofund:

 

·                  Our continuation as a going concern

·                  Ongoing research and development of theSmart Energy 25 flywheel and the Smart Energy MatrixTM multi-flywheel system

·                  The ramp up of our manufacturing andassembly capacity

·                  The build-out of facilities to providefrequency regulation services to the electricity grid

·                  Regulatory matters

·                  Working capital requirements; and

·                  The identification and development of newbusiness opportunities.

 

As we enter into productionof the Smart Energy 25 flywheel, which is the core component of the SmartEnergy MatrixTM flywheel system.  In order to complete development of theSmart Energy MatrixTM flywheel system, build, operate and receive fees forfrequency regulation services and have sufficient working capital to continueto execute our business plan through 2008, we will need to raise approximately$20 million of funding during the remainder of 2008.  Also, to achieve our long-term deploymentplan for additional frequency regulation facilities, we will need to raiseadditional capital either from a combination of project finance and equity transactions.

 

 

27

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**OperatingActivities**

 

Net cash used inoperating activities was approximately $2,963,000 and $2,791,000 for the threemonths ended March 31, 2008 and 2007, respectively.  The primarycomponent to the negative cash flow from operations is from net losses. For the three months ending March 31, 2008, we had a net loss ofapproximately $5,287,000.  Adjustments to reconcile net loss to cash flowin 2008 include non-cash stock compensation of approximately $751,000,depreciation and amortization of approximately $280,000, a net reduction indeferred rent of approximately $66,000 and cash received from the landlord tooffset the cost of leasehold improvements of $1,430,000. Changes in operatingassets and liabilities used approximately $203,000 of cash.   During thesame period in 2007, we had a net loss of approximately $3,090,000. Adjustments to reconcile net loss to cash flow include non-cash stockcompensation of approximately $580,000, depreciation and amortization ofapproximately $26,000, and a net reduction in the asset impairment reserve ofapproximately $7,000, offset by a gain on the sale of fixed assets ofapproximately $4,000, facility-related cash payments charged against restructuringreserves of approximately $91,000 and changes in operating assets andliabilities of approximately $219,000.

 

**InvestingActivities**

 

Net cash used ininvesting activities was approximately $2,435,000 and $42,000 for the threemonths ending March 31, 2008 and 2007, respectively.  The principal use of cash in 2008 and 2007,respectively, was the purchase of property and equipment in the amount ofapproximately $2,609,000 in 2008 and $46,000 in 2007, offset by the sale ofproperty and equipment of approximately $4,000 in 2007.  A reduction inrestricted cash related to the Wilmington lease that expired in 2007 providedapproximately $174,000 in cash in 2008.

 

**FinancingActivities**

 

Net cash provided byfinancing activities was approximately $18,000 and $9,717,000 for the firstthree months of 2008 and 2007, respectively. In 2008, we raised approximately $18,000 related to the reduction ofcosts previously accrued related to the sale of stock in 2007.  For 2007, we raised approximately $9,717,000from the sale of stock from our shelf registration.

 

We may evaluate possibleacquisitions of enterprises or technologies that we consider synergistic from amarket, technology or product perspective. We may make investments in companiesfor strategic business reasons or seek other strategic financing relationshipsthat benefit our business.

 

**Item3.  Quantitative and Qualitative Disclosure About Market Risk**

 

Our cashequivalents, which have maturities of less than three months, may expose ourassets to interest rate risk.  At March 31, 2008, we hadapproximately $109,000 of cash equivalents that were held in non-interestbearing accounts.  Also at March 31, 2008, we had approximately$466,000 of cash equivalents that were held in interest bearing checkingaccounts, and approximately $24,662,000 invested in interest-bearing moneymarket accounts at high-quality financial institutions, some of which areinvested in off-shore securities.  Thefair value of these investments approximates their cost. The funds invested inmoney market accounts may not be covered under FDIC Insurance, and thereforemay be some risk of loss, which we deem to below.

 

28

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**Item4.  Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

As of the end ofthe period covered by this report, we carried out an evaluation, under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures.  Based on the evaluation, both the ChiefExecutive Officer and the Chief Financial Officer concluded that our disclosurecontrols and procedures, as defined in Rules 13a – 15(e) and 15d – 15(e)promulgated under the Securities Exchange Act of 1934, were effective on March 31,2008.

 

*Management’sReport on Internal Control over Financial Reporting*

 

Our Management isresponsible for establishing adequate internal control over financialreporting, as that term is defined in Exchange Act rules 13a-15(f) and15d-15(f).  Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we conducted an evaluation of the effectiveness ofour internal control over financial reporting as of March 31, 2008 basedon the framework in internal control – Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO).  Based on that evaluation, our managementconcluded that our internal control over financial reporting was effective asof March 31, 2008, and that there was no change in our internal controlover financial reporting that materially affected, or is reasonably likely tomaterially affect, such internal control during the quarter ended on that date.

 

Management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2007 has been audited by Miller Wachman LLP,an independent registered public accounting firm, as stated in their reportwhich is included in our Annual Report on Form 10-K which was filed withthe SEC on March 17, 2008.

 

29

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**Part II — OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

OnOctober 9, 2007, Arete Power, Inc. filed a complaint against usclaiming damages from alleged willful infringement of U.S. Patent No. 6,710,489,entitled “Axially Free Flywheel System.” On November 30, 2007, we filed an Answer denying infringement and aCounterclaim seeking a declaratory judgment that the ‘489 patent isinvalid.  At the same time, we filed amotion to transfer the lawsuit from the Northern District of California to theDistrict of Massachusetts.  On February 22,2008, the Court granted our motion to transfer the lawsuit to the District ofMassachusetts.  We believe that thislawsuit is without merit and we plan to vigorously defend the Company againstthe lawsuit.

 

**Item1A.  Risk Factors**

 

There have notbeen any material changes during the quarter ended March 31, 2008 to therisk factors set forth in Part I, Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2007 and filed with the SEC on March 17,2008.

 

**Item 2.  Unregistered Sales of Equity Securities and Useof Proceeds**

 

None.

 

**Item 3.  Defaults Upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

None.

 

**Item 5.  Other Information**

 

None.

 

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**Item6.  Exhibits**

 
| **Exhibit** | ** ** | ** ** | ** ** | ** **                                                                                                                                                        | ** ** |
|-------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Number**  | ** ** | **Ref**    | ** ** | **Description  of Document**                                                                                                                                      | ** ** |
|        |       |       |       |                                                                                                                                                              |       |
| 3.1         |       | (1)        |       | Sixth Amended and Restated  Certificate of Incorporation.                                                                                                         |       |
|        |       |       |       |                                                                                                                                                              |       |
| 3.2         |       | (1)        |       | Certificate of Amendment  of the Sixth Amended and Restated Certificate of Incorporation, dated  June 25, 2007.                                              |       |
|        |       |       |       |                                                                                                                                                              |       |
| 3.3         |       | (1)        |       | Certificate of Amendment  of the Sixth Amended and Restated Certificate of Incorporation, dated  June 26, 2007.                                              |       |
|        |       |       |       |                                                                                                                                                              |       |
| 3.4         |       | (5)        |       | Amended and Restated  Bylaws, as amended.                                                                                                                         |       |
|        |       |       |       |                                                                                                                                                              |       |
| 3.5         |       | (2)        |       | Certificate of Designation  of Series A Junior Participating Preferred Stock, filed with The  Secretary of State of Delaware on October 4, 2002.        |       |
|        |       |       |       |                                                                                                                                                              |       |
| 4.1         |       | (3)        |       | Form of specimen  stock certificate.                                                                                                                         |       |
|        |       |       |       |                                                                                                                                                              |       |
| 10.1        |       | (4)        |       | Amended and Restated  Employment agreement dated February 14, 2008 between the Company and F.  William Capp.                                                 |       |
|        |       |       |       |                                                                                                                                                              |       |
| 10.2        |       | (4)        |       | Amended and Restated  Employment agreement dated February 14, 2008 between the Company and  James M. Spiezio.                                                |       |
|        |       |       |       |                                                                                                                                                              |       |
| 10.3        |       | (4)        |       | Amended and Restated  Employment agreement dated February 14, 2008 between the Company and  Matthew L. Lazarewicz.                                           |       |
|        |       |       |       |                                                                                                                                                              |       |
| 10.4        |       | (4)        |       | Restricted Stock Unit and  Option Agreement dated February 14, 2008 between the Company and F.  William Capp.                                                |       |
|        |       |       |       |                                                                                                                                                              |       |
| 10.5        |       | (4)        |       | Restricted Stock Unit and  Option Agreement dated February 14, 2008 between the Company and James  M. Spiezio.                                               |       |
|        |       |       |       |                                                                                                                                                              |       |
| 10.6        |       | (4)        |       | Restricted Stock Unit and  Option Agreement dated February 14, 2008 between the Company and Matthew  L. Lazarewicz.                                          |       |
|        |       |       |       |                                                                                                                                                              |       |
| 31.1        |       | +          |       | Certification of Principal  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                    |       |
|        |       |       |       |                                                                                                                                                              |       |
| 31.2        |       | +          |       | Certification of Principal  Financial and Accounting Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                     |       |
|        |       |       |       |                                                                                                                                                              |       |
| 32.1        |       | +          |       | Certification of Principal  Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |       |
|        |       |       |       |                                                                                                                                                              |       |
| 32.2        |       | +          |       | Certification of Principal  Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. |       |

 

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(1)          Incorporated by reference from the Form 10-Kfiled on March 17, 2008 (File No. 000-31973).

 

(2)          Incorporated by reference from the Form 10-Kfiled on March 30, 2006 (File No. 000-31973).

 

31

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(3)          Incorporated by reference from the Form S-3 filedon December 8, 2005 (File No. 333-130207).

 

(4)          Incorporated by reference from the Form 8-Kfiled on February 21, 2008 (File No. 000-31973).

 

(5)          Incorporated by reference from the Form 8-K filedon October 1, 1007 (File No. 000-31973).

 

+                 Filed herewith.

 

32

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                                |   | BEACON POWER  CORPORATION                            |
|-------------------------------------|--------|------------------------------------------------------|
|                                |   |                                                 |
|                                |   |                                                 |
| Date:    May 8, 2008 |   |                                                 | By: | /s/ F. William Capp |
|                                |   | F. William Capp                                      |
|                                |   | President and Chief  Executive Officer               |
|                                |   |                                                 |
|                                |   |                                                 |
| May 8, 2008                         |   |                                                 | By: | /s/ James M. Spiezio |
|                                |   | James M. Spiezio                                     |
|                                |   | Vice President of  Finance, Chief Financial Officer, |
|                                |   | Treasurer and Secretary                              |
|                                |   | Principal Financial  Officer                         |

 

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