** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

----

** **

**FORM 10-Q**

 

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| **x**      | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934 for the quarterly period ended June 30, 2010**                                                                  |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                                                                 |
| **or**     |
| ** ** | ** **                                                                                                                                                                                                                 |
| **o**      | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934 (For the transition period from         to         ).** |

 

**Commission File Number: 000-31973**

** **

**BeaconPower 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)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  x Yes o No

 

Indicateby check mark whether the registrant has submitted electronically and posted onit corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or such shorter period that theregistrant was required to submit and post such files).     Yes    o    No   o

 

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

 

| Large accelerated filer  o |   | Accelerated filer  x   |
|---------------------------------|--------|-----------------------------|
| Non-accelerated filer  o   |   | Smaller Reporting Company o |

 

Indicateby check mark whether the registrant is a shell company (as defined in rule 12b-2of the Exchange Act.) o Yes x No

 

Thenumber of shares of the Registrant’s common stock, par value $.01 per share,outstanding as of August 6, 2010 was 198,290,063.

 

 

 

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

 
| ** **                         | ** ** | ** **                                                                                                                                                                                                        | **Page**   |
|------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                         | ** ** | ** **                                                                                                                                                                                                        | ** ** |
| PART I. Financial Information |       |
|                               |       |
|                               | Item 1.    | Financial  Statements                                                                                                                                                                                             |       |
|                               |       |                                                                                                                                                                                                              |       |
|                               |       | Consolidated  Balance Sheets at June 30, 2010 and December 31, 2009                                                                                                                                     | 1          |
|                               |       |                                                                                                                                                                                                              |       |
|                               |       | Unaudited Consolidated Statements of Operations for  the three and six month periods ended June 30, 2010 and 2009, and for  the period from May 8, 1997 (date of inception) through June 30,  2010 | 3          |
|                               |       |                                                                                                                                                                                                              |       |
|                               |       | Unaudited Consolidated Statements of Cash Flows for  the three and six month periods ended June 30, 2010 and 2009 and for the  period from May 8, 1997 (date of inception) through June 30, 2010   | 4          |
|                               |       |                                                                                                                                                                                                              |       |
|                               |       | Unaudited Consolidated Statements of Stockholders’  Equity for the year ended December 31, 2009 and the six months ended  June 30, 2010                                                            | 6          |
|                               |       |                                                                                                                                                                                                              |       |
|                               |       | Notes to Unaudited Consolidated Financial Statements                                                                                                                                                              | 7          |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                       | 26         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 3.    | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                                                                       | 49         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 4.    | Controls and  Procedures                                                                                                                                                                                          | 49         |
|                               |       |                                                                                                                                                                                                              |       |
| PART II.  Other Information   |       |
|                               |       |
|                               | Item 1.    | Legal Proceedings                                                                                                                                                                                                 | 50         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 1A.   | Risk  Factors                                                                                                                                                                                                     | 50         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                                                      | 50         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 3.    | Defaults Upon  Senior Securities                                                                                                                                                                                  | 50         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 4.    | (Removed and Reserved)                                                                                                                                                                                            | 50         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 5.    | Other Information                                                                                                                                                                                                 | 50         |
|                               |       |                                                                                                                                                                                                              |       |
|                               | Item 6.    | Exhibits                                                                                                                                                                                                          | 50         |
|                               |       |                                                                                                                                                                                                              |       |
| Signatures                         | 52         |

 

ii

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**PART 1— FINANCIAL INFORMATION**

**Item 1.Financial Statements**

**BEACON POWER CORPORATION AND SUBSIDIARIES (A Development Stage Company)**

**ConsolidatedBalance Sheets**

 
|                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                           | ** ** | **2010**          | ** ** | **2009**              | ** ** |
|                                           | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                     |       |              |       |                  |       |
| Current assets:                                |       |              |       |                  |       |
| Cash and cash equivalents                      |       | $                 | 11,407,943 |                  | $          | 22,605,147 |   |
| Accounts receivable, net                       |       | 416,719           |       | 46,907                |       |
| Unbilled costs on contracts in progress        |       | 500,581           |       | 577,356               |       |
| Prepaid expenses and other current assets      |       | 575,638           |       | 636,887               |       |
| Total current assets                           |       | 12,900,881        |       | 23,866,297            |       |
| Property and equipment, net                    |       | 28,426,120        |       | 24,373,941            |       |
| Restricted cash                                |       | 212,564           |       | 212,557               |       |
| Deferred financing costs                       |       | 2,134,791         |       | 1,198,873             |       |
| Advance payments to suppliers                  |       | 4,917,214         |       | 235,879               |       |
| Other assets                                   |       | 196,745           |       | 114,933               |       |
| Total assets                                   |       | $                 | 48,788,315 |                  | $          | 50,002,480 |   |
| ** **                                     |       |              |       |                  |       |
| **Liabilities and Stockholders’  Equity** |       |              |       |                  |       |
| Current liabilities:                           |       |              |       |                  |       |
| Accounts payable                               |       | $                 | 3,839,841  |                  | $          | 1,154,613 |   |
| Accrued compensation and benefits              |       | 1,431,899         |       | 1,764,053             |       |
| Other accrued expenses                         |       | 2,952,270         |       | 1,543,507             |       |
| Advance billings on contracts                  |       | 2,296             |       | 35,418                |       |
| Accrued contract loss                          |       | 56,191            |       | 257,698               |       |
| Deferred rent - current                        |       | 151,433           |       | 138,558               |       |
| Current portion of long term debt              |       | 634,094           |       | 608,105               |       |
| Total current liabilities                      |       | 9,068,024         |       | 5,501,952             |       |
| Long term liabilities:                         |       |              |       |                  |       |
| Deferred rent - long term                      |       | 667,583           |       | 746,518               |       |
| Long term debt, net of unamortized discount    |       | 3,351,808         |       | 3,676,569             |       |
| Total long term liabilities                    |       | 4,019,391         |       | 4,423,087             |       |
| Commitments and contingencies (Note 7)         |       |              |       |                  |       |

 

1

----

 
|                                                                                                                                                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
|                                                                                                                                                                   | ** ** | **2010**          | ** ** | **2009**              | ** ** |
|                                                                                                                                                                   | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| Stockholders’ equity:                                                                                                                                             |       |              |       |                  |       |
| Preferred Stock, $.01 par value; 10,000,000 shares  authorized; no shares issued or outstanding                                                                        |       | —            |       | —                |       |
| Common stock, $.01 par value; 400,000,000 shares  authorized 190,657,140 and 171,641,622 shares issued at June 30, 2010  and December 31, 2009, respectively |       | 1,906,571         |       | 1,716,416             |       |
| Deferred stock compensation                                                                                                                                            |       | —            |       | —                |       |
| Additional paid-in-capital                                                                                                                                             |       | 251,553,836       |       | 245,029,557           |       |
| Deficit accumulated during the development stage                                                                                                                       |       | (217,046,668      | )          | (205,955,693          | )          |
| Treasury stock, 421,692 shares at cost                                                                                                                                 |       | (712,839          | )          | (712,839              | )          |
| Total stockholders’ equity                                                                                                                                        |       | 35,700,900        |       | 40,077,441            |       |
| Total liabilities and stockholders’ equity                                                                                                                        |       | $                 | 48,788,315 |                  | $          | 50,002,480 |   |
|                                                                                                                                                                        |            |                   |            |                       |            |  |  |

 

See notes to unaudited consolidated financial statements.

 

2

----

 

**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(A Development Stage Company)**

**Consolidated Statements ofOperations (Unaudited)**

** **
| ** **                                                      | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** **                | ** ** | ** **  | ** **  | **Cumulative  from**     | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|---------------------------|------------|-------------|-------------|--------------------------|------------|
| ** **                                                      | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** **                | ** ** | ** **  | ** **  | **May 8,  1997**    | ** ** |
| ** **                                                      | ** ** | ** **                           | ** ** | ** **                         | ** ** | ** **                | ** ** | ** **  | ** **  | **(date of  inception)** | ** ** |
| ** **                                                      | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** | **through June 30,** | ** ** |
| ** **                                                      | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010**                  | ** ** | **2009**    | ** **  | **2010**                 | ** ** |
| Revenue                                                         |       | $                                    | 165,540    |                               | $          | 281,705                   |       | $           | 401,020     |                     | $          | 392,641 |   | $ | 6,158,119 |   |
| Cost of goods sold (exclusive of items shown  separately below) |       | 72,048                               |       | 285,643                            |       | 255,141                   |       | 457,677     |        | 6,425,886                |       |
| Gross  profit (loss)                                            |       | 93,492                               |       | (3,938                             | )          | 145,879                   |       | (65,036     | )           | (267,767                 | )          |
| Operating  expenses:                                            |       |                                 |       |                               |       |                      |       |        |        |                     |       |
| Operations and maintenance                                      |       | 823,184                              |       | 768,957                            |       | 1,790,166                 |       | 1,546,093   |        | 4,721,481                |       |
| Research and development                                        |       | 1,889,331                            |       | 1,485,649                          |       | 3,961,768                 |       | 3,676,703   |        | 94,574,655               |       |
| Selling, general and administrative                             |       | 2,430,113                            |       | 1,995,349                          |       | 4,375,648                 |       | 3,892,811   |        | 69,540,159               |       |
| Loss on contract commitments                                    |       | (99,650                              | )          | —                             |       | (99,650                   | )          | 132,500     |        | 2,942,974                |       |
| Depreciation and amortization                                   |       | 545,642                              |       | 442,530                            |       | 1,075,478                 |       | 866,418     |        | 8,670,264                |       |
| Restructuring charges                                           |       | —                               |       | —                             |       | —                    |       | —      |        | 2,159,280                |       |
| Loss on impairment of assets                                    |       | —                               |       | —                             |       | —                    |       | —      |        | 4,663,916                |       |
| Total operating expenses                                        |       | 5,588,620                            |       | 4,692,485                          |       | 11,103,410                |       | 10,114,525  |        | 187,272,729              |       |
| Loss  from operations                                           |       | (5,495,128                           | )          | (4,696,423                         | )          | (10,957,531               | )          | (10,179,561 | )           | (187,540,496             | )          |
| Other  income (expense):                                        |       |                                 |       |                               |       |                      |       |        |        |                     |       |
| Interest income                                                 |       | 779                                  |       | 1,736                              |       | 9,627                     |       | 12,256      |        | 5,598,651                |       |
| Interest expense                                                |       | (58,611                              | )          | (75,712                            | )          | (144,962                  | )          | (143,013    | )           | (1,425,275               | )          |
| Gain on sale of investment                                      |       | —                               |       | —                             |       | —                    |       | —      |        | 3,562,582                |       |
| Other income (expense)                                          |       | 1,891                                |       | 3,691                              |       | 1,891                     |       | 3,691       |        | (235,936                 | )          |
| Total other income (expense), net                               |       | (55,941                              | )          | (70,285                            | )          | (133,444                  | )          | (127,066    | )           | 7,500,022                |       |
| Net  loss                                                       |       | (5,551,069                           | )          | (4,766,708                         | )          | (11,090,975               | )          | (10,306,627 | )           | (180,040,474             | )          |
| Preferred  stock dividends                                      |       | —                               |       | —                             |       | —                    |       | —      |        | (36,825,680              | )          |
| Accretion of convertible preferred stock                        |       | —                               |       | —                             |       | —                    |       | —      |        | (113,014                 | )          |
| Loss  to common shareholders                                    |       | $                                    | (5,551,069 | )                                  | $          | (4,766,708                | )          | $           | (11,090,975 | )                        | $          | (10,306,627 | ) | $ | (216,979,168 | ) |
| Loss  per share, basic and diluted                              |       | $                                    | (0.03      | )                                  | $          | (0.04                     | )          | $           | (0.06       | )                        | $          | (0.09 | ) |   |   |
| Weighted-average common shares outstanding                      |       | 185,319,012                          |       | 115,486,517                        |       | 180,450,201               |       | 112,262,766 |        |                     |       |

 

See notes to unaudited consolidated financial statements.

 

3

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**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(A Development Stage Company)**

**ConsolidatedStatements of Cash Flows (Unaudited)**

 
| ** **                                                                   | ** ** | ** **                          | ** **  | ** **        | ** ** | **Cumulative  from**     | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------|-------------|-------------------|------------|--------------------------|------------|
| ** **                                                                   | ** ** | ** **                          | ** **  | ** **        | ** ** | **May 8,  1997**    | ** ** |
| ** **                                                                   | ** ** | ** **                          | ** **  | ** **        | ** ** | **(date  of inception)** | ** ** |
| ** **                                                                   | ** ** | ** **                          | ** **  | ** **        | ** ** | **through**              | ** ** |
| ** **                                                                   | ** ** | **Six  months ended June 30,** | ** **  | **June 30,** | ** ** |
| ** **                                                                   | ** ** | **2010**                            | ** **  | **2009**          | ** ** | **2010**                 | ** ** |
| Cash flows from operating activities:                                        |       |                                |        |              |       |                     |       |
| Net loss                                                                     |       | $                                   | (11,090,975 | )                 | $          | (10,306,627              | )          | $ | (180,040,474 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                |        |              |       |                     |       |
| Depreciation and amortization                                                |       | 1,075,478                           |        | 866,418           |       | 8,670,266                |       |
| Loss (gain) on sale of fixed assets                                          |       | —                              |        | 347               |       | 210,012                  |       |
| Impairment of assets, net                                                    |       | —                              |        | —            |       | 4,551,147                |       |
| Interest expense relating to issuance of warrants                            |       | 26,738                              |        | 28,529            |       | 454,992                  |       |
| Non-cash charge for change in option terms                                   |       | —                              |        | —            |       | 346,591                  |       |
| Non-cash charge for settlement of lawsuit                                    |       | —                              |        | —            |       | 821,160                  |       |
| 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                                                     |       | 375,321                             |        | 564,723           |       | 5,244,968                |       |
| Deferred rent                                                                |       | (66,061                             | )           | (53,185           | )          | (610,986                 | )          |
| Cash received from landlord for build-out credit                             |       | —                              |        | —            |       | 1,430,000                |       |
| Changes in operating assets and liabilities:                                 |       |                                |        |              |       |                     |       |
| Accounts receivable                                                          |       | (369,812                            | )           | (51,158           | )          | (416,719                 | )          |
| Unbilled costs on government contracts                                       |       | 76,775                              |        | (222,763          | )          | (500,581                 | )          |
| Prepaid expenses and other current assets                                    |       | 61,249                              |        | 217,592           |       | (675,299                 | )          |
| Accounts payable                                                             |       | 2,685,228                           |        | (2,260,104        | )          | 3,839,841                |       |
| Accrued compensation and benefits                                            |       | (332,154                            | )           | (201,273          | )          | 1,431,899                |       |
| Advance billings on contracts                                                |       | (33,122                             | )           | 13,812            |       | 2,296                    |       |
| Accrued interest                                                             |       | —                              |        | —            |       | 275,560                  |       |
| Accrued loss on contract commitments                                         |       | (201,507                            | )           | 97,097            |       | 56,191                   |       |
| Other accrued expenses and current liabilities                               |       | 1,408,763                           |        | (1,551,294        | )          | 2,960,940                |       |
| Net cash used in operating activities                                        |       | (6,384,079                          | )           | (12,857,886       | )          | (149,053,134             | )          |
| Cash flows from investing activities:                                        |       |                                |        |              |       |                     |       |
| Purchase of investments                                                      |       | —                              |        | —            |       | (1,190,352               | )          |
| Sale of investments                                                          |       | —                              |        | —            |       | 4,752,934                |       |
| Restricted cash                                                              |       | (7                                  | )           | (28               | )          | (212,564                 | )          |
| Increase in other assets                                                     |       | (81,812                             | )           | —            |       | (608,817                 | )          |
| Purchases and manufacture of property and  equipment                         |       | (5,119,433                          | )           | (1,951,154        | )          | (41,170,203              | )          |
| Sale of property and equipment                                               |       | —                              |        | —            |       | 202,674                  |       |
| Advance payments to suppliers (net)                                          |       | (4,681,335                          | )           | (233,704          | )          | (4,917,214               | )          |
| Net cash used in investing activities                                        |       | (9,882,587                          | )           | (2,184,886        | )          | (43,143,542              | )          |
| Cash flows from financing activities:                                        |       |                                |        |              |       |                     |       |
| Initial public stock offering, net of expenses                               |       | —                              |        | —            |       | 49,341,537               |       |
| Stock offerings, net of expenses                                             |       | 1,513,354                           |        | 4,813,757         |       | 104,843,978              |       |
|                                                                              |            |                                     |             |                   |            |                          |            |  |  |  |

 

4

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| ** **                                          | ** ** | ** **                          | ** ** | ** **        | ** ** | **Cumulative  from**     | ** ** |
|-----------------------------------------------------|------------|-------------------------------------|------------|-------------------|------------|--------------------------|------------|
| ** **                                          | ** ** | ** **                          | ** ** | ** **        | ** ** | **May 8,  1997**    | ** ** |
| ** **                                          | ** ** | ** **                          | ** ** | ** **        | ** ** | **(date  of inception)** | ** ** |
| ** **                                          | ** ** | ** **                          | ** ** | ** **        | ** ** | **through**              | ** ** |
| ** **                                          | ** ** | **Six  months ended June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                          | ** ** | **2010**                            | ** ** | **2009**          | ** ** | **2010**                 | ** ** |
| Payment of dividends                                |       | —                              |       | —            |       | (1,159,373               | )          |
| Shares issued under employee stock purchase plan    |       | 60,522                              |       | 60,362            |       | 460,112                  |       |
| Exercise of employee stock options                  |       | —                              |       | —            |       | 2,304,091                |       |
| Issuance of debt                                    |       | —                              |       | —            |       | 4,615,155                |       |
| Repayment of debt                                   |       | (325,509                            | )          | —            |       | (485,296                 | )          |
| Warrants issued in relation to lease                |       | —                              |       | —            |       | 716,614                  |       |
| Cash paid for financing costs                       |       | (944,142                            | )          | (992,831          | )          | (2,159,124               | )          |
| 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               | )          |
| Warrant exercises                                   |       | 4,765,237                           |       | (100              | )          | 4,857,620                |       |
| Repurchase company stock                            |       | —                              |       | —            |       | (613,179                 | )          |
| Proceeds from notes payable issued to investors     |       | —                              |       | —            |       | 3,550,000                |       |
| Net cash provided by (used in) financing activities |       | 5,069,462                           |       | 3,881,188         |       | 203,604,619              |       |
| (Decrease) increase in cash and cash equivalents    |       | (11,197,204                         | )          | (11,161,584       | )          | 11,407,943               |       |
| Cash and cash equivalents, beginning of period      |       | 22,605,147                          |       | 14,357,475        |       | —                   |       |
| Cash and cash equivalents, end of period            |       | $                                   | 11,407,943 |              | $          | 3,195,891                |       | $ | 11,407,943 |   |
| Supplemental disclosure of cash flow information:   |       |                                |       |              |       |                     |       |
| Cash paid for interest                              |       | $                                   | 149,213    |              | $          | 116,735                  |       | $ | 946,253 |   |
| Cash paid for taxes                                 |       | $                                   | —     |              | $          | —                   |       | $ | 32,750 |   |
| Assets acquired through capital lease               |       | $                                   | —     |              | $          | —                   |       | $ | 535,445 |   |
| Warrants issued in relation to loan (non-cash)      |       | $                                   | —     |              | $          | —                   |       | $ | 227,946 |   |

 

See notes to unaudited consolidated financial statements.

 

5

----

 

**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(A Development Stage Company)**

**ConsolidatedStatements of Stockholders’ Equity (Unaudited)**

** **
| ** **                                        | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **          | ** ** | ** **             | ** **   | ** ** | ** ** | **Total**   | ** ** |
|---------------------------------------------------|------------|-------------------|------------|-------------|------------|-----------------|------------|---------------------|------------|------------------------|--------------|------------|------------|-------------|------------|
| ** **                                        | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Treasury  Stock** | ** ** | **Stockholders’** | ** **   |
| **Description**                                   | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**         | ** ** | **Shares**             | ** **   | **Amount** | ** ** | **Equity**  | ** ** |
| Balance, December 31, 2008                   |       | 107,433,190       |       | $           | 1,074,332  |            | $          | 212,145,254         |       | $                      | (186,895,207 | )          | 421,692    |        | $          | (712,839 | ) | $ | 25,611,540 |   |
| Issuance of officer restricted stock units        |       | 63,272            |       | 631         |       | (631            | )          | —              |       | —                 |         | —     |       | —      |       |
| Shares issued through ESPP                        |       | 200,102           |       | 2,001       |       | 121,768         |       | —              |       | —                 |         | —     |       | 123,769     |       |
| Stock-based compensation                          |       | —            |       | —      |       | 902,279         |       | —              |       | —                 |         | —     |       | 902,279     |       |
| Issuance of stock for cash, net of issuance costs |       | 63,712,933        |       | 637,131     |       | 31,770,825      |       | —              |       | —                 |         | —     |       | 32,407,956  |       |
| Warrant exercises                                 |       | 232,125           |       | 2,321       |       | 90,062          |       | —              |       | —                 |         | —     |       | 92,383      |       |
| Net loss                                          |       | —            |       | —      |       | —          |       | (19,060,486         | )          | —                 |         | —     |       | (19,060,486 | )          |
| Balance, December 31, 2009                   |       | 171,641,622       |       | 1,716,416   |       | 245,029,557     |       | (205,955,693        | )          | 421,692                |         | (712,839   | )          | 40,077,441  |       |
| Issuance of officer restricted stock units        |       | 26,714            |       | 267         |       | (267            | )          | —              |       | —                 |         | —     |       | —      |       |
| Shares issued through ESPP                        |       | 165,583           |       | 1,656       |       | 58,866          |       | —              |       | —                 |         | —     |       | 60,522      |       |
| Stock-based compensation                          |       | —            |       | —      |       | 375,321         |       | —              |       | —                 |         | —     |       | 375,321     |       |
| Issuance of stock for cash, net of issuance costs |       | 4,500,000         |       | 45,000      |       | 1,468,354       |       | —              |       | —                 |         | —     |       | 1,513,354   |       |
| Warrant exercises                                 |       | 14,323,221        |       | 143,232     |       | 4,622,005       |       | —              |       | —                 |         | —     |       | 4,765,237   |       |
| Net loss                                          |       | —            |       | —      |       | —          |       | (11,090,975         | )          | —                 |         | —     |       | (11,090,975 | )          |
| Balance, June 30, 2010                       |       | 190,657,140       |       | $           | 1,906,571  |            | $          | 251,553,836         |       | $                      | (217,046,668 | )          | 421,692    |        | $          | (712,839 | ) | $ | 35,700,900 |   |

 

See notes to unaudited consolidated financial statements.

 

6

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**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(A Development Stage Company)**

**Notes toUnaudited Consolidated Financial Statements**

 

**Note 1.  Nature of Businessand Operations**

* *

*Nature of Business*

 

BeaconPower Corporation (collectively the “Company,” “Beacon,” “we,” “our,” or “us”)(a development stage company) was incorporated on May 8, 1997 as a whollyowned subsidiary of SatCon Technology Corporation.  Since our inception, we have been primarilyengaged in the development of flywheel devices that store and recycle energy ona highly efficient basis.  In 2000, wecompleted an initial public offering of our common stock and raised approximately$49.3 million, net of offering expenses. Since our initial public offering, wehave raised approximately $109.7 million as of June 30, 2010, through thesale of our stock and exercise of warrants. Because we have not yet generated asignificant amount of revenue from our principal operations, we are accountedfor as a development stage company under the Financial Accounting StandardsBoard’s Accounting Standards Codification (ASC) Topic 915.

 

We expect to increase our revenues from the commercialization of ourflywheel energy storage systems to supply frequency regulation services to theelectricity grid in North America and from the sale of turnkey systems outrightor on a fractional basis, both within the United States and on a global basis.We believe that as we expand our production capabilities and continue to lowerour system costs, we will be able to market other cost-effective applicationsfor our flywheel systems that will further expand our revenues.

 

Weare focused on commercializing our Smart Energy MatrixTM flywheel system to providefrequency regulation services and to sell turnkey systems that will also beused to provide frequency regulation.  In the future, as the number of ourmerchant regulation facilities increases and we develop sustainable cash flowsfrom operations and the sale of turnkey plants, we expect to fund additionalplants from a combination of cash flow from operations, non-recourse projectfinancing and project equity.

* *

*Operations*

 

OnAugust 6, 2010, Stephentown Regulation Services, LLC (SRS), a wholly-ownedsubsidiary of Beacon Power Corporation (Beacon), closed on a loan guaranteed bythe Department of Energy (DOE), which, over time, will allow us to borrow up toapproximately $43 million.  As part ofthe loan closing, Beacon transferred $7 million in cash to SRS, into arestricted cash account. Approximately two weeks after closing, SRS will use aportion of this equity contribution to reimburse Beacon for allowable costspreviously incurred.  Monthlydisbursements from the loan are anticipated to begin in September, based uponeligible project spending.  Eachdisbursement will be subject to the satisfaction of certain conditions.  This loan will provide debt financing for62.5% of the estimated $69 million total project cost of our 20 megawatt (MW)plant currently under construction in Stephentown, New York. Our equitycontribution to the project is approximately $26 million of cash and in-kindassets which was fully funded at loan closing. Four MW of the 20 MW total are expected to be online and earning revenueby the end of 2010, and the remaining 16 MW are scheduled to be online andearning revenue by the end of the first quarter of 2011.

 

7

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Wecurrently have three MW of our Smart Energy MatrixTM operating and generatingfrequency regulation revenue within the New England Independent System Operatorregion (ISO-NE) under its Alternative Technologies Regulation pilot program.  A portion of these three MW will beredeployed to the Stephentown plant during the third quarter of 2010 in partialfulfillment of our equity contribution to that project.

 

Inaddition to the revenues we expect to generate from the Stephentown plant, weplan to increase our revenues by building additional 20 MW facilities,including one in the PJM Interconnection region (PJM), either in the Chicagoarea or in Hazle Township, Pennsylvania, and a plant in Glenville, New York. Wehave site control and have filed interconnection applications for two sites inthe Chicago area, as well as one in Hazle Township, PA, and one in Glenville,NY.  We have been awarded a $24 millionDOE Smart Grid stimulus grant for a plant in the PJM region, and in July 2010,we submitted a Phase II application for a DOE loan guarantee for the Glenvillefacility.

 

Weare also identifying other plant locations for future merchant facilities, aswell as marketing our systems to domestic and foreign utilities that lackopen-bid markets with the objective of selling our plants in those markets on aturnkey basis.  Additionally, we areexploring other potential flywheel applications, including the sale of systemsfor wind/diesel/flywheel energy storage hybrid power systems on islands andremote grids as well as military applications.

 

Wehave experienced net losses since our inception and, as of June 30, 2010, hadan accumulated deficit of approximately $217 million.  We do not expect tohave positive EBITDA (earnings before interest, taxes, depreciation and amortization)or positive cash flow from operations until we have deployed a sufficientnumber of merchant plants and/or sold turnkey systems. We will need to raiseadditional capital from a combination of equity and/or project financing, thesale of our systems and/or other sources to build regulation facilities,support operations at our Tyngsboro and other facilities, implement ourbusiness plan and continue as a going concern. Of the $11.4 million cash on hand as of June 30, 2010, $7 million wascontributed to the Stephentown project in August 2010, as required under theterms of the DOE loan, and thus is not available for general corporateoperating purposes. Based on our projected cash usage rates including theanticipated borrowings from the DOE loan and our equity contribution to theStephentown project, we believe we have sufficient cash to fund our operationsinto the fourth quarter of 2010. Weestimate that we will need to raise additional funds during the remainder of2010 through the issuance of equity securities or debt in order to fundoperations and execute our business plan. The amount of funds needed may range from $6 - 20 million, depending onwhen we order long-lead items and begin construction of our second plant.  Additional funding will be required in 2011.

 

**Note 2.  Basis of Presentation and Summary ofSignificant Accounting Policies**

 

**Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements have been preparedusing accounting principles generally accepted in the United States of Americaexcept that certain information and footnote disclosures normally included inconsolidated financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted in this Form 10-Q. We suggest that the consolidated financial statements presented herein be readin conjunction with our consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2009.  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 six months ended June 30, 2010 are not necessarily indicativeof the results that may be expected for the full year ending December 31, 2010.

* *

*Going Concern*

 

The accompanying consolidated financial statements have been preparedon a going concern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business.  As shown in our consolidated financialstatements, we have had minimal revenues, and have incurred significant lossesof approximately $217 million since our inception including losses during thesix months ending June 30, 2010, of approximately $11.1 million.  We have approximately $11.4 million of cashand cash equivalents on hand at June 30, 2010, which we believe, in combinationwith the anticipated proceeds from the DOE loan, is adequate to complete theconstruction of the Stephentown facility and finance our operations into thefourth quarter of 2010.  Since our cashrequirements for operation and construction of frequency regulation facilitiesbeyond that point exceed the cash we expect to generate from operations, we maybe unable to continue as a going concern. The consolidated financial statements do not include any adjustmentsrelating to the recoverability and classification of liabilities that might benecessary should we be unable to continue as a going concern.

 

8

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We recognize that our continuation as a going concern is dependent uponour ability to generate sufficient cash flow to allow us to satisfy ourobligations on a timely basis.  Thegeneration of sufficient cash flow is dependent, in the short term, on ourability to raise additional capital from a combination of equity and/or projectfinancing; and in the long term, on the successful operation of our merchantplants and on our sales of systems on a turnkey basis.  We believe that the successful achievement ofthese initiatives should provide us with sufficient resources to meet ourlong-term cash requirements.

 

*Reclassification of prior period amounts*

 

Certainprior period amounts have been reclassified to be consistent with currentperiod reporting.

* *

*Consolidation*

 

Theaccompanying consolidated financial statements include the accounts of BeaconPower Corporation and our subsidiary, Beacon Power Securities Corporation. InSeptember 2008, we established two wholly-owned subsidiaries, TyngsboroRegulation Services LLC and Tyngsboro Holding LLC.  In July 2009, weestablished two additional wholly-owned subsidiaries, Stephentown Holding LLCand Stephentown Regulation Services, LLC. As of June 30, 2010, these entitiesremain inactive. The frequency regulation service revenue and costs from theISO-NE pilot program are accounted for as part of Beacon Power Corporation. Allsignificant inter-company accounts and transactions have been eliminated inconsolidation.  In August 2010, uponclosing the DOE loan, Beacon’s equity and cash contributions to the Stephentownproject were transferred to SRS.

* *

*Loss per Share — Basic and Diluted*

 

Basicand diluted losses per share have been computed using the weighted-averagenumber of shares of common stock outstanding during each period. Warrants,options and other securities exercisable for common shares are used in thecalculation of fully diluted earnings per share (EPS) only if their conversionto common shares would decrease income or increase loss per share fromcontinuing operations.  Since the three and six-month periods ended June30, 2010, and 2009, reflect losses, including the potential conversion ofwarrants and options in the diluted EPS calculation would decrease loss pershare. Accordingly, they are considered anti-dilutive and are not included inthe calculation of loss per share.

** **

**Summary of Significant Accounting Policies**

 

*Use of Estimates*

 

Thepreparation of consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenues and expenses during the reporting period.  Actual resultscould differ from those estimates.

* *

*LeaseObligation and Deferred Rent*

 

InJuly 2007, we signed a seven-year operating lease with escalating payments on a103,000 square foot facility in Tyngsboro, Massachusetts. As part of this leaseagreement, we issued to the landlord 150,000 shares of our common stock and awarrant exercisable for 500,000 shares of our common stock in return for lowercash payments under the lease. (See Note 6: Commitments andContingencies.)  Additionally, thelandlord has reimbursed us for certain leasehold improvements we have made. Inaccordance with the Financial Accounting Standards Board’s (FASB’s) AccountingStandards Codification (ASC) Topic 840, “*Leases,*” thesereimbursements have been credited to “Deferred Rent”, and we have recorded rentexpense on a straight line basis. The current portion of the deferred rent isincluded in current liabilities, and the remainder is shown on the balancesheet as “Deferred rent — long term.”

* *

*Property and Equipment*

 

Propertyand equipment in service is stated at cost and depreciated using thestraight-line method over the estimated useful lives of the assets. Propertyand equipment are defined as tangible items with unit costs exceeding ourcapitalization threshold that are used in the operation of the business, arenot intended for resale and which have a useful life of one year or more. Thecost of fixed assets is defined as the purchase price of the item, as well asall of the costs necessary to bring it to the condition and location necessaryfor its intended use.  These costsinclude labor, overhead, capitalized interest and, if applicable, exit costs.Exit costs for 

 

9

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whichwe are obligated are accounted for in accordance with ASC Topic 410, “*Asset Retirement and Environmental Obligations*.”  No overhead is generally applied forinternally-constructed projects not directly related to our core business(e.g., leasehold improvements). Interest costs incurred during the constructionof major construction projects (such as the construction of our frequencyregulation plants) are capitalized in accordance with ASC Topic 835, Subtopic20, “*Interest — Capitalization of Interest*.”  The interest is capitalized until theunderlying asset is ready for its intended use, and is considered an integralpart of the total cost of acquiring a qualifying asset.  Thus, the capitalized interest costs areincluded in the calculation of depreciation expense once the constructed assetsare in service. Repair and maintenance costs are expensed as incurred.  Materials used in our development efforts areconsidered research and development materials, and are expensed as incurred inaccordance with ASC Topic 730, “Research and Development.”

 

Capitalassets are classified as “Construction in Progress” (CIP) when initiallyacquired, and reclassified to the appropriate asset account when placed intoservice, with the exception of land, which is capitalized upon purchase.Depreciation expense is not recorded on assets not yet placed into service.

 

Materialspurchased to build flywheels, power electronics and other components used inour frequency regulation installations are classified as CIP, along with therelated labor and overhead costs. Some components of the Smart Energy MatrixTM,such as the flywheels and power electronics, are considered “fungible” in thatthey can be moved and redeployed at a different location.  Non-fungible costs are costs which would notbe recovered if we redeployed the matrix or portions thereof.  In some cases, we may elect to deploy a SmartEnergy MatrixTM system at a location for the purpose of demonstrating ourtechnology or gaining experience operating in that particular market.  In these instances, the costs of the fungiblecomponents are capitalized, and the remaining costs, which may include suchcosts as site preparation, interconnection costs, capitalized interest andestimated exit costs, are expensed.

 

*Deferredfinancing costs*

 

Deferred financing costs represent legal, due diligence and otherdirect costs incurred to raise capital or obtain debt.  Direct costs include only “out-of-pocket” orincremental costs directly related to the effort, such as a finder’s fee andfees paid to outside consultants for accounting, legal or engineeringinvestigations or for appraisals.  Thesecosts will be capitalized if the efforts are successful, or expensed whenunsuccessful.  Indirect costs areexpensed as incurred. Deferred financing costs related to debt are amortizedover the life of the debt. Deferred financing costs related to issuing equityare charged to Paid in Capital.

 

*Advance payments to suppliers*

 

Advance payments to suppliers represent payments for custom materialsused in the manufacture of our flywheels or frequency regulation facilities.

 

*Loss on Contract Commitments*

 

Ourcontracts have been primarily for the development of demonstration units of newproducts, design of a frequency regulation plant, design of a flywheel for useby the Navy in their electric ships, and other work that supports our coreresearch and development efforts.  Mostof these contracts have been structured on a cost-share basis for which theexpected cost share has been recorded as a contract loss.  The “cost” basis allowable on these contractsis based on government-allowable overhead rates, which differ from overheadrates required by GAAP.  In particular,most of our stock compensation expense is not an allowable cost for thepurposes of calculating government-allowable rates.  As a consequence, we may incur losses on ourfinancial statements even for contracts granted on a cost-plus-fixed feebasis.  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.  Each quarter, we perform anestimate-to-complete analysis, and any changes to our original estimates arerecognized in the period in which they are determined.

* *

*Stock-Based Compensation*

 

Weaccount for stock-based compensation for employees in accordance with ASC Topic718, “*Compensation-Stock Compensation*.” Underthe fair value recognition provision of ASC Topic 718, stock-based compensationcost is measured at the grant date based on the fair value of the award and isrecognized as an expense as it is earned over the requisite service period,which is the vesting period. The fair value of the options on their grant dateis measured using the Black-Scholes option-pricing 

 

10

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model,which we believe yields a reasonable estimate of the fair value of the grantsmade. The valuation provisions of ASC Topic 718 apply to grants issued sinceJanuary 1, 2006 (the effective date) and to grants that were outstanding as ofthat date that are subsequently modified. Estimated compensation expense forgrants that were outstanding as of the effective date will be recognized overthe remaining vesting period.

 

Non-employeestock-based compensation is accounted for in accordance with ASC Topic 505, “*Equity-based payments to Non-Employees*.”  In accordance with this topic, costrecognized for non-employee share-based payment transactions is determined bythe fair value of whichever is more reliably measurable:  (a) the goods or services received; or (b)the equity instruments issued.

* *

*Restructuring and Asset Impairment Charges*

 

In accordance with ASC Topic 360, “*Property, Plant andEquipment*,” long-lived assets to be held and used are reviewed todetermine whether any events or changes in circumstances indicate that thecarrying value of the asset may not be recoverable.  The conditions considered include whether ornot the asset is in service, has become obsolete, or whether external marketcircumstances indicate that the carrying amount may not be recoverable.  We recognize a loss for the differencebetween the estimated fair value of the asset and the carrying amount. The fairvalue of the asset is measured using either available market prices orestimated discounted cash flows.

 

Incertain instances, we may determine that it is in the best interest of the Companyto move and re-deploy all or part of a Smart Energy MatrixTM system installed ata given location.  When such a decisionhas been made, we will determine which costs are associated with the movable(fungible) components, and which costs are non-fungible. We will record aperiod expense for the net book value associated with the non-fungiblecomponents.

 

Noasset impairment charges were considered necessary for the six months endedJune 30, 2010 or 2009.

 

*Revenue Recognition*

 

Although we have recorded revenues for ourresearch and development contracts and frequency regulation service from theISO-NE pilot program, our operations have not yet reached a level that wouldqualify us to emerge from the development stage.  Therefore we continue to be accounted for asa development stage company under ASC Topic 915, “Development Stage Entities.”

 

·                  *Frequency Regulation Revenue*

 

Revenue from frequency regulation is recognized whenit has been earned and is realized or realizable. Revenue from services is earnedeither as the services are performed or when they are complete and isconsidered realizable once the customer has committed to pay for the servicesand the customer’s ability to pay is not in doubt.  Frequency regulation revenue is calculated onan hourly basis, as services are provided, based on formulas specific to thetariffs in effect at the applicable ISO at bid award rates that are publishedby the ISO.  Frequency regulation servicerevenue is calculated using the applicable rates and formulas as services areprovided.

 

·                  *  Research and Development Contract RevenueRecognized on the Percentage-of-Completion Method*

 

We recognize contract revenue using thepercentage-of-completion method. We use labor hours as the basis for thepercentage of completion calculation, which is measured principally by thepercentage of labor hours incurred to date for each contract to the estimatedtotal labor hours for each contract at completion. Changes to total estimatedcontract costs or losses, if any, are recognized in the period in which theyare determined. Changes in project performance and conditions, estimatedprofitability, and final contract settlements may result in future revisions tocontract costs and revenue.  Revenuesrecognized in excess of amounts billed are classified as current assets, andincluded in “Unbilled costs on contracts in progress” in our balancesheets.  Amounts billed to clients in excess of revenues recognized todate are classified as current liabilities under “Advance billings oncontracts.”  Changes in project performance and conditions, estimatedprofitability, and final contract settlements may result in future revisions tocontract costs and revenue.

 

11

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Our research and development contracts are subjectto cost review by the respective contracting agencies. Our reported resultsfrom these contracts could change as a result of these reviews.

 

·                  *Inverter Sales*

 

Generally, revenue on inverter and related productsales is recognized on transfer of title, typically when products are shippedand all related costs are estimable.  Forsales to distributors, we make an adjustment to defer revenue until theproducts are subsequently sold by distributors to their customers.

 

*Cost of Goods Sold*

 

For frequency regulation revenue, cost of goods sold represents thecost of energy. Cost of goods sold for our research and development contractsis calculated on a percentage-of-completion basis, using the same percentage ofcontract costs (up to the total contract revenue amount) as is used tocalculate revenue. In the event that expected costs exceed total contractrevenue amount, the excess costs are charged to contract loss. We value ourproducts at the lower of cost or market. Costs in excess of this measurement are expensed in the period in whichthey are incurred.

 

*Fair Value of Financial Instruments*

 

Accounting for fair value measurements involves a single definition offair value, along with a conceptual framework to measure fair value, with afair value defined as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date. The fair value measurement hierarchy consists of threelevels:

 

·                  Level one—quoted market prices in activemarkets for identical assets or liabilities;Level two—inputs other than level one inputs that are either directly orindirectly observable, and

·                  Level three—unobservable inputs developedusing estimates and assumptions which are developed by the reporting entity andreflect those assumptions that a market participant would use.

 

We apply valuation techniques that (1) place greater reliance onobservable inputs and less reliance on unobservable inputs and (2) areconsistent with the market approach, the income approach and/or the costapproach, and include enhanced disclosures of fair value measurements in ourfinancial statements.

 

The carrying values of cash and cash equivalents, accounts receivable,other current assets, accounts payable, accrued expenses, and other currentliabilities approximate their fair values due to the short maturity of theseinstruments.  See Note 8 for debt fairvalue, which also approximates carrying value.

 

***Recently Issued Accounting Pronouncements and Regulations***

 

InApril 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-17,“*Revenue Recognition — Milestone Method (Topic605). *The objective of thisupdate is to provide guidance on defining a milestone and determining when itmay be appropriate to apply the milestone method of revenue recognition forresearch or development transactions, in particular for instances whereby aportion or all of the consideration is contingent upon milestone events such asachieving a specific result from the research or development efforts. Underthis guidance, a vendor can recognize consideration that is contingent uponachievement of a milestone in its entirety as revenue in the period in whichthe milestone is achieved only if the milestone meets all criteria to beconsidered substantive.  Determiningwhether a milestone is substantive is a matter of judgment made at theinception of the arrangement.  Inaddition, this update requires specific disclosures.  This update is effective on a prospectivebasis for milestones achieved in fiscal years, and interim periods within thoseyears, beginning on or after June 15, 2010.  Early adoption is permitted.  Although we do not currently have anycontracts for which the milestone method is being used for revenue recognition,this update could impact our accounting for future research and developmentcontracts.

 

***Recently Adopted Accounting Pronouncements and Regulations***

 

InJanuary 2010, the FASB issued ASU No. 2010-06, “*Fair Value Measurementsand Disclosures (Topic 820): Improving Disclosures about Fair ValueMeasurements.*” This ASU requires some new disclosures and clarifiessome existing disclosure requirements about fair value measurement as set forthin Codification Subtopic 820-10. The FASB’s objective is to improve these 

 

12

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disclosuresand, thus, increase the transparency in financial reporting. Specifically, ASU2010-06 amends Codification Subtopic 820-10 to now require:

 

·                  A reporting entity should disclose separatelythe amounts of significant transfers in and out of Level 1 and Level 2 fairvalue measurements and describe the reasons for the transfers; and

 

·                  In the reconciliation for fair valuemeasurements using significant unobservable inputs, a reporting entity shouldpresent separately information about purchases, sales, issuances, andsettlements.

 

Level1 inputs are quoted prices (unadjusted) in active markets for identical assetsor liabilities that the reporting entity has the ability to access at themeasurement date.  Level 2 inputs areinputs other than quoted prices included within Level 1 that are observable forthe asset or liability, either directly or indirectly. Level 3 inputs areunobservable inputs for the asset or liability.

Inaddition, ASU 2010-06 clarifies the requirements of the following existingdisclosures:

 

·                  For purposes of reporting fair valuemeasurement for each class of assets and liabilities, a reporting entity needsto use judgment in determining the appropriate classes of assets andliabilities; and

 

·                  A reporting entity should provide disclosuresabout the valuation techniques and inputs used to measure fair value for bothrecurring and nonrecurring fair value measurements.

 

Weadopted ASU 2010-06 as of January 1, 2010, except for the disclosuresabout purchases, sales, issuances, and settlements in the roll forward ofactivity in Level 3 fair value measurements. Those disclosures are effectivefor fiscal years beginning after December 15, 2010, and for interimperiods within those fiscal years. Early application is permitted.  There were no significant changes to ourfinancial accounting and reporting as a result of the issuance of ASU 2010-06.

 

**Note 3.  Accounts Receivable**

 

Ouraccounts receivable include amounts due from customers and are reported net ofa reserve for uncollectible accounts as follows:

 
| ** **                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Accounts receivable, trade      |       | $                 | 416,719    |                  | $          | 46,907 |   |
| Allowance for doubtful accounts |       | —            |       | —                |       |
| Accounts receivable, net        |       | $                 | 416,719    |                  | $          | 46,907 |   |

 

There was no allowance for doubtful accounts as of June 30, 2010,or December 31, 2009.  All accountsare expected to be collected.

 

Someof our research and development contracts contain holdback provisions thatallow our customers to withhold 10% from each invoice payment. Our accountsreceivable balance includes holdbacks of approximately $13,000 and $17,000 asof June 30, 2010 and December 31, 2009, respectively.  Theseholdbacks are payable once work has been satisfactorily completed and the finalreports have been delivered and approved. We believe the holdbacks will becollected upon completion of the contracts and collected within one year, andtherefore have not recorded any reserve against this amount.

 

13

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**Note 4.  Property and Equipment**

 

Detailsof our property and equipment follow:

 
| ** **                                         | ** ** | **Estimated**           | ** ** | **As  of:**                   | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|-------------------------------|------------|
| ** **                                         | ** ** | **Useful********Lives** | ** ** | **June 30,********2010** | ** ** | **December 31,********2009** | ** ** |
| Construction in Progress                           |       | Varied                  |       | $                             | 12,875,106 |   | $ | 7,941,125 |   |
| Land                                               |       |                    |       | 192,487                       |       | 192,487 |   |
| Smart Energy 25 flywheels                          |       | 20 years                |       | 6,241,732                     |       | 6,241,732 |   |
| Smart Energy MatrixTM installations - fungible |       | 20 years                |       | 1,571,649                     |       | 1,686,038 |   |
| Machinery and equipment                            |       | 5 - 10 years            |       | 3,343,960                     |       | 3,096,175 |   |
| Service vehicles                                   |       | 5 years                 |       | 16,763                        |       | 16,763 |   |
| Furniture and fixtures                             |       | 7 years                 |       | 700,624                       |       | 700,624 |   |
| Office equipment and software                      |       | 3 years                 |       | 1,077,992                     |       | 1,025,936 |   |
| Leasehold improvements                             |       | Lease term              |       | 7,804,607                     |       | 7,804,607 |   |
| Equipment under capital lease obligations          |       | Lease term              |       | 563,782                       |       | 563,783 |   |
| Total                                              |       |                    |       | $                             | 34,388,702 |   | $ | 29,269,270 |   |
| Less accumulated depreciation and amortization     |       |                    |       | (5,962,582                    | )          | (4,895,329 | ) |
| Property and equipment, net                        |       |                    |       | $                             | 28,426,120 |   | $ | 24,373,941 |   |

 

In November 2008, we deployed 1 MW of capacity under the ISO-NEAlternative Technologies pilot program (“pilot program”) with a systeminstalled inside our Tyngsboro facility. We deployed a second MW of capacityunder the pilot program in July 2009, and a third MW in December 2009.Both of these additional MWs are installed outside and adjacent to our facilityin Tyngsboro. The Smart Energy 25 flywheels shown above represent the cost ofthe flywheels and electronic control modules in use for this pilotprogram.  In addition, the “Smart EnergyMatrixTM installations — fungible” shown above represent the cost of ancillaryequipment, such as chillers, installed outside our facility. This equipment isconsidered fungible because it can be relocated to other sites.

 

Under the terms of ourTyngsboro facility lease, we will incur certain exit costs at termination ofour lease.  Estimated exit costs ofapproximately $243,000 relating to certain non-fungible equipment included inthe Smart Energy MatrixTM system operating outside of our facility were expensedin 2008 and carried in accrued expenses. Machinery and equipment and leasehold improvements include approximately$54,000 in estimated exit costs as of June 30, 2010, and December 31,2009, that are being depreciated over the remaining life of the assets.  In addition, we paid the Town of Stephentown,New York $75,000 to be held in escrow to cover any land clearing or exit costsat that site.  This amount is included in“Deferred financing costs” on our balance sheets.

 

In July 2008, we purchased land in Stephentown, New York, for theconstruction of a frequency regulation system, the cost of which is reflectedas “Land” in the schedule shown above. On August 31, 2009, we purchased an option to lease land inGlenville, New York, where we expect to build another 20 MW facility.  During the lease option period, we haveagreed to negotiate a ground lease to be entered into upon our unilateralexercise of the lease option.  Key termsof the ground lease were substantially delineated in the executed option of thelease.  The lease option expires on February 28,2011, but may be extended for an additional consecutive six-month period.  In consideration for this option, we arepaying the landlord a non-refundable fee of $4,550 per month in lease commitments.

 

14

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The components of “Construction in progress” (CIP), which representcosts related to assets that have not yet been placed into service and forwhich no depreciation expense has been taken, were as follows:

 
| ** **                                                                                    | ** ** | **As  of:**       | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                    | ** ** | **2010**          | ** ** | **2009** | ** ** |
| Materials to build production flywheels                                                       |       | $                 | 6,948,428  |   | $ | 5,665,670 |   |
| Smart Energy MatrixTM in progress                                                         |       | 5,467,491         |       | 1,955,481 |   |
| Deposits and other costs related to the  acquisition of land for frequency regulation systems |       | 47,670            |       | 43,002 |   |
| Machinery and equipment                                                                       |       | 266,776           |       | 260,840 |   |
| Leasehold improvements                                                                        |       | 144,741           |       | 16,132 |   |
| Construction in progress                                                                      |       | $                 | 12,875,106 |   | $ | 7,941,125 |   |

 

As of June 30, 2010, and December 31, 2009, approximately$12,464,000 and $7,621,000, respectively, of the total shown as CIP representcompleted flywheels not yet in service, materials to build flywheels and othercosts related to the Smart Energy MatrixTM installations under construction forour Stephentown site.

 

**Note 5.  DeferredFinancing Costs**

 

Details of our deferred financing costs are asfollows:

 
| ** **                                                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                      | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Prepaid financing costs associated with the DOE  loan guarantee                 |       | $                 | 2,066,703  |                  | $          | 1,124,300 |   |
| Deferred finance charges associated with the  MassDev loan, net of amortization |       | 68,088            |       | 74,573                |       |
| Total                                                                           |       | $                 | 2,134,791  |                  | $          | 1,198,873 |   |

 

**Note 6.  OtherAssets**

 

Other assets represent deferred costs forpatents, and are as follows:

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Patents                       |       | $                 | 198,649    |                  | $          | 115,097 |   |
| Less accumulated amortization |       | (1,904            | )          | (164                  | )          |
| Net other assets              |       | $                 | 196,745    |                  | $          | 114,933 |   |

 

**Note 7.  Commitments and Contingencies**

 

Thefollowing table summarizes our purchase obligations and the aggregatematurities and payments due for our contractual obligations as of June 30,2010, and for the subsequent five years:

 
| ** **             | ** ** | **Description  of Commitment** | ** ** |
|------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **Total** | ** ** |
| Period ending:         |       |                           |       |   |   |   |   |
| June 30, 2010     |       | $                              | —     |   | $ | 31,056,699 |   | $ | 31,056,699 |   |
| December 31, 2010 |       | 366,937                        |       |   |   | 366,937 |   |
| December 31, 2011 |       | 753,188                        |       |   |   | 753,188 |   |
| December 31, 2012 |       | 778,937                        |       |   |   | 778,937 |   |
| December 31, 2013 |       | 804,689                        |       |   |   | 804,689 |   |
| December 31, 2014 |       | 618,000                        |       |   |   | 618,000 |   |
|                        |            |                                |            |  |  |  |  |  |  |  |

 

15

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| ** **                                                     | ** ** | **Description  of Commitment** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                     | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **Total** | ** ** |
| Total Commitments                                              |       | $                              | 3,321,751  |   | $ | 31,056,699 |   | $ | 34,378,450 |   |
| Non-cancellable purchase obligations                           |       |                           |       | $ | 18,016,467 |   |   |   |
| Less advance payments to suppliers                             |       |                           |       | (4,917,214 | ) |   |   |
| Non-cancellable purchase obligations net of  advance payments: |       |                           |       | $ | 13,099,253 |   |   |   |
|                                                                |            |                                |            |  |  |  |  |  |  |  |

 

Asof June 30, 2010, we had purchase commitments with our suppliers ofapproximately $31.1 million. Of this amount, approximately $18 millionrepresents firm, non-cancelable commitments, against which we have made advancepayments totaling $4.9 million, leaving a net non-cancelable obligation ofapproximately $13.1 million as of June 30, 2010.  Total purchase commitments includeapproximately $28.3 million for materials required to build the flywheels,electronic control modules and other ancillary equipment needed forStephentown, of which $16.7 million are non-cancelable as of June 30,2010. The remaining commitments are for costs associated with closing the DOEloan, equipment and other operating expenses.

 

InJuly 2007, we signed a seven-year lease on our current corporateheadquarters, and relocated all of our operations to this facility in January 2008.  Our 103,000-square-foot facility is locatedat 65 Middlesex Road, Tyngsboro, Massachusetts. We believe our facility has a production capacity of approximately 600flywheels per year, and with further capital spending for equipment its capacitywill increase to approximately 1,000 flywheels per year.

 

Weprovided our landlord with an irrevocable letter of credit securing ourperformance under the lease with a balance at June 30, 2010, of $200,000,which is reduced periodically over the lease term.  This letter of creditis secured by a cash deposit, which is included in restricted cash in theaccompanying consolidated balance sheets. In addition to our rent payments, we are responsible for real estatetaxes and all operating expenses of the Tyngsboro facility.  Rent expense was approximately $294,000 duringthe six months ended June 30, 2010 and 2009.

 

In April 2010, we entered into two new landoption agreements.  The first of these isa two-year option that provides the right to purchase either of two propertiesin the Chicago area, but not both, for $1 million. Both properties are zonedindustrial, and contain certain improvements relevant to our planned use,including equipment required for physical interconnection to 138 KVAtransmission lines.  In consideration forthis option, we are paying the owner $2,000 per month.  If we elect to purchase the land, the optionpayments will be applied to the purchase price. A second option agreement was executed with an economic developmentagency of the State of Pennsylvania for a property situated in Hazle Township,Luzerne County. Under the terms of this two-year option, we are paying $2,500for each of four six-month option periods, or until the option is converted toa lease. The option allows us to lease the property for 21 years at the rate of$3,250 per month.  The site covered bythis option is located in an economic development zone, which provides anexemption from the payment of state sales tax on equipment used to build theplant. We expect to build the plant (for which we have received a $24 million DOEgrant award) on either one of the two sites located in the Chicago area or theHazle Township site in Luzerne County, Pennsylvania.

* *

*Legal Proceedings*

 

Wemay from time to time be subject to legal proceedings, often likely to involveroutine litigation 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, includingassumptions about potential actions by third parties.  A loss contingencyis recorded as a liability in the consolidated financial statements when it isboth (i) probable and known that a liability has been incurred and (ii) theamount of the loss is reasonably estimable.  If the reasonable estimate ofthe loss is a range and no amount within the range is a better estimate, theminimum amount of the range is recorded as a liability.  If a losscontingency is not probable or not reasonably estimable, a liability is notrecorded in the consolidated financial statements. There are no material legalproceedings pending.

 

16

----

 

**Note 8.  AccruedContract Loss**

 

Our contract loss reserves are as follows:

 
| ** **              | ** ** | **Six  months ended June 30,** | ** ** |
|-------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Beginning  balance      |       | $                                   | 257,698    |   | $ | 132,526 |   |
| Charges  for the period |       | (99,650                             | )          | 132,500 |   |
| Reductions              |       | (101,857                            | )          | (35,403 | ) |
| Ending  balance         |       | $                                   | 56,191     |   | $ | 229,623 |   |

 

Duringthe first quarter of 2009, we recorded a contract loss on the Tehachapicontract of approximately $133,000, which represents the difference between ouroverhead applied based on a “full production” rate, and the contract bid rate.

 

Inthe second quarter of 2010, we adjusted the overhead charged to our variouscontracts.  In addition, we closed outseveral contracts and adjusted the balances in the accrued contract lossreserve accordingly:

 

·                  The organization that originally sponsoredour NYSERDA PON 800 contract has undergone a variety of organizational changes,which have resulted in this contract being abandoned.  Unbilled allowable charges of approximately$8,000 were charged to the contract loss reserve, and the remaining reserve ofapproximately $46,000 was reversed in June 2010.

 

·                  We increased the costs charged to theNavy contract by approximately $43,000 based on an adjustment to overheadrates.  We increased the contract lossreserve by approximately $50,000, and we charged the additional overhead costs,plus an additional $7,000 in unbilled costs, against this reserve, since we areuncertain that the Navy will increase the funding on this contract.

 

·                  We received a development contract fromthe Pacific Northwest National Laboratories (PNNL) for $104,000, for which weexpected the total cost to be approximately $210,000.  Accordingly, we established a contract lossreserve during the fourth quarter of 2009 of approximately $106,000 for ourexpected cost share.  However, wecompleted the contract during the second quarter of 2010 at a total cost ofapproximately $59,000.  We adjusted costof sales to properly reflect the margin on this contract, and reversed thepreviously established loss reserve.

 

As of the end of June 2010, the remainingaccrued contract loss relates to our expected cost share portion of theTehachapi project.

 

**Note 9.  Long-Term Debt**

 

Long-termdebt is as follows, which approximates fair value:

 
| ** **                                             | ** ** | **As  of:**       | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|
| ** **                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                             | ** ** | **2010**          | ** ** | **2009** | ** ** |
| 6.5% Note Payable to MassDev, due  September 2015 |       | $                 | 4,129,859  |   | $ | 4,455,368 |   |
| Less unamortized discount (warrants)                   |       | (143,957          | )          | (170,694 | ) |
| Total                                                  |       | 3,985,902         |       | 4,284,674 |   |
| Less current portion of long term debt                 |       | (634,094          | )          | (608,105 | ) |
| Net long-term debt                                     |       | $                 | 3,351,808  |   | $ | 3,676,569 |   |

 

OnJune 30, 2008, we entered into an agreement with Massachusetts DevelopmentFinance Agency (“MassDev”) pursuant to which MassDev agreed to lend to theCompany up to $5 million. This loan derives from a funding collaborationbetween the Emerging Technology Fund of MassDev and the Massachusetts TechnologyCollaborative Business Expansion Initiative. The loan proceeds were used tohelp fund the expansion of our production facility.

 

TheMassDev loan is evidenced by a promissory note under which we were able torequest advances of up to $5 million total for the purchase of equipment andinstallation of certain building improvements at our Tyngsboro, Massachusettsfacility. The initial advance on the loan was made in October 2008 forapproximately $3.6 million. The final advance was made in October 2009 for

 

17

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approximately$1.0 million. The approximately $0.4 million balance of the loan commitment hasexpired. The note will mature 84 months after the initial advance and bears afixed annual interest rate of 6.5%.

 

Paymentsto MassDev began in November 2008. The payments were interest only duringthe first twelve months. In October 2009, and thereafter, the balance ofthe principal outstanding under the note is being amortized in equal monthlyinstallments of principal and interest over the remaining term of the note.Based on the amount outstanding as of June 30, 2010, principal paymentsrequired under the loan over the next five years, excluding discount due towarrants, are as follows:

 
| ** **               | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| Period ending:           |       |       |       |
| December 31, 2010   |       | $          | 334,051    |   |
| December 31, 2011   |       | 704,349    |       |
| December 31, 2012   |       | 751,618    |       |
| December 31, 2013   |       | 803,254    |       |
| December 31, 2014   |       | 857,819    |       |
| December 31, 2015   |       | 678,768    |       |
| Total payments remaining |       | $          | 4,129,859  |   |

 

Pursuantto the note, we entered into a security agreement which grants to MassDev anexclusive first priority security interest in all equipment and tenantimprovements substantially funded with the proceeds of the loan with anapproximate carrying value of $4,526,000 and $5,126,000 at June 30, 2010,and December 31, 2009, respectively. We also entered into a collateralassignment of lease agreement as additional security for the repayment ofborrowings.  This agreement grantsMassDev all rights, title and interest in and to our lease for the Tyngsborofacility in the event that we default on our obligations.

 

Aspartial consideration for the loan, on June 30, 2008, we issued MassDevtwo warrants. Each warrant provides for the purchase of 85,979 shares of ourcommon stock at an exercise price of $1.89 per share, subject to anyadjustments as set forth in the warrants. The warrants are exercisable forseven years commencing on June 30, 2008, and provide for registrationrights for the resale of the shares issued upon their exercise. MassDevassigned one of the warrants to the Massachusetts Technology Park Corporation (“MTPC”),as part of MTPC’s participation under the Massachusetts TechnologyCollaborative Business Expansion Initiative. The Black-Scholes fair value of the warrants is shown as a discountagainst the loan, and is being amortized over the life of the loan using theeffective interest method at an imputed interest rate of 1.124%.  The amortization of this discount resulted inapproximately $27,000 and $29,000 charged to interest expense during the sixmonths ended June 30, 2010 and 2009, respectively.  The effective interest rate of the loan,including the cost of the warrants and other deferred loan costs, isapproximately 8.55%.

 

**Note10.  Sale of Stock**

 

On February 19, 2009, we entered into a commonstock purchase agreement with Seaside 88, LP, valued at up to $18 million. Thisagreement was amended on June 19, 2009. The original agreement required Seaside to buy $1 million of commonstock once each month for up to 18 months, beginning on February 20, 2009,and on the 20th day of each month thereafter (or the next closest businessday,) at a purchase price reflecting a 20% discount to the volume weightedaverage trading price over the five-day trading period immediately before thepurchase.  The amended agreementmaintained the $18 million aggregate maximum purchase price, but acceleratedthe purchase to 1.5 million shares twice per month at a 14% discount to the10-day volume weighted average trading price. The agreement was structured inthree tranches, or segments, of six closings each. We exercised our options onboth additional tranches, meaning that there were 18 closings over the term ofthe agreement. In December 2009, we issued additional shares of stock througha public offering.  As part of theunderwriting conditions for that offering, we exercised our option to delay theSeaside purchases originally scheduled for December and January for aperiod of 60 days.  The Seaside purchasesresumed on February 5, 2010, and the final purchase under this agreementwas completed on March 5, 2010.

 

18

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Stock sales to Seaside through the final sale in March 2010are summarized:

 
| **Transaction  date**   | ** ** | **Aggregate  value** | ** ** | **Common  Shares Sold** | ** ** | **Sale  Price   per Share** | ** ** | **Net  Proceeds** | ** ** |
|-------------------------|------------|----------------------|------------|-------------------------|------------|-----------------------------|------------|-------------------|------------|
| February 20, 2009  |       | $                    | 1,000,000  |                    | 2,656,184  |                        | $          | 0.37648           |       | $ | 889,767 |   |
| March 20, 2009     |       | 1,000,000            |       | 2,896,200               |       | $                           | 0.34528    |              | 931,072    |   |
| April 20, 2009     |       | 1,000,000            |       | 1,912,777               |       | $                           | 0.52280    |              | 914,855    |   |
| May 20, 2009       |       | 1,000,000            |       | 1,647,772               |       | $                           | 0.60688    |              | 946,098    |   |
| June 22, 2009      |       | 1,193,895            |       | 1,500,000               |       | $                           | 0.79593    |              | 1,094,839  |   |
| July 6, 2009       |       | 1,118,430            |       | 1,500,000               |       | $                           | 0.74562    |              | 1,059,504  |   |
| July 20, 2009      |       | 932,670              |       | 1,500,000               |       | $                           | 0.62178    |              | 860,444    |   |
| August 5, 2009     |       | 939,255              |       | 1,500,000               |       | $                           | 0.62617    |              | 873,826    |   |
| August 20, 2009    |       | 895,260              |       | 1,500,000               |       | $                           | 0.59684    |              | 833,089    |   |
| September 8, 2009  |       | 989,295              |       | 1,500,000               |       | $                           | 0.65953    |              | 923,819    |   |
| September 21, 2009 |       | 940,155              |       | 1,500,000               |       | $                           | 0.62677    |              | 874,043    |   |
| October 5, 2009    |       | 925,575              |       | 1,500,000               |       | $                           | 0.61705    |              | 864,430    |   |
| October 20, 2009   |       | 941,955              |       | 1,500,000               |       | $                           | 0.62797    |              | 880,144    |   |
| November 5, 2009   |       | 864,300              |       | 1,500,000               |       | $                           | 0.57620    |              | 802,239    |   |
| November 20, 2009  |       | 829,605              |       | 1,500,000               |       | $                           | 0.55307    |              | 670,590    |   |
| February 5, 2010   |       | 585,150              |       | 1,500,000               |       | $                           | 0.39010    |              | 541,845    |   |
| February 22, 2010  |       | 541,500              |       | 1,500,000               |       | $                           | 0.36100    |              | 499,505    |   |
| March 5, 2010      |       | 529,350              |       | 1,500,000               |       | $                           | 0.35290    |              | 485,569    |   |
| Total Investment        |       | $                    | 16,226,395 |                    | 30,112,933 |                        |       |              | $          | 14,945,678 |   |

 

Because the stock was sold to Seaside at a pricebelow $1.85 per share, certain warrants issued in November 2005 wereadjusted according to the terms of those warrants, as discussed in Note 11below.

 

**Note 11.  Stock Warrants**

 

Wehave outstanding various series of warrants to purchase our common stock.Holders of the warrants are not entitled to receive dividends, vote, receivenotice of any meetings of stockholders or otherwise have any right asstockholders with respect to their warrant shares. The following schedule showswarrants outstanding as of June 30, 2010:

 
| **Description**                                         | ** ** | **Grant  Date** | ** ** | **Expiration    Date** | ** ** | **Strike  Price** | ** ** | **Issued  and  Outstanding As   of June 30,   2010** | ** ** |
|---------------------------------------------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|-----------------------------------------------------------|------------|
|                                                    |       |            |       |                   |       |              |       |                                                      |       |
| November 8, 2005 Financing (Investors)             |       | 11/8/2005       |       | 5/9/2011               |       | $                 | 1.0400     |                                                      | 6,291,118  |   |
| February 15, 2007 Shelf Issue                      |       | 2/15/2007       |       | 2/15/2012              |       | $                 | 1.3300     |                                                      | 6,261,786  |   |
| GFI Tyngsboro Lease                                     |       | 7/23/2007       |       | 7/22/2014              |       | $                 | 1.7700     |                                                      | 500,000    |   |
| September 10, 2007 Shelf Issue (Investors)         |       | 9/10/2007       |       | 3/11/2013              |       | $                 | 1.9900     |                                                      | 6,122,449  |   |
| September 10, 2007 Shelf Issue (Placement  Agents) |       | 9/10/2007       |       | 3/11/2013              |       | $                 | 1.9900     |                                                      | 153,061    |   |
| October 31, 2007 Shelf Issue                       |       | 10/31/2007      |       | 5/1/2013               |       | $                 | 2.9700     |                                                      | 5,431,805  |   |

 

19

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| **Description**                                        | ** ** | **Grant  Date** | ** ** | **Expiration    Date** | ** ** | **Strike  Price** | ** ** | **Issued  and  Outstanding As   of June 30,   2010** | ** ** |
|--------------------------------------------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|-----------------------------------------------------------|------------|
| June 30, 2007 Massachusetts Development Loan      |       | 6/30/2008       |       | 6/30/2015              |       | $                 | 1.8900     |                                                      | 171,958    |   |
| October 15, 2008 Shelf Issue                      |       | 10/15/2008      |       | 4/16/2014              |       | $                 | 1.2000     |                                                      | 8,700,000  |   |
| December 24, 2008 Shelf Issue                     |       | 12/24/2008      |       | 6/25/2014              |       | $                 | 0.7400     |                                                      | 8,966,000  |   |
| Series W - December 9, 2009 Public  Offering |       | 12/9/2009       |       | 12/9/2014              |       | $                 | 0.7000     |                                                      | 19,050,000 |   |
| Series X - December 9, 2009 Public  Offering |       | 12/9/2009       |       | 8/31/2010              |       | $                 | 0.2823     | *                                                         | 4,494,654  |   |
| Total warrants outstanding                             | ** ** | ** **      | ** ** | ** **             | ** ** | ** **        |       | 66,142,831                                                |       |

 

----

| * | These  warrants were issued with a floating exercise price, calculated at 85% of the  five day volume weighted average price of our common stock at the time of  exercise, but in no event less than $0.272 per share. The exercise price for  these warrants as of June 30, 2010, based on this calculation, was  $0.2823. |
|---|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Thefollowing shows changes to the warrants outstanding from December 31,2009, through June 30, 2010:

 
| ** **                                                                   | ** ** | **#  Warrants** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------|------------|
| Warrants outstanding as of December 31, 2009                            |       | 81,089,664      |       |
| Adjustments to 11/8/05 warrants due to Seaside  pricing for 2010 stock sales |       | 176,388         |       |
| May 2005 warrants expired                                               |       | (800,000        | )          |
| Series X warrants exercised                                             |       | (14,323,221     | )          |
| Warrants outstanding as of June 30, 2010                                |       | 66,142,831      |       |

 

Warrantswith activity during the six months ended June 30, 2010, are describedbelow:

* *

*May 2005 Financing Warrant*

 

Inconnection with the investment by Perseus 2000 Expansion, L.L.C., we issued awarrant for 800,000 shares of our common stock at an exercise price of$1.008.  These warrants were notexercised and expired on May 25, 2010.

* *

*November 2005 Financing 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 investors.The per-share exercise price for the warrant shares was $2.21. Each investorwarrant is exercisable at any time until May 9, 2011. The terms of thewarrants include anti-dilution provisions which require 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, amongother things, the issuance of additional shares of our common stock, orsecurities convertible into our common stock, at a price per share lower thanthe closing stock price on the date of the investment, which was $1.85.

 

Basedon the warrants’ anti-dilution provisions, the exercise price and the number ofwarrants were adjusted as shown below.

 
| ** **                                    | ** ** | **#  Warrants** | ** ** | **Exercise  Price** | ** ** |
|-----------------------------------------------|------------|-----------------|------------|---------------------|------------|
| Original Warrant                              |       | 2,960,527       |       | $                   | 2.21       |   |
| Adjustments based on anti-dilution provision: |       |            |       |                |       |
| Financing February 2007                  |       | 327,294         |       | $                   | 1.99       |   |
| Financing October 2008                   |       | 248,808         |       | $                   | 1.85       |   |
| Financing December 2008                  |       | 404,796         |       | $                   | 1.66       |   |
| Seaside 2/20/09 purchase                      |       | 72,542          |       | $                   | 1.63       |   |

 

20

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| ** **                | ** ** | **#  Warrants** | ** ** | **Exercise  Price** | ** ** |
|---------------------------|------------|-----------------|------------|---------------------|------------|
| Seaside 3/20/09 purchase  |       | 75,260          |       | $                   | 1.60       |   |
| Seaside 4/20/09 purchase  |       | 51,764          |       | $                   | 1.58       |   |
| Seaside 5/20/09 purchase  |       | 53,092          |       | $                   | 1.56       |   |
| Seaside 6/22/09 purchase  |       | 27,063          |       | $                   | 1.55       |   |
| Seaside 7/06/09 purchase  |       | 27,411          |       | $                   | 1.54       |   |
| Seaside 7/20/09 purchase  |       | 27,766          |       | $                   | 1.53       |   |
| Seaside 8/5/09 purchase   |       | 28,132          |       | $                   | 1.52       |   |
| Seaside 8/20/09 purchase  |       | 28,504          |       | $                   | 1.51       |   |
| Seaside 9/8/09 purchase   |       | 28,886          |       | $                   | 1.50       |   |
| Seaside 9/21/09 purchase  |       | 29,274          |       | $                   | 1.49       |   |
| Seaside 10/5/09 purchase  |       | 29,669          |       | $                   | 1.48       |   |
| Seaside 10/20/09 purchase |       | 30,072          |       | $                   | 1.47       |   |
| Seaside 11/05/09 purchase |       | 30,484          |       | $                   | 1.46       |   |
| Seaside 11/20/09 purchase |       | 30,905          |       | $                   | 1.45       |   |
| Public offering 12/9/09   |       | 1,602,481       |       | $                   | 1.07       |   |
| Seaside 2/05/10 purchase  |       | 57,686          |       | $                   | 1.06       |   |
| Seaside 2/22/10 purchase  |       | 58,786          |       | $                   | 1.05       |   |
| Seaside 3/5/10 purchase   |       | 59,916          |       | $                   | 1.04       |   |
| Adjusted Warrant:         |       | 6,291,118       |       | $                   | 1.04       |   |

 

*December 2009Series W and Series X Warrants*

 

InDecember 2009, we sold 38,100,000 units of the Company at a purchase priceof $0.544 per unit.  Each unit consistedof one share of our common stock, par value $0.01 per share; a Series Wwarrant to purchase 0.5 of a share of common stock at an exercise price of$0.70 per share exercisable through December 9, 2014; and an additionalinvestor rights warrant (Series X) to purchase 0.5 of a share of commonstock exercisable through August 31, 2010, at a floating exercise price.  The floating exercise price is equal to 85% ofthe five-day volume weighted average price of our common stock at the time ofexercise, but in no event less than $0.272 per share.  All of the warrants were exercisable uponissuance.  The units were issued pursuantto a prospectus supplement filed with the Securities and Exchange Commission inconnection with a registration statement on Form S-3 which becameeffective on September 15, 2009.

 

Thefollowing Series X warrants were exercised as of June 30, 2010:

 
| **Exercise  Dates:**   | ** ** | ** **             | ** ** | **Weighted  Average** | ** ** | ** **          | ** ** |
|------------------------|------------|------------------------|------------|-----------------------|------------|---------------------|------------|
| **From**               | ** ** | **To**                 | ** ** | **#  of Shares**      | ** ** | **Exercise  Price** | ** ** | **Proceeds** | ** ** |
| December 28, 2009 |       | January 7,  2010  |       | 765,331               |       | $                   | 0.4112     |   | $ | 314,723 |   |
| January 29, 2010  |       | February 3,  2010 |       | 400,000               |       | $                   | 0.3793     |   | 151,720 |   |
| March 1, 2010     |       | March 1,  2010    |       | 100,000               |       | $                   | 0.3392     |   | 33,920 |   |
| March 11, 2010    |       | March 12,  2010   |       | 4,800,000             |       | $                   | 0.3582     |   | 1,719,490 |   |
| March 26, 2010    |       | March 31,  2010   |       | 288,900               |       | $                   | 0.3655     |   | 105,605 |   |
| April 5, 2010     |       | April 8,  2010    |       | 358,000               |       | $                   | 0.3772     |   | 135,052 |   |
| April 26, 2010    |       | April 26,  2010   |       | 300,000               |       | $                   | 0.3688     |   | 110,640 |   |
| May 10, 2010      |       | May 14,  2010     |       | 296,800               |       | $                   | 0.3245     |   | 96,316 |   |
| May 24, 2010      |       | May 28,  2010     |       | 3,527,000             |       | $                   | 0.3057     |   | 1,078,294 |   |
| June 1, 2010      |       | June 4,  2010     |       | 1,227,929             |       | $                   | 0.3270     |   | 401,496 |   |
| June 7, 2010      |       | June 14,  2010    |       | 1,211,200             |       | $                   | 0.3003     |   | 363,669 |   |
| June 14, 2010     |       | June 17,  2010    |       | 946,672               |       | $                   | 0.2720     |   | 257,495 |   |
| June 22, 2010     |       | June 28,  2010    |       | 333,514               |       | $                   | 0.2723     |   | 90,800 |   |
|                   |       |                   |       | 14,555,346            |       |                |       | $ | 4,859,220 |   |

 

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**Note12.  Revenue and Cost of Goods Sold**

 

Abreakdown of our sales and the related cost of sales for the three and sixmonths ended June 30, 2010 and 2009, respectively, are as follows:

 
| ** **           | ** ** | **Three  months ended June 30, 2010** | ** ** | **Three  months ended June 30, 2009** | ** ** |
|----------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **Revenue**                                | ** ** | **Cost  of  Sales**                        | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Sales** | ** ** | **Margin** | ** ** |
| ** **           | ** ** | **(in thousands)**                         | ** ** |
| Frequency regulation |       | $                                          | 124        |                                       | $          | 96 |   | $ | 28 |   | $ | 52 |   | $ | 67 |   | $ | (15 | ) |
| Contract             |       | 31                                         |       | (24                                        | )          | 55 |   | 230 |   | 219 |   | 11 |   |
| Inverters and other  |       | 11                                         |       | —                                     |       | 11 |   | — |   | — |   | — |   |
| Total                |       | $                                          | 166        |                                       | $          | 72 |   | $ | 94 |   | $ | 282 |   | $ | 286 |   | $ | (4 | ) |

 
| ** **           | ** ** | **Six  months ended June 30, 2010** | ** ** | **Six  months ended June 30, 2009** | ** ** |
|----------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **           | ** ** | **Revenue**                              | ** ** | **Cost  of  Sales**                      | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Sales** | ** ** | **Margin** | ** ** |
| ** **           | ** ** | **(in thousands)**                       | ** ** |
| Frequency regulation |       | $                                        | 267        |                                     | $          | 200 |   | $ | 67 |   | $ | 116 |   | $ | 197 |   | $ | (81 | ) |
| Contract             |       | 110                                      |       | 55                                       |       | 55 |   | 274 |   | 261 |   | 13 |   |
| Inverters and other  |       | 24                                       |       | —                                   |       | 24 |   | 3 |   | — |   | 3 |   |
| Total                |       | $                                        | 401        |                                     | $          | 255 |   | $ | 146 |   | $ | 393 |   | $ | 458 |   | $ | (65 | ) |

 

FromNovember 2008 (when the ISO-NE pilot program began) until late April 2009,we were billed for all of the energy stored on our flywheels, rather than forour net energy usage.  Further, we werebilled at a retail rate.  However, sincelate April 2009, our energy costs have decreased substantially as we havebeen billed the wholesale rate for our net energy used, plus retailtransmission and distribution charges. The gross margin for frequency regulation for the first quarter of 2009was negative, due to the energy costs paid from January through April 2009.  Cost of energy during the first two quartersof 2010 was approximately $200,000, of which approximately $144,000, or 72%,represents retail transmission and distribution (T&D) charges billed by thelocal service provider.  Because ourStephentown facility will be connected to the grid at the transmission level,we will not incur T&D charges, and so we expect our gross margin to beconsiderably higher than in our Tyngsboro installation.

 

We provide a five-year limited product warranty for our Smart PowerM-series inverter product line and accrue for estimated future warranty costsin the period in which the revenue is recognized*.*  In 2004, we established a reserve for ourSmart Power M-series inventory as a result of lower than anticipated salesvolumes.  During 2010 and 2009, wecontinue to have very limited sales of our inverter products, which we are nolonger manufacturing. The costs related to these sales are not fully reflectedin the cost of goods sold as a result of the inventory having been reserved ina prior year.  Therefore, our cost ofgoods sold does not fully reflect the costs associated with these revenues.

 

**Note 13.  Stock-Based Compensation**

 

**Description of Plans**

 

*Stock Option Plan*

 

OurThird Amended and Restated 1998 Stock Incentive Plan (our “1998 Plan”) allowsfor the granting of stock options to purchase up to 23,000,000 shares of ourcommon stock.  Options may be granted to our employees, officers,directors, consultants and advisors. Under the terms of the option plan,incentive stock options are to be granted at the fair market value of ourcommon stock at the date of grant, and nonqualified stock options are to begranted at a price determined by our Board of Directors.  In general, ourBoard has authorized vesting periods of one to three years and terms of varyinglength but in no case more than 10 years.  Our stock option program is along-term retention program that is intended to attract, retain and provideincentives for talented employees, officers and directors, and to alignstockholder and employee interests.  We consider our option program 

 

22

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criticalto our operation and productivity; essentially all of our employeesparticipate.  At June 30, 2010, we had 16,195,530 shares reserved forissuance under this plan.  On July 21,2010, our stockholders approved our 2010 Stock Incentive Plan (our “2010 Plan”),which constituted an amendment, restatement and renaming of our 1998 Plan andwhich increased the shares available for issuance under the Stock IncentivePlan by an additional 15,000,000 shares.

 

*Employee Stock Purchase Plan*

 

OurEmployee Stock Purchase Plan (the “ESPP”) allows substantially all of ouremployees to purchase shares of our common stock at a discount through payrolldeductions.  All regular, full-time employees employed by us for at leastthree months on the dates the exercise periods begin (each May 1 and November 1)are eligible to participate in this plan. Participating employees may purchaseour common stock at a purchase price equal to 85% of the lower of the fairmarket value of our common stock at the beginning of an offering period or onthe exercise date.  Employees may designate up to 10% of their basecompensation for the purchase of common stock under this plan.  The ESPPprovides for the purchase of up to 2,000,000 shares of our common stock. At June 30, 2010, 42% of eligible employees are participating, and we had1,353,258 shares reserved for future issuance under this plan.

 

*Restricted Stock Unit Arrangements*

 

Our1998 Plan (and, since our stockholder meeting on July 21, 2010, our 2010Plan) permits the grant of restricted stock units (“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 June 30, 2010, and December 31, 2009, certain RSUs granted underthe officer employment agreements were vested but stock could not be issuedunder the terms of the RSU agreements because the trading window was closed toinsiders as of the respective vesting dates.

 

Restrictedstock unit activity as of December 31, 2009, and for the six months ended June 30,2010, is as follows:

 
| ** **                                           | ** ** | **Six  months ended  June 30,  2010** | ** ** | **Year  ended  December 31,  2009** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                           | ** ** | **(number of shares)**                     | ** ** |
| Shares issued related to vested RSUs:                |       |                                       |       |                                     |       |
| Based on prior year grants                           |       | 26,714                                     |       | 46,352                                   |       |
| Based upon current year executive officer  agreement |       | —                                     |       | 16,920                                   |       |
|                                                 |       |                                       |       |                                     |       |
| Vested RSUs not yet converted to stock (i)           |       | 10,338                                     |       | 16,376                                   |       |
|                                                 |       |                                       |       |                                     |       |
| RSU’s granted but not vested:                   |       |                                       |       |                                     |       |
| Related to 2008 executive officer agreement          |       | 9,414                                      |       | 18,810                                   |       |
| Related to 2009 executive officer agreement          |       | 33,833                                     |       | 45,113                                   |       |
| Related to performance-based executive plan (ii)     |       | —                                     |       | 1,265,823                                |       |

 

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(i)             RSUs vesting December 31,2009, were issued on April 8, 2010.

 

(ii)          Vesting of theperformance-based RSUs (PSUs) is subject to the achievement of performancerequirements. We did not meet the award conditions as of December 31,2009, and our executive management does not believe it is 

 

23

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probablethat the award will be earned in 2010 based on our current business plan.Accordingly, no compensation expense was recorded for this grant in 2009 or2010. On April 26, 2010, we entered into Letter Agreements with ourexecutive officers, under which the outstanding PSUs were terminated due to theinability to meet the performance goals. Pursuant to the termination of theseagreements, the shares of our stock reserved for issuance upon conversion of thePSUs became available for future issuance under the our Third Amended andRestated 1998 Stock Incentive Plan.

 

**Stock Option Plan Schedules**

 

Stockoption activity for the six months ended June 30, 2010, is as follows:

 
| ** **                            | ** ** | **Number  of********Shares** | ** ** | **Weighted-********Average********Exercise********Price** | ** ** | **Weighted-********Average********Fair********Value** | ** ** |
|---------------------------------------|------------|------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Outstanding, December 31, 2009   |       | 12,000,028                   |       | $                                                         | 1.18       |                                                  |       |   |
| Granted                               |       | 4,513,355                    |       | $                                                         | 0.39       |                                                  | $          | 0.23 |   |
| Exercised                             |       | —                       |       | $                                                         | —     |                                                  |       |   |
| Canceled, forfeited or expired        |       | (371,438                     | )          | $                                                         | (2.13      | )                                                     |       |   |
| Outstanding, June 30,  2010 |       | 16,141,945                   |       | $                                                         | 0.90       |                                                  |       |   |
|                                       |            |                              |            |                                                           |            |                                                       |            |  |  |

 

Thefollowing table summarizes information about stock options outstanding at June 30,2010:

 
| **Exercise********Price** | ** ** | **Number********of Options********Outstanding** | ** ** | **Weighted-********Average********Remaining********Contractual********Life (Years)** | ** ** | **Weighted-********Average********Exercise********Price** | ** ** | **Number********of Options********Vested** | ** ** | **Vested********Weighted-********Average********Exercise********Price** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| $0.26  - $0.74            |       | 8,942,207                                       |       | 7.65                                                                                 |       | $                                                         | 0.52       |                                       | 4,228,461  |                                                                    | $          | 0.66 |   |
| $0.80  - $1.46            |       | 5,536,789                                       |       | 6.15                                                                                 |       | $                                                         | 1.07       |                                       | 4,842,752  |                                                                    | $          | 1.04 |   |
| $1.51  - $2.19            |       | 1,335,699                                       |       | 6.06                                                                                 |       | $                                                         | 1.78       |                                       | 1,322,521  |                                                                    | $          | 1.78 |   |
| $4.10  - $5.27            |       | 222,250                                         |       | 0.60                                                                                 |       | $                                                         | 4.40       |                                       | 222,250    |                                                                    | $          | 4.40 |   |
| $6.00  - $9.31            |       | 105,000                                         |       | 0.26                                                                                 |       | $                                                         | 6.40       |                                       | 105,000    |                                                                    | $          | 6.40 |   |
| Total                     |       | 16,141,945                                      |       | 6.86                                                                                 |       | $                                                         | 0.90       |                                       | 10,720,984 |                                                                    | $          | 1.10 |   |

 

**Stock Compensation**

 

Weaccount for our stock compensation in accordance with ASC Topic 718. We use theBlack-Scholes option pricing model to determine the fair value of stock optionsand employee stock purchase plan shares. The valuations determined using thismodel are affected by our stock price as well as assumptions we make regardinga number of complex and subjective variables, including our stock pricevolatility, expected life of the option, risk-free interest rate and expecteddividends, if any.

 

Weestimate the volatility of our common stock by using historicalvolatility.  We estimate the expected term of the option grant, anddetermine a risk-free interest rate based on U.S. Treasury issues withremaining terms similar to the expected term of the stock or options. We do notanticipate paying any cash dividends in the foreseeable future and therefore usean expected dividend yield of zero in our valuation model. We are required toestimate forfeitures at the time of grant and revise those estimates insubsequent periods. All stock-based payment awards are amortized as they areearned over the requisite service periods of the awards, which are generallythe vesting periods.

 

Restrictedstock units (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.

 

24

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Duringthe first quarter of 2009, 20,000 options were granted to a consultant.  Half of these options vested on May 5,2009, and the remainder were scheduled to vest on November 5, 2009,subject to the consultant’s continued service to the Company.  In accordance with ASC Topic 505-50, “*Equity-Based Payments to Non-Employees*,” the measurementdates for these options was determined to be the vesting dates.  The consultant’s services were terminated asof the end of June 2009. The non-vested options were forfeited as of thetermination date.  Under the terms of theoption agreement, the consultant had three months from the termination date toexercise his vested options.  They werenot exercised within that time, and consequently the options were forfeited.

 

Theassumptions used to value stock option grants for the three and six monthsended June 30, 2010, were as follows:

 
|                                                                                     | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|
|                                                                                     | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** |
| Risk-free  interest rate                                                                 |       | 1.11%-1.67%                          |       | 0.34% - 1.36%                      |   | 1.11% - 1.67% |   | 0.34%-1.36% |
| Expected  life of option                                                                 |       | 3.5                                  |       | .75 - 3.5 years                    |   | 3.5 |   | .75 - 3.5 years |
| Expected dividend payment rate, as a percentage of  the stock price on the date of grant |       | 0%                                   |       | 0%                                 |   | 0% |   | 0% |
| Assumed  volatility                                                                      |       | 81% - 91%                            |       | 77% - 90%                          |   | 81% - 91% |   | 77% - 90% |
| Expected  forfeitures                                                                    |       | 8.3%                                 |       | 8.3%                               |   | 8.3% |   | 8.3% |

 

Stock-basedcompensation expense recognized on our consolidated statement of operations forthe three and six months ended June 30, 2010 and 2009 are as follows:

 
| ** **                                    | ** ** | **Three  months ended June 30,** | ** ** | **Six  months ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Operations and maintenance                    |       | $                                     | 14,609     |                                | $          | 29,615 |   | $ | 29,681 |   | $ | 64,112 |   |
| Research and development                      |       | 67,241                                |       | 101,694                             |       | 106,522 |   | 209,387 |   |
| Selling, general and administrative           |       | 166,355                               |       | 154,402                             |       | 239,118 |   | 291,224 |   |
| Total stock compensation expense              |       | $                                     | 248,205    |                                | $          | 285,711 |   | $ | 375,321 |   | $ | 564,723 |   |
|                                          |       |                                  |       |                                |       |   |   |   |   |
| Components of stock compensation expense:     |       |                                  |       |                                |       |   |   |   |   |
| Compensation expense related to RSUs          |       | $                                     | 3,877      |                                | $          | 20,671 |   | $ | 8,960 |   | $ | 28,725 |   |
| Compensation expense related to stock options |       | 244,328                               |       | 265,040                             |       | 366,361 |   | 535,998 |   |
| Total stock compensation expense              |       | $                                     | 248,205    |                                | $          | 285,711 |   | $ | 375,321 |   | $ | 564,723 |   |

 

Asof June 30, 2010, there was approximately $887,000 of unrecognizedcompensation cost, adjusted for estimated forfeitures, related to unvestedstock-based payments granted to our employees and directors. Total unrecognizedcompensation cost will be adjusted for future changes in estimated forfeituresand recognized over the remaining vesting periods of the stock option grants.

 

**Note14.****Potential Delisting of the Company’sStock**

 

OnSeptember 16, 2009, we received a letter from the Nasdaq Stock Marketindicating that our common stock was subject to delisting on March 15,2010 if the requirements of Rule 5550(a)(2), which requires a minimum bidprice of $1.00 per share, were not met. On March 16, 2010, we received a letter from the Nasdaq StockMarket, notifying us that Nasdaq had granted us an additional 180 days toregain compliance with the $1.00 minimum share price rule. The Company’ssecurities will continue to be listed on the Nasdaq Capital Market until atleast September 13, 2010. If, at any time before September 13, 2010,the bid price of the Company’s common stock closes at $1.00 per share or morefor a minimum**of 10 consecutivebusiness days, Nasdaq will provide us written notification that we comply withthe rule. However, there can be no assurance that we will be able to meet theNasdaq Stock Market’s minimum bid price requirements within the extended graceperiods and we therefore may lose our eligibility for quotation on the NasdaqStock Market.  At our annual meeting ofstockholders on July 21, 2010, our stockholders approved theimplementation of a reverse stock split at a ratio of between 1-for-2 and1-for-10, which could be used, in the discretion of the Board at the ratio (if any)chosen by the Board, to regain compliance with the minimum bid price rule eitherprior to September 13, 2010 or during any listing panel appeals processthat we may elect to pursue.  Noguarantees can be made, however, that the Company will regain compliance withNasdaq’s ongoing listing rules.

 

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**Note 15.  SubsequentEvents**

 

OnAugust 6, 2010, Stephentown Regulation Services, LLC (SRS), a wholly-ownedsubsidiary of Beacon Power Corporation (Beacon), closed on a loan guaranteed bythe Department of Energy (DOE), which, over time, will allow us to borrow up toapproximately $43 million.  As part ofthe loan closing, Beacon transferred $7 million in cash to SRS, into arestricted cash account. Approximately two weeks after closing, SRS will use aportion of this equity contribution to reimburse Beacon for allowable costspreviously incurred.  Monthlydisbursements from the loan are anticipated to begin in September, based uponeligible project spending.  Eachdisbursement will be subject to the satisfaction of certain conditions.  This loan will provide debt financing for62.5% of the estimated $69 million total project cost of our 20 megawatt (MW)plant currently under construction in Stephentown, New York. Our equitycontribution to the project is approximately $26 million of cash and in-kindassets which was fully funded at loan closing.

 

On July 2, 2010, we entered into a common stockpurchase agreement with Aspire Capital Fund LLC (Aspire), an Illinois limitedliability company, which provides that, upon the terms and subject to theconditions and limitations set forth therein, Aspire is committed to purchaseup to an aggregate of $25.0 million of our shares of common stock over the termof the purchase agreement.  Inconsideration for entering into the purchase agreement, we issued 3,086,420shares of our common stock to Aspire. These shares are referred to as the “Commitment Shares.”   Under this agreement, we have sold Aspire1,534,210 shares of common stock at a purchase price of $0.324 per share, foran aggregate purchase price of $500,000. Following this initial purchase, from time to time over the 26-monthterm of the agreement, we have the right, in our sole discretion, to presentAspire with a purchase notice directing them to purchase up to 400,000 sharesof our common stock per trading day (up to an aggregate of $24.5 million of ourcommon stock) at a price per share calculated as the lower of (i) thelowest trading price on the date of sale or (ii) the arithmetic average ofthe three lowest closing sale prices for the common stock during the 12consecutive business days ending on the business day immediately preceding thepurchase date of those securities.  We andAspire may mutually agree to increase the number of shares that can be sold perbusiness day to as much as an additional 1,000,000 shares per businessday.  However, we cannot sell shares onany trading day in which the closing sale price of our stock is less than$0.25.  Also, unless our stockholdersapprove the transaction at some later date, we may not sell shares to Aspire ata purchase price less than $0.34, which is the sum of the last consolidatedclosing sale price of our common stock on July 1, 2010, the trading dayimmediately preceding the date of the purchase agreement, and $0.03.  We will control the timing and amount of anysales of our common stock to Aspire, and will always know the purchase pricebefore we give notice to sell any shares to Aspire.  There are no trading volume requirements orrestrictions under the agreement.  Thenet proceeds we receive will depend on the frequency and prices at which wesell shares of stock to Aspire.  Themaximum proceeds we may receive over the 26-month term of the agreement is $25million.  These sales are being madeunder our Registration Statements on Form S-3.  We also entered into a Registration RightsAgreement with Aspire, dated July 2, 2010, under which we agreed to keepthe registration statements effective, and under which we agree to indemnifyAspire for certain liabilities in connection with the sale of the securities.As of the date of this report, we have not sold any shares to Aspire under thisagreement following the initial $500,000 purchase.

 

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

 

**Note Regarding Forward Looking Statements**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statementsconcerning, among other things, our expected future revenues, operations andexpenditures, sources and uses of capital and estimates of the potentialmarkets for our products and services.  Such statements made may fallwithin the meaning of the Private Securities Litigation Reform Act of 1995, asamended.  All such forward-looking statements are necessarily onlyestimates of future results and the actual results we achieve may differmaterially from these projections due to a number of factors as discussed inthe section entitled “Risk Factors” of this Form 10-Q. New risks can ariseand it is not possible for management to predict all such risks, nor canmanagement assess the impact of all such risks on our business or the extent towhich any factor, or combination of factors, may cause actual results to differmaterially from those contained in any forward-looking statement.  Giventhese risks and uncertainties, investors should not place undue reliance onforward-looking statements as a prediction of actual results.  Allforward-looking statements speak only as of the date of this Quarterly Reporton Form 10-Q.  We undertake no obligation to revise or updatepublicly any forward-looking statement in order to reflect any event orcircumstance that may arise after the date of this Quarterly Report on Form 10-Q,other than as required by law.

 

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**Overview**

 

Wedesign, manufacture and operate flywheel-based energy storage systems that weare beginning to deploy in company-owned merchant plants that sell frequencyregulation services in open-bid markets (which we refer to as our “sale ofservices” or “merchant plant” model). We also intend to sell systems on aturnkey equipment basis in domestic and overseas markets that lack open-bidauction mechanisms.  We may also shareownership of some plants with utilities or other investors; enter into bilateralcontracts with utilities that provide or purchase regulation services tosatisfy their obligations to pay for or provide regulation services; and/orparticipate in pilot programs to demonstrate our technology. Our flywheelsystems support stable, reliable and efficient electricity grid operation. Weexpect the market for our systems to benefit from increased electricity demandand the rapid expansion of intermittent renewable resources, including wind andsolar.

 

Our Smart Energy 25 flywheelsystem includes the flywheel and its associated power electronics. A SmartEnergy MatrixTM is an array of ten Smart Energy 25 flywheel systems thatprovides 1 MW of energy storage. A frequency regulation installation includesone or more Smart Energy MatricesTM, along with ancillary equipment and sitework. A typical full-scale installation would have a capacity of 20 MW, capableof +/- 20 MW, or a 40 MW regulation range.

 

The location of our merchant plants and the sequence in which they willbe constructed will depend on a number of factors, including but not limitedto:

 

·                  Availability of grants, loans or otherfunding sources (including funds received from investors for the purchase ofall or part of certain systems)

 

·                  Comparative market pricing available forfrequency regulation in different markets

 

·                  Our ability to receive appropriate revenuesand payments within the market rules of each regional market

 

·                  Our ability to interconnect at transmissionvoltage and obtain grid interconnection approvals

 

·                  Availability and cost of land

 

·                  Ability to secure all necessary environmentaland other permits and approvals

 

Our production facility is capable of producing up to 600 flywheels peryear. We have a second phase manufacturing build-out planned which willincrease the annual manufacturing capacity to more than 1,000 flywheels.

 

In November 2008, we began to provide 1MW of frequency regulationservice through the ISO-NE pilot program. We added a second MW of capacity inJuly 2009, and third in December 2009. Our flywheel systems have been on-line and available for provision offrequency regulation service 98% of the time, on average, since January 1,2009, and have been earning revenue from frequency regulation services.

 

Duringthe first quarter of  2010, we began torecruit and hire the first few of approximately 50 planned new employees at ourTyngsboro, Massachusetts headquarters, which will ultimately include hardwareengineers, project managers, market data analysts, and sales directors (bothU.S. and international), as well as positions in purchasing, finance, site development,manufacturing and production. This workforce expansion will enable us to rampup production of our grid-scale flywheel energy storage systems, which will beinstalled in our 20 MW plant in Stephentown, New York, now under construction.A portion of this plant is expected to begin earning revenue by providingfrequency regulation in the fourth quarter of 2010.

 

Thedecision to expand our workforce comes following a series of positive events in2009, including more than a full year of operation on the New England grid;receipt of a $43-million loan guarantee commitment from the U.S. Department ofEnergy (DOE) which closed on August 6, 2010 or; and the award of a $24-millionDOE smart grid stimulus grant. We also raised $20 million in equity investmentin December 2009, a portion of which provided the remaining equity required toclose the loan guaranteed by the DOE for our Stephentown plant. Thecontinuation and timing of any such workforce expansion will ultimately besubject to our access to additional capital and our cash flow position.

 

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From inception through June 30, 2010, we have incurred losses ofapproximately $217 million. We currently do not expect to become cash flowpositive until we have deployed a sufficient number of merchant plants and/orsold turnkey systems.

 

For the sale of frequency regulation services in the United States, ourprimary market focus is on the geographic regions of the domestic grid underFederal Energy Regulatory Committee (FERC) regulation that provide open-bidmarkets. These regions and their Independent System Operator (ISO) or RegionalTransmission Operator (RTO) designations are: New England (ISO-NE); California(California ISO or CAISO); New York (New York ISO or NYISO); Mid-Atlantic (PJMInterconnection); and Midwest ISO (MISO). These regional ISOs/RTOs, or gridoperators purchase frequency regulation services from independent providers inopen-bid markets that they manage and maintain. For example, under an open-bidmarket like that operated by NYISO, grid operators forecast the need forfrequency regulation as a percentage of expected power demand, and approvedsuppliers submit bids for these services. Bids are stacked from lowest tohighest prices until the cumulative amount of bids is sufficient to meet thecalculated need. The price submitted by the highest selected bidder determinesthe price paid to every bidder that has been selected to provide service fromthe bid stack, although each ISO may calculate payments based on formulas thatyield different revenue results, even with equivalent frequency regulationclearing prices.

 

We have also recently initiated market development efforts in Texas(ERCOT), which is not regulated by FERC. ERCOT is not subject to FERC Order No.890, which mandated that non-generation resources like ours be allowed tocompete in these open-bid markets. However, we expect that as ERCOT continuesto expand its wind resources in Texas, and issues related to increasing windpenetration and grid stability become better understood, the potential benefitsof applying our technology in ERCOT to help balance frequency and maintain gridstability and reliability will increase. We are currently evaluating whethermarket rule modifications will be needed to allow us to enter the ERCOT marketon an economically attractive basis.

 

For the sale of plants on a turnkey basis, our market focus in theUnited States is on geographic regions that lack open-bid markets forregulation services.  Within this marketsegment, our primary focus will be on utilities that are experiencing or expectto experience increased requirements for regulation capacity due to the currentor projected impacts of increased deployment of variable wind generation intheir balancing areas. Our secondary focus will be on the largest cooperativeand government-owned utilities. Internationally, we are actively investigatingthe most suitable countries for market entry, both for the sale of services viamerchant plants and for the outright sale of plants.

 

Our Smart Energy MatrixTMstores excess energy when power on the grid exceeds demand and injects it backto the grid when demand exceeds generated power. Our systems respond up to 100times faster than fossil fuel generators that provide frequency regulation.Certain ISOs have implemented or are considering tariff changes that wouldprovide additional or enhanced payment mechanisms to compensate resources, suchas ours, for faster regulation response.

 

Our flywheel systems alsomake it easier for the grid to integrate intermittent renewable energy sources,such as wind and solar power, whose variability increases the need forregulation.  Because our flywheels onlyrecycle electricity already generated, they do not consume fossil fuel orproduce carbon dioxide (CO2)greenhouse gasemissions or other air pollutants, such as nitrogen oxide or sulfur dioxide. Inaddition, the energy conversion efficiency of our flywheels does notsignificantly degrade over time or as a function of the number ofcharge/discharge cycles incurred. We believe that our low operating costs willallow us to participate with a favorable profit margin in the open-bid markets,and utilities in non-open bid markets will also find the attributes of oursystem attractive and will purchase our systems on a turnkey basis.

 

In 2009 we began marketing and business development activities outsideof the United States, including the development of relationships with strategicpartners in preparation for selling systems on a turnkey basis.  In order to be able to participate in some ofthese markets, we have initiated an engineering design program that will allowour system to operate at 50 Hz.

 

Growth in both the US and international markets are expected from acombination of additional factors, including:

 

·                  Greater use of renewableenergy sources — especially wind and solar generation

 

·                  Long-term growth in thedemand for electricity

 

·                  Increased operating costsfor conventional generation

 

·                  Government regulations andmarket forces aimed at reducing CO2 emissions.

 

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Webelieve that our operating cost structure will be significantly lower than mostincumbent frequency regulation service providers. Our Smart Energy 25 flywheelhas been designed to operate with low energy losses, minimal mechanicalmaintenance for 20 or more years and no significant degradation in energyconversion efficiency. In particular, our technology is different from mostfrequency regulation providers in that it does not use fossil fuel, which isthe largest variable cost for most competing frequency regulation providers.

 

Since our Smart Energy MatrixTM does not burn fuel, the environmentalbenefits of our technology are significant. An internally-commissioned studysuggests that our technology’s ability to reduce carbon dioxide (CO2) may reduce CO2 emissions by up to 89% compared toconventional frequency regulation service providers.  We believe that the cleaner performance ofour flywheel systems (as contrasted to frequency regulation services suppliedby fossil fuel resources) can be expected to offer significant value toregulators, grid operators, and utilities facing increasing demands to lower CO2 emissions. If the federal government implements a carbon-reduction program in theform of a cap-and-trade program or carbon tax, we believe that the resultingcosts to carbon-intensive regulation providers will increase faster than ourcarbon-related costs, which are associated with the purchase of a small amountof electrical make-up energy.

 

In some states, additional environmentally related revenues may beavailable in the form of renewable energy credits or other credits.  For example, Massachusetts recently passedlegislation that provides alternative compliance payments for qualifyingflywheel storage units when they inject energy into the ISO-NE grid.  In 2009, we began earning alternative energy credits under the MassachusettsAlternative Energy Portfolio Standard (APS) program, and selling them to utilitiesor other retail electricity suppliers that need to meet mandated APSrequirements, thus creating a limited source of incremental revenue.

 

**Regulatory and Market Affairs**

 

Sincelate 2009 we have been actively engaged in promoting the benefits of payingfast-response regulation resources on the basis of actual system performancerather than nominal capacity. On May 26, 2010, FERC held a Technical Conferenceon Frequency Regulation Compensation and invited our Chief Executive Officer,F. William Capp, to present on the concept of “pay-for-performance”.  Subsequently, on June 16, 2010, we submittedcomments to FERC reiterating our support of tariffs that compensate regulationresources based on performance.   We willcontinue to engage in this dialogue in an effort to encourage the expansion ofperformance-based tariffs in all ISO markets. Currently, ISO-NE is the onlygrid operator that utilizes a performance-based tariff that rewards resourcesfor speed. Other ISOs, including PJM, are considering changing their tariffs toprovide higher revenues for faster performance. Should performance-basedregulation tariffs be widely adopted, the economics of our plants may beenhanced and our addressable markets may expand.

 

We continue to make progress with each of the ISOs byworking with them directly to implement changes to market rules to allow energystorage technologies to participate on a non-discriminatory basis in theirregulation markets. The ISOs have demonstrated a heightened commitment to workcollaboratively with us to integrate our technology into their grids.  In addition to market rule changes, severalISOs are evaluating or proposing changes to their regulation dispatch signalsin order to ensure that our Smart Energy systems are deployed most efficientlyand effectively for the benefit of the power grid. These changes would takebetter advantage of our flywheels’ fast-response capability, while recognizingthat our resource has limited energy storage capacity. The proposed market rulechanges, coupled with more efficient regulation dispatch signals, will allowour resource to maximize its regulation revenue while minimizing ourconsumption and cost of electricity. The current status of each open-bid ISOmarket is as follows:

 

·                  New York ISO: We believe that NYISO presentsthe most favorable grid operating region for the first full-scale commercialdeployment of our systems. After extensive collaboration with us and withmarket stakeholders, on March 11, 2009, NYISO submitted new tariff and marketrules for Limited Energy Storage Resources (LESRs) to provide frequencyregulation to the New York power grid. The LESR tariff and market rule changeswere approved by FERC on May 15, 2009, with an effective implementation date ofMay 12, 2009.  The NYISO regulationservices market is now fully open to flywheel energy storage. The new rulesrecognize the unique operating characteristics of our technology and remedy keyaspects of the previously existing regulation tariff for generators that wouldotherwise limit our technology.  NYISO’sregulation dispatch method for LESRs will take advantage of the LESRs’ fastresponse rates and maximize their deployment. The energy level in our flywheelswill be actively managed by NYISO to maintain regulation capability to theextent possible by charging/discharging as necessary.  The new LESR tariff will also allow us to netour electricity costs at wholesale rates. We believe the new tariff and dispatch mechanisms will provide a highlyeffective and efficient method for integrating our flywheels into the NYISOregulation market.

 

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·                  ISO New England: On November 18, 2008, ISO-NElaunched an Alternative Technologies Regulation pilot program to comply withFERC Order No. 890.  The purpose of theAlternative Technologies Regulation pilot program is to evaluate theperformance of new technologies like ours that had been ineligible toparticipate in ISO-NE’s regulation market, determine how these technologies canbest be used to meet New England’s regulation requirements, allow programparticipants to operate in a realistic market environment where they canevaluate their market viability, and provide operating experience that ISO-NEcan use to formulate permanent market rules. On February 2, 2010, ISO-NE began working with stakeholders to develop aproposal for permanent market rules for alternative technologies. ISO-NEexpects to continue to develop its rules proposal during the second and thirdquarters of 2010 and then take its proposal through the normal New EnglandPower Pool (NEPOOL) stakeholder process during the fourth quarter.  Once a proposal is approved by NEPOOL, itwill be submitted to FERC for approval. Until new permanent market rules forenergy storage are implemented we will continue to earn revenue through thepilot program.  We began participating inthe pilot program with a 1 MW resource located inside our plant in Tyngsboro inNovember 2008,  added another 1 MWoutside our Tyngsboro facility in July 2009 and added a third MW in December2009.  Until April 2009, the pilotresource was sent a regulation signal that was similar to one for a traditionalgenerator and therefore did not recognize that our technology providesregulation in a different manner than a traditional generator.  After discussions with ISO-NE, in May 2009,we convinced the ISO to implement a regulation dispatch signal for our pilotproject that better recognizes our system’s unique capabilities and is similarto the dispatch method developed by NYISO. This new dispatch signal hasimproved the economics of our energy storage resources.  We are continuing to work with ISO-NE toimplement a NYISO- style dispatch signal in the permanent rules at theconclusion of the pilot program. In addition, as also discussed above, we areworking to have opportunity cost payments included in the permanent marketrules so that the payments made for our resource are comparable to those madeto other parties that provide a similar service. However, there are noguarantees that these changes will be implemented in the final rules.

 

·                  California ISO: CAISO is in the process ofopening its frequency regulation market to energy storage technologies and weare actively participating in this process.  In February 2009, FERC ordered CAISO to make modifications to its tariffto ensure that non-generation resources are treated comparably to otherresources in the CAISO regulation market. We are actively engaged in this FERC proceeding and in the stakeholderprocess at CAISO.  Through this process,we continue to work with CAISO and its stakeholders to promote the lessonslearned and best practices from other ISOs for integrating energy storage intothe regulation market.  CAISO hasinitiated a stakeholder process to review the product features needed tointegrate more renewable energy sources on their grid. Based on discussionswith CAISO, we expect this effort to result in proposed rules that will allowLESR participation in the regulation market by late 2010 or early 2011.  In addition, as part of an overall evaluationof their Ancillary Services market in 2010, they plan to consider whether itwould be beneficial to create a separate fast regulation product or institute aperformance payment, like ISO-NE’s mileage payment. In addition, the currentdefinition contained in the Western Electricity Coordinating Council (WECC)Reliability Standards for Regulating Reserves only refers to generationresources.  WECC has a proposal whicheliminates this “generator” definitional issue and will allow storage toprovide regulation.  Their proposal is currentlypending at FERC.

 

·                  Midwest ISO: On February 25, 2008, FERCapproved the creation of an Ancillary Services Market (ASM) in the Midwest ISOto begin operating on January 6, 2009. As part of its approval, FERC required MISO to make further changes toits ASM to remove barriers to new technologies to provide regulationservice.  On April 25, 2008, MISO fullycomplied with FERC’s directives by filing a request for an entirely newregulation resource category specifically designed for stored energy resources(“SER”), including our flywheel technology. FERC approved this tariff on December 18, 2008.  This was the first such tariff in the UnitedStates designed specifically to accommodate energy storage-based regulationresources.  In May 2009, MISO, with thesupport of its market stakeholders, submitted to FERC additional tariffmodifications to enhance the dispatch algorithm for SERs to better utilizetheir regulation capabilities and maximize their revenues in the MISOmarket.  On December 31, 2009, FERCapproved these tariff modifications.  Thenew MISO market rules for SERs took effect on January 1, 2010.

 

·                  PJM Interconnection: PJM amended its tarifflanguage to comply with FERC Order No. 890 and stated that its current rulesallow non-generation resources like ours to fully participate in its regulationmarket. PJM’s market rules allow us to enter the market. In the summer of 2009PJM adopted a regulation dispatch signal for energy storage resources thattakes partial advantage of our system’s fast-response capability, maximizesbenefits to PJM’s grid and pays us for the benefits of our resource.  In July 2010, PJM submitted tariff revisionsto FERC for approval which clarify and amend certain aspects of PJM’s tariff inorder to ensure we can net our energy consumption at wholesale rates andtherefore minimize our costs to provide service in PJM.  These tariff changes were unanimouslyendorsed by PJM’s stakeholder at the June 3, 2010 Members Committeemeeting.  Most recently, a senior PJMofficial has stated PJM’s interest in developing a “pay-for-performance”mechanism in their regulation market.

 

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·                  ERCOT: Since ERCOT is not regulated by theFederal Energy Regulatory Commission, in the past, we have focused our effortson the other ISOs.  As the amount of windgeneration in Texas increases and therefore the demand for fast frequencyregulation resources rises, and as we demonstrate the effectiveness of oursystem in other ISOs, we believe our technology will become increasinglyattractive in the ERCOT market. Consequently, we have begun to focus ourattention on this market. On April 13, 2010, ERCOT held an energy storageworkshop to begin the process of evaluating whether market rule changes will beneeded to allow energy storage units such as ours to enter this market on aneconomic basis. We are actively participating in this initiative.

** **

**Researchand Development Applications**

 

InJuly 2010, we were selected by the DOE to negotiate a $2.25 million award insupport of developing a next-generation flywheel energy storage system. TheAdvanced Research Projects Agency—Energy (ARPA-E), an agency within DOE thatprovides R&D funding for transformational new energy technologies andsystems, made the award based on our proposal to develop a highly advanced “flyingring” flywheel system.  The developmentprogram would take place over a three-year period beginning later this year,and is valued at a total of $2.8 million, pending contractual agreement.  ARPA-E grant recipients share a portion ofthe program cost, and we would contribute $560,000, or 20%, of the $2.8 millionprogram total.  Our proposal calls forinitiating development of a next-generation flywheel energy storage module witha size of 100 kWh and 100kW, capable of storing four times the energy atone-eighth the cost-per-energy-unit, as compared to our current Gen 4 flywheel.  The new flywheel would be capable of morethan 40,000 full charge/discharge cycles in its lifetime, thereby achieving acost per storage cycle below ARPA-E’s goal of $0.025/kWh.

 

Weexpect that the ARPA-E-funded flywheel system, if carried through to acommercial product, would be suitable for a variety of other applications wherethe cost per unit of stored energy is the most critical factor, and the numberof charge-discharge cycles is somewhat less important.  These applications include:  large-scale ramping and load followingsupport for wind and solar power in a way that reduces the need for standbyregional peak power generator capacity; wind-diesel-storage hybrid systems thatreduce diesel fuel consumption on island-based grids; and uninterruptible powersupply (UPS) applications that require an hour or more of assured power.

 

**Discussion of Operations**

 

Wehave experienced net losses since our inception and, as of June 30, 2010, hadan accumulated deficit of approximately $217 million.  We are focused oncommercializing our Smart Energy MatrixTM flywheel system for frequencyregulation and the sale of turnkey systems. We do not expect to havepositive EBITDA (earnings before interest, taxes, depreciation andamortization) or positive cash flow from operations until we have deployed asufficient number of merchant plants and/or sold turnkey systems. Moreover, wemust raise additional capital from a combination of equity, debt and/or turnkeysales to execute our business plan and continue as a going concern.  In the future, as the number of our merchantregulation facilities increases and we develop sustainable cash flows fromoperations and the sale of turnkey plants, we expect to fund additional plantsfrom a combination of cash flow from operations, non-recourse project financingand project equity.

 

OnNovember 18, 2008, we began operating our first 1 MW Smart Energy MatrixTM onthe electricity grid in Tyngsboro, Massachusetts. The 1 MW system was installedunder ISO New England’s Alternative Technologies Regulation pilot program. Thepilot program was approved by FERC as part of ISO New England’s compliance withFERC Order No. 890, which is intended to promote greater competition inelectricity markets, strengthen the reliability of the grid, and allowso-called “non-generation” resources (which include our flywheel technology),to participate in frequency regulation markets on a non-discriminatorybasis.  The pilot program allows us togenerate revenue for regulation services while ISO-NE develops permanent marketrules that will govern application of the technology. We added a secondmegawatt of capacity in Tyngsboro in July 2009, and a third megawatt inDecember 2009, all of which are currently earning revenue through the pilotprogram. Although we plan to redeploy a portion of these three MW to theStephentown site, we expect to continue to operate at least one MW of capacityin the ISO-NE pilot program until permanent market rules for energy storage arefinalized.

 

OnAugust 6, 2010, SRS, a wholly-owned subsidiary of Beacon, closed on a loanguaranteed by the DOE, which, over time, will allow us to borrow up toapproximately $43 million.  As part ofthe loan closing, Beacon transferred $7 million in cash to SRS, into arestricted cash account. Approximately two weeks after closing, SRS will use aportion of this equity contribution to reimburse Beacon for allowable costspreviously incurred.  Monthlydisbursements from the loan are anticipated to begin in September, based uponeligible project spending.  Eachdisbursement will be subject to the satisfaction of certain conditions.  This loan will provide debt financing for62.5% of the estimated $69 million total project cost of our 20 MW plantcurrently under construction in Stephentown, 

 

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New York. Our equity contribution to theproject is approximately $26 million of cash and in-kind assets which was fullyfunded at loan closing.

 

Ofthe $26 million not financed by the loan, we have already incurredapproximately $18.9 million in eligible project expenditures, which are part ofour equity contribution to the project. A significant portion of this in-kind contribution comes from theredeployment of a portion of the three MW of storage assets from Tyngsboro tothe Stephentown site. The remaining $7 million was raised through the sale ofunits comprised of common stock and warrants on December 9, 2009. Four of the20 MW are expected to be online and earning revenue in Stephentown by the endof 2010. The remaining 16 MW are scheduled to be online and earning revenue bythe end of the first quarter of 2011.

 

OnAugust 31, 2009, we purchased an option to lease land in Glenville, New York,where we expect to build a 20 MW facility at some time in the future.  During the lease option period, we haveagreed to negotiate in good faith a ground lease to be entered into upon ourunilateral exercise of the lease option. Key terms of the ground lease were substantially delineated in theexecuted option to the lease. In August 2010, we extended this lease option fora six-month period, and it may be extended for an additional six-month period.

 

In April 2010, we entered into two new land optionagreements.  The first of these is atwo-year option that provides the right to purchase either of two properties inthe Chicago area, but not both, for $1 million. Both properties are zonedindustrial, and contain certain improvements relevant to our planned use,including equipment required for physical interconnection to 138 KVAtransmission lines.  In consideration forthis option, we are paying the owner $2,000 per month. If we elect to purchasethe land, the option payments will be applied to the purchase price.   A second option agreement was executed withan economic development agency of the State of Pennsylvania for a propertysituated in Hazle Township, Luzerne County. Under the terms of this two-yearoption, we are paying $2,500 for each of four six-month option periods, oruntil the option is converted to a lease. The option allows us to lease theproperty for 21 years at the rate of $3,250 per month.  The site covered by this option is located inan economic development zone, which provides an exemption from the payment ofstate sales tax on equipment used to build the plant. We expect to build theplant (for which we have received a $24 million DOE grant award) on one of thetwo sites located in the Chicago area, or the Hazle Township site in LuzerneCounty, Pennsylvania.

 

InJuly 2010, the New York State legislature passed a law that specificallyexempts flywheel-based energy storage facilities of less than 80 MW from NewYork Public Service Commission (PSC) jurisdiction. Prior to this new statute,we were required to apply for (and had obtained) PSC approval via a certificateof public convenience and necessity, or CPCN, for the Stephentown facility. Thenew exemption is expected to relieve us from the regulatory burden of having toprovide the PSC with periodic updates and obtain PSC approval of facilitydocuments for our Stephentown plant. It will also eliminate entirely the needfor us to apply for additional CPCNs, as would otherwise have been required forour planned Glenville, New York, regulation plant, currently being developed.

 

Asof the end of July 2010, we have installed 110 flywheel foundations inStephentown, and have delivered and begun installing 4 MW of power electronicsand support systems. We have also delivered and begun installing the firstflywheels at the site.  By the end of thefourth quarter of 2010, we expect to have 4 MW of frequency regulation capacityconnected and earning revenue.

 

Our interconnection request for the 20 MW Stephentown plant includesNYSEG as the transmission provider. Before we can enter into an interconnection agreement with NYISO, wewere required to complete a System Impact Study, which is now complete, and bein the Facilities Study process.  Thepurpose of these studies is to confirm that our facility can be safely andreliably interconnected with the grid, and to identify any utility upgrades orother equipment that may be needed. Construction and development of this siteis also subject to certain state and local permitting processes. Afterexecuting an Engineering and 

 

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Procurement contract (E&P), necessary upgrades to grid equipment topermit such interconnection will begin, in a timeline roughly parallel to ourconstruction of the facility. We expect the plant to be partially on-line andto begin earning some revenue in the fourth quarter of 2010, although this willrequire expediting the interconnection process with NYSEG and NYISO.  NYSEG has agreed to allow us perform thedesign engineering and procurement of materials for the upgrade of their substationin order to help speed the interconnection process.

 

OnMay 24, 2010, we announced that we have signed a contract with the New YorkState Energy Research and Development Authority (NYSERDA) relating to agrant to pay for a portion of the interconnection and other aspects of theStephentown facility. This $2 million grant will also fund certain otherproject aspects, including a visitor information center to be built at theStephentown site. The grant is being accounted for as a reduction of eligibleproject costs, on a pro-rata basis, as expenses are incurred.

 

The first 20 MW plant will cost approximately $69million, of which approximately $55 million is direct equipment and facilitycosts. The remainder of the cost estimate includes contingency, legal,consulting and administrative costs.  Some of these costs are either unique to theDOE loan guarantee process or are greater than we expect will be incurred inthe construction of subsequent similar facilities.  Excluding the cost of land, the secondmerchant plant is estimated to cost approximately $50 million, of which the DOEgrant announced in November 2009 will provide approximately $24 million.

 

In 2010 and 2011, we willcontinue to have capital needs that will require additional funding through acombination of equity, debt and/or cash proceeds from the sale of plants tofund operations as we continue to build and deploy flywheel plants. The amountof debt and equity required will depend on the mixof merchant plants and plants sold on a turnkey basis.  Our deploymentplans are affected by the timing of a number of factors and activities,including but not limited to the following:

 

·                  The timing offunds disbursement from the DOE-guaranteed loan, the receipt of funds from theNYSERDA grant and the DOE Stimulus Grant

 

·                  Corporate orproject financing and its availability

 

·                  Equitytransactions and the amounts thereof

 

·                  Sale of turnkeyplants and the amount of associated margin and terms and conditions of thosesales

 

·                  Receipt ofenvironmental and site-related permits and approvals

 

·                  Receipt of gridinterconnection approvals.

 

Sinceour inception in 1997 we have funded our development primarily through the saleof common stock.  In November 2000, wecompleted our initial public offering, raising approximately $49.3 million netof offering expenses. Since our initial public offering, we have raisedapproximately $109.7 million as of June 30, 2010, through the sale of our stockand exercise of warrants. We estimate thatwe will need to raise additional funds during the remainder of 2010 through theissuance of equity securities or debt in order to fund operations and executeour business plan.  The amount of fundsneeded may range from $6 - 20 million, depending on when we order long-leaditems and begin construction of our second plant.  Additional funding will be required in 2011.

 

Our profit and losses as well as uses of cash may fluctuatesignificantly from quarter to quarter due to fluctuations in revenues, costs ofdevelopment, costs of materials to build flywheels and other components of ourSmart Energy MatrixTM and the market price for regulation services.In addition, our cash may fluctuate by period due to the timing of capitalexpenditures for expanding manufacturing capabilities and/or construction offrequency regulation facilities and the related timing of project financing orequity raises. These fluctuations in cash requirements could put additionalpressure on our cash position. There can be no assurance that we will be ableto raise the required capital on a timely basis or that sufficient funds will beavailable to us on terms that we deem acceptable, if they are available at all.See “— Liquidity and Capital Resources” below for more information concerningour access to and uses for capital.

 

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*Revenues*

 

Our revenue during the six months ended June 30, 2010, and 2009, cameprimarily from three sources:

 

·                  Frequency regulation service revenue from theISO-NE pilot program

 

·                  Research and development contracts, for whichrevenue has been recognized using the percentage-of-completion method

 

·                  Sales of inverters, accessories and APScredits.

 

Ourbusiness plan anticipates earning revenue primarily from the provision offrequency regulation service and the sale of  turnkey flywheel systems.  We alsoearn revenue from the sale of APS certificates or similar “clean energy”credits.  However, revenue from suchcredits has not been material. In the past, we have also earned revenue fromresearch and development contracts with government agencies, and we continue topursue similar contracts. In addition, we have a small inventory of invertersand accessories that we sell, although that revenue is insignificant.

 

ISO-NEhas a three-part payment model for regulation service:

 

1.               Payment for theresource’s MWs of capacity that are scheduled to perform regulation, referredto as “Time-On-Regulation.”

 

2.               Payment basedon the degree to which a resource changes its output, referred to as “RegulationService” or “Mileage.”  Fast-responseresources receive higher mileage payments than slower-responding resources.

 

3.               Payment tocompensate generators for lost revenue as a consequence of providing frequencyregulation rather than conventional power generation, referred to as “OpportunityCost.”

 

Revenueswe are currently receiving from this pilot program are less than those that weexpect to receive under permanent market rules, principally because underISO-NE’s pilot program rules, we are not eligible for opportunity costpayments, which represent approximately one-third of the revenue received byconventional regulating generators. We expect that ISO-NE will develop aproposal for permanent market rules before the end of 2010, which, if approvedby FERC, will enable us to receive the economic equivalent of this payment component.Additionally, we expect ISO-NE’s new market rules to retain apay-for-performance feature, whereby fast-response regulation resources, suchas our flywheels, will continue to receive higher-than-average mileage paymentson the basis of their greater speed and effectiveness.

 

Inrecent months, the Federal Energy Regulatory Commission (FERC) has shownincreasing support for the concept of paying fast-response regulation resourceson the basis of actual system performance rather than nominal capacity. We willcontinue to engage in this dialogue in an effort to encourage the expansion ofperformance-based tariffs. Currently, ISO-NE is the only grid operator thatutilizes a performance-based tariff that rewards resources for speed. OtherISOs, including PJM, are considering changing their tariffs to provide higherrevenues for faster performance. Should performance-based regulation tariffs bewidely adopted, the economics of our plants may be enhanced and our addressablemarkets may expand. No assurance can be given that such tariffs will be widelyadopted.

 

*Cost of Goods Sold*

 

Cost of goods sold for frequency regulation services consists of thecost of energy. Cost of goods sold for research and development contracts isbeing recorded on the percentage-of-completion method and consists primarily ofdirect labor and material, subcontracting and associated overhead costs.  Cost of goods sold does not reflect the truecost of any inverter sales, because our inverter inventory was fullywritten-off during a prior year.

 

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*Operations and Maintenance*

 

Operationsand maintenance (O&M) expenses are related to manufacturing, materialshandling, purchasing, Smart Energy MatrixTM operations, and expensednon-fungible costs associated with certain installations. Since our current productionlevels are still well below our facility’s full capacity, O&M costs for thesix-month periods ended June 30, 2010 and 2009 include a significant amount ofunabsorbed overhead.  In addition, costsassociated with running the 3 MW resource for the ISO-NE pilot program andcertain non-fungible costs associated with certain Smart Energy MatrixTMinstallations are also included in O&M. O&M expenses will increase in2010 as we ramp up our production capacity and begin to operate and maintain theStephentown facility.

* *

*Research and Development*

 

Researchand development (R&D) represents the cost of compensation and benefits forresearch and development staff, as well as materials and supplies used in theengineering design and development process. We expect R&D expenses in 2010 to be higher than in 2009 due toefforts to reduce the cost of the Smart Energy MatrixTM and modify our systemsto operate at 50 Hz for use outside the United States.

* *

*Selling, General and Administrative Expenses*

 

Our selling expenses consist primarily of compensation and benefits forregulatory affairs, sales and marketing personnel and related businessdevelopment expenses and regulatory compliance efforts. General andadministrative expenses consist primarily of compensation and benefits relatedto our corporate staff, professional fees, insurance and travel. Overall, weexpect our selling, general and administrative expenses for fiscal 2010 to behigher than in 2009 primarily due to increased staffing as we ramp up toconstruct and operate the Stephentown site, replace our Enterprise ResourcePlanning (ERP) system and identify and develop additional sites.

 

*Loss on Contract Commitments*

 

Our contracts have been primarily for the development of demonstrationunits of new products and the design of a frequency regulation plant. As such,the work has supported 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.  Each quarter we performan estimate-to-complete analysis, and any changes to our original estimates arerecognized in the period in which they are determined.  Based on this analysis and the completion ofseveral of our contracts, we recorded a credit to our contract loss reserve inthe second quarter of 2010.

 

*Depreciation and Amortization*

 

Our depreciation and amortization is primarily related to depreciationon capital expenditures and the amortization of lease and leasehold costsrelated to our facilities.  Depreciationexpense will increase substantially in future periods as we build and deployour frequency regulation installations.

 

*Interest and Other Income/Expense, net*

 

Ournon-operating income and expenses are primarily attributable to interest incomeresulting from cash on hand.

 

**Critical Accounting Policies and Estimates**

 

Thepreparation of financial statements requires management to make estimates andjudgments that may significantly affect the reported amounts of assets,liabilities, revenues, expenses and related disclosures. On an ongoing basis,management evaluates our estimates and assumptions including, but not limitedto, those related to revenue recognition, asset impairments, inventoryvaluation, warranty reserves and other assets and liabilities.  Managementbases its estimates on historical experience and various other assumptions thatit believes to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  Actualresults may differ from these estimates under different assumptions orconditions.

 

35

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*Revenue Recognition*

 

Althoughwe have shipped products and recorded contract and frequency regulation servicerevenues, our operations have not yet reached a level that would qualify us toemerge from the development stage. Therefore we continue to be accounted for as a development stage companyunder Financial Accounting Standards Board’s (FASB’s) Accounting StandardsCodification (ASC) Topic 915,*“Development StageEntities.”*

 

·                  *FrequencyRegulation Service Revenue*

 

Revenuefrom frequency regulation is recognized when it has been earned and is realizedor realizable. Revenue from services is earned either as the services areperformed or when they are complete, and is considered realizable once thecustomer has committed to pay for the services and the customer’s ability topay is not in doubt.  Frequencyregulation service revenue is calculated on an hourly basis, as services areprovided, based on formulas specific to the tariffs in effect at the applicableISO at bid award rates that are published by the ISO. In general, we recognizeas revenue the amounts reported by the ISO.

 

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

 

We recognize contract revenues using the percentage-of-completionmethod. We use labor hours as the basis for the percentage-of-completioncalculation, which is measured principally by the percentage of labor hoursincurred to date for each contract to the estimated total labor hours for eachcontract at completion. Changes to total estimated contract costs or losses, ifany, are recognized in the period in 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 in excess of revenues recognized to date areclassified as current liabilities under “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.

 

Ourresearch and development contracts are subject to cost review by the respectivecontracting agencies. Our reported results from these contracts could changeadversely as a result of these reviews.

 

·                  Product Sales

 

Generally,revenue on inverter and related product sales is recognized on transfer oftitle, typically when products are shipped, and all related costs areestimable.  For sales to distributors, wemake an adjustment to defer revenue until products are subsequently sold bydistributors to their customers.

 

*Loss on Contract Commitments*

 

Our contracts have been primarily for the development of demonstrationunits of new products, the design of a frequency regulation facility oralternative uses for our flywheels.  Assuch, the work has supported our core research and development efforts.  We establish reserves for anticipated losseson contract commitments if, based on our cost estimates to complete thecommitment, we determine that the cost to complete the contract will exceed thetotal 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.

 

*FixedAssets*

 

Property and equipment in service is stated at cost and depreciatedusing the straight-line method over the estimated useful lives of the assets.Property and equipment are defined as tangible items with unit costs exceedingour capitalization threshold that are used in the operation of the business,are not intended for resale and which have a useful life of one year or more.The cost of fixed assets is defined as the purchase price of the item, as wellas all of the costs necessary to bring it to the condition and locationnecessary for its intended use.  Thesecosts include material, labor, overhead, capitalized interest and, ifapplicable, exit costs. Exit costs for which we are obligated are accounted forin accordance with ASC 410, “*Asset Retirement andEnvironmental Obligations*.” No overhead is generally applied forinternally-constructed projects not directly related to our core business(e.g., leasehold improvements).  Interestcosts incurred during the construction of major capital projects (such as theconstruction of our frequency regulation plants) are capitalized in accordancewith ASC Topic 835, Subtopic 20, “*Interest — Capitalizationof Interest*.”  

 

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The interest is capitalized until the underlying asset is ready for itsintended use, and is considered an integral part of the total cost of acquiringa qualifying asset. Thus, the capitalized interest costs are included in thecalculation of depreciation expense once the constructed assets are in service.Repair and maintenance costs are expensed as incurred.  Materials used in our development efforts areconsidered research and development materials, and are expensed as incurred inaccordance with ASC 730, “*Research and Development*.”

 

Capital assets are classified as “Construction in Progress” wheninitially acquired, and reclassified to the appropriate asset account whenplaced into service, with the exception of land, which is capitalized uponpurchase. Depreciation expense is not recorded on assets not yet placed intoservice.

 

Materials purchased to build flywheels, power electronics and othercomponents used in our frequency regulation installations are classified asCIP, along with the related labor and overhead costs. Some components of theSmart Energy MatrixTM, such as the flywheels and power electronics, areconsidered “fungible” in that they can be moved and redeployed at a differentlocation.  Non-fungible costs are costswhich would not be recovered if we redeployed the matrix or portions thereof.  In some cases, we may elect to deploy a SmartEnergy MatrixTM system at a location for the purpose of demonstrating ourtechnology or gaining experience operating in that particular market.  In these instances, the costs of the fungiblecomponents are capitalized, and the remaining costs, which may include suchcosts as site preparation, interconnection costs, capitalized interest andestimated exit costs, are expensed.

 

*Impairment of Long-Lived Assets*

 

Inaccordance with ASC 360 “*Property, Plant and Equipment*”long-lived assets we hold and use are reviewed to determine whether any eventsor changes in circumstances indicate that the carrying value of the asset maynot be recoverable.  The conditions to beconsidered include whether or not the asset is in service, has become obsolete,is damaged, or whether external market circumstances indicate that the carryingamount may not be recoverable.  Whenappropriate we recognize a loss for the difference between the estimated fairvalue of the asset and the carrying amount. The fair value of the asset is measured using either available marketprices or estimated discounted cash flows.

 

Incertain instances, we may determine that it is in the best interest of theCompany to re-deploy all or part of a Smart Energy MatrixTM system installed ata given location.  When such adetermination has been made, we will determine which costs are associated withthe movable (fungible) components, and which costs are non-fungible. We will recorda period expense for the net book value associated with the non-fungiblecomponents.

 

Basedon our analysis, no asset impairment charges were considered necessary as ofJune 30, 2010, or 2009.

 

*Fair Value of Financial Instruments*

 

Accounting for fair value measurements involves a single definition offair value, along with a conceptual framework to measure fair value, with afair value defined as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date. The fair value measurement hierarchy consists of threelevels:

 

·                  Level one—quoted market prices in activemarkets for identical assets or liabilities

 

·                  Level two—inputs other than level one inputsthat are either directly or indirectly observable

 

·                  Level three—unobservable inputs developedusing estimates and assumptions which are developed by the reporting entity andreflect those assumptions that a market participant would use.

 

We apply valuation techniques that (1) place greater reliance onobservable inputs and less reliance on unobservable inputs and (2) areconsistent with the market approach, the income approach and/or the costapproach, and include enhanced disclosures of fair value measurements in ourfinancial statements.

 

The carrying values of cash and cash equivalents, accounts receivable,other current assets, accounts payable, accrued expenses, and other currentliabilities approximate their fair values due to the short maturity of theseinstruments.  See Note 9 to our unauditedconsolidated financial statements contained in Part 1, Item 1 of this reportfor debt fair value, which also approximates carrying value.

 

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*Deferredfinancing costs*

 

We will defer our direct costs incurred to raise capital. Direct costsinclude only “out-of-pocket” or incremental costs directly related to theeffort, such as a finder’s fee and fees paid to outside consultants foraccounting, legal or engineering investigations or for appraisals.  These costs will be charged to AdditionalPaid In Capital when the efforts are successful, or expensed whenunsuccessful.  Indirect costs areexpensed as incurred.

 

**Results of Operations**

 

***Comparison of Three and Six Months ended June 30, 2010 and2009***

* *
| ** **                               | ** ** | **Three  months ended June 30,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **2010**                         | ** ** | **2009** | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                               | ** ** | **(in thousands)**               | ** ** |
| Revenue                                  |       | $                                | 165        |   | $ | 282 |   | $ | (117 | ) | -41 | % |
| Cost of goods sold                       |       | 72                               |       | 286 |   | (214 | ) | -75 | % |
| Gross margin                             |       | 93                               |       | (4 | ) | 97 |   | 2425 | % |
| Operating expenses:                      |       |                             |       |   |   |   |   |   |   |
| Operations and maintenance               |       | 823                              |       | 769 |   | 54 |   | 7 | % |
| Research and development                 |       | 1,889                            |       | 1,486 |   | 403 |   | 27 | % |
| Selling, general and administrative      |       | 2,430                            |       | 1,995 |   | 435 |   | 22 | % |
| Loss on contract commitments             |       | (100                             | )          | — |   | (100 | ) | n/a |   |
| Depreciation and amortization            |       | 546                              |       | 443 |   | 103 |   | 23 | % |
| Total operating expenses                 |       | 5,588                            |       | 4,693 |   | 895 |   | 19 | % |
| Loss from operations                     |       | (5,495                           | )          | (4,697 | ) | (798 | ) | 17 | % |
| Interest and other income (expense), net |       | (56                              | )          | (70 | ) | 14 |   | -20 | % |
| Net loss                                 |       | $                                | (5,551     | ) | $ | (4,767 | ) | $ | (784 | ) | 16 | % |

* *
| ** **                               | ** ** | **Six  months ended June 30,** | ** ** |
|------------------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **2010**                       | ** ** | **2009** | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                               | ** ** | **(in thousands)**             | ** ** |
| Revenue                                  |       | $                              | 401        |   | $ | 393 |   | $ | 8 |   | 2 | % |
| Cost of goods sold                       |       | 255                            |       | 458 |   | (203 | ) | -44 | % |
| Gross margin                             |       | 146                            |       | (65 | ) | 211 |   | 325 | % |
| Operating expenses:                      |       |                           |       |   |   |   |   |   |   |
| Operations and maintenance               |       | 1,790                          |       | 1,546 |   | 244 |   | 16 | % |
| Research and development                 |       | 3,962                          |       | 3,677 |   | 285 |   | 8 | % |
| Selling, general and administrative      |       | 4,376                          |       | 3,893 |   | 483 |   | 12 | % |
| Loss on contract commitments             |       | (100                           | )          | 133 |   | (233 | ) | -175 | % |
| Depreciation and amortization            |       | 1,076                          |       | 866 |   | 210 |   | 24 | % |
| Total operating expenses                 |       | 11,104                         |       | 10,115 |   | 989 |   | 10 | % |
| Loss from operations                     |       | (10,958                        | )          | (10,180 | ) | (778 | ) | 8 | % |
| Interest and other income (expense), net |       | (133                           | )          | (127 | ) | (6 | ) | 5 | % |
| Net loss                                 |       | $                              | (11,091    | ) | $ | (10,307 | ) | $ | (784 | ) | 8 | % |

 

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*Revenue*

 

The following table provides details of our revenuesfor the three and six months ended June 30, 2010, and 2009.

 
| ** **                | ** ** | **Percent**                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended June  30,** | ** ** | **Cumulative  Contract**

**Value  Earned as  of June 30,** | ** ** | **Total  Contract** | ** ** | **Remaining  Value** | ** ** |
|---------------------------|------------|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|-------------------------------------------------------------|------------|---------------------|------------|----------------------|------------|
| ** **                | ** ** | **complete**               | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010**                                                    | ** ** | **2009**            | ** ** | **2010**             | ** ** | **Value** | ** ** | **(Backlog)** | ** ** |
| ** **                | ** ** | **(dollars in thousands)** |       |
| **Frequency regulation:** | ** ** | ** **                 |       | $                                | 124        |                           | $          | 52                                                          |       | $                   | 267        |                 | $          | 116 | * * | * * | * * | * * |   |   |   |
| **Contracts:**            | ** ** | ** **                 | * *   | * *                         | * *   | * *                       | * *   | * *                                                    | * *   | * *            | * *   | * *             | * *   | * * |   |   |   |
| NAVSEA                    |       | 100.0                      | %          | —                           |       | 149                            |       | —                                                      |       | 178                 |       | $                    | 500        |   | $ | 500 |   | $ | — |   |
| Tehachapi                 |       | 74.9                       | %          | 1                                |       | 81                             |       | 26                                                          |       | 96                  |       | 187                  |       | 250 |   | 63 |   |
| PNNL                      |       | 100.0                      | %          | 30                               |       | —                         |       | 84                                                          |       | —              |       | 104                  |       | 104 |   | — |   |
| Total Contract Revenue    |       |                       |       | $                                | 31         |                           | $          | 230                                                         |       | $                   | 110        |                 | $          | 274 |   | $ | 791 |   | $ | 854 |   | $ | 63 |   |
| **Other:**                |       |                       |       | 11                               |       | —                         |       | 24                                                          |       | 3                   |       |                 |       |   |   |   |   |
| Total                     |       |                       |       | $                                | 166        |                           | $          | 282                                                         |       | $                   | 401        |                 | $          | 393 |   |   |   |   |   |   |   |

 

Revenuefor the six months ended June 30, 2010 increased by approximately $8,000, or2%.  Frequency regulation revenue earnedthrough our participation in the ISO-NE pilot program increased byapproximately $151,000, or 130%.  Revenuefrom research and development contracts decreased by approximately $164,000,due primarily to the completion of several contracts.  Other revenue, derived from the sale ofinverters, accessories and APS credits earned from providing regulationservice, increased by approximately $21,000.

 

Wehad 3 MW of capacity in service in the first half of 2010, as compared to 1 MWin the first half of 2009.  We providedapproximately 263,200 megawatt-hours (MWh) of regulation service in the firsttwo quarters of 2010, or approximately 87,700 MWh per MW of capacity inservice, as compared to approximately 77,200 MWh in the first two quarters of2009, an increase of 13.6%.  Although ourproductivity improved, our revenue per MW dropped from approximately $116,000in the first half of 2009 to approximately $89,000 in the same period in 2010,due to a reduction in the average clearing price for frequency regulation. Theaverage clearing price per MWh for the six months ended June 30, 2010 was$7.53, as compared to $11.03 during the same period in 2009.

 

Revenueswe are currently earning from the ISO-NE pilot program are less than those thatwe expect to receive under permanent market rules. Under pilot program marketrules, we are not eligible for opportunity cost payments, which representapproximately one-third of the revenue received by conventional regulatinggenerators. We are encouraging ISO-NE to develop permanent market rules thatwill provide an additional payment component for alternative technologies thatwould be approximately equal to opportunity cost. As noted above, we expectISO-NE to develop permanent market rules before the end of this year that willhave the effect of compensating us for the opportunity cost component that wedo not currently receive under the ISO-NE pilot program. The trend at otherISOs has been to incorporate features in their tariffs that intrinsicallycompensate all resources, including energy storage providers, for opportunitycost.

 

Contract revenue for the six-month period ended June 30, 2010, wasapproximately $110,000, a decrease of $164,000 or 60%, as compared to the firsthalf of 2009, primarily because most of the contracts were substantiallycompleted prior to or during the quarter.

 

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*Cost of Goods Sold*

 

Cost of goods sold for the three and six monthsended June 30, 2010, and 2009 are as follows:

 
|                      |   | **Three  months ended June 30, 2010** |       | **Three  months ended June 30, 2009** |       |
|---------------------------|--------|---------------------------------------|------------|---------------------------------------|------------|
|                      |   | **Revenue**                           | ** ** | **Cost  of  Sales**                   | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Sales** | ** ** | **Margin** |   |
|                      |   | **(in thousands)**                    |       |
| Frequency regulation      |   | $                                     | 124        |                                  | $          | 96 |   | $ | 28 |   | $ | 52 |   | $ | 67 |   | $ | (15 | ) |
| Contracts                 |   | 31                                    |       | (24                                   | )          | 55 |   | 230 |   | 219 |   | 11 |   |
| Inverters and APS credits |   | 11                                    |       | —                                |       | 11 |   | — |   | — |   | — |   |
| Total                     |   | $                                     | 166        |                                  | $          | 72 |   | $ | 94 |   | $ | 282 |   | $ | 286 |   | $ | (4 | ) |

 
|                      |   | **Six  months ended June 30, 2010** |       | **Six  months ended June 30, 2009** |       |
|---------------------------|--------|-------------------------------------|------------|-------------------------------------|------------|
|                      |   | **Revenue**                         | ** ** | **Cost  of  Sales**                 | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Sales** | ** ** | **Margin** |   |
|                      |   | **(in thousands)**                  |       |
| Frequency regulation      |   | $                                   | 267        |                                | $          | 200 |   | $ | 67 |   | $ | 116 |   | $ | 197 |   | $ | (81 | ) |
| Contracts                 |   | 110                                 |       | 55                                  |       | 55 |   | 274 |   | 261 |   | 13 |   |
| Inverters and APS credits |   | 24                                  |       | —                              |       | 24 |   | 3 |   | — |   | 3 |   |
| Total                     |   | $                                   | 401        |                                | $          | 255 |   | $ | 146 |   | $ | 393 |   | $ | 458 |   | $ | (65 | ) |

 

Cost of goods sold, inclusive of our frequency regulation services,research and development contracts, and inverter and other sales decreased fromapproximately $286,000 in the second quarter of 2009 to approximately $72,000during the equivalent period of 2010, despite tripling the frequency regulationcapacity in service during that period. During the second quarter of 2010 and2009, cost of goods sold includes approximately $96,000 and $67,000,respectively, for the cost of energy associated with the generation offrequency regulation revenue under the ISO-NE pilot program.  This significant improvement resulted fromISO-NE’s decision to allow us to net the energy consumption of our regulationresource and pay the wholesale rate for net energy usage, as further explainedbelow. Consequently, our average gross margin on frequency regulation servicesduring the second quarter of 2010 was 22.6%, compared to a negative gross marginof 28.8% for the second quarter of 2009. The gross margin for the first half of 2010 was 25%, compared to anegative gross margin of 69.8%, for the first half of 2009.

 

Duringthe first six months of the pilot program (which included the first four monthsof 2009), our electricity costs for operating the Smart Energy MatrixTM inTyngsboro were unusually high.  Ourconnection to the grid for the pilot program was made through National Griddistribution lines, rather than directly to the ISO through transmission lines,due to cost and time factors. Consequently, from November 2008 through late April 2009, we paid theretail price for our gross withdrawals from the grid instead of paying thewholesale price for the net electricity (withdrawals minus injections), plusretail transmission and distribution charges. In late April 2009, ISO-NE and our local distribution companyimplemented a change that reduced our cost of electricity by netting theelectricity withdrawn and injected into the grid, and billing for that netusage at the wholesale rate.  Inaddition, a new regulation dispatch signal implemented by ISO-NE in May 2009reduced the net amount of electricity we need to purchase.  While we are still paying retail transmissionand distribution charges, the reduction in energy costs resulting from theadjustment that allows us to net our energy costs has enabled us to earnpositive gross margins since May 2009.  However, that margin has been dropping due to a continuing decrease inthe ISO-NE clearing price for frequency regulation, as discussed above. Webelieve that the reduction in clearing price is due to lower electricity demandresulting from current economic conditions, and that regulation pricing willincrease as the economy recovers and the need for regulation capacity rises.

 

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We expect the cost of electricity to be significantly lower for our 20MW facilities than for the ISO-NE pilot resource, because we plan to beconnected to transmission-level (rather than to distribution-level) powerlines, and thus will not be subject to transmission and distribution fees.Those fees have represented approximately 72% of our cost of energy during thefirst half of 2010. Pro forma gross margin for frequency regulation servicesfor the first half of 2010, calculated without transmission or distributioncharges, would have been approximately 78.7%.

 

We recorded a credit in cost of sales for contracts in the secondquarter of 2010 as a result of completing the PNNL contract for substantiallyless than originally estimated, as discussed earlier under “Loss on ContractCommitments.”

 

*Operations and Maintenance Expense*

 

Forthe three and six months ended June 30, 2010, operations and maintenanceexpenses increased by approximately $54,000, or 7% and $244,000, or 16%,respectively, in comparison to the equivalent periods in 2009. See the tablebelow for explanations of the factors which were responsible for the mostsignificant changes.

 
| ** **                      | ** ** | **Three  months  ended June 30,** | ** ** | **Six  months  ended June 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                         | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **(in thousands)**                          | ** ** | ** **                                | ** ** |
| Period Ended June 30, 2009 |       | $                                           | 769        |                                      | $          | 1,546                                                                                                                                                                                                                                                                                                               |       |   |   |
| Expense materials               |       | 67                                          |       | 101                                       |       | Increased  spending for small tools and equipment, tooling and non-recurring expenses,  and production supplies.                                                                                                                                                                                                    |       |
| Salaries and benefits           |       | 129                                         |       | 137                                       |       | Increased  staffing as we ramp up manufacturing and construction of our Stephentown  facility, along with higher costs for benefits, particularly employee health  insurance.                                                                                                                                       |       |
| Subcontractors and consultants  |       | 75                                          |       | (96                                       | )          | For  the six month period, 2009 costs were higher due to contractor costs  associated with completing non-fungible costs of the 3 MW matrix in  Tyngsboro. The increase in the second quarter of 2010 is primarily due to  costs associated with the Stephentown site.                                              |       |
| Legal                           |       | (53                                         | )          | (81                                       | )          | In  2009, legal and tax advice represents primarily costs associated with the set  up of our frequency regulation operations in New York.                                                                                                                                                                           |       |
| Allocations and overhead        |       | (263                                        | )          | (178                                      | )          | In  June 2010, the NYSERDA grant was finalized, and is being recorded as a  reduction of expenses. Accordingly, we credited “Allocations out” for $225K  based on the cumulative eligible spending to date. The remainder represents  higher overhead applied based on increasing production levels. |       |
|                                 |            |                                             |            |                                           |            |                                                                                                                                                                                                                                                                                                                     |            |  |  |

 

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| ** **                      | ** ** | **Three  months  ended June 30,** | ** ** | **Six  months  ended June 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Stock Compensation              |       | (15                                         | )          | (34                                       | )          | Although  a number of options were granted in the second quarter, most of those options  do not begin to vest until the third quarter, thus no compensation expense  was recorded as of June 30, 2010 for those options. The reduction in  stock compensation year to date is due to declining expense amounts for prior  year grants based upon the use of the accelerated method of calculating stock  compensation expense. |       |
| Occupancy                       |       | 61                                          |       | 207                                       |       | Increase  due primarily to the cost of repairing the roof at our Tyngsboro facility,  and lease option costs for the property in Glenville.                                                                                                                                                                                                                                                                                         |       |
| Travel                          |       | 5                                           |       | 18                                        |       | Increase  in travel, including travel to the Stephentown site.                                                                                                                                                                                                                                                                                                                                                                      |       |
| Hiring expenses                 |       | 21                                          |       | 21                                        |       | Increase  due to new hires to support increased production for Stephentown.                                                                                                                                                                                                                                                                                                                                                         |       |
| Other                           |       | 27                                          |       | 149                                       |       | Year  to date increase includes $114K for costs previously included in CIP for the  construction of the 2MW system in service in Tyngsboro which determined to be  “non-fungible” and so were expensed in Q1, 2010.                                                                                                                                                                                                       |       |
| Period Ended June 30, 2010 |       | $                                           | 823        |                                      | $          | 1,790                                                                                                                                                                                                                                                                                                                                                                                                                               |       |   |   |
|                                 |            |                                             |            |                                           |            |                                                                                                                                                                                                                                                                                                                                                                                                                                     |            |  |  |

 

*Research and Development Expense*

 

Researchand development expenses increased by approximately $403,000, or 27%, for thesecond quarter of 2010 as compared to the second quarter of 2009, and byapproximately $285,000, or 8% year over year. See the table below forexplanations of the factors which were responsible for the most significantchanges.

 
| ** **                      | ** ** | **Three  months  ended June 30,** | ** ** | **Six  months  ended June  30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **(in  thousands)**                         | ** ** | ** **                       | ** ** |
|                            |       |                                        |       |                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                      |       |
| Period Ended June 30, 2009 |       | $                                           | 1,486      |                             | $          | 3,677                                                                                                                                                                                                                                                                                                                                                                                                                     |       |   |   |
| Expense materials               |       | 85                                          |       | (5                               | )          | In  2009, the materials cost included in R&D are primarily the cost of  redesigning and replacing motors as part of the motor-stator redesign needed  to reduce the operating temperature of the flywheels and engineering efforts  to reduce the cost of the flywheels. In the second quarter of 2010, expense  materials for R&D primarily relates to work developing lower cost  components for our flywheels. |       |
|                                 |            |                                             |            |                                  |            |                                                                                                                                                                                                                                                                                                                                                                                                                           |            |  |  |

 

42

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| ** **                      | ** ** | **Three  months  ended June 30,** | ** ** | **Six  months  ended June  30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                                                      | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|----------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                            |       |                                        |       |                             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                             |       |
| Salaries and benefits           |       | 127                                         |       | 140                              |       | Increase  represents more hours charged to R&D by manufacturing staff in 2010 than  in 2009. The manufacturing staff has been working with engineering to improve  the tools and procedures used to manufacture the flywheels as part of our  cost reduction efforts.                                                                                                                                                                        |       |
| Subcontractors and consultants  |       | 20                                          |       | 27                               |       | Increased  use of contractors                                                                                                                                                                                                                                                                                                                                                                                                                    |       |
| Legal                           |       | 9                                           |       | 9                                |       | Increase  in legal costs related to patents.                                                                                                                                                                                                                                                                                                                                                                                                     |       |
| Allocations and overhead        |       | 175                                         |       | 123                              |       | The  increase in overhead allocation in 2010 from 2009 is a result in the increase  in the level of production, along with project management labor charged to  the Stephentown project.                                                                                                                                                                                                                                                         |       |
| Stock Compensation              |       | (34                                         | )          | (103                             | )          | Although  a number of options were granted in the second quarter, most of those options  do not begin to vest until the third quarter of 2010; therefore no  compensation expense was recorded as of June 30, 2010 for these options.  The reduction in stock compensation year to date is due to declining expense  amounts for prior year grants based upon the use of the accelerated method of  calculating stock compensation expense. |       |
| Occupancy                       |       | 31                                          |       | 99                               |       | Increase  due to cost to repair the roof at our Tyngsboro facility.                                                                                                                                                                                                                                                                                                                                                                              |       |
| Travel                          |       | 10                                          |       | 21                               |       | Increase  in travel.                                                                                                                                                                                                                                                                                                                                                                                                                             |       |
| Other                           |       | (20                                         | )          | (26                              | )          |                                                                                                                                                                                                                                                                                                                                                                                                                                             |       |
| Period Ended June 30, 2010 |       | $                                           | 1,889      |                             | $          | 3,962                                                                                                                                                                                                                                                                                                                                                                                                                                            |       |   |   |
|                                 |            |                                             |            |                                  |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |            |  |  |

 

*Selling, General and Administrative Expense*

 

Selling, general and administrative expenses totaled approximately$2,430,000 and $1,995,000 for the three months ended June 30, 2010, and2009, respectively, which represents an increase of approximately $435,000, or22%, period over period. For the six-month period ended June 30, 2010,selling, general and administrative expenses increased by approximately$483,000, or 12%, period over period.

 

Significant changes in spending are explained in the table shown below.

 

43

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| ** **                          | ** ** | **Three  months  ended June 30,** | ** **  | **Six  months  ended June 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                         | ** ** |
|-------------------------------------|------------|---------------------------------------------|-------------|-------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                |       |                                        |        | **(in thousands)**                        |       |                                                                                                                                                                                                                                                                                                                                                |       |
| Period Ended  June 30, 2009    |       | $                                           |  1,995 |                                      | $          |  3,893                                                                                                                                                                                                                                                                                                                                         |       |   |   |
| Stock Compensation                  |       | 12                                          |        | (52                                       | )          | Increase  in the second quarter of 2010 due to grants to the Executive Officers as part  of their 2010 Executive Agreements. On a year to date basis, stock  compensation expense is lower largely due to declining expense amounts for  prior year grants based upon the use of the accelerated method of calculating  stock compensation expense. |       |
| Legal, audit and professional fees  |       | 139                                         |        | 124                                       |       | Increase  in use of outside legal services and higher audit fees.                                                                                                                                                                                                                                                                                   |       |
| Public company / investor relations |       | (111                                        | )           | (119                                      | )          | 2009  was higher than 2010 due to costs associated with the Seaside stock  agreement.                                                                                                                                                                                                                                                               |       |
| Salaries and benefits               |       | 249                                         |        | 288                                       |       | Increase  due to new hires, primarily to support the administrative cost of managing the  Stephentown project and market sale of turnkey systems.                                                                                                                                                                                                   |       |
| Taxes                               |       | 10                                          |        | 30                                        |       | Increase  in Delaware Franchise tax                                                                                                                                                                                                                                                                                                                 |       |
| Small tools and equipment           |       | 13                                          |        | 27                                        |       | Increase  represents primarily the cost of computer equipment for new hires                                                                                                                                                                                                                                                                         |       |
| Subcontractors and consultants      |       | 54                                          |        | 59                                        |       | Increased  use of consultants, especially in regards to international marketing efforts.                                                                                                                                                                                                                                                            |       |
| Allocations and overhead            |       | (68                                         | )           | (63                                       | )          | Represents  G&A overhead allocated to the Navy and other contracts.                                                                                                                                                                                                                                                                             |       |
| Occupancy                           |       | 6                                           |        | 15                                        |       | Occupancy  increased due to cost of building repairs.                                                                                                                                                                                                                                                                                               |       |
| Hiring Expense                      |       | 88                                          |        | 112                                       |       | Cost  associated with new hires.                                                                                                                                                                                                                                                                                                                    |       |
| Conferences and trade shows         |       | 23                                          |        | 24                                        |       | Increased  attendance at conferences and trade shows as part of business development and  marketing efforts.                                                                                                                                                                                                                                        |       |
| Travel                              |       | 14                                          |        | 29                                        |       | Increase  in travel, in particular, related to international marketing efforts.                                                                                                                                                                                                                                                                     |       |
| Other                               |       | 6                                           |        | 9                                         |       |                                                                                                                                                                                                                                                                                                                                                |       |
| Period Ended June 30, 2010     |       | $                                           | 2,430       |                                      | $          | 4,376                                                                                                                                                                                                                                                                                                                                               |       |   |   |

 

*Loss on Contract Commitments*

 

InApril 2008, we were awarded a subcontract to provide a flywheel energystorage system in support of a wind integration research and developmentproject in Tehachapi, California, sponsored by the California EnergyCommission.  We will receiveapproximately $250,000, in total, to offset R&D expenses and willcontribute an additional $87,000 of engineering resources for the project,bringing the R&D total to approximately $337,000.  Accordingly, we recorded a charge ofapproximately $87,000 to the contract loss reserve during 2008 to reflect theexpected “cost share” portion of the Tehachapi contract. During the firstquarter of 2009, we increased the loss reserve for the Tehachapi contract by$132,500, bringing the total contract loss to approximately $219,000.  This increase is based on the differencebetween the overhead rate that was bid on this fixed price contract and ourforecasted overhead rate.  No additionswere considered necessary to the loss reserve for the Tehachapi contract duringthe six months ended June 30, 2010.

 

44

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Duringthe fourth quarter of 2009, we began work on the PNNL contract. According tothe terms of the contract, we expected to incur R&D costs of approximately$210,000, and to receive approximately $104,000 to offset those costs.  Accordingly, during the fourth quarter of2009, we recorded a charge of approximately $106,000 for our “cost share”portion of this contract. We completed the contract during the second quarterof 2010, at a total cost of approximately $59,000.  In June 2010, we adjusted cost of salesto properly reflect the margin on this contract, and reversed the previouslyestablished loss reserve.

 

On February 3, 2009, we announced that we entered into a contractwith NAVSEA to evaluate the use of flywheel energy storage for multipleshipboard applications that we expect will lead to a conceptual design of aflywheel system for future naval surface combatants and possible retrofit intoexisting navy ships.  The value of theinitial research and development work is estimated at $900,000, $500,000 ofwhich has already been appropriated. Subsequent phases involve work estimated at up to an additional $2.1million.  This contract was awarded on a “costplus fixed fee” basis.  After finaloverhead rate adjustments, we increased the costs charged to the Navy contractby approximately $43,000.  We recorded a contract loss reserve ofapproximately $50,000 in the second quarter of 2010, since the total costsexceed the total appropriated to date for the contract, and we charged theadditional overhead costs, plus an additional $7,000 in unbilled costs againstthis reserve.

 

The organization that originally sponsoredour NYSERDA PON 800 contract has undergone a variety of organizational changes,which have resulted in this contract being terminated.  Unbilled allowable charges of approximately$8,000 were charged to the contract loss reserve, and the remaining reserve ofapproximately $46,000, was reversed in June 2010.

 

*Depreciation and Amortization*

 

Depreciationand amortization expense increased from approximately $443,000 during the threemonths ended June 30, 2009, to approximately $546,000 for the same periodin 2010, an increase of approximately $103,000, or 23%.  For the six month periods ended June 30,2010, the increase was approximately $210,000, or 24%, over the same period of2009. The increase in depreciation and amortization results primarily from thecapitalization of flywheel and related equipment that was placed into servicein July and December of 2009, as well as machinery and equipmentpurchased in the fourth quarter of 2009 and the first half of 2010.  As of June 30, 2010, we hadapproximately $12.9 million in “Construction in progress,” of whichapproximately $6.9 million is for flywheels or materials to build flywheels andapproximately $5.5 million are costs related to the construction of SmartEnergy MatrixTM systems.

* *

*Interest and Other Income (Expense), net*

 

Averagecash balances during the first six months of 2010 were approximately $10.5million higher, on average, than during the same period in 2009. However,interest rates were significantly lower in 2010.  As a result of the lower interest rates,interest income for the first six months of 2010 was approximately $2,600 lowerthan during the first six months of 2009.

 

Interestexpense for the six months ended June 31, 2010 and 2009 was as follows:

 
| ** **              | ** ** | **Six  months ended June 30,** | ** ** |
|-------------------------|------------|-------------------------------------|------------|
| ** **              | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| Interest incurred       |       | $                                   | 149,213    |   | $ | 116,735 |   |
| Loan discount amortized |       | 26,737                              |       | 28,529 |   |
| Interest capitalized    |       | (30,988                             | )          | (2,251 | ) |
| Net interest expense    |       | $                                   | 144,962    |   | $ | 143,013 |   |

 

Interestexpense and the loan discount amortization increased due to the final drawdownon the MassDev loan which was made during the fourth quarter of 2009.  These increases were partially offset byhigher interest capitalized on the Stephentown project.

 

45

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*Net Loss*

 

Asa result of the changes discussed above, the net loss for the three monthsended June 30, 2010 was approximately $5,551,000, which represents anincrease in the loss of approximately $784,000, or 16% over the second quarterof 2009.  For the six months ended June 30,2010, and 2009, net loss was approximately $11,091,000 and $10,307,000,respectively.

** **

**Liquidity and Capital Resources**

** **
| ** **                                | ** ** | **Six  months ended June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **2010**                            | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **(in thousands)**                  | ** ** |
| Cash and cash equivalents                 |       | $                                   | 11,408     |   | $ | 3,196 |   |
| Working capital                           |       | 3,833                               |       | (1,232 | ) |
| Cash provided by (used in)                |       |                                |       |   |   |
| Operating activities                      |       | (6,384                              | )          | (12,858 | ) |
| Investing activities                      |       | (9,882                              | )          | (2,185 | ) |
| Financing activities                      |       | 5,069                               |       | 3,881 |   |
| Net decrease in cash and cash equivalents |       | $                                   | (11,197    | ) | $ | (11,162 | ) |
| Current ratio                             |       | 1.4                                 |       | 0.8 |   |

 

Our cash requirements depend on many factors including, but not limitedto, the cost to build our flywheels and frequency regulation facilities,research and development activities, facility costs, and our sales, general andadministrative expenses.  Since we arestill in the development stage and have not yet generated significant revenuefrom our principal operations, we do not generate enough cash from operationsto satisfy our working capital requirements. We expect to make significant expenditures this year and beyond to fundour operations, increase our manufacturing capacity, and build and deploy ourfrequency regulation plants.

 

Wehave experienced net losses since our inception and, as of June 30, 2010,had an accumulated deficit of approximately $217 million.  We do notexpect to have positive EBITDA (earnings before interest, taxes, depreciationand amortization) or positive cash flow from operations until we have deployeda sufficient number of merchant plants and/or sold turnkey systems. We willneed to raise additional capital from a combination of equity and/or projectfinancing, the sale of our systems and/or other sources to build regulationfacilities, support operations at our Tyngsboro and other facilities, implementour business plan and continue as a going concern.

 

We deployed one megawatt of frequency regulationcapacity in 2008, and deployed two additional megawatts in 2009.  In 2010, we plan to re-deploy a portion ofthe three megawatts from the pilot program to the site of our 20 MW plant inStephentown, New York. This plant will cost approximately $69 million. We brokeground in November 2009, and we expect to complete the production of mostof the flywheels needed for that plant in 2010. Although we expect to begin to generate revenue from part of thatfacility late in 2010, we do not expect to complete construction until the endof the first quarter of 2011.  We alsoplan to continue the development of two more 20 MW plants, one in the PJMinterconnection, and the other in Glenville, NY, which is in the NYISO. The pace of development and the completiondates for these two additional plants will depend on obtaining sufficientfunding.

 

Our first 20 MW plant isbeing financed by $26 million of cash and in-kind assets that we havecontributed to the project on August 6, 2010, upon closing the $43 million loanguaranteed by DOE and provided by the Federal Financing Bank (FFB). In 2010 and2011, we will continue to have capital needs to fund operations and the ongoingdeployment of frequency regulation facilities. Of the $11.4 million cashon hand as of June 30, 2010, $7 million represents our required cashinvestment towards eligible project costs for the Stephentown plant under theterms of the DOE loan, and thus is not available for our general corporateoperating purposes. Based on our projected cash usage rates, exclusive of theanticipated borrowings from the DOE loan and our equity contribution to theStephentown project, we believe we have sufficient cash to fund our operationsinto the fourth quarter of 2010. Weestimate that we will need to raise additional funds during the remainder of2010 through the issuance of equity securities or debt in order to fundoperations and execute our business plan. The amount of funds needed may range from $6 - $20 million, depending onwhen we order long-lead items and begin construction of our second plant.  Additional funding will be required in 2011.

 

46

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The amount of debt and equityrequired will depend on the mix of merchant plants andplants sold on a turnkey basis.  Our deployment plans areaffected by the timing of a number of factors and activities, including but notlimited to the following:

 

·                  The timing offunds disbursement from the DOE-guaranteed loan, the receipt of funds from theNYSERDA grant and the DOE stimulus grant

 

·                  Corporate orproject financing and its availability

 

·                  Equitytransactions and the amounts thereof

 

·                  Sale of turnkeyplants and the amount of associated margin and terms and conditions of thosesales

 

·                  Receipt ofenvironmental and site-related permits and approvals

 

·                  Receipt of gridinterconnection approvals.

 

OnAugust 6, 2010, SRS, a wholly-owned subsidiary of Beacon, closed on a loanguaranteed by the DOE, which, over time, will allow us to borrow up toapproximately $43 million.  As part ofthe loan closing, Beacon transferred $7 million in cash to SRS, into arestricted cash account. Approximately two weeks after closing, SRS will use aportion of this equity contribution to reimburse Beacon for allowable costspreviously incurred.  Monthlydisbursements from the loan are anticipated to begin in September, based uponeligible project spending.  Eachdisbursement will be subject to the satisfaction of certain conditions,including, without limitation, the timing of the execution of aninterconnection agreement with NYISO; hence the ramp up of cash burn will beaffected by the same timing.

 

InNovember 2009, we were notified by the Department of Energy that we havebeen awarded a stimulus grant of $24 million for use in construction of a 20 MWplant to be located in the PJM Interconnection. The grant for the PJM facility results from one of our applications forthe DOE Smart Grid demonstration project funding, known as Funding OpportunityRegulation Ancillary Services projects.

 

On July 2, 2010, we entered into a common stockpurchase agreement with Aspire Capital Fund LLC (Aspire), an Illinois limitedliability company, which provides that, upon the terms and subject to theconditions and limitations set forth therein, Aspire is committed to purchaseup to an aggregate of $25.0 million of our shares of common stock over the termof the purchase agreement.  In considerationfor entering into the purchase agreement, we issued 3,086,420 shares of ourcommon stock to Aspire.  These shares arereferred to as the “Commitment Shares.”  Under this agreement, we have sold Aspire 1,534,210 shares of commonstock at a purchase price of $0.324 per share, for an aggregate purchase priceof $500,000.  Following this initialpurchase, from time to time over the 26-month term of the agreement, we havethe right, in our sole discretion, to present Aspire with a purchase noticedirecting them to purchase up to 400,000 shares of our common stock per tradingday (up to an aggregate of $24.5 million of our common stock) at a price pershare calculated as the lower of (i) the lowest trading price on the dateof sale or (ii) the arithmetic average of the three lowest closing saleprices for the common stock during the 12 consecutive business days ending onthe business day immediately preceding the purchase date of thosesecurities.  We and Aspire may mutuallyagree to increase the number of shares that can be sold per business day to asmuch as an additional 1,000,000 shares per business day.  However, we cannot purchase shares on anytrading day in which the closing sale price of our stock is less than $0.25.  Also, unless our stockholders approve thetransaction at some later date, we may not sell shares to Aspire at a purchaseprice less than $0.34, which is the sum of the last consolidated closing saleprice of our common stock on July 1, 2010, the trading day immediatelypreceding the date of the purchase agreement, and $0.03.  We will control the timing and amount of anysales of our common stock to Aspire, and will always know the purchase pricebefore we give notice to sell any shares to Aspire.  There are no trading volume requirements orrestrictions under the agreement.  Thenet proceeds we receive will depend on the frequency and prices at which wesell shares of stock to Aspire.  Themaximum proceeds we may receive over the 26-month term of the agreement is $25million.  These sales are being madeunder our Registration Statements on 

 

47

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Form S-3. We also entered into a Registration Rights Agreement with Aspire, dated July 2,2010, under which we agreed to keep the registration statements effective, andunder which we agree to indemnify Aspire for certain liabilities in connectionwith the sale of the securities. As of the date of t his report, we have notsold any shares to Aspire under this agreement following the initial $500,000 purchase.

 

**Operating Activities**

 

Netcash used in operating activities was approximately $6,384,000 and $12,858,000for the six months ended June 30, 2010, and 2009, respectively.  Theprimary component of the negative cash flows from operations is from our netlosses.  For the six months ended June 30, 2010, we had a net loss ofapproximately $11,091,000.  Adjustments to reconcile net loss to cash flowin 2010 include non-cash stock compensation of approximately $375,000,depreciation and amortization of approximately $1,075,000, interest expense onwarrants of approximately $27,000, partially offset by a net increase indeferred rent of approximately ($66,000) and changes in operating assets andliabilities of approximately $3,295,000.

 

Duringthe same period in 2009, we had a net loss of approximately $10,307,000. Adjustments to reconcile net loss to cash flow for the period include non-cashstock compensation of approximately $565,000, depreciation and amortization ofapproximately $866,000,  interest expenseon warrants of approximately $29,000, partially offset by a net increase indeferred rent of approximately ($53,000) and changes in operating assets andliabilities of approximately ($3,958,000).

 

**Investing Activities**

 

Netcash used in investing activities was approximately $9,883,000 and $2,185,000for the six months ending June 30, 2010, and 2009, respectively.  The principal use of cash in 2010 was thepurchase and manufacture of property and equipment in the amount ofapproximately $5,119,000, increase in other assets (patents) of approximately$82,000, and advance payments to suppliers for materials to be used in themanufacture of property and equipment of approximately $4,681,000.  For the six months ended June 30, 2009,the principal use of cash was the purchase of property and equipment in theamount of approximately $1,951,000 and advance payments to suppliers formaterials to be used in the manufacture of property and equipment ofapproximately $234,000.

** **

**Financing Activities**

 

Netcash provided by financing activities was approximately $5,069,000 and$3,881,000 for the first six months of 2010 and 2009, respectively.  In 2010, funds were provided by the sale ofstock to Seaside of approximately $1,513,000, the exercise of warrants ofapproximately $4,765,000 and the issuance of stock under the employee stockpurchase plan of approximately $61,000.  These were offset partially by cash paid for financing costs (primarilyfor the DOE loan) of approximately $944,000 and approximately $326,000 in repaymentof the MassDev loan.  For the first sixmonths of 2009, funds were provided by the sale of stock to Seaside ofapproximately $4,814,000 and the issuance of stock under the employee stockpurchase plan of approximately $60,000. These were partially offset by cash paid for financing costs (primarilyfor the DOE loan) of approximately $993,000.

 

Thefollowing table summarizes our commitments and debt at June 30, 2010:

 
| ** **                            | ** ** | **Description  of Commitment** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **MassDev  Loan** | ** ** | **Total** | ** ** |
| Period ending:                        |       |                           |       |   |   |   |   |   |   |
| June 30, 2010                    |       | $                              | —     |   | $ | 31,056,699 |   | $ | — |   | $ | 31,056,699 |   |
| December 31, 2010                |       | 366,937                        |       |   |   | 334,051 |   | 700,988 |   |
| December 31, 2011                |       | 753,188                        |       |   |   | 704,349 |   | 1,457,537 |   |
| December 31, 2012                |       | 778,937                        |       |   |   | 751,618 |   | 1,530,555 |   |
| December 31, 2013                |       | 804,689                        |       |   |   | 803,254 |   | 1,607,943 |   |
| December 31, 2014                |       | 618,000                        |       |   |   | 857,819 |   | 1,475,819 |   |
| December 31, 2015                |       |                           |       |   |   | 678,767 |   | 678,767 |   |
| Total Commitments                     |       | $                              | 3,321,751  |   | $ | 31,056,699 |   | $ | 4,129,858 |   | $ | 38,508,308 |   |
| Non-cancellable purchase obligations: |       |                           |       | $ | 18,016,467 |   |   |   |   |   |
| Less advance payments to suppliers    |       |                           |       | (4,917,214 | ) |   |   |   |   |

 

48

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| ** **                                                     | ** ** | **Description  of Commitment** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                     | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **MassDev  Loan** | ** ** | **Total** | ** ** |
| Non-cancellable purchase obligations net of advance  payments: |       |                           |       | $ | 13,099,253 |   |   |   |   |   |
|                                                                |            |                                |            |  |  |  |  |  |  |  |

 

Asof June 30, 2010, we had purchase commitments with our suppliers ofapproximately $31.1 million. Of this amount, approximately $18.0 millionrepresents firm, non-cancelable commitments, against which we have made advancepayments totaling $4.9 million, leaving a net non-cancelable obligation ofapproximately $13.1 million as of June 30, 2010.  Total purchase commitments includeapproximately $28.3 million for materials required to build the flywheels,electronic control modules and other ancillary equipment needed forStephentown, of which $16.7 million are non-cancelable as of June 30,2010. The remaining commitments are for costs associated with closing the DOEloan, equipment and other operating expenses.

 

**Item 3.  Quantitative and Qualitative Disclosureabout Market Risk**

 

Ourcash equivalents and investments, all of which have maturities of less thanninety days, could expose us to interest rate risk.  At June 30, 2010, we had approximately$1,018,000 of cash equivalents that were held in a non-interest bearingchecking account.  Also at June 30,2010, we had approximately $10.6 million of cash equivalents that were held ininterest-bearing money market accounts at high-quality financial institutions,some of which are invested in off-shore securities. The fair value of theseinvestments approximates their cost. A 10% change in interest rates wouldchange the investment income realized on an annual basis by an immaterialamount.  The funds invested in moneymarket accounts may not be covered under FDIC Insurance, and therefore may beat some risk of loss. However, the money market accounts are invested primarilyin government funds, such as Treasury Bills. Approximately $10.4 million of our cash on hand at June 30, 2010,was invested in mutual funds at a brokerage firm that has purchasedsupplementary insurance through Lloyd’s of London. This insurance coverageprovides protection above the Securities Investor Protection Corporation (SIPC)coverage in the event that the broker becomes insolvent.  SIPC protects against the loss of securitiesup to a total of $500,000 (of which $100,000 may be in cash) per client.  The supplemental insurance provided by thebroker would cover investments at that brokerage firm up to a maximum of $1billion, including up to $1.9 million per client for the cash portion of anyremaining shortfall.  SIPC and thesupplemental insurance do not cover market losses; however, management believesthe risk of substantial market losses is low because our funds are investedprimarily in government funds.

** **

**Item 4.  Controls and Procedures**

* *

*Evaluationof Disclosure Controls and Procedures*

 

Asof the end of the period covered by this report, we carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design 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) promulgatedunder the Securities Exchange Act of 1934, were effective as of June 30,2010.

* *

*InternalControl over Financial Reporting*

 

Therewas no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) promulgated under the Securities Act of 1934) that materiallyaffected, or is reasonably likely to materially affect, such internal controlover financial reporting during the quarter ended June 30, 2010.

 

49

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**Part II— OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

None.

 

**Item 1A.  Risk Factors**

 

Inaddition to other information set forth in this report, you should carefullyconsider the factors described in Part I, Item 1A of our AnnualReport on Form 10-K for the year ended December 31, 2009, filed withthe SEC on March 15, 2010.  Thosefactors could materially affect our business, financial condition or futureresults. The risks described in such reports are not the only risks we face.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial may also have a materially adverse effect onour business, financial condition and/or operating results.

** **

**Item 2.  Unregistered Sales of Equity Securitiesand Use of Proceeds**

 

None.

 

**Item 3.  Defaults Upon Senior Securities**

 

None.

** **

**Item 4.  (Removed and reserved)**

 

**Item 5.  Other Information**

 

None.

** **

**Item 6.  Exhibits**

** **
| **Exhibit  Number** | ** ** | **Ref** | ** ** | **Description  of Document**                                                                                                                                |
|---------------------|------------|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |    |       |                                                                                                                                                        |
| 3.1                 |       | (1)     |       | Sixth  Amended and Restated Certificate of Incorporation,                                                                                                   |
|                |       |    |       |                                                                                                                                                        |
| 3.2                 |       | (1)     |       | Certificate  of Amendment of 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                 |       | (2)     |       | Certificate  of Amendment of the Sixth Amended and Restated Certificate of Incorporation,  dated June 11, 2009                                         |
|                |       |    |       |                                                                                                                                                        |
| 3.5                 |       | (3)     |       | Amended  and Restated Bylaws, as amended.                                                                                                                   |
|                |       |    |       |                                                                                                                                                        |
| 3.6                 |       | (4)     |       | Certificate  of Designations of Series A Junior Participating Preferred Stock, filed  with the Secretary of State of Delaware on October 4, 2002. |
|                |       |    |       |                                                                                                                                                        |
| 10.1                |       | (5)     |       | Amended  and Restated Employment Agreement between the Company and F. William Capp.                                                                         |
|                |       |    |       |                                                                                                                                                        |
| 10.2                |       | (5)     |       | Amended  and Restated Employment Agreement between the Company and James M. Spiezio.                                                                        |

 

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| **Exhibit  Number** | ** ** | **Ref** | ** ** | **Description  of Document**                                                                                                                                |
|---------------------|------------|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |    |       |                                                                                                                                                        |
| 10.3                |       | (5)     |       | Amended  and Restated Employment Agreement between the Company and Matthew L.  Lazarewicz.                                                                  |
|                |       |    |       |                                                                                                                                                        |
| 10.4                |       | (5)     |       | Amended  and Restated Employment Agreement between the Company and Judith Judson.                                                                           |
|                |       |    |       |                                                                                                                                                        |
| 10.5                |       | (5)     |       | Form of  Option Agreement between the Company and each of F. William Capp, James  Spiezio, Matthew L. Lazarewicz and Judith Judson.                    |
|                |       |    |       |                                                                                                                                                        |
| 10.6                |       | (5)     |       | Form of  Restricted Stock Unit Agreement between the Company and each of F. William  Capp, James Spiezio, Matthew L. Lazarewicz and Judith Judson.     |
|                |       |    |       |                                                                                                                                                        |
| 10.7                |       | (5)     |       | Letter  Agreement between the Company and F. William Capp.                                                                                                  |
|                |       |    |       |                                                                                                                                                        |
| 10.8                |       | (5)     |       | Letter  Agreement between the Company and James M. Spiezio.                                                                                                 |
|                |       |    |       |                                                                                                                                                        |
| 10.9                |       | (5)     |       | Letter  Agreement 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 |
|                |       |    |       |                                                                                                                                                        |
| 32.1                |       | +       |       | 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 Form 10-K filed on March 17, 2008 (File  No. 000-31973).     |
|----------------------------------------------------------------------------------------------------------------------|
| (2) Incorporated  by reference from the Form 10-Q filed on August 6, 2009 (File  No. 000-31973). |
| (3) Incorporated  by reference from the Form 8-K filed on October 1, 2007 (File  No. 000-31973). |
| (4) Incorporated  by reference from the 10-K filed on March 30, 2006 (File  No. 000-31973.).          |
| (5) Incorporated  by reference from the Form 8-K filed on April 30, 2010 (File  No. 000-31973).  |
| +  Filed herewith.                                                                                                   |

 

51

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|              |                 | BEACON  POWER CORPORATION                            |
|-------------------|----------------------|------------------------------------------------------|
|              |                 |                                                 |   |
| Date:   | August 9,  2010 | By:                                                  | /s/  F. William Capp |
|              |                 | F.  William Capp                                     |
|              |                 | President  and Chief Executive Officer               |
|              |                 | Principal  Executive Officer                         |
|              |                 |                                                 |   |
|              | August 9,  2010 | 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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