Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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

 

**for the quarterly period ended September 30,2010**

 

**or**

 

**o****         Transition ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

** **

**(Forthe 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 onits 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 November 5, 2010 was 199,890,859.

 

 

 

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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 September 30, 2010 and December 31, 2009                                                                                                                                           |       | 1          |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                |       | Unaudited Consolidated Statements of Operations for  the three and nine month periods ended September 30, 2010 and 2009, and  for the period from May 8, 1997 (date of inception) through  September 30, 2010 |       | 2          |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                |       | Unaudited Consolidated Statements of Cash Flows for  the three and nine month periods ended September 30, 2010 and 2009 and  for the period from May 8, 1997 (date of inception) through  September 30, 2010  |       | 3          |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                |       | Unaudited Consolidated Statements of Stockholders’  Equity for the year ended December 31, 2009 and the nine months ended  September 30, 2010                                                                 |       | 5          |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                |       | Notes to Unaudited Consolidated Financial Statements                                                                                                                                                                         |       | 6          |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                | 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                                                                                                                                                                                                     |       | 50         |
|                                |       |                                                                                                                                                                                                                         |       |       |
| 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                                                                                                                                                                 |       | 51         |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                | Item 3.    | Defaults  Upon Senior Securities                                                                                                                                                                                             |       | 51         |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                | Item 4.    | (Removed and  Reserved)                                                                                                                                                                                                      |       | 51         |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                | Item 5.    | Other Information                                                                                                                                                                                                            |       | 51         |
|                                |       |                                                                                                                                                                                                                         |       |       |
|                                | Item 6.    | Exhibits                                                                                                                                                                                                                     |       | 51         |
|                                |       |                                                                                                                                                                                                                         |       |       |
| Signatures                          |       | 53                                                                                                                                                                                                                           |

 

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**PART 1— FINANCIAL INFORMATION**

 

**Item 1.Financial Statements**

 

**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(A Development Stage Company)**

**ConsolidatedBalance Sheets**

** **
| ** **                                                                                                                                                                        | ** ** | **September 30,********2010** | ** ** | **December 31,********2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **(unaudited)**                    | ** ** | ** **                        | ** ** |
| **Assets**                                                                                                                                                                        |       |                               |       |                              |       |
| Current assets:                                                                                                                                                                   |       |                               |       |                              |       |
| Cash and cash equivalents                                                                                                                                                         |       | $                                  | 3,040,125  |                              | $          | 22,605,147 |   |
| Accounts receivable, net                                                                                                                                                          |       | 1,558,523                          |       | 46,907                            |       |
| Unbilled costs on contracts in progress                                                                                                                                           |       | 21,310                             |       | 577,356                           |       |
| Prepaid expenses and other current assets                                                                                                                                         |       | 482,062                            |       | 636,887                           |       |
| Total current assets                                                                                                                                                              |       | 5,102,020                          |       | 23,866,297                        |       |
| Property and equipment, net                                                                                                                                                       |       | 42,282,061                         |       | 24,373,941                        |       |
| Restricted cash                                                                                                                                                                   |       | 3,228,926                          |       | 212,557                           |       |
| Deferred financing costs                                                                                                                                                          |       | 3,657,985                          |       | 1,198,873                         |       |
| Advance payments to suppliers                                                                                                                                                     |       | 3,484,772                          |       | 235,879                           |       |
| Other assets                                                                                                                                                                      |       | 220,087                            |       | 114,933                           |       |
| Total assets                                                                                                                                                                      |       | $                                  | 57,975,851 |                              | $          | 50,002,480 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                                    |       |                               |       |                              |       |
| Current liabilities:                                                                                                                                                              |       |                               |       |                              |       |
| Accounts payable                                                                                                                                                                  |       | $                                  | 5,707,050  |                              | $          | 1,154,613 |   |
| Accrued compensation and benefits                                                                                                                                                 |       | 1,927,812                          |       | 1,764,053                         |       |
| Other accrued expenses                                                                                                                                                            |       | 4,059,270                          |       | 1,543,507                         |       |
| Advance billings on contracts                                                                                                                                                     |       | 1,877                              |       | 35,418                            |       |
| Accrued contract loss                                                                                                                                                             |       | 1,114,093                          |       | 257,698                           |       |
| Deferred rent - current                                                                                                                                                           |       | 157,871                            |       | 138,558                           |       |
| Current portion of long term debt                                                                                                                                                 |       | 647,661                            |       | 608,105                           |       |
| Total current liabilities                                                                                                                                                         |       | 13,615,634                         |       | 5,501,952                         |       |
| Long term liabilities:                                                                                                                                                            |       |                               |       |                              |       |
| Deferred rent - long term                                                                                                                                                         |       | 628,115                            |       | 746,518                           |       |
| Long term debt, net of unamortized discount                                                                                                                                       |       | 11,383,946                         |       | 3,676,569                         |       |
| Total long term liabilities                                                                                                                                                       |       | 12,012,061                         |       | 4,423,087                         |       |
| Commitments and contingencies (Note 7)                                                                                                                                            |       |                               |       |                              |       |
| 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; 200,041,762 and 171,641,622 shares issued at September 30, 2010  and December 31, 2009, respectively |       | 2,000,418                          |       | 1,716,416                         |       |
| Additional paid-in-capital                                                                                                                                                        |       | 253,645,992                        |       | 245,029,557                       |       |
| Deficit accumulated during the development stage                                                                                                                                  |       | (222,585,415                       | )          | (205,955,693                      | )          |
| Treasury stock, 421,692 shares at cost                                                                                                                                            |       | (712,839                           | )          | (712,839                          | )          |
| Total stockholders’ equity                                                                                                                                                   |       | 32,348,156                         |       | 40,077,441                        |       |
| Total liabilities and stockholders’ equity                                                                                                                                   |       | $                                  | 57,975,851 |                              | $          | 50,002,480 |   |

 

Seenotes to unaudited consolidated financial statements.

 

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**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(A Development Stage Company)**

**Consolidated Statements ofOperations (Unaudited)**

 
| ** **                                                      | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** **                      | ** ** | ** **  | ** **  | **Cumulative from**          | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------|------------|-------------|-------------|-----------------------------------|------------|
| ** **                                                      | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** **                      | ** ** | ** **  | ** **  | **May 8, 1997**         | ** ** |
| ** **                                                      | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** **                      | ** ** | ** **  | ** **  | **(date of inception)** | ** ** |
| ** **                                                      | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** | **through September  30,** | ** ** |
| ** **                                                      | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010**                        | ** ** | **2009**    | ** **  | **2010**                          | ** ** |
| Revenue                                                         |       | $                                                        | 124,355    |                                                    | $          | 273,096                         |       | $           | 525,375     |                              | $          | 665,736 |   | $ | 6,282,474 |   |
| Cost of goods sold (exclusive of items shown  separately below) |       | 118,533                                                  |       | 246,844                                                 |       | 373,674                         |       | 704,520     |        | 6,544,419                         |       |
| Gross profit (loss)                                             |       | 5,822                                                    |       | 26,252                                                  |       | 151,701                         |       | (38,784     | )           | (261,945                          | )          |
| Operating expenses:                                             |       |                                                     |       |                                                    |       |                            |       |        |        |                              |       |
| Operations and maintenance                                      |       | 195,411                                                  |       | 621,109                                                 |       | 1,985,578                       |       | 2,167,203   |        | 4,916,893                         |       |
| Research and development                                        |       | 1,509,219                                                |       | 1,625,910                                               |       | 5,470,987                       |       | 5,302,613   |        | 96,083,874                        |       |
| Selling, general and administrative                             |       | 2,185,046                                                |       | 1,463,545                                               |       | 6,560,695                       |       | 5,356,356   |        | 71,725,206                        |       |
| Loss on contract commitments                                    |       | 1,070,487                                                |       | —                                                  |       | 970,836                         |       | 132,500     |        | 4,013,460                         |       |
| Depreciation and amortization                                   |       | 515,789                                                  |       | 479,121                                                 |       | 1,591,268                       |       | 1,345,539   |        | 9,186,054                         |       |
| Restructuring charges                                           |       | —                                                   |       | —                                                  |       | —                          |       | —      |        | 2,159,280                         |       |
| Loss on impairment of assets                                    |       | —                                                   |       | —                                                  |       | —                          |       | —      |        | 4,663,916                         |       |
| Total operating expenses                                        |       | 5,475,952                                                |       | 4,189,685                                               |       | 16,579,364                      |       | 14,304,211  |        | 192,748,683                       |       |
| Loss from operations                                            |       | (5,470,130                                               | )          | (4,163,433                                              | )          | (16,427,663                     | )          | (14,342,995 | )           | (193,010,628                      | )          |
| Other income (expense):                                         |       |                                                     |       |                                                    |       |                            |       |        |        |                              |       |
| Interest income                                                 |       | 392                                                      |       | 434                                                     |       | 10,020                          |       | 12,690      |        | 5,599,044                         |       |
| Interest (expense) income                                       |       | (15,042                                                  | )          | 77,931                                                  |       | (160,003                        | )          | (65,081     | )           | (1,440,316                        | )          |
| Gain on sale of investment                                      |       | —                                                   |       | —                                                  |       | —                          |       | —      |        | 3,562,582                         |       |
| Other income (expense)                                          |       | (53,967                                                  | )          | (7,013                                                  | )          | (52,076                         | )          | (3,322      | )           | (289,903                          | )          |
| Total other income (expense), net                               |       | (68,617                                                  | )          | 71,352                                                  |       | (202,059                        | )          | (55,713     | )           | 7,431,407                         |       |
| Net loss                                                        |       | (5,538,747                                               | )          | (4,092,081                                              | )          | (16,629,722                     | )          | (14,398,708 | )           | (185,579,221                      | )          |
| Preferred stock dividends                                       |       | —                                                   |       | —                                                  |       | —                          |       | —      |        | (36,825,680                       | )          |
| Accretion of convertible preferred stock                        |       | —                                                   |       | —                                                  |       | —                          |       | —      |        | (113,014                          | )          |
| Loss to common shareholders                                     |       | $                                                        | (5,538,747 | )                                                       | $          | (4,092,081                      | )          | $           | (16,629,722 | )                                 | $          | (14,398,708 | ) | $ | (222,517,915 | ) |
| Loss per share, basic and diluted                               |       | $                                                        | (0.03      | )                                                       | $          | (0.03                           | )          | $           | (0.09       | )                                 | $          | (0.12 | ) |   |   |
| Weighted-average common shares outstanding                      |       | 198,229,342                                              |       | 122,929,999                                             |       | 186,441,706                     |       | 115,857,585 |        |                              |       |

 

See notes to unauditedconsolidated financial statements.

 

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**BEACON POWER CORPORATION AND SUBSIDIARIES**

**(ADevelopment Stage Company)Consolidated Statements of Cash Flows (Unaudited)**

 
| ** **                                                                   | ** ** | **Nine months ended September 30,** | ** **  | **Cumulative from********May 8, 1997********(date of inception)********through********September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------|-------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2010**                            | ** **  | **2009**                                                                                                                            | ** ** | **2010** | ** ** |
| Cash flows from operating activities:                                        |       |                                |        |                                                                                                                                |       |   |   |
| Net loss                                                                     |       | $                                   | (16,629,722 | )                                                                                                                                   | $          | (14,398,708 | ) | $ | (185,579,221 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                |        |                                                                                                                                |       |   |   |
| Depreciation and amortization                                                |       | 1,591,268                           |        | 1,345,539                                                                                                                           |       | 9,186,056 |   |
| Loss (gain) on sale of disposition of assets                                 |       | —                              |        | 7,180                                                                                                                               |       | 210,012 |   |
| Impairment of assets, net                                                    |       | —                              |        | —                                                                                                                              |       | 4,551,147 |   |
| Interest expense relating to issuance of warrants                            |       | 39,343                              |        | 33,849                                                                                                                              |       | 467,597 |   |
| 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 to service provider                              |       | 15,739                              |        | —                                                                                                                              |       | 1,601,393 |   |
| Services and interest expense paid in preferred  stock                       |       | —                              |        | —                                                                                                                              |       | 11,485 |   |
| Gain on sale of investments                                                  |       | —                              |        | —                                                                                                                              |       | (3,562,582 | ) |
| Stock-based compensation                                                     |       | 684,374                             |        | 745,462                                                                                                                             |       | 5,554,021 |   |
| Deferred rent                                                                |       | (99,091                             | )           | (79,777                                                                                                                             | )          | (644,016 | ) |
| Cash received from landlord for build-out credit                             |       | —                              |        | —                                                                                                                              |       | 1,430,000 |   |
| Changes in operating assets and liabilities:                                 |       |                                |        |                                                                                                                                |       |   |   |
| Accounts receivable                                                          |       | (1,511,616                          | )           | (34,480                                                                                                                             | )          | (1,558,523 | ) |
| Unbilled costs on government contracts                                       |       | 556,046                             |        | (369,901                                                                                                                            | )          | (21,310 | ) |
| Prepaid expenses and other current assets                                    |       | 154,825                             |        | 292,591                                                                                                                             |       | (581,723 | ) |
| Accounts payable                                                             |       | 4,552,437                           |        | (2,717,809                                                                                                                          | )          | 5,707,050 |   |
| Accrued compensation and benefits                                            |       | 163,759                             |        | 203,468                                                                                                                             |       | 1,927,812 |   |
| Advance billings on contracts                                                |       | (33,541                             | )           | 23,916                                                                                                                              |       | 1,877 |   |
| Accrued interest                                                             |       | —                              |        | —                                                                                                                              |       | 275,560 |   |
| Accrued loss on contract commitments                                         |       | 856,395                             |        | 68,742                                                                                                                              |       | 1,114,093 |   |
| Other accrued expenses and current liabilities                               |       | 2,515,763                           |        | (1,664,444                                                                                                                          | )          | 4,067,940 |   |
| Net cash used in operating activities                                        |       | (7,144,021                          | )           | (16,544,372                                                                                                                         | )          | (149,813,076 | ) |
| Cash flows from investing activities:                                        |       |                                |        |                                                                                                                                |       |   |   |
| Purchase of investments                                                      |       | —                              |        | —                                                                                                                              |       | (1,190,352 | ) |
| Sale of investments                                                          |       | —                              |        | —                                                                                                                              |       | 4,752,934 |   |
| Restricted cash                                                              |       | (3,016,369                          | )           | (2,532                                                                                                                              | )          | (3,228,926 | ) |
| Increase in other assets                                                     |       | (105,154                            | )           | (52,461                                                                                                                             | )          | (632,159 | ) |
| Purchases and manufacture of property and  equipment                         |       | (19,483,873                         | )           | (2,434,945                                                                                                                          | )          | (55,534,643 | ) |
| Sale of property and equipment                                               |       | —                              |        | —                                                                                                                              |       | 202,674 |   |
| Advance payments to suppliers (net)                                          |       | (3,248,893                          | )           | (269,624                                                                                                                            | )          | (3,484,772 | ) |
| Net cash used in investing activities                                        |       | (25,854,289                         | )           | (2,759,562                                                                                                                          | )          | (59,115,244 | ) |
| Cash flows from financing activities:                                        |       |                                |        |                                                                                                                                |       |   |   |
| Initial public stock offering, net of expenses                               |       | —                              |        | —                                                                                                                              |       | 49,341,537 |   |
|                                                                              |            |                                     |             |                                                                                                                                     |            |  |  |  |  |  |

 

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| ** **                                           | ** ** | **Nine months ended September 30,** | ** ** | **Cumulative from********May 8, 1997********(date of inception)********through********September 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                            | ** ** | **2009**                                                                                                                            | ** ** | **2010** | ** ** |
| Stock offerings, net of expenses                     |       | 2,237,764                           |       | 10,149,416                                                                                                                          |       | 105,568,388 |   |
| 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                                     |       | 8,199,546                           |       | —                                                                                                                              |       | 12,814,701 |   |
| Repayment of debt                                    |       | (491,955                            | )          | —                                                                                                                              |       | (651,742 | ) |
| Warrants issued in relation to lease                 |       | —                              |       | —                                                                                                                              |       | 716,614 |   |
| Cash paid for financing costs and other assets       |       | (2,474,627                          | )          | (927,930                                                                                                                            | )          | (3,689,609 | ) |
| 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                                    |       | 5,902,038                           |       | (100                                                                                                                                | )          | 5,994,421 |   |
| Repurchase company stock                             |       | —                              |       | —                                                                                                                              |       | (613,179 | ) |
| Proceeds from notes payable issued to investors      |       | —                              |       | —                                                                                                                              |       | 3,550,000 |   |
| Net cash provided by (used in) financing  activities |       | 13,433,288                          |       | 9,281,748                                                                                                                           |       | 211,968,445 |   |
| (Decrease) increase in cash and cash equivalents     |       | (19,565,022                         | )          | (10,022,186                                                                                                                         | )          | 3,040,125 |   |
| Cash and cash equivalents, beginning of period       |       | 22,605,147                          |       | 14,357,475                                                                                                                          |       | — |   |
| Cash and cash equivalents, end of period             |       | $                                   | 3,040,125  |                                                                                                                                | $          | 4,335,289 |   | $ | 3,040,125 |   |
| Supplemental disclosure of cash flow information:    |       |                                |       |                                                                                                                                |       |   |   |
| Cash paid for interest                               |       | $                                   | 216,103    |                                                                                                                                | $          | 176,070 |   | $ | 1,013,143 |   |
| 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.

 

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

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

** **
| ** **                                            | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** **  | ** **              | ** **   | ** **             | ** **   | ** ** | ** ** | **Total**   | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|-------------|-------------------------|--------------|------------------------|--------------|------------|------------|-------------|------------|
| ** **                                            | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained**   | ** **  | **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            |       | 37,052                |       | 371         |       | (371           | )           | —                  |         | —                 |         | —     |       | —      |       |
| Shares issued through ESPP                            |       | 165,583               |       | 1,656       |       | 58,866         |        | —                  |         | —                 |         | —     |       | 60,522      |       |
| Stock-based compensation                              |       | —                |       | —      |       | 683,846        |        | —                  |         | —                 |         | —     |       | 683,846     |       |
| Executive performance-based RSU compensation  expense |       | —                |       | —      |       | 528            |        | —                  |         | —                 |         | —     |       | 528         |       |
| Warrants issued to service provider                   |       | —                |       | —      |       | 15,739         |        | —                  |         | —                 |         | —     |       | 15,739      |       |
| Issuance of stock for cash, net of issuance costs     |       | 9,929,630             |       | 99,296      |       | 2,138,468      |        | —                  |         | —                 |         | —     |       | 2,237,764   |       |
| Warrant exercises                                     |       | 18,267,875            |       | 182,679     |       | 5,719,359      |        | —                  |         | —                 |         | —     |       | 5,902,038   |       |
| Net loss                                              |       | —                |       | —      |       | —         |        | (16,629,722             | )            | —                 |         | —     |       | (16,629,722 | )          |
| Balance, September 30,2010                       |       | 200,041,762           |       | $           | 2,000,418  |           | $           | 253,645,992             |         | $                      | (222,585,415 | )          | 421,692    |        | $          | (712,839 | ) | $ | 32,348,156 |   |

 

See notes to unauditedconsolidated financial statements.

 

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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 $111.6 million as of September 30, 2010, throughthe sale of our stock and exercise of warrants. Because we have not yetgenerated a significant amount of revenue from our principal operations, we areaccounted for as a development stage company under the Financial AccountingStandards Board’s Accounting Standards Codification (ASC) Topic 915.

 

Weexpect to increase our revenues from the commercialization of our flywheelenergy 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 toprovide frequency regulation services and to sell turnkey systems that willalso be used to provide frequency regulation.  In the future, as thenumber of our merchant regulation facilities increases and we developsustainable cash flows from operations and the sale of turnkey plants, weexpect to fund additional plants from a combination of cash flow fromoperations, non-recourse project financing and project equity.

 

*Operations*

 

OnAugust 6, 2010, our wholly-owned subsidiary, Stephentown RegulationServices, LLC (SRS), closed on a loan with the Federal Financing Bank (FFB)guaranteed by the Department of Energy (DOE), which, over time, will allow usto borrow up to approximately $43 million. As part of the loan closing, Beacon contributed approximately $26million to SRS representing its equity in the project by transferring $7million in cash to SRS, and providing other in-kind equity of approximately$18.9 million. Approximately two weeks after closing, SRS used approximately $4million of this cash equity contribution to reimburse Beacon for allowablecosts previously incurred.  Monthlydisbursements from the loan began in September, and are based upon eligibleproject spending.  Each loan disbursementis 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. Four MW of the 20MW total are expected to be online and earning revenue by the end of 2010, andthe remaining 16 MW were scheduled to be online and earning revenue by the endof the first quarter of 2011.  However,during the quarter we experienced a delay in the delivery of a key componentfrom a supplier that may impact our ability to be at a full 20 MW of operationin Stephentown by the end of the first quarter of 2011. We expect to have aminimum of 16 MW in operation by that date, with the remainder, if any,operational during the second quarter of 2011.

 

Wehad three MW of our Smart Energy MatrixTM operating and generating frequencyregulation revenue within the New England Independent System Operator region(ISO-NE) under its Alternative Technologies Regulation pilot program until mid-August 2010,when we began to redeploy a portion of these assets to the Stephentown plant inpartial fulfillment of our equity contribution for SRS.

 

Inaddition to the revenues we expect to generate from the Stephentown plant, weplan to increase our revenues by building additional 20 MW facilities, whichare currently under development.  We havebeen awarded a $24 million DOE Smart Grid stimulus grant to support a plant inthe Mid-Atlantic ISO (PJM) region.  Thisplant will likely be built either in the Chicago Heights, Illinois, areaor in Hazle Township, Pennsylvania. We have site control and have filedinterconnection applications for two sites in the Chicago area, as well as onein Hazle Township, PA, and one in Glenville, NY.

 

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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. In September 2010 we were also awarded a two-year ARPA-Edevelopment contract which we expect will provide us with $2.2 million todevelop the initial design of a new type of flywheel that would have thecapability of storing four times the energy as our current Gen4 flywheel.  If successful, this new flywheel design wouldbe capable of delivering 100 kW for up to one hour.  Additional effort would be required once adesign is developed before this new flywheel could be commercialized. Targetmarkets for this device would include ramp mitigation for wind and solargeneration whose power output may exceed local ramp rate limitations, demandlimiting for commercial, industrial, institutional and government facilitiesthat pay high electricity demand charges, and back-up power supply for aportion of the Uninterruptable Power Supply (UPS) market that requires extendedtime to achieve orderly shutdown because the customer lacks back-up generationcapability.

 

Wehave experienced net losses since our inception and, as of September 30,2010, had an accumulated deficit of approximately $222.6 million.  We donot expect to have positive EBITDA (earnings before interest, taxes,depreciation and amortization) or positive cash flow from operations until wehave deployed a sufficient number of merchant plants and/or sold turnkeysystems. We will need to raise additional capital to continue to buildregulation facilities, support operations at our Tyngsboro and otherfacilities, implement our business plan and continue as a going concern.  We expect these funds to come from acombination of equity and/or project financing, the sale of our systems and/orother sources. We have $3 million cash on hand as of September 30, 2010,which can be used for general corporate purposes, and an additional $3 millionof which belongs to SRS and thus can only be used for eligible project costs(included in Restricted cash on our balance sheet). Based on our projected cashusage rates including the anticipated borrowings from the FFB loan guaranteedby the DOE and our equity contribution to the Stephentown project, we havesufficient cash to fund our operations into the fourth quarter of 2010. We estimate that we will need to raise approximately$15 to $20 million during the remainder of 2010 and 2011 in order to fundoperations.  Additional funds would berequired to order long-lead items and begin construction of our second merchantplant from a combination of project finance and equity in addition to the DOEgrant.

 

**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 nine months ended September 30, 2010 are not necessarilyindicative of the results that may be expected for the full year ending December 31,2010.

 

*Going Concern*

 

Theaccompanying consolidated financial statements have been prepared on a goingconcern 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 $222.6 million since our inception including losses during thenine months ending September 30, 2010, of approximately $16.6million.  We have approximately $3million of cash and cash equivalents on hand at September 30, 2010, which,in combination with the anticipated proceeds from the FFB loan and theremaining $3 million we contributed to SRS for the Stephentown project, isadequate to complete the construction of the Stephentown facility and financeour operations into the fourth quarter of 2010. Since our cash needs beyond that point exceed the cash we expect togenerate from operations, we may be unable to continue as a going concern.  The consolidated financial statements do notinclude any adjustments relating to the recoverability and classification ofliabilities that might be necessary should we be unable to continue as a goingconcern.

 

Werecognize that our continuation as a going concern is dependent upon ourability to generate sufficient cash flow to allow us to satisfy our obligationson a timely basis.  The generation of sufficientcash flow is dependent, in the short term, on our ability to raise additionalcapital from a combination of equity and/or project financing; and in the longterm, on the successful 

 

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operation of our merchantplants and on our sales of turnkey systems. We believe that the successfulachievement of these initiatives should provide us with sufficient resources tomeet our long-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 subsidiaries, Beacon Power Securities Corporation,Stephentown Holding LLC and Stephentown Regulation Services, LLC (SRS).  In August 2010, as required to close theFFB loan, Beacon’s equity and cash contributions to the Stephentown projectwere transferred to SRS.  The borrowingsfrom the FFB loan are a liability of SRS, and are guaranteed in part by Beacon.

 

InSeptember 2008, we established other two wholly-owned subsidiaries,Tyngsboro Regulation Services LLC and Tyngsboro Holding LLC, which remaininactive as of September 30, 2010. The frequency regulation servicerevenue and costs from the ISO-NE pilot program are accounted for as part ofBeacon Power Corporation All significant inter-company accounts andtransactions have been eliminated in consolidation.

 

*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, optionsand other securities exercisable for common shares are used in the calculationof fully diluted earnings per share (EPS) only if their conversion to commonshares would decrease income or increase loss per share from continuingoperations.  Since the three and nine-month periods ended September 30,2010, and 2009, reflect losses, including the potential conversion of warrantsand options in the diluted EPS calculation would decrease loss per share.Accordingly, they are considered anti-dilutive and are not included in thecalculation 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.

 

*Debt*

 

Debtis recorded on our balance sheet at par value or stated value adjusted forunamortized discount or premium. Discounts and premiums generally are capitalized and amortized over thelife of the debt and are recorded in Interest Expense using the interestmethod. Costs directly related to the issuance of debt are amortized over thelife of the debt and are recorded in Depreciation and Amortization Expense.  We have elected not to mark any of our debtto fair value through earnings.

 

*LeaseObligation and Deferred Rent*

 

InJuly 2007, we signed a seven-year operating lease with escalating paymentson a 103,000 square foot facility in Tyngsboro, Massachusetts. As part of thislease agreement, we issued to the landlord 150,000 shares of our common stockand a warrant exercisable for 500,000 shares of our common stock in return forlower cash payments under the lease. (See Note 6: Commitments and Contingencies.)  Additionally, the landlord has reimbursed usfor certain leasehold improvements we have made. In accordance with theFinancial Accounting Standards Board’s (FASB’s) Accounting StandardsCodification (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.”

 

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*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 which we are obligated are accounted for in accordance with ASCTopic 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*

 

Deferredfinancing costs represent legal, due diligence and other direct costs incurredto raise capital or obtain debt.  Directcosts include 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 capitalized if theefforts are successful, or expensed when unsuccessful.  Indirect costs are expensed as incurred.Deferred financing costs related to debt are amortized over the life of thedebt. Deferred financing costs related to issuing equity are charged to Paid inCapital.

 

*Advancepayments to suppliers*

 

Advancepayments to suppliers represent payments for custom materials used in themanufacture 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 fee basis.  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.  Eachquarter, we perform an estimate-to-complete analysis, and any changes to ouroriginal estimates are recognized in the period in which they are determined.

 

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*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 model, which we believe yieldsa reasonable estimate of the fair value of the grants made. The valuationprovisions of ASC Topic 718 apply to grants issued since January 1, 2006(the effective date) and to grants that were outstanding as of that date thatare subsequently modified. Estimated compensation expense for grants that wereoutstanding as of the effective date will be recognized over the remainingvesting 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) theequity instruments issued.

 

*Restructuring and Asset Impairment Charges*

 

Inaccordance with ASC Topic 360, “*Property, Plant andEquipment*,” long-lived assets to be held and used are periodicallyreviewed to determine whether any events or changes in circumstances indicatethat the carrying 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 theCompany to move and redeploy all or part of a Smart Energy MatrixTM systeminstalled at a given location.  When sucha decision is made, we will determine which costs are associated with themovable (fungible) components, and which costs are non-fungible. We will recorda period expense for the net book value associated with the non-fungiblecomponents.

 

Noasset impairment charges were considered necessary for the nine months ended September 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.”

 

·      *FrequencyRegulation 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.  Frequency regulationrevenue is calculated on an hourly basis, as services are provided, based onformulas specific to the tariffs in effect at the applicable ISO at bid awardrates that are published by the ISO. Frequency regulation service revenue is calculated using the applicablerates and formulas as services are provided.

 

·      *Researchand Development Contract Revenue Recognized on the Percentage-of-CompletionMethod*

 

Werecognize contract revenue using the percentage-of-completion method. We uselabor hours as the basis for the percentage of completion calculation, which ismeasured principally by the percentage of labor hours incurred to date for eachcontract to the estimated total labor hours for each contract at completion.Changes to total estimated contract costs or losses, if any, are recognized inthe period in which they are determined. Changes in project performanceand conditions, estimated profitability, and final contract settlements mayresult in future revisions to contract costs and revenue.  Revenues recognized in excess of 

 

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amountsbilled are classified as current assets, and included in “Unbilled costs oncontracts in progress” in our balance sheets.  Amounts billed to clientsin excess of revenues recognized to date are classified as current liabilitiesunder “Advance billings on contracts.”  Changes in project performance andconditions, estimated profitability, and final contract settlements may resultin future revisions to contract costs and revenue.

 

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

 

·                  *Sale ofAlternative Renewable Energy Credits*

 

Underthe Massachusetts Alternative Energy Portfolio Standard (APS) program, ourflywheel energy storage frequency regulation assets operating within theCommonwealth of Massachusetts are credited with producing a type of RenewableEnergy Credit (REC) known as an Alternative Renewable Energy Credit.  These have a market value, and we recognizerevenue on the sale of such credits as revenue when sold on the open market.

 

·                  *InverterSales*

 

Generally, revenue on inverter and related product sales is recognizedon transfer of title, typically when products are shipped and all related costsare estimable.  For sales todistributors, we make an adjustment to defer revenue until the products aresubsequently sold by distributors to their customers.

 

*Cost ofGoods Sold*

 

Forfrequency regulation revenue, cost of goods sold represents the cost of energy.Cost of goods sold for our research and development contracts is calculated ona percentage-of-completion basis, using the same percentage of contract costs(up to the total contract revenue amount) as is used to calculate revenue. Inthe event that expected costs exceed total contract revenue amount, the excesscosts are charged to contract loss. We value our products at the lower of costor market.  Costs in excess of thismeasurement are expensed in the period in which they are incurred.

 

*Fair Value of Financial Instruments*

 

Accountingfor fair value measurements involves a single definition of fair value, alongwith a conceptual framework to measure fair value, with a fair value defined asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date. The fair value measurement hierarchy consists of threelevels:

 

·            Levelone—quoted market prices in active markets for identical assets or liabilities;

·            Leveltwo—inputs other than level one inputs that are either directly or indirectlyobservable, and

·            Levelthree—unobservable inputs developed using estimates and assumptions which aredeveloped by the reporting entity and reflect those assumptions that a marketparticipant would use.

 

Weapply valuation techniques that (1) place greater reliance on observableinputs and less reliance on unobservable inputs and (2) are consistentwith the market approach, the income approach and/or the cost approach, andinclude enhanced disclosures of fair value measurements in our financialstatements.

 

Thecarrying values of cash and cash equivalents, accounts receivable, other currentassets, accounts payable, accrued expenses, and other current liabilitiesapproximate 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***

 

None.

 

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

 

None.

 

**Note 3.  Accounts Receivable**

 

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

 
| ** **                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Accounts receivable, trade      |       | $                      | 1,558,523  |                  | $          | 46,907 |   |
| Allowance for doubtful accounts |       | —                 |       | —                |       |
| Accounts receivable, net        |       | $                      | 1,558,523  |                  | $          | 46,907 |   |

 

Therewas no allowance for doubtful accounts as of September 30, 2010, or December 31,2009.  All accounts are expected to becollected.

 

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 $19,000 and $17,000 asof September 30, 2010 and December 31, 2009, respectively. These holdbacks are payable once work has been satisfactorily completed and thefinal reports have been delivered and approved. We believe the holdbacks willbe collected upon completion of the contracts and collected within one year, andtherefore have not recorded any reserve against this amount.

 

**Note 4.  Property and Equipment**

 

Detailsof our property and equipment follow:

 
| ** **                                         | ** ** | **Estimated** | ** ** | **As of:**        | ** ** |
|----------------------------------------------------|------------|---------------|------------|------------------------|------------|
| ** **                                         | ** ** | **Useful**    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                         | ** ** | **Lives**     | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Construction in Progress                           |       | Varied        |       | $                      | 27,055,191 |   | $ | 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      |       | 2,526,337              |       | 1,686,038 |   |
| Machinery and equipment                            |       | 5 - 10 years  |       | 2,475,990              |       | 3,096,175 |   |
| Service vehicles                                   |       | 5 years       |       | 16,763                 |       | 16,763 |   |
| Furniture and fixtures                             |       | 7 years       |       | 798,263                |       | 700,624 |   |
| Office equipment and software                      |       | 3 years       |       | 1,077,992              |       | 1,025,936 |   |
| Leasehold improvements                             |       | Lease term    |       | 7,804,606              |       | 7,804,607 |   |
| Equipment under capital lease obligations          |       | Lease term    |       | 563,783                |       | 563,783 |   |
| Total                                              |       |          |       | $                      | 48,753,144 |   | $ | 29,269,270 |   |
| Less accumulated depreciation and amortization     |       |          |       | (6,471,083             | )          | (4,895,329 | ) |
| Property and equipment, net                        |       |          |       | $                      | 42,282,061 |   | $ | 24,373,941 |   |

 

InNovember 2008, we deployed 1 MW of capacity under the ISO-NE AlternativeTechnologies pilot program (“pilot program”) with a system installed inside ourTyngsboro facility. We deployed a second MW of capacity under the pilot programin July 2009, and a third MW in December 2009.  Both of these additional MWs were installedoutside and adjacent to our facility in Tyngsboro.  In August 2010, we moved a portion ofthe two MW installed outside our facility to the Stephentown site as part ofour equity contribution to that project. The Smart Energy 25 flywheels shown above represent the cost of theflywheels and electronic control modules in use for this pilot program.  In addition, the “Smart Energy MatrixTMinstallations — fungible” shown above 

 

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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 our Tyngsboro facility lease, we will incur certainexit costs at termination of our lease. Estimated exit costs of approximately $267,000 relating to certainnon-fungible equipment included in the Smart Energy MatrixTM system operatingoutside of our facility were expensed in 2008 and carried in accruedexpenses.  Machinery and equipment andleasehold improvements include approximately $54,000 in estimated exit costs asof September 30, 2010, and December 31, 2009, that are beingdepreciated 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 sheet.

 

InJuly 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.

 

Thecomponents of “Construction in progress” (CIP), which represent costs relatedto assets that have not yet been placed into service and for which nodepreciation expense has been taken, were as follows:

 
| ** **                                                                                    | ** ** | **As of:**        | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                    | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Materials to build production flywheels                                                       |       | $                      | 1,518,719  |   | $ | 5,665,670 |   |
| Smart Energy 25 flywheels                                                                     |       | 13,669,323             |       | — |   |
| Smart Energy MatrixTM in progress                                                         |       | 11,165,034             |       | 1,955,481 |   |
| Deposits and other costs related to the  acquisition of land for frequency regulation systems |       | 48,188                 |       | 43,002 |   |
| Machinery and equipment                                                                       |       | 292,755                |       | 260,840 |   |
| Software                                                                                      |       | 121,620                |       | — |   |
| Leasehold improvements                                                                        |       | 239,552                |       | 16,132 |   |
| Construction in progress                                                                      |       | $                      | 27,055,191 |   | $ | 7,941,125 |   |

 

Asof September 30, 2010, and December 31, 2009, approximately$26,353,000 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 and other potential sites.

 

**Note 5.  DeferredFinancing Costs**

 

Details of our deferred financing costs are as follows:

 
| ** **                                                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Prepaid financing costs associated with the DOE  loan guarantee |       | $                      | 3,593,139  |                  | $          | 1,124,300 |   |
| Deferred finance charges associated with the  MassDev loan      |       | 64,846                 |       | 74,573                |       |
| Total                                                           |       | $                      | 3,657,985  |                  | $          | 1,198,873 |   |

 

**Note 6.  Other Assets**

 

Other assets represent deferred costs for patents,and are as follows:

 

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| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Patents                       |       | $                      | 226,038    |                  | $          | 115,097 |   |
| Less accumulated amortization |       | (5,951                 | )          | (164                  | )          |
| Net other assets              |       | $                      | 220,087    |                  | $          | 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 September 30,2010, and for the subsequent five years:

 
| ** **                                                     | ** ** | **Description of Commitment** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                     | ** ** | **Operating leases**               | ** ** | **Purchase  Obligations** | ** ** | **Total** | ** ** |
| Period ending:                                                 |       |                                    |       |   |   |   |   |
| September 30, 2010                                        |       | $                                       | —     |   | $ | 22,636,516 |   | $ | 22,636,516 |   |
| December 31, 2010                                         |       | 186,688                                 |       |   |   | 186,688 |   |
| 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 |   |
| Total Commitments                                              |       | $                                       | 3,141,502  |   | $ | 22,636,516 |   | $ | 25,778,018 |   |
| Non-cancellable purchase obligations:                          |       |                                    |       | $ | 15,000,992 |   |   |   |
| Less advance payments to suppliers                             |       |                                    |       | (3,484,772 | ) |   |   |
| Non-cancellable purchase obligations net of  advance payments: |       |                                    |       | $ | 11,516,220 |   |   |   |

 

Asof September 30, 2010, we had purchase commitments with our suppliers ofapproximately $22.6 million. Of this amount, approximately $15 millionrepresents firm, non-cancelable commitments against which we have made advancepayments totaling $3.5 million, leaving a net non-cancelable obligation ofapproximately $11.5 million as of September 30, 2010.  Total purchase commitments includeapproximately $19.6 million for materials required to build the flywheels,electronic control modules and other ancillary equipment needed for Stephentown,of which $13.0 million are non-cancelable as of September 30, 2010. Theremaining commitments are for 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 itscapacity will 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 September 30, 2010, of$200,000, which is reduced periodically over the lease term.  This letterof credit is secured by a cash deposit, which is included in restricted cash inthe accompanying consolidated balance sheets. In addition to our rent payments, we are responsible for real estate taxesand all operating expenses of the Tyngsboro facility.  Rent expense was approximately $442,000during the nine months ended September 30, 2010 and 2009.

 

OnAugust 31, 2009, we purchased an option to lease land in Glenville, NewYork, as a location where we could 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 leasecommitments.  More attractive siteoptions may be developed in the same or other markets, and these factors willbe evaluated over the next four to six 

 

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months before decidingwhether to extend the lease option on the Glenville site for another six-monthperiod to maintain it as a viable potential location for a future 20 MW plant.

 

In April 2010, we entered into two land optionagreements:

 

·                  The first of these is a two-year option that provides the right topurchase either of two properties in the Chicago area, but not both, for $1million. Both properties are zoned industrial, and contain certain improvementsrelevant to our planned use, including equipment required for physicalinterconnection to 138 KVA transmission lines. In consideration for this option, we are paying the owner $2,000 permonth.  If we elect to purchase the land,the option payments will be applied to the purchase price.

 

·                  The second is an option to lease approximately 5.5acres in Humboldt North Industrial Park, located in Luzerne County, HazleTownship, Pennsylvania.  The site iszoned for industrial use.  The option wasexecuted with the Greater Hazleton Community Area New Development Organization, Inc.,also known as CAN DO, Inc., a Pennsylvania Industrial DevelopmentOrganization.  Under the terms of thistwo-year option, we are paying $2,500 for each of four six-month periods, oruntil the option is converted to a lease. The option allows us to lease the property for 21 years at the rate of$3,250 per month.  The Hazle Townshipsite is located within an economic development zone that would exempt us fromhaving to pay any state tax on materials and equipment used to build a plant onthis site.

 

We expect to build the plant for which we havereceived a $24 million DOE grant award on either one of the two sites locatedin the Chicago area or the Hazle 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.

 

**Note 8.  AccruedContract Loss**

 

Ourcontract loss reserves are as follows:

 
| ** **             | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Beginning balance      |       | $                                | 257,698    |                            | $          | 132,526 |   |
| Charges for the period |       | 970,836                          |       | 238,562                         |       |
| Reductions             |       | (114,441                         | )          | (113,390                        | )          |
| Ending balance         |       | $                                | 1,114,093  |                            | $          | 257,698 |   |

 

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:

 

·                  Thesponsor of our NYSERDA PON 800 contract has undergone a variety oforganizational changes, which have resulted in this contract beingabandoned.  Unbilled allowable charges ofapproximately $8,000 were charged to the contract loss reserve, and theremaining reserve of approximately $46,000 was reversed in June 2010.

 

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·                  Weincreased the costs charged to the Navy contract by approximately $43,000 basedon an adjustment to overhead rates.  Weincreased the contract loss reserve by approximately $50,000, and we chargedthe additional overhead costs, plus an additional $7,000 in unbilled costs,against this reserve, since we are uncertain that the Navy will increase thefunding on this contract.

 

·                  Wereceived a development contract from the Pacific Northwest NationalLaboratories (PNNL) for $104,000, for which we expected the total cost to beapproximately $210,000.  Accordingly, we established acontract loss reserve during the fourth quarter of 2009 of approximately$106,000 for our expected cost share. However, we completed the contract during the second quarter of 2010 ata total cost of approximately $59,000. We adjusted cost of sales to properly reflect the margin on thiscontract, and reversed the previously established loss reserve.

 

In September 2010, we signed a contract withthe DOE’s Advanced Research Projects Agency — Energy (ARPA-E) to developcritical components of a highly advanced “flying ring” flywheel energy storagesystem over a two-year period, for which we expect to receive $2,245,876.  In addition, we are expected to contribute anadditional 20% of program costs. Accordingly, we recorded a contract lossduring the third quarter of 2010 of $1,070,000, which represents our cost shareportion of the contract, plus the difference between our GAAP overhead rate andthe contract bid rate.

 

As of the end of September 2010, no otheradjustments were considered necessary to our contract loss reserve.

 

**Note 9.  Long-Term Debt**

 

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

 
| ** **                                                        | ** ** | **As of:**        | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                        | ** ** | **2010**               | ** ** | **2009** | ** ** |
| 3.04% Note Payable to Federal Financing Bank, due  June 2030 |       | $                      | 8,199,546  |   | $ | — |   |
| 6.5% Note Payable to MassDev, due  September 2015            |       | 3,963,412              |       | 4,455,368 |   |
| Subtotal                                                          |       | 12,162,958             |       | 4,455,368 |   |
| Less unamortized discount (warrants)                              |       | (131,351               | )          | (170,694 | ) |
| Total                                                             |       | 12,031,607             |       | 4,284,674 |   |
| Less current portion of long term debt                            |       | (647,661               | )          | (608,105 | ) |
| Net long-term debt                                                |       | $                      | 11,383,946 |   | $ | 3,676,569 |   |

 

Basedon the amounts outstanding as of September 30, 2010, principal paymentsrequired under the DOE and MassDev loans over the next five years, excludingdiscount due to warrants, are as follows:

 
| ** **               | ** ** | **MassDev Loan** | ** ** | **Federal Financing  Bank Loan** | ** ** | **Total** | ** ** |
|--------------------------|------------|-----------------------|------------|--------------------------------------------|------------|-----------|------------|
| Period ending:           |       |                  |       |                                       |       |      |       |
| December 31, 2010   |       | $                     | 168,429    |                                       | $          | —    |       | 168,429 |   |
| December 31, 2011   |       | 704,406               |       | —                                     |       | 704,406   |       |
| December 31, 2012   |       | 751,678               |       | 227,765                                    |       | 979,443   |       |
| December 31, 2013   |       | 803,318               |       | 455,530                                    |       | 1,258,848 |       |
| December 31, 2014   |       | 857,887               |       | 455,530                                    |       | 1,313,417 |       |
| December 31, 2015   |       | 677,694               |       | 455,530                                    |       | 1,133,224 |       |
| Thereafter               |       | —                |       | 6,605,191                                  |       | 6,605,191 |       |
| Total payments remaining |       | $                     | 3,963,412  |                                       | $          | 8,199,546 |       | $ | 12,162,958 |   |
|                          |            |                       |            |                                            |            |           |            |  |  |  |

 

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*FederalFinancing Bank Loan (DOE loan)*

 

OnAugust 6, 2010, SRS, a wholly-owned subsidiary of Beacon PowerCorporation, entered into a future advance promissory note with the FederalFinancing Bank (FFB), and guaranteed by the DOE (FFB loan).  The FFB is an instrument of the U.S.government that is under the general supervision of the U.S. Secretary of theTreasury.  Under the DOE loan guarantee,the FFB has made available to us a multi-draw term loan facility in an aggregateprincipal amount of up to $43.1 million to finance up to 62.5% of the eligiblecosts of the Stephentown project. At the closing of the loan, Beaconcontributed the remaining 37.5% of the expected project costs in the form of$18.9 million in inventory, assets, and eligible project costs and $7 millionin cash, which was deposited into an SRS cash account (known as the “BaseEquity Account”) controlled by the collateral agent.  Therefore, we expect to receive 100%reimbursement from the FFB for ongoing budgeted project costs until such timeas 62.5% of the aggregate of all eligible project costs have been funded.  After 62.5% of the aggregate of all eligibleproject costs have been funded with loan proceeds, (a) 62.5% of eachrequest for funding will be funded with loan proceeds from the FFB, and (b) 37.5%of each request for funding will be funded with the proceeds taken from theBase Equity Account.  However, we areresponsible for any cost overruns for the project.  As of September 30, 2010, we have drawndown $4 million of the cash that was initially contributed to the Base EquityAccount, and have received advances of $8.2 million from the FFB.

 

Thelast day to receive an advance under the FFB Future Advance Promissory Note foreligible project costs is May 30, 2012, and the loan will mature on June 15,2030.  Each advance bears interest at aper annum rate determined by the Secretary of the Treasury as of the date ofthe advance and will be based on the Treasury yield curve and the scheduledprincipal installments for such advance, plus a .375% premium.  Interest on advances under the FFB loan ispayable quarterly in arrears. Principal payments are due in 72 equal quarterlyinstallments, beginning on September 15, 2012 through June 15, 2030.

 

Advanceson the loan facilities may be voluntarily prepaid at any time at a pricedetermined based on interest rates at the time of prepayment for loans madefrom the Secretary of the Treasury to FFB for obligations with an identicalpayment schedule to the advance being prepaid, which could result in the advancebeing prepaid at a discount, at par or at a premium. The loan facilities aresubject to mandatory prepayments of differing amounts with net cash proceedsreceived from certain dispositions, loss events with respect to property andother extraordinary receipts.  Allobligations under the FFB loan are secured by substantially all property ownedby SRS, which was $34.2 million as of September 30, 2010.

 

TheFFB loan documents contain customary covenants that include, among others,requirements that the project be conducted in accordance with the business planfor the project, property and assets be maintained in good working order, andthat the borrower stay in compliance with all applicable environmental laws andother governmental rules, including Federal Energy Regulatory Committee (FERC)rules.  It places limitations on SRS’sability to use any loss proceeds, incur indebtedness, incur liens, makeinvestments or loans, enter into mergers and acquisitions, dispose of assets orpurchase capital items except for expenditures contemplated by the projectbudget or operating plan or from the proceeds of insurance, pay dividends ormake distribution on capital stock, pay indebtedness, limitations on paymentsof management, advisory or similar fees to affiliates, enter into certainaffiliate transactions, enter into new lines of business and enter into certainrestrictive agreements, in each case subject to customary exceptions.

 

TheFFB loan also contains certain financial covenants. As of the last day of eachfiscal quarter, SRS is required to:

 

·                  maintain aminimum ratio of current assets to current liabilities

 

·                  maintain amaximum leverage ratio

 

·                  commencing thefirst fiscal quarter to end after the first anniversary of the projectcompletion date, maintain a specified debt service coverage ratio

 

·                  commencingafter the project completion date, maintain an amount equal to the debt servicereserve requirement unless an alternative form of security reasonablysatisfactory to the DOE has been provided; provided that, in the event of anywithdrawal from the debt service reserve account, we must restore the amount ondeposit in the debt service reserve account within ninety days of suchwithdrawal. The debt service reserve requirement is an amount equal to the amountof debt service due on the immediately succeeding two quarterly payment dates.

 

·                  commencing onthe first anniversary of the project completion date, maintain specifiedamounts in a maintenance reserve account and project capital account.  If SRS draws from these accounts, it isrequired to restore the accounts to the required amounts within ninety days ofthe withdrawal. The required maintenance reserve is an amount 

 

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projectedto be equal to six months of plant maintenance and fixed operating costs,currently anticipated to be approximately $559,000 for the initial year ofproject operation.  The amount requiredto be maintained in the reserve account will be recalculated prior to thebeginning of each fiscal year. Beacon has guaranteed, as sole owner of theborrower, to replenish the debt service reserve account up to a maximum of$2,397,000.  The project capital accountrequirement is $1,000,000.

 

TheFFB loan facility documents also contain customary events of default, subjectin some cases to customary cure periods for certain defaults.  It shall not be considered a breach of any ofthe financial covenants so long as within thirty days of the delivery ofquarterly or annual financial statements showing the breach of any suchcovenants, SRS causes Beacon to contribute cash through Stephentown Holding LLCto SRS in an amount necessary to cure such breach.

 

TheFFB loan requires SRS to establish and maintain collateral cash accounts with acollateral agent.  The collateral agenthas sole dominion and control over, and the exclusive right of withdrawal fromall project accounts, other than the operating disbursement account and themaintenance reserve account.  All revenuemust be deposited in the collateral cash account for subsequent flow to theremaining project accounts, as mandated.

 

AlthoughSRS is the borrower under the FFB loan, Beacon Power Corporation has committedto pay all costs and expenses incurred to complete the project in excess ofamounts funded under the loan facility. Beacon has executed an Engineering, Procurement and Constructionagreement with SRS, and as such has provided certain facility and flywheelsystem warranties.  In addition, as soleequity owner of the borrower, Beacon has guaranteed all payment and performanceobligations of the borrower through the project completion date. Beacon willprovide administrative services and operation and maintenance services to SRS,and will be paid for those services, according to the terms of agreementsbetween those parties.

 

*MassDevloan*

 

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 MassachusettsTechnology Collaborative Business Expansion Initiative. The loan proceeds wereused to help 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 forapproximately $1.0 million. The approximately $0.4 million balance of the loancommitment has expired. The note will mature 84 months after the initialadvance and bears a fixed annual interest rate of 6.5%.

 

Paymentsto MassDev began in November 2008. The payments were interest only duringthe first twelve months. Since October 2009, the balance of the principaloutstanding under the note is being amortized in equal monthly installments ofprincipal and interest over the remaining term of the note.

 

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 $4,252,000 and $5,126,000 at September 30,2010, and December 31, 2009, respectively. We also entered into acollateral assignment of lease agreement as additional security for therepayment of borrowings.  This agreementgrants MassDev all rights, title and interest in and to our lease for theTyngsboro facility in the event that we default on our obligations.   In addition, the MassDev loan requires us tomaintain a minimum cash balance of $1,500,000 at all times during the term ofthe loan.

 

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 $39,000 and $34,000 charged to interest expense during the ninemonths ended September 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%.

 

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**Note10.  Sale of Stock**

 

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 sold Aspire 1,543,210shares of common stock at a purchase price of $0.324 per share, for anaggregate purchase price of $500,000 on July 6, 2010.  Following this initial purchase, from time totime over the 26-month term of the agreement, we have the right, in our solediscretion, to present Aspire with a purchase notice directing them to purchaseup to 400,000 shares of our common stock per trading day (up to an aggregate of$24.5 million of our common stock) at a price per share calculated as the lowerof (i) the lowest trading price on the date of sale or (ii) thearithmetic average of the three lowest closing sale prices for the common stockduring the 12 consecutive business days ending on the business day immediatelypreceding the purchase date of those securities.  We and Aspire may mutually agree to increasethe number of shares that can be sold per business day to as much as anadditional 1,000,000 shares per business day. Under the terms of the agreement,unless our stockholders approve the transaction at some later date, we may notsell shares to Aspire at a purchase price less than $0.34, which is the sum ofthe last consolidated closing sale price of our common stock on July 1,2010, the trading day immediately preceding the date of the purchase agreement,plus $0.03.  We will control the timingand amount of any sales of our common stock to Aspire, and will always know thepurchase price before 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, including the availability of the facility inlight of the minimum purchase price.  Themaximum proceeds we may receive over the 26-month term of the agreement is $25million.  These sales are being madeunder our two available shelf 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.Following the initial purchase, and as of September 30, 2010, we have sold800,000 shares to Aspire for $0.34 per share, for gross proceeds of $272,000.

 

On February 19, 2009, we entered into a commonstock purchase agreement with Seaside 88, LP, valued at up to $18 million.  This agreement was amended on June 19,2009.  The original agreement requiredSeaside to buy $1 million of common stock once each month for up to 18 months,beginning on February 20, 2009, and on the 20th day of each monththereafter (or the next closest business day), at a purchase price reflecting a20% discount to the volume weighted average trading price over the five-daytrading period immediately before the purchase. The amended agreement maintained the $18 million aggregate maximumpurchase price, but accelerated the purchase to 1.5 million shares twice permonth at a 14% discount to the 10-day volume weighted average tradingprice.  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. Separately, in December 2009, we issued additional sharesof stock through a public offering.  Aspart of the underwriting conditions for that offering, we exercised our optionto delay the Seaside purchases originally scheduled for December and January fora period of 60 days.   The Seasidepurchases resumed on February 5, 2010, and the final purchase under thisagreement was completed on March 5, 2010.

 

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    |   |
|                           |            |                      |            |                              |            |                                     |            |                       |            |  |  |  |

 

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| **Transaction date** | ** ** | **Aggregate  value** | ** ** | **Common  Shares Sold** | ** ** | **Sale Price  per Share** | ** ** | **Net Proceeds** | ** ** |
|---------------------------|------------|----------------------|------------|------------------------------|------------|-------------------------------------|------------|-----------------------|------------|
| 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    |                  | 673,590    |   |
| February 5, 2010     |       | 585,150              |       | 1,500,000                    |       | $                                   | 0.39010    |                  | 549,498    |   |
| February 22, 2010    |       | 541,500              |       | 1,500,000                    |       | $                                   | 0.36100    |                  | 506,813    |   |
| March 5, 2010        |       | 529,350              |       | 1,500,000                    |       | $                                   | 0.35290    |                  | 495,545    |   |
| Total Investment          |       | $                    | 16,226,395 |                         | 30,112,933 |                                |       |                  | $          | 14,973,615 |   |
|                           |            |                      |            |                              |            |                                     |            |                       |            |  |  |  |

 

Because the stock was sold to Seaside and Aspire ata price below $1.85 per share, certain warrants issued in November 2005were adjusted 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 September 30, 2010:

 
| **Description**                                         | ** ** | **Grant Date** | ** ** | **Expiration  Date** | ** ** | **Strike Price** | ** ** | **Issued and  Outstanding As  of September  30, 2010** | ** ** |
|---------------------------------------------------------|------------|---------------------|------------|----------------------|------------|-----------------------|------------|----------------------------------------------------------------------------|------------|
| November 8, 2005 Financing (Investors)             |       | 11/8/2005           |       | 5/9/2011             |       | $                     | 1.02       | *                                                                          | 6,414,473  |   |
| February 15, 2007 Shelf Issue                      |       | 2/15/2007           |       | 2/15/2012            |       | $                     | 1.33       |                                                                       | 6,261,786  |   |
| GFI Tyngsboro Lease                                     |       | 7/23/2007           |       | 7/22/2014            |       | $                     | 1.77       |                                                                       | 500,000    |   |
| September 10, 2007 Shelf Issue (Investors)         |       | 9/10/2007           |       | 3/11/2013            |       | $                     | 1.99       |                                                                       | 6,122,449  |   |
| September 10, 2007 Shelf Issue (Placement  Agents) |       | 9/10/2007           |       | 3/11/2013            |       | $                     | 1.99       |                                                                       | 153,061    |   |
| October 31, 2007 Shelf Issue                       |       | 10/31/2007          |       | 5/1/2013             |       | $                     | 2.97       |                                                                       | 5,431,805  |   |
| June 30, 2007 Massachusetts Development Loan       |       | 6/30/2008           |       | 6/30/2015            |       | $                     | 1.89       |                                                                       | 171,958    |   |
| October 15, 2008 Shelf Issue                       |       | 10/15/2008          |       | 4/16/2014            |       | $                     | 1.20       |                                                                       | 8,700,000  |   |
| December 24, 2008 Shelf Issue                      |       | 12/24/2008          |       | 6/25/2014            |       | $                     | 0.74       |                                                                       | 8,966,000  |   |
| Series W - December 9, 2009 Public  Offering  |       | 12/9/2009           |       | 12/9/2014            |       | $                     | 0.70       |                                                                       | 19,050,000 |   |
| Series Y - Supplier Warrants August 19,  2010 |       | 8/19/2010           |       | 6/15/2015            |       | $                     | 0.72       |                                                                       | 116,666    |   |
| Total warrants outstanding                              | ** ** | ** **          | ** ** | ** **           | ** ** | ** **            |       | 61,888,198                                                                 |       |

 

----

*                 Reflectsanti-dilution adjustments to November 2005 warrants to date.  Exercise of these warrants at a purchaseprice below the market price of our common stock on the date of the investmentis limited by the terms of the warrants.

 

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

 

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| ** **                                                                   | ** ** | **# 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             |       |
| Adjustments to 11/8/05 warrants due to Aspire  pricing for 2010 stock sales  |       | 123,355             |       |
| Perseus warrants expired                                                     |       | (800,000            | )          |
| Series X warrants expired                                               |       | (550,000            | )          |
| Warrants issued to service provider                                          |       | 116,666             |       |
| Series X warrants exercised                                             |       | (18,267,875         | )          |
| Warrants outstanding as of September 30, 2010                           |       | 61,888,198          |       |

 

Warrantswith activity during the nine months ended September 30, 2010, aredescribed below:

 

*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.  The warrant also contains language thatlimits the total number of shares we can issue in the financing transaction(including upon exercise of the warrants) at an effective price less than theclosing price at the time of the investment to 19.99% of the number of sharesof common stock outstanding prior to the investment.

 

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:          |       |                |       |                    |       |
| Cumulative adjustments through December 31,  2009 |       | 3,154,203           |       | $                       | 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       |   |
| Aspire 7/2/10 purchase                                 |       | 123,355             |       | $                       | 1.02       |   |
| Adjusted Warrant                                       |       | 6,414,473           |       | $                       | 1.02       |   |

 

*December 2009Series W and Series X Warrants*

 

InDecember 2009, we sold 38,100,000 units at a price of $0.544 perunit.  Each unit consisted of one shareof our common stock, par value $0.01 per share; a Series W warrant topurchase 0.5 of a share of common stock at an exercise price of $0.70 per shareexercisable through December 9, 2014; and an additional investor rightswarrant (Series X) to purchase 0.5 of a share of common stock exercisablethrough August 31, 2010, at a floating exercise price.  The floating exercise price was equal to 85%of the five-day volume weighted average price of our common stock at the timeof exercise, 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.

 

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ThroughAugust 31, 2010, Series X warrants to purchase 18,500,000 shares ofcommon stock were exercised at exercise prices ranging from $0.272 to $0.4122,for total net proceeds of $5,902,038. The remaining 550,000 warrants were notexercised and expired as of August 31, 2010.

 

*August 2010 Service Provider Warrants*

 

In connection with services provided to us by aservice provider, we issued warrants to three individuals to purchasean aggregate of 116,666 shares of our common stock, at a per-share exerciseprice of $0.72. The warrants were exercisable as of August 19, 2010, andexpire on June 15, 2015.  The unitswere issued pursuant to an exemption from the registration requirements of thefederal securities law.

 

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

 

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

 
| ** **                | ** ** | **Three months ended September 30, 2010** | ** ** | **Three months ended September 30, 2009** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                | ** ** | **Revenue**                                                        | ** ** | **Cost of  Sales**                                            | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost of  Sales** | ** ** | **Margin** | ** ** |
| ** **                | ** ** | **(in thousands)**                                            | ** ** |
| Frequency regulation      |       | $                                                                  | 74         |                                                               | $          | 82 |   | $ | (8 | ) | $ | 63 |   | $ | 49 |   | $ | 14 |   |
| Contract                  |       | 35                                                                 |       | 37                                                                 |       | (2 | ) | 211 |   | 198 |   | 13 |   |
| Inverters and APS credits |       | 15                                                                 |       | —                                                             |       | 15 |   | (1 | ) | — |   | (1 | ) |
| Total                     |       | $                                                                  | 124        |                                                               | $          | 119 |   | $ | 5 |   | $ | 273 |   | $ | 247 |   | $ | 26 |   |

 
| ** **                | ** ** | **Nine months ended September 30, 2010** | ** ** | **Nine months ended September 30, 2009** | ** ** |
|---------------------------|------------|-------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                | ** ** | **Revenue**                                                       | ** ** | **Cost of  Sales**                                           | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost of  Sales** | ** ** | **Margin** | ** ** |
|                      |       | **(in thousands)**                                           |       |
| Frequency regulation      |       | $                                                                 | 341        |                                                              | $          | 282 |   | $ | 59 |   | $ | 180 |   | $ | 247 |   | $ | (67 | ) |
| Contract                  |       | 145                                                               |       | 91                                                                |       | 54 |   | 485 |   | 458 |   | 27 |   |
| Inverters and APS credits |       | 39                                                                |       | —                                                            |       | 39 |   | 1 |   | — |   | 1 |   |
| Total                     |       | $                                                                 | 525        |                                                              | $          | 373 |   | $ | 152 |   | $ | 666 |   | $ | 705 |   | $ | (39 | ) |

 

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 threequarters of 2010 was approximately $282,000, of which approximately $199,000,or 70%, represents retail transmission and distribution (T&D) chargesbilled by the local service provider. Because our Stephentown facility will be connected to the grid at thetransmission level, we will not incur T&D charges, and so we expect ourgross margin to be higher than in our Tyngsboro installation.

 

Weprovide a five-year limited product warranty for our Smart Power M-seriesinverter product line and accrue for estimated future warranty costs in theperiod 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.

 

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**Note 13.  Stock-Based Compensation**

 

**Description of Plans**

 

*Stock Option Plan*

 

OnJuly 21, 2010, our stockholders approved our 2010 Stock Incentive Plan(our “2010 Plan”), which constituted an amendment, restatement and renaming ofour Third Amended and Restated 1998 Plan and which increased the sharesavailable for issuance under the Stock Incentive Plan by an additional15,000,000 shares.  Our 2010 Plan allowsfor the granting of stock options, restricted stock, restricted stock units andother equity awards with respect to up to 38,000,000 shares of our commonstock.  At September 30, 2010, we had 17,021,811 shares reserved forfuture issuance under this plan.

 

Optionsmay be granted to our employees, officers, directors, consultants and advisors.Under the terms of the option plan, incentive stock options are to be grantedat the fair market value of our common stock at the date of grant, andnonqualified stock options are to be granted at a price determined by our Boardof Directors.  In general, our Board has authorized vesting periods of oneto three years and terms of varying length but in no case more than 10years.  Our stock option program is a long-term retention program that isintended to attract, retain and provide incentives for talented employees,officers and directors, and to align stockholder and employee interests. We consider our option program critical to our operation and productivity;essentially all of our employees participate.

 

*Restricted Stock Unit Arrangements*

 

Our2010 Plan permits the grant of restricted stock units (“RSUs”) to ouremployees, 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 which become vested or payable onaccount of attainment of one or more performance goals established annually bythe Board over such performance periods as the Board may designate, with suchvesting events subject to the recipient officer being employed by us during theperiod ending with the milestones. The unvested portion of any RSU or PSU grantis subject to forfeiture upon the holder’s resignation or termination forcause.  As of September 30, 2010,and December 31, 2009, certain RSUs granted under the officer employmentagreements were vested but stock could not be issued under the terms of the RSUagreements because the trading window was closed to insiders as of therespective vesting dates.

 

Restrictedstock unit activity for the year ended December 31, 2009, and for the ninemonths ended September 30, 2010, is as follows:

 
| ** **                                           | ** ** | **Nine months ended  September 30,********2010** | ** ** | **Year ended  December 31,********2009** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **(number of shares)**                                | ** ** |
| Shares issued related to vested RSUs:                |       |                                                            |       |                                               |       |
| Based on prior year grants                           |       | 37,052                                                          |       | 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          |       | 4,716                                                           |       | 18,810                                             |       |
| Related to 2009 executive officer agreement          |       | 28,193                                                          |       | 45,113                                             |       |
| Related to performance-based executive plan (ii)     |       | 550,274                                                         |       | 1,265,823                                          |       |

 

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| (i)    | RSUs  vesting December 31, 2009, were issued on April 8, 2010.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| (ii)   | Vesting  of the performance-based RSUs (PSUs) is subject to the achievement of performance  requirements and the continued employment of the officer as of the  determination date.  The 2010 grant is  based upon the achievement of certain Adjusted EBITDA goals for the 2011 or  2012 fiscal years, with the minimum payout at $8.5 million Adjusted EBITDA,  and the target award paid out if we achieve an adjusted EBITDA of $46  million.  Vesting of RSUs for Adjusted  EBITDA between $8.5 million and $46 million will be interpolated on a  straight line basis.  Adjusted EBITDA  is defined as net income before the effect of interest expenses, income  taxes, depreciation, amortization, and equity compensation expenses. |

 

*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 base compensationfor the purchase of common stock under this plan.  The ESPP provides forthe purchase of up to 2,000,000 shares of our common stock.  At September 30,2010, 42% of eligible employees are participating, and we had 1,353,258 sharesreserved for future issuance under this plan.

 

**Stock Option Plan Schedules**

 

Stockoption activity for the nine months ended September 30, 2010, is asfollows:

 
| ** **                           | ** ** | **Number of********Shares** | ** ** | **Weighted-********Average********Exercise********Price** | ** ** | **Weighted-********Average********Fair********Value** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Outstanding, December 31, 2009  |       | 12,000,028                       |       | $                                                         | 1.14       |                                                  |       |   |
| Granted                              |       | 5,106,700                        |       | $                                                         | 0.39       |                                                  | $          | 0.22 |   |
| Exercised                            |       | —                           |       | $                                                         | —     |                                                  |       |   |
| Canceled, forfeited or expired       |       | (671,438                         | )          | $                                                         | (2.82      | )                                                     |       |   |
| Outstanding, September 30, 2010 |       | 16,435,290                       |       | $                                                         | 0.83       |                                                  |       |   |
|                                      |            |                                  |            |                                                           |            |                                                       |            |  |  |

 

Thefollowing table summarizes information about stock options outstanding at September 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           |       | 9,465,552                                |       | 7.58                                                              |       | $                                      | 0.51       |                                | 4,850,177  |                                            | $          | 0.63 |   |
| $0.80 - $1.46           |       | 5,536,789                                |       | 5.93                                                              |       | $                                      | 1.07       |                                | 5,014,025  |                                            | $          | 1.04 |   |
| $1.51 - $2.19           |       | 1,335,699                                |       | 5.87                                                              |       | $                                      | 1.78       |                                | 1,326,853  |                                            | $          | 1.78 |   |
| $2.50 - $3.10           |       | 0                                        |       | 0.00                                                              |       | $                                      | 0.00       |                                | 0          |                                            | $          | 0.00 |   |
| $4.10 - $5.27           |       | 22,250                                   |       | 0.90                                                              |       | $                                      | 5.27       |                                | 22,250     |                                            | $          | 5.27 |   |
| $6.00 - $9.31           |       | 75,000                                   |       | 0.21                                                              |       | $                                      | 6.52       |                                | 75,000     |                                            | $          | 6.52 |   |
| Total                   |       | 16,435,290                               |       | 6.84                                                              |       | $                                      | 0.84       |                                | 11,288,305 |                                            | $          | 1.00 |   |

 

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**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 thereforeuse an expected dividend yield of zero in our valuation model. We are requiredto estimate 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.

 

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.

 

Inthe third quarter of 2010, three options with varying exercise prices andvesting dates were granted to a consultant. These options vest quarterly, on various dates beginning on August 4,2010 and continuing until May 26, 2013. The measurement date for these options was determined to be the vestingdates.  Thus, as of September 30,2010, 24,570 of the 70,000 options granted to this consultant had vested andhad been valued.   The remaining 45,430options have not vested yet and thus have not been valued as of September 30,2010.

 

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

 
| ** **                     | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                     | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Risk-free interest rate        |       | .77%-.91%                                                |       | NA                                                      |       | .77% - 1.67% |   | 0.34%-1.36% |   |
| Expected life of option        |       | 3.5                                                      |       | NA                                                      |       | 3.5 |   | .75 - 3.5 years |   |
| Expected dividend payment rate |       | 0%                                                       |       | NA                                                      |       | 0% |   | 0% |   |
| Assumed volatility             |       | 75% - 81%                                                |       | NA                                                      |       | 75% - 91% |   | 77% - 90% |   |
| Expected forfeitures           |       | 8.3%                                                     |       | NA                                                      |       | 8.3% |   | 8.3% |   |

 

Stock-basedcompensation expense recognized on our consolidated statement of operations forthe three and nine months ended September 30, 2010 and 2009 is as follows:

 

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| ** **                                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Operations and maintenance                    |       | $                                                        | 44,199     |                                                    | $          | 25,424 |   | $ | 73,880 |   | $ | 89,536 |   |
| Research and development                      |       | 100,933                                                  |       | 73,675                                                  |       | 207,455 |   | 283,062 |   |
| Selling, general and administrative           |       | 163,921                                                  |       | 81,640                                                  |       | 403,039 |   | 372,864 |   |
| Total stock compensation expense              |       | $                                                        | 309,053    |                                                    | $          | 180,739 |   | $ | 684,374 |   | $ | 745,462 |   |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Components of stock compensation expense:     |       |                                                     |       |                                                    |       |   |   |   |   |
| Compensation expense related to RSUs          |       | $                                                        | 3,356      |                                                    | $          | 9,200 |   | $ | 12,316 |   | $ | 37,925 |   |
| Compensation expense related to stock options |       | 305,697                                                  |       | 171,539                                                 |       | 672,058 |   | 707,537 |   |
| Total stock compensation expense              |       | $                                                        | 309,053    |                                                    | $          | 180,739 |   | $ | 684,374 |   | $ | 745,462 |   |

 

Asof September 30, 2010, there was approximately $669,000 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 14, 2010, we received a letter from The Nasdaq Stock Marketinforming us that our common shares had failed to comply with the $1.00 minimumbid price required for continued listing on The Nasdaq Capital Market underListing Rule 5550(a)(2), and as a result, without further action our commonshares would be subject to delisting. The letter further stated we could appealthe Nasdaq Staff delisting determination to a Nasdaq listing qualificationspanel. It added that the authority of the panel to grant additional time tocompanies was recently modified such that a panel could allow continued listingfor up to 180 calendar days from September 14, 2010, if deemedappropriate.   We are appealing the Staff’sdetermination. The appeal will stay the delisting of our common stock from TheNasdaq Capital Market until a hearing is completed (which occurred in October 2010)and the listing qualifications panel issues its written decision. We expect toreceive a decision in late November 2010.

 

Ourappeal requesting additional time highlighted the three 20 MW frequencyregulation facilities in development, with revenues from the first plantexpected before the end of 2010. In addition, we expect to see tangibleprogress toward pay-for-performance market tariffs in the next six months. Suchtariffs would provide a substantial improvement in our financial outlook.  There can be no assurance that the listingqualifications panel will approve our request for additional time for continuedlisting, nor that we will be able to meet the Nasdaq Stock Market’s minimum bidprice requirements within any extended grace period and we therefore may loseour eligibility for quotation on the Nasdaq Stock Market.  At our annual meeting of stockholders on July 21,2010, our stockholders approved the implementation of a reverse stock split ata ratio of between 1-for-2 and 1-for-10, which could be used, in the discretionof the Board at the ratio (if any) chosen by the Board, to regain compliancewith the minimum bid price rule, either now or during any extension period orlisting panel appeals process that we may elect to pursue.  No guarantees can be made, however, that theCompany will regain compliance with Nasdaq’s ongoing listing rules.

 

**Note 15.  SubsequentEvents**

 

None.

 

**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 developments and the actual results we

 

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achievemay differ materially from these projections due to a number of factors asdiscussed or referenced in the section entitled “Risk Factors” of this Form 10-Q.New risks can arise and it is not possible for management to predict all suchrisks, nor can management assess the impact of all such risks on our businessor the extent to which any factor, or combination of factors, may cause actualresults to differ materially from those contained in any forward-lookingstatement.  Given these risks and uncertainties, investors should notplace undue reliance on forward-looking statements as a prediction of actualresults.  All forward-looking statements speak only as of the date of thisQuarterly Report on Form 10-Q.  We undertake no obligation to reviseor update publicly any forward-looking statement in order to reflect any eventor circumstance that may arise after the date of this Quarterly Report on Form 10-Q,other than as required by law.

 

**Overview**

 

Wedesign, manufacture and operate flywheel-based energy storage systems that weare beginning to deploy in company-owned merchant plants that will sellfrequency regulation services in open-bid markets (which we refer to as our “saleof services” 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 intobilateral contracts with utilities that provide or purchase regulation servicesto satisfy 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 flywheel system includes the flywheel and itsassociated power electronics. A Smart Energy MatrixTM is an array of ten SmartEnergy 25 flywheel systems that provides 1 MW of energy storage. A frequencyregulation installation includes one or more Smart Energy MatricesTM, along withancillary equipment and site work. A typical full-scale installation would havea capacity of 20 MW, capable of +/- 20 MW, or a 40 MW regulation range.

 

Thelocation of our merchant plants and the sequence in which they will beconstructed will depend on a number of factors, including but not limited to:

 

·                  Availability ofgrants, loans or other funding sources (including funds received from investorsfor the purchase of all or part of certain systems)

 

·                  Comparative marketpricing available for frequency regulation in different markets

 

·                  Our ability toreceive appropriate revenues and payments within the market rules of eachregional market

 

·                  Our ability tointerconnect at transmission voltage and obtain grid interconnection approvals

 

·                  Availabilityand cost of land

 

·                  Ability tosecure all necessary environmental and other permits and approvals

 

Ourproduction facility is capable of producing up to 600 flywheels per year. Wehave a second phase manufacturing build-out planned which would increase theannual manufacturing capacity to more than 1,000 flywheels.

 

InNovember 2008, we began to provide 1 MW of frequency regulation servicethrough the ISO-NE pilot program. We added a second MW of capacity in July 2009,and a third in December 2009.  In August 2010,we began to redeploy a portion of the latter two megawatts to our Stephentownplant. 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.  The redeployment of a portion of thisregulation capacity to Stephentown has resulted in a decrease in the frequencyregulation revenue earned for the third quarter of 2010, compared to the priorquarter.

 

Duringthe first quarter of 2010, we began to recruit and hire the first few ofapproximately 40 planned new employees at our Tyngsboro, Massachusettsheadquarters, which will ultimately include hardware engineers, projectmanagers, market data analysts, and sales directors (both U.S. andinternational), as well as positions in purchasing, finance, site development,manufacturing and production. The decision to expand our workforce comesfollowing a series of positive events in 2009, including more than a full yearof operation on the New England grid; receipt of a $43 million loan guaranteecommitment from the DOE which closed on August 6, 2010; and the award of a$24 million DOE smart grid stimulus grant. We also raised $20 million in equityinvestment in December 

 

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2009,a portion of which provided the remaining equity required to close the loanguaranteed by the DOE for our Stephentown plant.  This workforce expansion will enable us toramp up production of our grid-scale flywheel energy storage systems, whichwill be installed in our Stephentown plant now under construction. A portion ofthis plant is expected to begin earning revenue by providing frequencyregulation in the fourth quarter of 2010. The continuation and timing of any such workforce expansion willultimately be subject to our access to additional capital and our cash flowposition.

 

Frominception through September 30, 2010, we have incurred losses ofapproximately $222.6 million. We currently do not expect to become cash flowpositive until we have deployed a sufficient number of merchant plants and/orsold turnkey systems.

 

Forthe sale of frequency regulation services in the United States, our primarymarket focus is on the geographic regions of the domestic grid under FERCregulation that provide open-bid markets. These regions and their IndependentSystem Operator (ISO) or Regional Transmission Operator (RTO) designations are:New England (ISO-NE); California (California ISO or CAISO); New York (New YorkISO or NYISO); Mid-Atlantic (PJM Interconnection); and Midwest ISO (MISO).These regional ISOs/RTOs, or grid operators purchase frequency regulationservices from independent providers in open-bid markets that they manage andmaintain. For example, under an open-bid market like that operated by NYISO,grid operators forecast the need for frequency regulation as a percentage ofexpected power demand, and approved suppliers submit bids for these services.Bids are stacked from lowest to highest prices until the cumulative amount ofbids is sufficient to meet the calculated need. The price submitted by the highestselected bidder determines the price paid to every bidder that has beenselected to provide service from the bid stack, although each ISO may calculatepayments based on formulas that yield different revenue results, even withequivalent frequency regulation clearing prices.

 

Wehave also recently initiated market development efforts in Texas (ERCOT).Because ERCOT is not regulated by FERC, it is not subject to FERC Order No. 890,which mandated that non-generation resources like ours be allowed to compete inthese open-bid markets. However, we expect that as ERCOT continues to expandits wind resources in Texas, and issues related to increasing wind penetrationand grid stability become better understood, the potential benefits of applyingour technology in ERCOT to help balance frequency and maintain grid stabilityand reliability will increase in value. We have been working to identify andrecommend market rule modifications that will be needed to allow us toenter the ERCOT market on an economically attractive basis.

 

Forthe sale of plants on a turnkey basis, our market focus in the United States ison geographic regions that lack open-bid markets for regulation services.  Within this market segment, our primary focuswill be on utilities that are experiencing or expect to experience increasedrequirements for regulation capacity due to the current or projected impacts ofincreased deployment of variable wind generation in their balancing areas. Oursecondary focus will be on the largest cooperative and government-ownedutilities. Internationally, we are actively pursuing opportunities for the saleof services via merchant plants and for the outright sale of plants in a numberof countries, both directly and with the assistance of local marketing and distributionpartners.

 

Our Smart Energy MatrixTM stores excess energy when power on the gridexceeds demand and injects it back to the grid when demand exceeds generatedpower. Our systems respond up to 100 times faster than fossil fuel generatorsthat provide frequency regulation. Certain ISOs have implemented or areconsidering tariff changes that would provide additional or enhanced paymentmechanisms (“performance pricing”) to compensate resources, such as ours, forfaster regulation response. The Federal Energy Regulatory Commission (FERC) isalso in the process of considering the implementation of performance pricing ona national basis for ISOs that fall within FERC jurisdiction.

 

Our flywheel systems also make it easier for the grid to integrateintermittent renewable energy sources, such as wind and solar power, whosevariability increases the need for regulation. Because our flywheels only recycle electricity already generated, theydo not consume fossil fuel or produce carbon dioxide (CO2)greenhouse gas emissions or other air pollutants,such as nitrogen oxide or sulfur dioxide. In addition, the energy conversionefficiency of our flywheels does not significantly degrade over time or as afunction of the number of charge/discharge cycles incurred. We believe that ourlow operating costs will allow us to participate with a favorable profit marginin the open-bid markets, and utilities in non-open bid markets will also findthe attributes of our system attractive and will purchase our systems on aturnkey basis.

 

In2009 we began marketing and business development activities outside of theUnited 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.

 

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Webelieve that growth in both the US and international markets can be expectedfrom a combination of additional factors, including:

 

·                  Greater use of renewable energy sources –especially wind and solar generation

 

·                  Long-term growth in the demand forelectricity

 

·                  Increased operating costs for conventionalgeneration

 

·                  Government regulations and market forcesaimed at reducing CO2 emissions.

 

Webelieve that our operating cost structure will be significantly lower than thatof most incumbent frequency regulation service providers. Our Smart Energy 25flywheel has been designed to operate with low energy losses, minimalmechanical maintenance for 20 or more years and no significant degradation inenergy conversion efficiency. In particular, our technology is different frommost frequency regulation providers in that it does not use fossil fuel, whichis the largest variable cost for most competing frequency regulationproviders.  Further, while batteryproviders have entered the market for frequency regulation services, we believewe have a significant advantage insofar as our technology is capable ofperforming an extensive number of charge/discharge cycles without anydegradation of energy storage capacity. In contrast, the storage capacity of chemical batteries degrades as afunction of increasing cycles, which increases their lifecycle costs.

 

Sinceour Smart Energy MatrixTM does not burn fuel, the environmental benefits of ourtechnology are significant. An internally commissioned study suggests that ourtechnology may reduce carbon dioxide (CO2) by up to 89% compared to conventional frequency regulationservice providers.  We believe that thecleaner performance of our flywheel systems (in contrast to frequencyregulation services supplied by fossil fuel resources) can be expected to offersignificant value to regulators, grid operators, and utilities facingincreasing 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 at a faster ratethan our carbon-related costs, which are associated with the purchase of asmall amount of electrical make-up energy.

 

Insome states, additional environmentally related revenues may be available inthe form of renewable energy credits or other credits.  In 2009, we began earning alternative energy credits under theMassachusetts Alternative Energy Portfolio Standard (APS) program, and sellingthem to utilities or other retail electricity suppliers that need to meetmandated APS requirements, thus creating a limited source of incrementalrevenue.

 

**Regulatoryand 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 TechnicalConference on Frequency Regulation Compensation and invited our Chief ExecutiveOfficer, F. William Capp, to present on the concept of “pay-for-performance.”  Subsequently, on June 16, 2010, wesubmitted comments to FERC reiterating our support of tariffs that compensateregulation resources based on performance.  We will continue to engage in this dialogue in an effort to encouragethe expansion of performance-based tariffs in all ISO markets. Currently, ISO-NEis the only grid operator that utilizes a performance-based tariff that rewardsresources for speed of response. Other ISOs, including PJM, are consideringchanging their tariffs to provide higher revenues for faster performance.Should performance-based regulation tariffs be widely adopted, the economics ofour plants in areas of the country managed by FERC may be significantlyenhanced, and our economically 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 allowenergy storage technologies to participate on a non-discriminatory basis intheir regulation markets. The ISOs have demonstrated a heightened commitment towork collaboratively with us to integrate our technology into their grids.  In addition to market rule changes,several ISOs are evaluating or proposing changes to their regulation dispatchsignals in 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 rule changes,coupled with more efficient regulation dispatch signals, will allow ourresource to maximize its regulation revenue while minimizing our consumptionand cost of electricity. The current status of each open-bid ISO market is asfollows:

 

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·                  New York ISO:After extensive work with NYISO and its stakeholders, on May 15, 2009 FERCapproved tariff and market rule changes to fully open the regulationservices market to flywheel energy storage. The new rules recognize theunique operating characteristics of our technology and remedy key aspects ofthe previously existing regulation tariff for generators that would otherwiselimit our technology.  We believe the newtariff and dispatch mechanisms will provide a highly effective and efficientmethod for integrating our flywheels into the NYISO regulation market.

 

·                  ISO NewEngland: On November 18, 2008, ISO-NE launched an AlternativeTechnologies Regulation pilot program to comply with FERC Order No. 890.  The purpose of the Alternative TechnologiesRegulation pilot program is to evaluate the performance of new technologieslike ours that had been ineligible to participate in ISO-NE’s regulationmarket, determine how these technologies can best be used to meet New England’sregulation requirements, allow program participants to operate in a realisticmarket environment where they can evaluate their market viability, and provideoperating experience that ISO-NE can use to formulate permanent marketrules.  On February 2, 2010, ISO-NEbegan working with stakeholders to develop a proposal for permanent market rules foralternative technologies. ISO-NE continued to develop its rules proposalduring the second and third quarters of 2010 and plans to present its proposalto the New England Power Pool (NEPOOL) Markets Committee during the fourthquarter. Once a proposal is approved by NEPOOL, it will be submitted to FERCfor approval. Until new permanent market rules for energy storage areimplemented, we will continue to earn revenue through the pilot program.  We began participating in the pilot programwith a 1 MW resource located inside our plant in Tyngsboro in November 2008,  added another 1 MW outside our Tyngsborofacility in July 2009 and added a third MW in December 2009.  A substantial portion of the latter tworesources was redeployed to our Stephentown facility beginning in August 2010.We expect that ISO-NE’s proposal will include a NYISO- style dispatch signaland, as also discussed above, that will have the effect of compensating us forthe opportunity cost component that we do not currently receive under the ISO-NEpilot program. However, there are no guarantees that these changes will beimplemented in the final rules.

 

·                  California ISO:CAISO has initiated a stakeholder process to finalize the design elements tofully integrate flywheels into its Regulation Up and Down markets by spring2011.  Furthermore, FERC has directedCAISO to file by March 2011 a report on its progress to open itsRegulation markets to flywheels.   We areactively engaged in this FERC proceeding and in the stakeholder process atCAISO.

 

·                  Midwest ISO: OnFebruary 25, 2008, FERC approved the creation of an Ancillary ServicesMarket (ASM) in the Midwest ISO to begin operating on January 6,2009.  As part of its approval, FERCrequired MISO to make further changes to its ASM to remove barriers to newtechnologies to provide regulation service. On April 25, 2008, MISO fully complied with FERC’s directives byfiling a request for an entirely new regulation resource category specificallydesigned for stored energy resources (“SER”), including our flywheeltechnology.  FERC approved this tariff onDecember 18, 2008.  This was thefirst such tariff in the United States designed specifically to accommodateenergy storage-based regulation resources. In May 2009, MISO, with the support of its market stakeholders,submitted to FERC additional tariff modifications to enhance the dispatchalgorithm for SERs to better utilize their regulation capabilities and maximizetheir revenues in the MISO market.  On December 31,2009, FERC approved these tariff modifications. The new MISO market rules for SERs took effect on January 1,2010.

 

·                  PJMInterconnection: PJM amended its tariff language to comply with FERC Order No. 890and stated that its current rules allow non-generation resources like oursto fully participate in its regulation market. PJM’s market rules allow usto enter the market. In the summer of 2009 PJM adopted a regulation dispatchsignal for energy storage resources that takes partial advantage of our system’sfast-response capability, maximizes benefits to PJM’s grid and pays us for thebenefits of our resource.  In July 2010,PJM submitted tariff revisions to FERC for approval which clarify and amendcertain aspects of PJM’s tariff in order to ensure we can net our energyconsumption at wholesale rates and therefore minimize our costs to provideservice in PJM.  These tariff changeswere unanimously endorsed by PJM’s stakeholder at the June 3, 2010 MembersCommittee meeting and approved by FERC on September 3, 2010.  Most recently, a senior PJM official hasstated PJM’s interest in developing a “pay-for-performance” mechanism in theirregulation market.

 

·                  ERCOT: SinceERCOT is not regulated by the Federal Energy Regulatory Commission, in the pastwe have focused our efforts on the other ISOs. As the amount of wind generation in Texas increases and therefore thedemand for fast frequency regulation resources rises, and as we demonstrate theeffectiveness of our system in other ISOs, we believe our technology willbecome increasingly attractive in the ERCOT market. Consequently, we have begunto focus our attention on this market. On April 13, 2010, ERCOT held anenergy storage workshop to begin the process of evaluating whether market rule changeswill be needed to allow energy storage units such as ours to enter this marketon an economic basis. In 

 

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August 2010ERCOT launched a working group specifically focused on developing the market rule changesnecessary to integrate storage into its Regulation markets.  We are actively participating in thisinitiative.

 

**Researchand Development Applications**

 

InSeptember 2010, we finalized a contract with the DOE’s Advanced ResearchProjects Agency — Energy (ARPA-E) to develop critical components of ahighly-advanced “flying ring” flywheel energy storage system over a two yearperiod. ARPA-E is an agency within DOE that provides R&D funding fortransformational new energy technologies and systems. The award is valued at atotal of $2.8 million. ARPA-E grant recipients share a portion of the programcost, and we would contribute a minimum of $560,000, or 20%, of the $2.8million program total.  The actualcontract net cost is expected to be higher due to the difference betweencontract and our GAAP overhead rates. Our proposal calls for initiating development of a next-generationflywheel energy storage module with a size of 100kWh and 100kW, capable ofstoring four times the energy at one-eighth the cost-per-energy-unit, ascompared to our current Gen 4 flywheel. The new flywheel would be capable of more than 40,000 fullcharge/discharge cycles in its lifetime, thereby achieving a cost per storagecycle below ARPA-E’s goal of $0.025/kWh. If we are successful in developing the initial design, additional effortwould be required before this new flywheel could be commercialized.

 

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.  One new application of particular interest tothe DOE is so-called “ramping” support for wind and solar power. The goal wouldbe to provide one hour of flywheel storage as an energy-balancing resource forintermittent renewable energy assets, and thereby reduce the amount offossil-based backup power that might be used to provide the same effect.  The benefit would be to enable significantlygreater market penetration of renewable generation resources in a clean andsustainable way.  Some of the technologydeveloped under the APRA-E program may also lead to reduced costs and increasedperformance for our current generation of flywheels.  Other potential applications include wind-diesel-storagehybrid systems that reduce diesel fuel consumption on island-based grids,uninterruptible power supply (UPS) applications that require an hour or more ofassured power, and electrical demand limiting for commercial, industrial,institutional and government facilities that pay high demand charges undertime-of-use electricity tariffs.

 

**Discussionof Operations**

 

Wehave experienced net losses since our inception and, as of September 30,2010, had an accumulated deficit of approximately $222.6 million.  We arefocused on commercializing our Smart Energy MatrixTM flywheel system forfrequency regulation and the sale of turnkey systems. 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. Moreover, we must raiseadditional capital from a combination of equity, debt and/or turnkey sales toexecute 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.

 

InNovember 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 in December 2009,all of which have earned revenue through the pilot program. Although we haveredeployed a portion of these three MW to the Stephentown site, we expect tocontinue to operate at least one MW of capacity in the ISO-NE pilot programuntil permanent market rules for energy storage in ISO-NE are finalized.

 

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 to finance 62.5% of the estimated $69 million totalproject cost of our 20 MW plant currently under construction in Stephentown,New York.  At the closing of the loan,Beacon contributed the remaining 37.5% of the expected project costs in theform of $18.9 million in inventory, assets, and eligible project costs and $7million in cash, which was deposited into an SRS cash account (known as the “BaseEquity Account) controlled by the collateral agent. We expect to receive 100%reimbursement from the FFB for ongoing budgeted project costs until such timeas 62.5% of the aggregate of all eligible project costs have been funded.  After 62.5% of the aggregate of all eligibleproject costs have been funded with loan proceeds, (a) 

 

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62.5%of each request for funding will be funded with loan proceeds from the FFB, and(b) 37.5% of each request for funding will be funded with the proceedstaken from the Based Equity Account. However, we are responsible for any cost overruns for the project.  As of September 30, 2010, we have drawndown approximately $4 million of the cash that was contributed to the project,and have received advances of $8.2 million under the FFB loan for eligibleproject expenditures. Going forward, each monthly disbursement from the loanwill be subject to the satisfaction of certain conditions.  See “—Liquidity and Capital Resources” below.

 

Fourof the 20 MW in Stephentown are expected to be online and earning revenue bythe end of 2010. The remaining 16 MW were scheduled to be online and earningrevenue by the end of the first quarter of 2011. However, during the quarter weexperienced a delay in the delivery of a key component from a supplier that mayimpact our ability to be at a full 20 MW of operation in Stephentown by the endof the first quarter of 2011. We expect to have a minimum of 16 MW in operationby that date, with the remainder, if any, operational during the second quarterof 2011.

 

In April 2010, we entered into two 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 oursecond 20 MW plant (for which we have received a $24 million DOE grant award)on one of the two sites located in the Chicago area, or the Hazle Township sitein Luzerne County, Pennsylvania.

 

Wealso hold an option to lease land in Glenville, New York, where we expected tobuild a 20 MW facility at some time in the future.  In August 2010, we extended this leaseoption for a six-month period.  Subsequently,we learned that the Department of Energy elected not to extend a loan guaranteefor the proposed Glenville plant.  Moreattractive site options may be developed in the same or other markets, andthese factors will be evaluated over the next four to six months beforedeciding whether to extend the lease option on the Glenville site for anothersix-month period to maintain it as a viable potential location for a future 20MW plant.

 

InJuly 2010, the New York State legislature passed a law that specifically exemptsflywheel-based energy storage facilities of less than 80 MW from New YorkPublic Service Commission (PSC) jurisdiction. Prior to this new statute, wewere required to apply for (and had obtained) PSC approval via a certificate ofpublic 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 have been required should wedecide to build a plant in Glenville, New York, or elsewhere within the NYISOregion.

 

OnSeptember 14, 2010, we signed an interconnection agreement for our 20 MWplant in Stephentown with NYISO and NYSEG. Necessary upgrades to grid equipment to permit our interconnection arein process. NYSEG has agreed to allow us to perform the design engineering andprocurement of materials for the upgrade of their substation in order to helpspeed the interconnection process. Construction on the Stephentown substation is in process and is onschedule to be partially on-line and earning revenue before the end of theyear.

 

OnMay 24, 2010, we announced that we 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 other projectaspects, including a visitor information center to be built at the Stephentownsite. The grant is being accounted for as a reduction of eligible projectcosts, on a pro-rata basis, as expenses are incurred.

 

The first 20 MW plant will cost approximately $69million, of which approximately $55 million is equipment and facility costs.The remainder of the cost estimate includes contingency, legal, consulting andadministrative costs.  Some of thesecosts are either unique to the DOE loan guarantee process or are greater thanwe expect will be incurred in the construction of subsequent similarfacilities.  Excluding the cost of land,our second merchant plant is estimated to cost approximately $53 million, ofwhich the DOE grant 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 

 

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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 associated margin and terms and conditions of those sales

 

·                  Receipt ofenvironmental and site-related permits and approvals

 

·                  Receipt of gridinterconnection approvals

 

·                  Cash flowgenerated by in-service plants.

 

Sinceour inception in 1997 we have funded our development primarily through the saleof common stock.  In November 2000,we completed our initial public offering, raising approximately $49.3 millionnet of offering expenses. Since our initial public offering, we have raisedapproximately $111.6 million as of September 30, 2010, through the sale ofour stock and exercise of warrants. Weestimate that we will need to raise approximately $15 to $20 million during theremainder of 2010 and 2011 in order to fund operations.  Additional funds would be required to orderlong-lead items and begin construction of our second merchant plant from acombination of project finance and equity in addition to the DOE grant.

 

Ourprofit and losses as well as uses of cash may fluctuate significantly fromquarter to quarter due to fluctuations in revenues, costs of development, costsof materials to build flywheels and other components of our Smart 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 willbe available to us on terms that we deem acceptable, if they are available atall. See “— Liquidity and Capital Resources” below for more informationconcerning our access to and uses for capital.

 

*Revenues*

 

Ourrevenue during the nine months ended September 30, 2010, and 2009, cameprimarily from three sources:

 

·                  Frequencyregulation service revenue from the ISO-NE pilot program

 

·                  Research anddevelopment contracts, for which revenue has been recognized using thepercentage-of-completion method

 

·                  Sales ofinverters, accessories and APS credits.

 

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.”

 

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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, to takeeffect, if approved by FERC, in mid-2011. These rules will enable us to receive the economic equivalent ofthis payment component. Additionally, we expect ISO-NE’s new market rules toretain a pay-for-performance feature, whereby fast-response regulationresources, such as our flywheels, will continue to receive higher-than-averagemileage payments on the basis of their greater speed and effectiveness.

 

Inrecent months, FERC has shown increasing support for the concept of payingfast-response regulation resources on the basis of actual system performancerather than nominal capacity. We will continue to engage in this dialogue in aneffort to encourage the expansion of performance-based tariffs. Currently, ISO-NEis the only grid operator that utilizes a performance-based tariff that rewardsresources for speed. Other ISOs, including PJM, are considering changing theirtariffs to provide higher revenues for faster performance. Shouldperformance-based regulation tariffs be widely adopted, the economics of ourplants may be enhanced and our addressable markets may expand. No assurance canbe given that such tariffs will be widely adopted.

 

*Cost of Goods Sold*

 

Costof goods sold for frequency regulation services consists of the cost of energy.Cost of goods sold for research and development contracts is being recorded onthe percentage-of-completion method and consists primarily of direct labor andmaterial, 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.

 

*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 currentproduction levels are still well below our facility’s full capacity, O&Mcosts for the nine months ended September 30, 2010 and 2009 include a significantamount of unabsorbed overhead.  Inaddition, costs associated with running the 3 MW resource for the ISO-NE pilotprogram and certain non-fungible costs associated with certain Smart EnergyMatrixTM installations are also included in O&M. O&M expenses willincrease as we ramp up our production capacity and begin to operate andmaintain the Stephentown 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*

 

Ourselling expenses consist primarily of compensation and benefits for regulatoryaffairs, sales and marketing personnel and related business developmentexpenses and regulatory compliance efforts. General and administrative expensesconsist primarily of compensation and benefits related to our corporate staff,professional fees, insurance and travel. Overall, we expect our selling,general and administrative expenses for fiscal 2010 to be higher than in 2009primarily due to increased staffing as we ramp up to construct and operate theStephentown site and identify and develop additional sites.

 

*Loss on Contract Commitments*

 

Ourcontracts have been primarily for the development of demonstration units of newproducts and the design of a frequency regulation plant. As such, the work hassupported our core research and development efforts.  Most of these contracts 

 

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have been structured on acost-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 an increase to our contract loss reservein the quarter of 2010 for our expected cost share portion of the ARPA-Econtract.

 

*Depreciation and Amortization*

 

Ourdepreciation and amortization is primarily related to depreciation on capitalexpenditures and the amortization of lease and leasehold costs related to ourfacilities.  Depreciation expense willincrease substantially in future periods as we build and deploy our frequencyregulation 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.

 

*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*

 

Werecognize contract revenues using the percentage-of-completion method. We uselabor hours as the basis for the percentage-of-completion calculation, which ismeasured principally by the percentage of labor hours incurred to date for eachcontract to the estimated total labor hours for each contract at completion.Changes to total estimated contract costs or losses, if any, are recognized inthe period in which they are determined. Revenues recognized in excess of amounts billed are classified ascurrent assets, and included in “Unbilled costs on contracts in process” in ourbalance sheets.  Amounts billed toclients in excess of revenues recognized to date are classified as currentliabilities 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.   In addition to our government contracts, wehave a small engineering contract where we are paid on a per-hour basis forengineering services provided.  Revenue onthis contract is recognized as hours are worked.

 

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.

 

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·            *Sale ofAlternative Renewable Energy Credits*

 

Underthe Massachusetts Alternative Energy Portfolio Standard (APS) program, ourflywheel energy storage frequency regulation assets operating within theCommonwealth of Massachusetts are credited with producing a type of RenewableEnergy Credit (REC) known as an Alternative Renewable Energy Credit.  These have a market value, and we recognizerevenue on the sale of such credits as revenue when sold on the open market.

 

·            *ProductSales*

 

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*

 

Ourcontracts have been primarily for the development of demonstration units of newproducts, the design of a frequency regulation facility or alternative uses forour flywheels.  As such, the work hassupported 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*

 

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 material, labor, overhead, capitalized interest and, if applicable,exit costs. Exit costs for which we are obligated are accounted for inaccordance 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*.”  The interest iscapitalized until the underlying asset is ready for its intended use, and isconsidered an integral part of the total cost of acquiring a qualifying asset.Thus, the capitalized interest costs are included in the calculation ofdepreciation expense once the constructed assets are in service. Repair andmaintenance costs are expensed as incurred. Materials used in our development efforts are considered research anddevelopment materials, and are expensed as incurred in accordance with ASC 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 and estimatedexit costs, are expensed.

 

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*Impairment of Long-Lived Assets*

 

Inaccordance with ASC 360 “*Property, Plant andEquipment*” long-lived assets we hold and use are reviewed todetermine whether any events or changes in circumstances indicate that thecarrying value of the asset may not be recoverable.  The conditions to be considered includewhether or not the asset is in service, has become obsolete, is damaged, orwhether external market circumstances indicate that the carrying amount may notbe recoverable.  When appropriate werecognize a loss for the difference between the estimated fair value of theasset 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 theCompany to redeploy all or part of a Smart Energy MatrixTM system installed at agiven 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 willrecord a period expense for the net book value associated with the non-fungiblecomponents.

 

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

 

*Fair Value of Financial Instruments*

 

Accountingfor fair value measurements involves a single definition of fair value, alongwith a conceptual framework to measure fair value, with a fair value defined asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date. The fair value measurement hierarchy consists of threelevels:

 

·                  Levelone—quoted market prices in active markets for identical assets or liabilities

 

·                  Leveltwo—inputs other than level one inputs that are either directly or indirectlyobservable

 

·                  Levelthree—unobservable inputs developed using estimates and assumptions which aredeveloped by the reporting entity and reflect those assumptions that a marketparticipant would use.

 

Weapply valuation techniques that (1) place greater reliance on observableinputs and less reliance on unobservable inputs and (2) are consistentwith the market approach, the income approach and/or the cost approach, and includeenhanced disclosures of fair value measurements in our financial statements.

 

Thecarrying values of cash and cash equivalents, accounts receivable, othercurrent 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 thisreport for debt fair value, which also approximates carrying value.

 

*Deferredfinancing costs*

 

Wewill defer our direct costs incurred to raise capital. Direct costs includeonly “out-of-pocket” or incremental costs directly related to the effort, suchas a finder’s fee and fees paid to outside consultants for accounting, legal orengineering investigations or for appraisals. These costs will be charged to Additional Paid In Capital when theefforts are successful, or expensed when unsuccessful.  Indirect costs are expensed as incurred.

 

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**Results of Operations**

 

***Comparison of Three and Nine Months ended September 30,2010 and 2009***

* *
| ** **                               | ** ** | **Three months ended September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                 | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                               | ** ** | **(in thousands)**                                  | ** ** |
| Revenue                                  |       | $                                                        | 124        |   | $ | 273 |   | $ | (149 | ) | -55 | % |
| Cost of goods sold                       |       | 119                                                      |       | 247 |   | (128 | ) | -52 | % |
| Gross margin                             |       | 5                                                        |       | 26 |   | (21 | ) | -81 | % |
| Operating expenses:                      |       |                                                     |       |   |   |   |   |   |   |
| Operations and maintenance               |       | 195                                                      |       | 621 |   | (426 | ) | -69 | % |
| Research and development                 |       | 1,509                                                    |       | 1,626 |   | (117 | ) | -7 | % |
| Selling, general and administrative      |       | 2,185                                                    |       | 1,463 |   | 722 |   | 49 | % |
| Loss on contract commitments             |       | 1,070                                                    |       | — |   | 1,070 |   | NA |   |
| Depreciation and amortization            |       | 516                                                      |       | 479 |   | 37 |   | 8 | % |
| Total operating expenses                 |       | 5,475                                                    |       | 4,189 |   | 1,286 |   | 31 | % |
| Loss from operations                     |       | (5,470                                                   | )          | (4,163 | ) | (1,307 | ) | 31 | % |
| Interest and other income (expense), net |       | (69                                                      | )          | 71 |   | (140 | ) | -197 | % |
| Net loss                                 |       | $                                                        | (5,539     | ) | $ | (4,092 | ) | $ | (1,447 | ) | 35 | % |

* *
| ** **                               | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                               | ** ** | **(in thousands)**                                 | ** ** |
| Revenue                                  |       | $                                                       | 525        |   | $ | 666 |   | $ | (141 | ) | -21 | % |
| Cost of goods sold                       |       | 373                                                     |       | 705 |   | (332 | ) | -47 | % |
| Gross margin                             |       | 152                                                     |       | (39 | ) | 191 |   | -490 | % |
| Operating expenses:                      |       |                                                    |       |   |   |   |   |   |   |
| Operations and maintenance               |       | 1,986                                                   |       | 2,167 |   | (181 | ) | -8 | % |
| Research and development                 |       | 5,471                                                   |       | 5,303 |   | 168 |   | 3 | % |
| Selling, general and administrative      |       | 6,561                                                   |       | 5,356 |   | 1,205 |   | 22 | % |
| Loss on contract commitments             |       | 971                                                     |       | 132 |   | 839 |   | 636 | % |
| Depreciation and amortization            |       | 1,591                                                   |       | 1,346 |   | 245 |   | 18 | % |
| Total operating expenses                 |       | 16,580                                                  |       | 14,304 |   | 2,276 |   | 16 | % |
| Loss from operations                     |       | (16,428                                                 | )          | (14,343 | ) | (2,085 | ) | 15 | % |
| Interest and other income (expense), net |       | (202                                                    | )          | (56 | ) | (146 | ) | 261 | % |
| Net loss                                 |       | $                                                       | (16,630    | ) | $ | (14,399 | ) | $ | (2,231 | ) | 15 | % |

 

*Revenue*

 

The following table provides details of ourrevenues for the three and nine months ended September 30, 2010, and 2009.

 

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| ** **                                           | ** ** | ** **                           | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **Cumulative**     | ** ** | ** **          | ** ** | ** **           | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------|------------|---------------------|------------|----------------------|------------|
| ** **                                           | ** ** | ** **                           | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **Contract**       | ** ** | ** **          | ** ** | ** **           | ** ** |
| ** **                                           | ** ** | ** **                           | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **Value**          | ** ** | ** **          | ** ** | ** **           | ** ** |
| ** **                                           | ** ** | ** **                           | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | **Earned as** | ** ** | ** **          | ** ** | ** **           | ** ** |
| ** **                                           | ** ** | **Percent**                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** | **of  September**  | ** ** | **Total  Contract** | ** ** | **Remaining  Value** | ** ** |
| ** **                                           | ** ** | **complete**                         | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010**           | ** ** | **2009**            | ** ** | **30, 2010**    | ** ** | **Value** | ** ** | **(Backlog)** | ** ** |
| ** **                                           | ** ** | **(dollars in thousands)** | ** ** |
| **Frequency regulation:**                            |       |                                 |       | $                                                    | 74         |                                                | $          | 63                 |       | $                   | 341        |                 | $          | 180 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contracts:**                                       | ** ** | ** **                           | * *   | * *                                             | * *   | * *                                            | * *   | * *           | * *   | * *            | * *   | * *             | * *   | * * |   |   |   |
| ** **                                           | ** ** | ** **                           | * *   | * *                                             | * *   | * *                                            | * *   | * *           | * *   | * *            | * *   | * *             | * *   | * * |   |   |   |
| NAVSEA                                               |       | 100.0                                | %          | —                                               |       | 182                                                 |       | —             |       | 360                 |       | $                    | 500        |   | $ | 500 |   | — |   |
| Tehachapi                                            |       | 81.0                                 | %          | 15                                                   |       | 29                                                  |       | 41                 |       | 125                 |       | 203                  |       | 250 |   | 47 |   |
| Pacific Northwest Laboratories                       |       | 100.0                                | %          | —                                               |       | —                                              |       | 84                 |       | —              |       | 104                  |       | 104 |   | — |   |
| ARPA-E                                               |       | 0.4                                  | %          | 9                                                    |       | —                                              |       | 9                  |       | —              |       | 9                    |       | 2,246 |   | 2,237 |   |
| ABIOMED                                              |       | NA                                   |       | 11                                                   |       | —                                              |       | 11                 |       | —              |       | 11                   |       | NA |   | NA |   |
| Total Contract Revenue                               |       |                                 |       | $                                                    | 35         |                                                | $          | 211                |       | $                   | 145        |                 | $          | 485 |   | $ | 827 |   | $ | 3,100 |   | $ | 2,284 |   |
| **Other (inverters, accessories and  APS credits):** | ** ** | ** **                           |       | 15                                                   |       | (1                                                  | )          | 39                 |       | 1                   |       |                 |       |   |   |   |   |
| **Total revenue:**                                   | ** ** | ** **                           |       | $                                                    | 124        |                                                | $          | 273                |       | $                   | 525        |                 | $          | 666 |   |   |   |   |   |   |   |
|                                                      |            |                                      |            |                                                      |            |                                                     |            |                    |            |                     |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |

 

Revenuefor the nine months ended September 30, 2010 decreased by approximately$141,000, or 21%, over the same period in 2009. Frequency regulation revenue earned through our participation in theISO-NE pilot program increased by approximately $161,000, or 89%.  Revenue from research and developmentcontracts decreased by approximately $340,000 in 2010, primarily due to thecompletion of several contracts in 2009 or earlier in 2010.  Other revenue, derived from the sale ofinverters, accessories and APS credits earned from providing regulationservice, increased by approximately $38,000.

 

Wehad 3 MW of capacity in service until mid-August 2010, as compared to 1 MWin the first half of 2009.  The second MWwas put into service in July 2009 and the third MW in December 2009.  The capacity available for the ISO-NE pilotbegan to decrease in August 2010, when we began to redeploy 2 MW fromStephentown to Tyngsboro. We provided approximately 346,800 megawatt-hours(MWh) of regulation service in the first three quarters of 2010, orapproximately 127,400 MWh per MW of capacity in service, as compared toapproximately 109,200 MWh per MW of capacity in service during the same periodof 2009, an increase of 16.7%.  Althoughour productivity improved, our revenue per MW dropped from approximately$140,000 in the first nine months of 2009 to approximately $125,000 in the sameperiod in 2010, due to a reduction in the average clearing price for frequencyregulation.

 

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 design permanent market rules before the end of this year forimplementation, if approved, in mid-2011 that will have the effect ofcompensating us for the opportunity cost component that we do not currentlyreceive under the pilot program. The trend at other ISOs has been toincorporate features in their tariffs that intrinsically compensate all resources,including energy storage providers, for opportunity cost.

 

Contractrevenue for the nine-month period ended September 30, 2010, wasapproximately $145,000, a decrease of $340,000 or 70%, as compared to the ninemonths of 2009, primarily because most of the contracts were substantiallycompleted prior to or during the quarter. However, we have begun work on two new contracts: the ARPA-E contract,for which we expect to earn $2.2 million over a 2-year period, and the ABIOMEDcontract, for which we are being paid on an hourly basis for engineering workperformed.  We anticipate revenue ofapproximately $45,000 on the ABIOMED contract.

 

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*Cost of Goods Sold*

 

Cost of goods sold for the three and nine monthsended September 30, 2010, and 2009 was as follows:

 
| ** **                | ** ** | **Three months ended September 30, 2010** | ** ** | **Three months ended September 30, 2009** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                | ** ** | **Revenue**                                                        | ** ** | **Cost of  Sales**                                            | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost of  Sales** | ** ** | **Margin** | ** ** |
| ** **                | ** ** | **(in thousands)**                                            | ** ** |
| Frequency regulation      |       | $                                                                  | 74         |                                                               | $          | 82 |   | $ | (8 | ) | $ | 63 |   | $ | 49 |   | $ | 14 |   |
| Contract                  |       | 35                                                                 |       | 37                                                                 |       | (2 | ) | 211 |   | 198 |   | 13 |   |
| Inverters and APS credits |       | 15                                                                 |       | —                                                             |       | 15 |   | (1 | ) | — |   | (1 | ) |
| Total                     |       | $                                                                  | 124        |                                                               | $          | 119 |   | $ | 5 |   | $ | 273 |   | $ | 247 |   | $ | 26 |   |

 
| ** **                | ** ** | **Nine months ended September 30, 2010** | ** ** | **Nine months ended September 30, 2009** | ** ** |
|---------------------------|------------|-------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                | ** ** | **Revenue**                                                       | ** ** | **Cost of  Sales**                                           | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost of  Sales** | ** ** | **Margin** | ** ** |
| ** **                | ** ** | **(in thousands)**                                           | ** ** |
| Frequency regulation      |       | $                                                                 | 341        |                                                              | $          | 282 |   | $ | 59 |   | $ | 180 |   | $ | 247 |   | $ | (67 | ) |
| Contract                  |       | 145                                                               |       | 91                                                                |       | 54 |   | 485 |   | 458 |   | 27 |   |
| Inverters and APS credits |       | 39                                                                |       | —                                                            |       | 39 |   | 1 |   | — |   | 1 |   |
| Total                     |       | $                                                                 | 525        |                                                              | $          | 373 |   | $ | 152 |   | $ | 666 |   | $ | 705 |   | $ | (39 | ) |

 

Costof goods sold, inclusive of our frequency regulation services, research anddevelopment contracts, and inverter and other sales decreased fromapproximately $247,000 in the third quarter of 2009 to approximately $119,000during the third quarter of 2010. During the third quarter of 2010 and 2009,cost of goods sold includes approximately $82,000 and $49,000, respectively,for the cost of energy associated with the generation of frequency regulationrevenue under the ISO-NE pilot program. The increase is due primarily to the increase in the MW capacityavailable during the periods reported.

 

Ona year to date basis, our average gross margin on frequency regulation waspositive 17.3% for 2010, as compared to a negative 37.2% margin for 2009. Thissignificant improvement resulted from ISO-NE’s decision to allow us to net theenergy consumption of our regulation resource and pay the wholesale rate fornet energy usage as of late April 2009. During the first six months of thepilot program (which included the first four months of 2009), our electricitycosts for operating the Smart Energy MatrixTM in Tyngsboro were unusuallyhigh.  Our connection to the grid for thepilot program was made through National Grid distribution lines, rather thandirectly to the ISO through transmission lines, due to cost and timefactors.  Consequently, from November 2008through late April 2009, we paid the retail price for our grosswithdrawals from the grid instead of paying the wholesale price for the netelectricity (withdrawals minus injections), plus retail transmission anddistribution charges.  In late April 2009, ISO-NEand our local distribution company implemented a change that reduced our costof electricity by netting the electricity withdrawn and injected into the grid,and billing for that net usage at the wholesale rate.  In addition, a new regulation dispatch signalimplemented by ISO-NE in May 2009 reduced the net amount of electricity weneed to purchase.  While we are stillpaying retail transmission and distribution charges, the reduction in energycosts resulting from the adjustment that allows us to net our energy costsenabled us to earn positive gross margins beginning in May 2009.  During the third quarter, we began to utilizeour pilot resource to test flywheels going to Stephentown, and therefore werenot operating these units at maximum efficiency.  Due to this, combined with a continuingdecrease in the ISO-NE clearing price for frequency regulation, margins werenegative during the third quarter. We believe that the reduction in clearingprice is due to lower electricity demand resulting from current economicconditions, and that regulation pricing will increase as the economy recoversand the need for regulation capacity rises.

 

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 andwe will be billed for our energy at the wholesale rate. Those fees haverepresented approximately 72% of our cost of energy during the first ninemonths of 2010. Of the $282,000 cost of energy during the first nine

 

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monthsof 2010, approximately $199,000 represented transmission and distributioncharges for the period.  Such chargesrepresented approximately 67% of the $82,000 cost of energy for the thirdquarter.  If we had been connected totransmission-level (rather than to distribution-level) power lines, our grossmargins for each period would have been substantially higher.

 

Werecorded a credit in cost of sales for contracts in the second quarter of 2010as a result of completing the PNNL contract for substantially less thanoriginally estimated, as discussed earlier under “Loss on Contract Commitments.”

 

*Operations and Maintenance Expense*

 

Forthe three months ended September 30, 2010, operations and maintenance(O&M) expenses decreased by $426,000, or 69%.  For the nine months ended September 30,2010, O&M expenses decreased by approximately $181,000, or 8%. See thetable below for explanations of the factors which were responsible for the mostsignificant changes.

 
| ** **                           | ** ** | **Three months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                    | ** ** |
|--------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(in thousands)**                          | ** ** | ** **                                      | ** ** |
| Period ended September 30, 2009 |       | $                                                | 621        |                                            | $          | 2,167                                                                                                                                                                                                                                                                                                                                          |       |   |   |
| Expense  materials                   |       | 271                                              |       | 372                                             |       | Increased  spending for small tools and equipment, tooling and non-recurring expenses,  and production supplies.                                                                                                                                                                                                                          |       |
| Salaries  and benefits          |       | 140                                              |       | 276                                             |       | 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      |       | 835                                              |       | 740                                             |       | Increase  due primarily to costs associated with the interconnection at Stephentown,  most of which will be reimbursed by the NYSERDA grant.  The grant reimbursement credit is included  with “Allocations and Overhead” below.                                                                                                |       |
| Legal                           |       | (20                                              | )          | (101                                            | )          | In  2009, higher legal and tax advice resulted from the set up of our frequency  regulation operations in New York.                                                                                                                                                                                                                            |       |
| Allocations  and overhead            |       | (1,727                                           | )          | (1,905                                          | )          | In  June 2010, the NYSERDA grant was finalized, and is being recorded as a  reduction of expenses. Accordingly, we credited “Allocations out” for $1,018K  based on the cumulative eligible spending to date.   The remainder represents higher overhead  applied based on increasing production levels.              |       |
| Stock  Compensation             |       | 19                                               |       | (16)                                            |       | 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.   The increase during the third quarter is due to employee and officer  grants made in the second quarter which have begun to vest. |       |
| Occupancy  and repairs               |       | 7                                                |       | 211                                             |       | Increase  year to date due primarily to the cost of repairs to the roof at our  Tyngsboro facility, and lease option costs future plant sites.                                                                                                                                                                                                 |       |
| Software  and maintenance            |       | 10                                               |       | 10                                              |       | Increase  in software costs.                                                                                                                                                                                                                                                                                                                   |       |
| Travel                          |       | 7                                                |       | 25                                              |       | Increase  in travel.                                                                                                                                                                                                                                                                                                                           |       |
|                                      |            |                                                  |            |                                                 |            |                                                                                                                                                                                                                                                                                                                                                |            |  |  |

 

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| ** **                            | ** ** | **Three months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Comment**                                                                                                                                                                                  | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Hiring  expense                       |       | 1                                                |       | 22                                              |       | Increase  due to new hires to support increased production for Stephentown.                                                                                                                  |       |
| Other                                 |       | 31                                               |       | 185                                             |       | Year  to date increase includes $114K for labor previously charged to the  construction of the 2MW system in service in Tyngsboro which were written off  as “non-fungible” costs. |       |
| Period  ended September 30, 2010 |       | $                                                |  195  |                                            | $          | 1,986                                                                                                                                                                                        |       |   |   |
|                                       |            |                                                  |            |                                                 |            |                                                                                                                                                                                              |            |  |  |

 

*Research and Development Expense*

 

Forthe three months ended September 30, 2010, research and development(R&D) expenses decreased by $117,000, or 7%.  For the nine months ended September 30,2010, R&D expenses increased by approximately $168,000, or 3%.

 
| ** **                            | ** ** | **Three months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                                                      | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Period  ended September 30, 2009 |       | $                                                | 1,626      |                                            | $          |  5,303                                                                                                                                                                                                                                                                                                                                                                                                                                      | * *   |   |   |
| Expense  materials                    |       | (485                                             | )          | (490                                            | )          | In  2009, the materials cost included in R&D were 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 2010, spending on expense materials for R&D decreased and now  primarily relates to work developing lower cost components for our flywheels.         |       |
| Salaries  and benefits                |       | (45                                              | )          | 95                                              |       | Year  to date, the 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.   In the third  quarter, there was less time charged to R&D by manufacturing staff than  during the third quarter of last year. |       |
| Subcontractors  and consultants       |       | 272                                              |       | 298                                             |       | Increased  use of contractors.                                                                                                                                                                                                                                                                                                                                                                                                                   |       |
| Legal                            |       | 9                                                |       | 18                                              |       | Increase  in legal costs related to patents.                                                                                                                                                                                                                                                                                                                                                                                                     |       |
| Allocations  and overhead             |       | 90                                               |       | 213                                             |       | Reduction  in overhead allocated to contracts, especially the Navy contract which was  substantially completed in 2009.                                                                                                                                                                                                                                                                                                                          |       |
|                                       |            |                                                  |            |                                                 |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                  |            |  |  |

 

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| ** **                            | ** ** | **Three months  ended  September 30,** | ** **  | **Nine months  ended  September 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                  | ** ** |
|---------------------------------------|------------|--------------------------------------------------|-------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Stock  Compensation              |       | 27                                               |        | (76                                             | )          | Year  to date, 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. Expense for the quarter  increased because employee and officer options granted in the second quarter  began to vest in the third quarter of 2010.  |       |
| Occupancy                             |       | 2                                                |        | 101                                             |       | Year  to date increase due to cost to repair the roof at our Tyngsboro  facility.                                                                                                                                                                                                                                                                                       |       |
| Travel                           |       | 14                                               |        | 35                                              |       | Increase  in travel.                                                                                                                                                                                                                                                                                                                                                         |       |
| Other                                 |       | (1                                               | )           | (26                                             | )          |                                                                                                                                                                                                                                                                                                                                                                         |       |
| Period  ended September 30, 2010 |       | $                                                |  1,509 |                                            | $          | 5,471                                                                                                                                                                                                                                                                                                                                                                        |       |   |   |
|                                       |            |                                                  |             |                                                 |            |                                                                                                                                                                                                                                                                                                                                                                              |            |  |  |

 

*Selling, General and Administrative Expense*

 

Selling,general and administrative expenses totaled approximately $2,185,000 and$1,463,000 for the three months ended September 30, 2010, and 2009,respectively, which represents an increase of approximately $722,000, or 49%,period over period. For the nine-month period ended September 30, 2010,selling, general and administrative expenses increased by approximately$1,205,000, or 22%, period over period.

 

Significant changes inspending are explained in the table shown below.

 
|                                  |       | **Three months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Comment**                                                                                                                                       |       |
|---------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | ** **                                       | ** ** | **(in thousands)**                         | ** ** | ** **                                                                                                                                        | ** ** |
| Period  ended September 30, 2009 |       | $                                                | 1,463      |                                            | $          | 5,356                                                                                                                                             |       |   |   |
| Stock  Compensation                   |       | 82                                               |       | 30                                              |       | Increase  due to option grants to new hires, officers, and other employees, many of  which began to vest during the third quarter.                |       |
| Legal,  audit and professional fees   |       | (6                                               | )          | 117                                             |       | Increase  in use of outside legal services and higher audit fees.                                                                                 |       |
| Public  company / investor relations  |       | 136                                              |       | 17                                              |       | Increase  due to cost of the annual meeting, proxy, and annual report.                                                                            |       |
| Salaries  and benefits                |       | 256                                              |       | 544                                             |       | Increase  due to new hires, primarily to support the administrative cost of managing  the Stephentown project and market sale of turnkey systems. |       |
| Taxes                                 |       | 6                                                |       | 36                                              |       | Increase  in Delaware Franchise tax                                                                                                               |       |
| Small  tools and equipment            |       | (7                                               | )          | 20                                              |       | Year  to date, increase represents primarily the cost of computer equipment for new  hires                                                        |       |
| Subcontractors  and consultants       |       | 81                                               |       | 141                                             |       | Increased  use of consultants, especially in regards to international marketing efforts.                                                          |       |
|                                       |            |                                                  |            |                                                 |            |                                                                                                                                                   |            |  |  |

 

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|                                  |   | **Three months  ended  September 30,** | ** ** | **Nine months  ended  September 30,** | ** ** | **Comment**                                                                                                                                                                                                                      |   |
|---------------------------------------|--------|--------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Allocations  and overhead             |   | 38                                               |       | (26                                             | )          | Represents  G&A overhead allocated to the Navy and other contracts.  The allocation credit in the third quarter  of 2010 was lower than during the prior year because the Navy contract had previously  been completed. |   |
| Occupancy                             |   | 1                                                |       | 16                                              |       | Occupancy  increased year to date due to cost of building repairs.                                                                                                                                                               |   |
| Benefit  administration               |   | 11                                               |       | 13                                              |       | Increase  due to new hires, and higher payroll processing fees related to change in  payroll cycle to weekly for hourly employees to comply with Davis-Bacon Act  requirements.                                                  |   |
| Hiring  Expense                       |   | 54                                               |       | 166                                             |       | Cost  associated with new hires.                                                                                                                                                                                                 |   |
| Conferences  and trade shows          |   | 16                                               |       | 40                                              |       | Increased  attendance at conferences and trade shows as part of business development and  marketing efforts.                                                                                                                     |   |
| Travel                                |   | 43                                               |       | 72                                              |       | Increase  in travel.                                                                                                                                                                                                             |   |
| Other                                 |   | 11                                               |       | 19                                              |       |                                                                                                                                                                                                                             |   |
| Period  ended September 30, 2010 |   | $                                                | 2,185      |                                            | $          |  6,561                                                                                                                                                                                                                      |   |   |   |
|                                       |        |                                                  |            |                                                 |            |                                                                                                                                                                                                                                  |        |  |  |

 

*Loss on Contract Commitments*

 

In September 2010, we signed a contract withthe DOE’s Advanced Research Projects Agency — Energy (ARPA-E) to developcritical components of a highly advanced “flying ring” flywheel energy storagesystem over a two year period, for which we expect to receive $2,245,876.  In addition, we are expected to contribute anadditional 20% of program costs. Accordingly, we recorded a contract lossduring the third quarter of 2010 of $1,070,000, which represents our cost shareportion of the contract, plus the difference between our GAAP overhead rate andthe contract bid rate.

 

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 receive approximately$250,000, in total, to offset R&D expenses and will contribute anadditional $87,000 of engineering resources for the project, bringing theR&D total to approximately $337,000. Accordingly, we recorded a charge of approximately $87,000 to the contractloss reserve during 2008 to reflect the expected “cost share” portion of theTehachapi contract. During the first quarter of 2009, we increased the lossreserve for the Tehachapi contract by $132,500, bringing the total contractloss to approximately $219,000.  Thisincrease was based on the difference between the overhead rate that was bid onthis fixed price contract and our forecasted overhead rate.  No additions were considered necessary to theloss reserve for the Tehachapi contract during the nine months ended September 30,2010.

 

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.

 

OnFebruary 3, 2009, we announced that we entered into a contract with NAVSEAto evaluate the use of flywheel energy storage for multiple shipboard applicationsthat we expect will lead to a conceptual design of a flywheel system for futurenaval surface combatants and possible retrofit into existing navy ships.  The value of the initial research anddevelopment work is estimated at $900,000, $500,000 of which has already beenappropriated and is complete.  Subsequentphases, if funded, would 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 

 

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lossreserve of approximately $50,000 in the second quarter of 2010, since the totalcosts exceed the total appropriated to date for the contract, and we chargedthe additional overhead costs, plus an additional $7,000 in unbilled costsagainst this reserve.

 

The organization that originally sponsored ourNYSERDA PON 800 contract has undergone a variety of organizational changes,which have resulted in this contract being terminated.  Unbilled allowable charges of approximately $8,000were 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 $479,000 during the threemonths ended September 30, 2009, to approximately $516,000 for the sameperiod in 2010, an increase of approximately $37,000, or 8%.  For the nine month period ended September 30,2010, the increase was approximately $245,000, or 18%, 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 nine months of 2010.  As of September 30, 2010, we hadapproximately $27.0 million in CIP of which approximately $13.7 million is forflywheels or materials to build flywheels and approximately $10.9 million arecosts related to the construction of our Stephentown facility.

 

*Interest and Other Income (Expense), net*

 

Averagecash balances during the first nine months of 2010 were approximately $8.0million higher than during the same period in 2009. However, interest rateswere significantly lower in 2010.  As a resultof the lower interest rates, interest income for the first nine months of 2010was approximately $2,700 lower than during the first nine months of 2009.

 

Interestexpense for the nine months ended September 30, 2010 and 2009 was asfollows:

 
| ** **                             | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| Cash paid for interest on MassDev loan |       | $                                                       | 216,103    |   | $ | 176,070 |   |
| Accrued interest on FFB loan           |       | 683                                                     |       | — |   |
| Amortization of MassDev warrants       |       | 39,342                                                  |       | 33,849 |   |
| Less: Interest capitalized             |       | (96,125                                                 | )          | (144,838 | ) |
| Net interest expense                   |       | $                                                       | 160,003    |   | $ | 65,081 |   |

 

Interestexpense and the loan discount amortization increased due to the final drawdownon the MassDev loan which was made during the fourth quarter of 2009.

 

*Net Loss*

 

Asa result of the changes discussed above, the net loss for the three monthsended September 30, 2010 was approximately $5,539,000, which represents anincrease in the loss of approximately $1,447,000, or 35% over the third quarterof 2009.  For the nine months ended September 30,2010, and 2009, net loss was approximately $16,630,000 and $14,399,000,respectively.

 

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**Liquidity and Capital Resources**

 
| ** **                                | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                                | ** ** | **(in thousands)**                                 | ** ** |
| Cash and cash equivalents                 |       | $                                                       | 3,040      |   | $ | 4,335 |   |
| Working capital                           |       | (8,514                                                  | )          | (104 | ) |
| Cash provided by (used in)                |       |                                                    |       |   |   |
| Operating activities                      |       | (7,144                                                  | )          | (16,544 | ) |
| Investing activities                      |       | (25,853                                                 | )          | (2,760 | ) |
| Financing activities                      |       | 13,433                                                  |       | 9,282 |   |
| Net decrease in cash and cash equivalents |       | $                                                       | (19,564    | ) | $ | (10,022 | ) |
| Current ratio                             |       | 0.4                                                     |       | 1.0 |   |

 

Ourcash requirements depend on many factors including, but not limited to, thecost to build our flywheels and frequency regulation facilities, research anddevelopment 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 September 30, 2010,had an accumulated deficit of approximately $222.6 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.  During the third quarter of 2010, weredeployed a substantial portion of the three megawatts from the pilot programto the site of our 20 MW plant in Stephentown, New York. This plant will costapproximately $69 million. We broke ground in November 2009, and we expect tocomplete the production of most of the flywheels needed for that plant in2010.  Although we expect to begin togenerate revenue from part of that facility late in 2010, we do not expect tocomplete construction until the end of the first quarter of 2011.  We also plan to continue the development ofadditional merchant plants, and are currently evaluating several sites for thatpurpose. The pace of development andthe completion dates for future plants will depend on obtaining sufficientfunding.

 

Our first 20 MW plant isbeing financed by the $43 million loan guaranteed by the DOE and provided bythe FFB, together with the $26 million of cash and in-kind assets that wecontributed to the project on August 6, 2010, upon closing the loan. Weanticipate receiving monthly disbursements from this loan, based upon eligibleproject spending.  Each disbursement willbe subject to the satisfaction of certain conditions.  In 2010 and 2011, we will continue to havecapital needs to fund operations and the ongoing deployment of frequencyregulation facilities. We have $3 million cash on hand as of September 30,2010, which can be used for general corporate purposes, and an additional $3million which belongs to SRS and thus can only be used for eligible projectcosts for the Stephentown plant (included in Restricted cash on our balancesheet).

 

Thelast day to receive an advance under the FFB Future Advance Promissory Note foreligible project costs is May 30, 2012, and the loan will mature on June 15,2030.  Each advance bears interest at aper annum rate determined by the Secretary of the Treasury as of the date ofthe advance and will be based on the Treasury yield curve and the scheduledprincipal installments for such advance, plus a .375% premium. The interestrate on the September 2010 loan draw was 2.664% plus the .375% premium, or 3.039%total. Interest on advances under the FFB loan is payable quarterly in arrears.Principal payments are due in 72 equal quarterly installments, beginning onSeptember 15, 2012 through June 15, 2030.

 

TheFFB loan also contains certain financial covenants.  As of the last day of each fiscal quarter,our subsidiary SRS, as borrower under the loan, is required to maintain aminimum ratio of current assets to current liabilities, maintain a maximumleverage ratio and, commencing the first fiscal quarter to end after the firstanniversary of the project completion date, maintain a specified debt servicecoverage ratio.  In addition, after theproject completion date, SRS will be required to maintain an amount equal tothe debt 

 

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servicereserve requirement unless an alternative form of security reasonablysatisfactory to the DOE has been provided; provided that, in the event of anywithdrawal from the debt service reserve account, we must restore the amount ondeposit in the debt service reserve account within ninety days of suchwithdrawal. The debt service reserve requirement is an amount equal to theamount of debt service due on the immediately succeeding two quarterly paymentdates.  Commencing on the firstanniversary of the project completion date, SRS will be required to maintainspecified amounts in a maintenance reserve account and project capitalaccount.  If SRS draws from theseaccounts, it is required to restore the accounts to the required amounts withinninety days of the withdrawal. The required maintenance reserve is an amountprojected to be equal to six months of plant maintenance and fixed operatingcosts, currently anticipated to be approximately $559,000 for the initial yearof project operation.  The amountrequired to be maintained in the reserve account will be recalculated prior tothe beginning of each fiscal year.  Wehave guaranteed, as sole owner of the borrower, to replenish the debt servicereserve account up to a maximum of $2,397,000. The project capital account requirement is $1,000,000.

 

Theterms of the FFB loan also limit the ability of SRS to pay dividends to BeaconPower Corporation out of cash generated from the Stephentown operations, otherthan distributions for reimbursement of eligible project expenses. Among otherconditions, such dividends or distributions to us can be made only after (i)the physical completion of the project, (ii) 6 months have passed from thetime SRS has made two scheduled principal and interest payments on the loan(which payments are scheduled to begin in September 2012) and SRS has otherwiseachieved “project completion” with respect to the Stephentown project; (iii)SRS has generated cash available for servicing the debt in the previous twofiscal quarters sufficient to meet the next scheduled payment, and has a12-month debt service coverage ratio of at least 1.40:1.00; (iv) the debtservice reserve account will exceed required amounts after giving effect to thedistribution, and (v) no event of default or potential event of default existsunder the loan documents, before or giving effect to the distribution.  Cash generated by SRS from the Stephentownproject thus may not be available to Beacon Power Corporation for our generalcorporate operating purposes as and when it is generated by theStephentown project.

 

Basedon our projected cash usage rates, exclusive of the anticipated borrowings fromthe FFB loan and our equity contribution to the Stephentown project, we believewe have sufficient cash to fund our operations into the fourth quarter of 2010.We estimate that we will need to raiseadditional funds during the remainder of 2010 and in 2011 through the issuanceof equity securities or debt in order to fund operations and execute ourbusiness plan.  We estimate that we willneed to raise approximately $15 to $20 million during the remainder of 2010 and2011 in order to fund operations. Additional funds would be required to order long-lead items and beginconstruction of our second plant from a combination of project finance andequity.

 

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 of funds disbursement from the FFBloan, the receipt of funds from the NYSERDA grant and the DOE stimulus grant

 

·                  Corporate or project financing and itsavailability

 

·                  Equity transactions and the amounts thereof

 

·                  Sale of turnkey plants and the associatedmargin and terms and conditions of those sales

 

·                  Receipt of environmental and site-relatedpermits and approvals

 

·                  Receipt of grid interconnection approvals.

 

InNovember 2009, we were notified by the Department of Energy that we have beenawarded 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.  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 sold Aspire 1,543,210shares of common stock at a purchase price of $0.324 per share, for anaggregate purchase price of $500,000 on July 6, 2010.  Following this initial purchase, from time to

 

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time over the 26-month term of the agreement, wehave the right, in our sole discretion, to present Aspire with a purchasenotice directing them to purchase up to 400,000 shares of our common stock pertrading day (up to an aggregate of $24.5 million of our common stock) at aprice per share calculated as the lower of (i) the lowest trading price on thedate of 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.  Under the terms of the agreement unless ourstockholders approve the transaction at some later date, we may not sell sharesto Aspire at a purchase price less than $0.34, which is the sum of the lastconsolidated closing sale price of our common stock on July 1, 2010, thetrading day immediately preceding the date of the purchase agreement, and $0.03.We will control the timing and amount of any sales of our common stock toAspire, and will always know the purchase price before we give notice to sellany shares to Aspire.  There are notrading volume requirements or restrictions under the agreement.  The net proceeds we receive will depend onthe frequency and prices at which we sell shares of stock to Aspire, includingthe availability of the facility in light of the minimum purchase price.  The maximum proceeds we may receive over the26-month term of the agreement is $25 million. These sales are being made under our Registration Statements on FormS-3.  We also entered into a RegistrationRights Agreement 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.Following the initial purchase, and as of September 30, 2010, we have sold800,000 shares to Aspire for $0.34 per share, for gross proceeds of $272,000.

 

**Operating Activities**

 

Netcash used in operating activities was approximately $7,144,000 and $16,544,000for the nine months ended September 30, 2010, and 2009, respectively.  Theprimary component of the negative cash flows from operations is from our netlosses.  For the nine months ended September 30, 2010, we had a net lossof approximately $16,630,000.  Adjustments to reconcile net loss to cashflow in 2010 include non-cash stock compensation of approximately $684,000,depreciation and amortization of approximately $1,591,000, interest expense onwarrants of approximately $39,000, warrants issued to a service provider ofapproximately $16,000, partially offset by a net increase in deferred rent ofapproximately ($99,000) and changes in operating assets and liabilities ofapproximately $7,255,000.

 

Duringthe same period in 2009, we had a net loss of approximately $14,399,000. Adjustments to reconcile net loss to cash flow for the period include non-cashstock compensation of approximately $746,000, depreciation and amortization ofapproximately $1,346,000, interest expense on warrants of approximately$34,000, loss on disposition of fixed asset of approximately $7,000, partiallyoffset by a net increase in deferred rent of approximately ($80,000) andchanges in operating assets and liabilities of approximately ($4,198,000).

 

**Investing Activities**

 

Netcash used in investing activities was approximately $25,854,000 and $2,760,000for the nine months ending September 30, 2010, and 2009, respectively.  The principal use of cash in 2010 was thepurchase and manufacture of property and equipment in the amount ofapproximately $19,484,000, increase of restricted cash of approximately$3,016,000 (representing the balance of the cash contributed to SRS), increasein other assets (patents) of approximately $105,000, and advance payments tosuppliers for materials to be used in the manufacture of property and equipmentof approximately $3,249,000.  For thenine months ended September 30, 2009, the principal use of cash was thepurchase of property and equipment in the amount of approximately $2,435,000,advance payments to suppliers for materials to be used in the manufacture ofproperty and equipment of approximately $270,000, increase in restricted cashof approximately $3,000, and increase in other assets (patents) ofapproximately $52,000.

 

**Financing Activities**

 

Netcash provided by financing activities was approximately $13,433,000 and$9,282,000 for the first nine months of 2010 and 2009, respectively.  In 2010, funds were provided by a loan drawon the FFB loan guaranteed by the DOE of approximately $8,200,000, the sale ofstock to Seaside and Aspire of approximately $2,238,000, the exercise ofwarrants of approximately $5,902,000 and the issuance of stock under theemployee stock purchase plan of approximately $60,000.   These were offset partially by cash paid forfinancing costs (primarily for the FFB loan) of approximately $2,475,000 andapproximately $492,000 in repayment of the MassDev loan.  For the first nine months of 2009, funds wereprovided by the sale of stock to Seaside of approximately $10,150,000 and theissuance of stock under the employee stock purchase plan of approximately$60,000.  These were partially offset bycash paid for financing costs (primarily for the FFB loan) of approximately$928,000.

 

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

 
| ** **                                                     | ** ** | **Description of Commitment** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                     | ** ** | **Operating  leases**                   | ** ** | **Purchase  Obligations** | ** ** | **MassDev  Loan** | ** ** | **Federal  Financing  Bank Loan** | ** ** | **Total** | ** ** |
| Period ending:                                            |       |                                    |       |   |   |   |   |   |   |   |   |
| September 30, 2010                                             |       | $                                       | —     |   | $ | 22,636,516 |   | $ | — |   | $ | — |   | $ | 22,636,516 |   |
| December 31, 2010                                              |       | 186,688                                 |       |   |   | 168,429 |   | — |   | 355,117 |   |
| December 31, 2011                                              |       | 753,188                                 |       |   |   | 704,406 |   | — |   | 1,457,594 |   |
| December 31, 2012                                              |       | 778,937                                 |       |   |   | 751,678 |   | 227,765 |   | 1,758,380 |   |
| December 31, 2013                                              |       | 804,689                                 |       |   |   | 803,318 |   | 455,530 |   | 2,063,537 |   |
| December 31, 2014                                              |       | 618,000                                 |       |   |   | 857,887 |   | 455,530 |   | 1,931,417 |   |
| December 31, 2015                                              |       | —                                  |       |   |   | 677,694 |   | 455,530 |   | 1,133,224 |   |
| Thereafter                                                     |       | —                                  |       |   |   | — |   | 6,605,191 |   | 6,605,189 |   |
| Total Commitments                                              |       | $                                       | 3,141,502  |   | $ | 22,636,516 |   | $ | 3,963,412 |   | $ | 8,199,546 |   | $ | 37,940,974 |   |
| Non-cancellable purchase obligations:                          |       |                                    |       | $ | 15,000,992 |   |   |   |   |   |   |   |
| Less advance payments to suppliers                             |       |                                    |       | (3,484,772 | ) |   |   |   |   |   |   |
| Non-cancellable purchase obligations net of  advance payments: |       |                                    |       | $ | 11,516,220 |   |   |   |   |   |   |   |

 

Asof September 30, 2010, we had purchase commitments with our suppliers ofapproximately $22.6 million. Of this amount, approximately $15 millionrepresents firm, non-cancelable commitments against which we have made advancepayments totaling $3.5 million, leaving a net non-cancelable obligation ofapproximately $11.5 million as of September 30, 2010.  Total purchase commitments includeapproximately $19.6 million for materials required to build the flywheels,electronic control modules and other ancillary equipment needed for Stephentown,of which $13.0 million are non-cancelable as of September 30, 2010. Theremaining commitments are for 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 September 30, 2010, we had approximately$3,000,000 of cash equivalents that were held in a non-interest bearingchecking account.  Approximately $753,000of our cash on hand at September 30, 2010, was invested in mutual fundsinvested primarily in government funds, such as Treasury Bills at a brokeragefirm that has purchased supplementary insurance through Lloyd’s of London. Thisinsurance coverage provides protection above the Securities Investor ProtectionCorporation (SIPC) coverage in the event that the broker becomesinsolvent.  SIPC protects against theloss of securities up to a total of $500,000 (of which $100,000 may be in cash)per client.  The supplemental insuranceprovided by the broker would cover investments at that brokerage firm up to amaximum of $1 billion, including up to $1.9 million per client for the cashportion of any remaining shortfall.  A10% change in interest rates would change the investment income realized on anannual basis by an immaterial amount. SIPC and the supplemental insurance donot cover market losses; however, management believes the risk of substantialmarket losses is low because our funds are invested primarily in governmentfunds.  In addition, SRS hold $3 millionin a non-interest-bearing restricted cash account, managed by the collateralagent that can be used only to fund eligible project costs, of which $250,000 isinsured by the Federal Deposit Insurance Corporation (FDIC).

 

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**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 September 30,2010.

 

*InternalControl over Financial Reporting*

 

Therewas no change in our internal control over financial reporting (as defined inRules 13a-15(f) and 15d-15(f) promulgated under the Securities Act of 1934) thatmaterially affected, or is reasonably likely to materially affect, suchinternal control over financial reporting during the quarter ended September30, 2010.

 

**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 Annual Report on Form10-K for the year ended December 31, 2009, filed with the SEC on March 15,2010, and the additional or supplemented risk factor shown below.  Those factors could materially affect ourbusiness, financial condition or future results. The risks described in suchreports are not the only risks we face. Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial may also havea materially adverse effect on our business, financial condition and/oroperating results.

 

Thefactor described on page 29 of the Annual Report on Form 10-K under the caption“Our stock may be removed from The Nasdaq Stock Market” is hereby updated toreflect the following information:   OnSeptember 14, 2010, at the end of the previously applicable grace periodsprovided under the Nasdaq Listing Rules, we received a letter from The NasdaqStock Market informing us that our common shares had failed to comply with the$1.00 minimum bid price required for continued listing on The Nasdaq CapitalMarket under Listing Rule 5550(a)(2), and as a result, without further actionour common shares would be subject to delisting.  The letter further stated we could appeal theNasdaq Staff delisting determination to a Nasdaq listing qualificationspanel.  It added that the authority ofthe panel to grant additional time to companies was recently modified such thata panel could allow continued listing for up to 180 calendar days fromSeptember 14, 2010, if deemed appropriate. We have appealed the Staff’s determination.  The appeal will stay the delisting of ourcommon stock from The Nasdaq Capital Market until a hearing is completed andthe listing qualifications panel issues its written decision.  Our hearing was held in October 2010, and weexpect to receive a decision in late November 2010.

 

Ourappeal requesting additional time highlighted the three 20 MW frequencyregulation facilities in development, with revenues from the first plantexpected before the end of 2010.  Inaddition, we expect to see tangible progress toward pay-for-performance markettariffs in the next six months.  Suchtariffs would provide a substantial improvement in our financial outlook.  There can be no assurance that the listingqualifications panel will approve our request for additional time for continuedlisting, nor that we will be able to meet the Nasdaq Stock Market’s minimum bidprice requirements within any extended grace period, and we therefore may loseour eligibility for quotation on the Nasdaq Stock Market.  At our annual meeting of stockholders on July21, 2010, our stockholders approved the implementation of a reverse stock splitat a ratio of between 1-for-2 and 1-for-10, which could be used, in thediscretion of the Board at the ratio (if any) chosen by the Board, to regaincompliance with the minimum bid price rule, either now or during any extensionor listing panel appeals process that we may elect to pursue.  No guarantees can be made, however, that wewill regain compliance with Nasdaq’s ongoing listing rules.

 

***If frequency regulation service pricing decreases over anextended period, it may have a material adverse impact on plant revenues, cashflow and our ability to raise equity or pay debt.***

 

Over the longer term, the market pricing forfrequency regulation services tends to follow the pricing for energy. Hence,when the price of energy drops, frequency regulation prices may be adverselyaffected, which could materially affect our revenue.

 

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Electricityprices have been below recent historical averages due to the economicrecession, and the impact of a decrease in natural gas commodity prices.  While we believe these are temporary trends,if they should continue indefinitely, this could have a material adverse effecton revenues, cash flow and our ability to raise equity or pay debt.

 

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

 

OnAugust 19, 2010, we issued warrants to purchase 116,666 shares of our commonstock at a purchase price of $0.72 per share to three individuals in connectionwith services provided to us by a service provider.  The warrants will expire on June 15, 2015.  The warrants were issued in a transactionexempt from the registration requirements of the Securities Act of 1933, asamended, under section 4(2) thereof or under one or more exemptions promulgatedthereunder, based on the nature of the investors and the circumstances of theoffering.

 

**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              |       | &      |       | Common  Agreement by and among Stephentown Regulation Services LLC, U.S. Department  of Energy and Midland Loan Services, Inc. dated August 6, 2010.      |
|              |       |       |       |                                                                                                                                                      |
| 10.2              |       | +          |       | Corporate  Guaranty from Beacon Power Corporation to the U.S. Department of Energy and  Midland Loan Services, Inc. dated August 6, 2010.                 |
|              |       |       |       |                                                                                                                                                      |
| 10.3              |       | +          |       | Completion  Guaranty from Beacon Power Corporation to the U.S. Department of Energy and  Midland Loan Services, Inc. dated August 6, 2010.                |
|              |       |       |       |                                                                                                                                                      |
| 10.4              |       | +          |       | Note  Purchase Agreement by and among the Federal Financing Bank, Stephentown  Regulation Services, LLC and the Secretary of Energy dated August 6, 2010. |

 

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| **Exhibit ** | ** ** | ** ** | ** ** | ** **                                                                                                                                             |
|-------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**        | ** ** | **Ref**    | ** ** | **Description of Document**                                                                                                                  |
|              |       |       |       |                                                                                                                                                   |
| 10.5              |       | +          |       | Future  Advance Promissory Note dated August 6, 2010 issued by Stephentown Regulation  Services LLC to the Federal Financing Bank.                     |
|              |       |       |       |                                                                                                                                                   |
| 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.).                                                                                           |
| & | Filed  herewith.  Confidential treatment has  been requested as to certain portions, which portions have been separately  filed with the Securities and Exchange Commission. |
| +     | Filed  herewith.                                                                                                                                                                  |

 

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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:    November 9, 2010 |                                                 | By: | /s/  F. William Capp |
|                                     | F.  William Capp                                     |
|                                     | President  and Chief Executive Officer               |
|                                     | Principal  Executive  Officer                   |
|                                     |                                                 |   |
| November 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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