**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

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**x****Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2006**

**or**

**o****Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (For the transition period from        to        ).**

**Commission File Number: 000-31973**

**Beacon Power Corporation**

(Exact name of registrant as specified in its charter)

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

 

| **234 Ballardvale  Street**              |   | ** **     |
|------------------------------------------|--------|----------------|
| **Wilmington, Massachusetts**            |   | **01887-1032** |
| (Address of principal executive offices) |   | (Zip code)     |

 

**(978) 694-9121**

(Registrant’s telephone number, including area code)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  x Yes  o No

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act.)

| Large accelerated filer  o |   | Accelerated  filer  o |   | Non-accelerated  filer  x |
|---------------------------------|--------|----------------------------|--------|--------------------------------|

 

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

The number of shares of the Registrant’s common stock, par value $.01 per share, outstanding as of October 27, 2006 was 59,367,374.

 

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**BEACON POWERCORPORATION AND SUBSIDIARY(A Development Stage Company)Table of Contents**
|                                | ** ** | ** ** | ** **                                                                                                                                                                                                                                       | ** ** | **Page** | ** ** |
|--------------------------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| PART  I. Financial Information |       |       |                                                                                                                                                                                                                                             |
|                           | Item 1.    |       | Financial Statements                                                                                                                                                                                                                             |       |     |       |
|                           |       |       | Consolidated  Balance Sheets at September 30, 2006 (unaudited) and December 31, 2005  (audited).                                                                                                                                                 |       | 1        |       |
|                           |       |       | Unaudited  Consolidated Statements of Operations for the three months ended September  30, 2006 and 2005, the nine months ended September 30, 2006 and 2005 and for  the period from May 8, 1997 (date of inception) through September 30, 2006. |       | 2        |       |
|                           |       |       | Unaudited  Consolidated Statements of Cash Flows for the nine months ended  September 30, 2006 and 2005 and for the period from May 8, 1997 (date of  inception) through September 30, 2006.                                           |       | 3        |       |
|                           |       |       | Notes to  Unaudited Consolidated Financial Statements.                                                                                                                                                                                           |       | 4        |       |
|                           | Item 2     |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.                                                                                                                                                     |       | 11       |       |
|                           | Item 3.    |       | Quantitative  and Qualitative Disclosures about Market Risk.                                                                                                                                                                                     |       | 19       |       |
|                           | Item 4.    |       | Controls and  Procedures.                                                                                                                                                                                                                        |       | 19       |       |
| PART II. Other  Information    |       |       |                                                                                                                                                                                                                                             |
|                           | Item 1.    |       | Legal Proceedings.                                                                                                                                                                                                                               |       | 20       |       |
|                           | Item  1A.  |       | Risk Factors.                                                                                                                                                                                                                                    |       | 20       |       |
|                           | Item 2.    |       | Unregistered  Sales of Equity Securities and Use of Proceeds.                                                                                                                                                                                    |       | 20       |       |
|                           | Item 3.    |       | Defaults Upon  Senior Securities.                                                                                                                                                                                                                |       | 20       |       |
|                           | Item 4.    |       | Submission of  Matters to a Vote of Security Holders.                                                                                                                                                                                            |       | 20       |       |
|                           | Item 5.    |       | Other Information.                                                                                                                                                                                                                               |       | 21       |       |
|                           | Item  6.   |       | Exhibits.                                                                                                                                                                                                                                        |       | 21       |       |
| Signatures                     |       | 22         |                                                                                                                                                                                                                                             |

 

i

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**PART 1 — FINANCIALINFORMATION**

**Item 1. Financial Statements**

**BEACON POWERCORPORATION AND SUBSIDIARY(A Development Stage Company)Consolidated Balance Sheets**
| ** **                                                                                                                                                                       | ** ** | **September 30,**    | ** ** | **December 31,**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                       | ** ** | **2006 (unaudited)** | ** ** | **2005 (audited)** | ** ** |
| **Assets**                                                                                                                                                                       | ** ** | ** **                | ** ** | ** **              | ** ** |
| Current assets:                                                                                                                                                                  |       |                      |       |                    |       |
| Cash and cash equivalents                                                                                                                                                        |       | $                         | 8,164,431  |                    | $          | 13,890,162 |   |
| Accounts receivable, trade, net                                                                                                                                                  |       | 174,304                   |       | 588,440                 |       |
| Unbilled costs on contracts in progress                                                                                                                                          |       | 247,470                   |       | 437,759                 |       |
| Prepaid expenses and other current assets                                                                                                                                        |       | 254,311                   |       | 777,385                 |       |
| Total current assets                                                                                                                                                             |       | 8,840,516                 |       | 15,693,746              |       |
| Property and  equipment, net                                                                                                                                                     |       | 281,839                   |       | 212,296                 |       |
| Restricted cash                                                                                                                                                                  |       | 219,568                   |       | 219,568                 |       |
| Total assets                                                                                                                                                                     |       | $                         | 9,341,923  |                    | $          | 16,125,610 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                   | ** ** | ** **                | ** ** | ** **              | ** ** |
| Current  liabilities:                                                                                                                                                            |       |                      |       |                    |       |
| Accounts payable                                                                                                                                                                 |       | $                         | 128,831    |                    | $          | 137,290 |   |
| Accrued compensation and benefits                                                                                                                                                |       | 677,737                   |       | 151,318                 |       |
| Other accrued expenses                                                                                                                                                           |       | 873,763                   |       | 844,742                 |       |
| Advance billings on contracts                                                                                                                                                    |       | 261,771                   |       | 74,820                  |       |
| Accrued contract loss                                                                                                                                                            |       | 661,845                   |       | 548,614                 |       |
| Restructuring reserve                                                                                                                                                            |       | 438,924                   |       | 713,469                 |       |
| Total current liabilities                                                                                                                                                        |       | 3,042,871                 |       | 2,470,253               |       |
|                                                                                                                                                                             |       |                      |       |                    |       |
| Commitments and  contingencies (Note 5)                                                                                                                                          |       |                      |       |                    |       |
|                                                                                                                                                                             |       |                      |       |                    |       |
| Stockholders’  equity:                                                                                                                                                      |       |                      |       |                    |       |
| Preferred Stock, $.01 par value; 10,000,000 shares  authorized; no shares issued or outstanding                                                                                  |       | —                    |       | —                  |       |
| Common stock, $.01 par value; 110,000,000 shares  authorized; 59,307,374 and 58,700,036 shares issued and outstanding at September  30, 2006 and December 31, 2005, respectively |       | 593,074                   |       | 587,000                 |       |
| Deferred stock compensation                                                                                                                                                      |       | (142,684                  | )          | (1,063,145              | )          |
| Additional paid-in-capital                                                                                                                                                       |       | 154,066,259               |       | 153,089,842             |       |
| Deficit accumulated during the development stage                                                                                                                                 |       | (147,504,758              | )          | (138,245,501            | )          |
| Treasury stock, 421,692 shares at cost                                                                                                                                           |       | (712,839                  | )          | (712,839                | )          |
| Total stockholders’ equity                                                                                                                                                  |       | 6,299,052                 |       | 13,655,357              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                 |       | $                         | 9,341,923  |                    | $          | 16,125,610 |   |

 

Seenotes to unaudited consolidated financial statements.

1

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**BEACON POWERCORPORATION AND SUBSIDIARY(A Development Stage Company)Consolidated Statements of Operations (Unaudited)**
| ** **                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** **                      | ** ** | ** ** | ** ** | **Cumulative  from**          | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** **                      | ** ** | ** ** | ** ** | **May 8, 1997**     | ** ** |
| ** **                                  | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** **                      | ** ** | ** ** | ** ** | **(date of  inception)** | ** ** |
| ** **                                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** | **through  September 30,** | ** ** |
| ** **                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006**                        | ** ** | **2005**   | ** ** | **2006**                      | ** ** |
| Revenue                                     |       | $                                                    | 277,343    |                                                | $          | 304,064                         |       | $          | 775,376    |                          | $          | 1,258,503 |   | $ | 3,138,512 |   |
| Cost of goods sold                          |       | 237,986                                              |       | 347,554                                             |       | 689,329                         |       | 1,352,018  |       | 3,722,438                     |       |
| Gross profit                                |       | 39,357                                               |       | (43,490                                             | )          | 86,047                          |       | (93,515    | )          | (583,926                      | )          |
| Operating expenses:                         |       |                                                 |       |                                                |       |                            |       |       |       |                          |       |
| Selling, general  and administrative        |       | 1,715,617                                            |       | 1,849,322                                           |       | 5,273,025                       |       | 4,130,271  |       | 43,863,218                    |       |
| Research and  development                   |       | 1,314,390                                            |       | 357,703                                             |       | 3,462,230                       |       | 994,234    |       | 58,746,008                    |       |
| Loss on sales and  contract commitments     |       | 279,083                                              |       | —                                              |       | 966,869                         |       | 1,056,566  |       | 2,877,141                     |       |
| Depreciation and  amortization              |       | 24,334                                               |       | 20,994                                              |       | 72,752                          |       | 62,103     |       | 4,293,749                     |       |
| Restructuring  charges                      |       | —                                               |       | —                                              |       | —                          |       | —     |       | 2,159,280                     |       |
| Loss on  impairment of assets               |       | —                                               |       | —                                              |       | —                          |       | —     |       | 4,663,916                     |       |
| Total operating  expenses                   |       | 3,333,424                                            |       | 2,228,019                                           |       | 9,774,876                       |       | 6,243,174  |       | 116,603,312                   |       |
| Loss from operations                        |       | (3,294,067                                           | )          | (2,271,509                                          | )          | (9,688,829                      | )          | (6,336,689 | )          | (117,187,238                  | )          |
| Other income (expense):                     |       |                                                 |       |                                                |       |                            |       |       |       |                          |       |
| Interest income                             |       | 115,079                                              |       | 27,423                                              |       | 410,162                         |       | 59,433     |       | 4,455,081                     |       |
| Interest expense                            |       | —                                               |       | —                                              |       | —                          |       | —     |       | (1,093,703                    | )          |
| Gain on sale of  investment                 |       | —                                               |       | —                                              |       | —                          |       | —     |       | 3,562,582                     |       |
| Other income  (expense)                     |       | 13,983                                               |       | 100,644                                             |       | 19,410                          |       | 124,033    |       | (235,286                      | )          |
| Total other income  (expense), net          |       | 129,062                                              |       | 128,067                                             |       | 429,572                         |       | 183,466    |       | 6,688,674                     |       |
| Net loss                                    |       | (3,165,005                                           | )          | (2,143,442                                          | )          | (9,259,257                      | )          | (6,153,223 | )          | (110,498,564                  | )          |
| Preferred stock dividends                   |       | —                                               |       | —                                              |       | —                          |       | —     |       | (36,825,680                   | )          |
| Accretion of convertible preferred stock    |       | —                                               |       | —                                              |       | —                          |       | —     |       | (113,014                      | )          |
| Loss to common shareholders                 |       | $                                                    | (3,165,005 | )                                                   | $          | (2,143,442                      | )          | $          | (9,259,257 | )                             | $          | (6,153,223 | ) | $ | (147,437,258 | ) |
| Loss per share, basic and diluted           |       | $                                                    | (0.06      | )                                                   | $          | (0.04                           | )          | $          | (0.16      | )                             | $          | (0.13 | ) |   |   |
| Weighted-average  common shares outstanding |       | 59,218,443                                           |       | 48,524,912                                          |       | 58,958,108                      |       | 45,634,899 |       |                          |       |

 

Seenotes to unaudited consolidated financial statements.

2

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**BEACON POWERCORPORATION AND SUBSIDIARY(A Development Stage Company)Consolidated Statements of Cash Flows (Unaudited)**
| ** **                                                                   | ** ** | ** **                                              | ** ** | ** **                          | ** ** | **Cumulative from**          | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                              | ** ** | ** **                          | ** ** | **May 8, 1997**         | ** ** |
| ** **                                                                   | ** ** | ** **                                              | ** ** | ** **                          | ** ** | **(date of inception)** | ** ** |
| ** **                                                                   | ** ** | **Nine months ended September 30,** | ** ** | **through September 30,** | ** ** |
| ** **                                                                   | ** ** | **2006**                                                | ** ** | **2005**                            | ** ** | **2006**                          | ** ** |
| Cash flows from  operating activities:                                       |       |                                                    |       |                                |       |                              |       |
| Net loss                                                                     |       | $                                                       | (9,259,257 | )                                   | $          | (6,153,223                        | )          | $ | (110,498,564 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                                    |       |                                |       |                              |       |
| Depreciation and amortization                                                |       | 72,752                                                  |       | 62,103                              |       | 4,293,750                         |       |
| Loss on sale of fixed assets                                                 |       | —                                                  |       | 87,365                              |       | 196,169                           |       |
| Impairment of assets                                                         |       | (40,389                                                 | )          | (111,754                            | )          | 4,491,638                         |       |
| Restricted cash                                                              |       | —                                                  |       | 90,443                              |       | (219,568                          | )          |
| (Expenses paid) restructuring charge                                         |       | (274,545                                                | )          | (257,660                            | )          | 438,924                           |       |
| Reserve for officers note                                                    |       | —                                                  |       | (102,044                            | )          | —                            |       |
| Interest expense relating to issuance of warrants                            |       | —                                                  |       | —                              |       | 371,000                           |       |
| Non-cash charge for change in option terms                                   |       | —                                                  |       | —                              |       | 346,591                           |       |
| Non-cash charge for settlement of lawsuit                                    |       | —                                                  |       | —                              |       | 303,160                           |       |
| Amortization of deferred consulting expense, net                             |       | —                                                  |       | —                              |       | 1,160,784                         |       |
| Amortization of deferred stock compensation                                  |       | 920,461                                                 |       | 621,153                             |       | 3,557,037                         |       |
| Options and warrants issued for consulting services                          |       | —                                                  |       | —                              |       | 1,585,654                         |       |
| Services and interest expense paid in preferred  stock                       |       | —                                                  |       | —                              |       | 11,485                            |       |
| Gain on sale of investments                                                  |       | —                                                  |       | —                              |       | (3,562,582                        | )          |
| Stock-based compensation                                                     |       | 943,589                                                 |       | —                              |       | 943,589                           |       |
| Changes in operating assets and liabilities:                                 |       |                                                    |       |                                |       |                              |       |
| Accounts receivable                                                          |       | 414,136                                                 |       | (92,391                             | )          | (174,304                          | )          |
| Inventory                                                                    |       | —                                                  |       | 222,593                             |       | —                            |       |
| Unbilled costs under government contracts                                    |       | 190,289                                                 |       | (600,625                            | )          | (247,470                          | )          |
| Prepaid expenses and other current assets                                    |       | 523,074                                                 |       | 561,758                             |       | (353,971                          | )          |
| Accounts payable                                                             |       | (8,459                                                  | )          | (269,369                            | )          | 128,831                           |       |
| Accrued compensation and benefits                                            |       | 526,419                                                 |       | 59,766                              |       | 677,737                           |       |
| Advance billings on contracts                                                |       | 186,951                                                 |       | —                              |       | 261,771                           |       |
| Accrued interest                                                             |       | —                                                  |       | —                              |       | 275,560                           |       |
| Accrued loss on contract commitments                                         |       | 113,231                                                 |       | 299,235                             |       | 661,845                           |       |
| Other accrued expenses and current liabilities                               |       | 29,021                                                  |       | 261,196                             |       | 882,433                           |       |
| Net cash used in operating activities                                        |       | (5,662,727                                              | )          | (5,321,454                          | )          | (94,468,501                       | )          |
| Cash flows from  investing activities:                                       |       |                                                    |       |                                |       |                              |       |
| Purchase of investments                                                      |       | —                                                  |       | (1,000,000                          | )          | (1,190,352                        | )          |
| Sale of investments                                                          |       | —                                                  |       | —                              |       | 4,752,934                         |       |
| Increase in other assets                                                     |       | —                                                  |       | —                              |       | (412,072                          | )          |
| Purchases of property and equipment                                          |       | (142,524                                                | )          | (39,713                             | )          | (8,636,928                        | )          |
| Sale of property and equipment                                               |       | 40,618                                                  |       | 28,800                              |       | 239,215                           |       |
| Net cash used in investing activities                                        |       | (101,906                                                | )          | (1,010,913                          | )          | (5,247,203                        | )          |
| Cash flows from  financing activities:                                       |       |                                                    |       |                                |       |                              |       |
| Initial public stock offering, net of expenses                               |       | —                                                  |       | —                              |       | 49,341,537                        |       |
| Private stock offering, net of expenses                                      |       | —                                                  |       | 3,953,571                           |       | 17,108,477                        |       |
| Payment of dividends                                                         |       | —                                                  |       | —                              |       | (1,159,373                        | )          |
| Shares issued under employee stock purchase plan                             |       | 10,302                                                  |       | 1,738                               |       | 142,367                           |       |
| Exercise of employee stock options                                           |       | 28,600                                                  |       | 656,159                             |       | 2,177,822                         |       |
| Cash paid for financing costs                                                |       | —                                                  |       | 327,646                             |       | —                            |       |
| Issuance of preferred stock                                                  |       | —                                                  |       | —                              |       | 32,868,028                        |       |
| Repayment of subscription receivable                                         |       | —                                                  |       | —                              |       | 5,000,000                         |       |
| Proceeds from capital leases                                                 |       | —                                                  |       | —                              |       | 495,851                           |       |
| Repayment of capital leases                                                  |       | —                                                  |       | —                              |       | (1,031,395                        | )          |
| Repurchase company stock                                                     |       | —                                                  |       | (319,420                            | )          | (613,179                          | )          |
| Proceeds from notes payable issued to investors                              |       | —                                                  |       | —                              |       | 3,550,000                         |       |
| Net cash provided by (used in) financing activities                          |       | 38,902                                                  |       | 4,619,694                           |       | 107,880,135                       |       |
| (Decrease)  increase in cash and cash equivalents                            |       | (5,725,731                                              | )          | (1,712,673                          | )          | 8,164,431                         |       |
| Cash and cash  equivalents, beginning of period                              |       | 13,890,162                                              |       | 5,097,188                           |       | —                            |       |
| Cash and cash  equivalents, end of period                                    |       | $                                                       | 8,164,431  |                                | $          | 3,384,515                         |       | $ | 8,164,431 |   |
| Supplemental  disclosure of cash flow information:                           |       |                                                    |       |                                |       |                              |       |
| Cash paid for interest                                                       |       | $                                                       | —     |                                | $          | —                            |       | $ | 488,126 |   |
| Cash paid for taxes                                                          |       | $                                                       | —     |                                | $          | —                            |       | $ | 32,750 |   |
| Assets acquired  through capital lease                                       |       | $                                                       | —     |                                | $          | —                            |       | $ | 535,445 |   |

 

Seenotes to unaudited consolidated financial statements.

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**BEACON POWERCORPORATION AND SUBSIDIARY(A Development Stage Company)Notes to Unaudited Consolidated Financial Statements**

**Note 1.  Nature of Business and Operations**

*Natureof Business*

Beacon Power Corporation(the “Company”, “Beacon”, “we”, “our”, or “us”) (a development stage company)was incorporated on May 8, 1997.  Sinceour inception, we have been primarily engaged in the development of flywheeldevices for kinetic energy storage and conversion of that kinetic energy touseful electrical power.  During 2000 wecompleted an initial public offering of our common stock and raisedapproximately $49.3 million net of offering expenses, and during 2005 we raisedapproximately $17 million via private placements of our common stock.  We expect to generate revenues in the futurefrom the commercialization of our flywheel energy storage systems to supplyfrequency regulation services to the electricity grid.  In addition, we believe as thecommercialization of our technologies continues other cost-effective applicationsfor our flywheel systems will develop that will provide additional revenues.Because we have not yet generated a significant amount of revenue from ourexpected principal operations, we are accounted for as a development stagecompany under Statement of Financial Accounting Standards No. 7.

*Operations*

We have experienced netlosses since our inception and, as of September 30, 2006, had an accumulateddeficit of approximately $148 million. We are focused on the development and commercialization of our SmartEnergy MatrixTM flywheel system for frequency regulation and completion of ourresearch and development contracts.  Thecompletion of development and deployment of our Smart Energy MatrixTM flywheelsystem will require substantial additional outlays of capital.

We do not expect to become profitable or cash-flowpositive until at least 2009 and must raise additional equity to execute ourbusiness plan and continue as a going concern. Based on our planned cash usage rates we believe that we have adequatecash to fund operations into the early part of the first quarter of 2007.  We expect to raise capital to execute ourbusiness plan by issuing and selling additional common stock in an equityfinancing.  We expect these financingactivities to be completed later this year or early 2007.  Toward this objective, a RegistrationStatement on Form S-3 was filed with the Securities and Exchange Commission onSeptember 1, 2006.

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

**Basis ofPresentation**

The accompanyingunaudited consolidated financial statements have been prepared using accountingprinciples generally accepted in the United States of America except thatcertain information and footnote disclosures normally included in consolidatedfinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted in this Form 10-Q.  We suggest that the consolidated financialstatements presented herein be read in conjunction with our consolidatedfinancial statements and notes thereto included in our Annual Report on Form10-K, for the year ended December 31, 2005. 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.  Operating results for the nine months ended September30, 2006 are not necessarily indicative of the results that may be expected forthe full year ending December 31, 2006.

*GoingConcern*

The accompanyingconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. As shown in our consolidated financial statements, we have had minimalrevenues, and incurred losses of approximately $148 million since our inception,including losses during the nine months ending September 30, 2006 ofapproximately $9.3 million.  We haveapproximately $8.2 million of cash and cash equivalents on hand at September30, 2006.  Since our operating cashrequirements far exceed any cash generated from operations, we may be unable tocontinue as a going concern.  Theconsolidated financial statements contained herein do not include anyadjustments relating to the recoverability and classification of liabilitiesthat might be necessary should we be unable to continue as a going concern.

We recognize that our continuation as a going concernis dependent upon our ability to generate sufficient cash flow to allow us tosatisfy our obligations on a timely basis. The generation of sufficient cash flow is dependent, in the short term,on our ability to obtain additional equity financing, and in the long term, onour ability to successfully establish a share of the frequency regulationmarket based on deploying our Smart Energy MatrixTM flywheel systems that arenow under development.

4

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*Consolidation*

The accompanyingconsolidated financial statements include the accounts of Beacon Power Corporationand our subsidiary Beacon Power Securities Corporation.  Our former subsidiary, Beacon Acquisition Co.,was inactive in 2005 and was dissolved in January 2006.  All significant inter-company accounts andtransactions have been eliminated in consolidation.

*Loss per Share — Basic andDiluted*

Basic and dilutedlosses per share have been computed using the weighted-average number of sharesof common stock outstanding during each period. Warrants, options and other securitiesexercisable for common shares are used in the calculation of fully-diluted EPSonly if their conversion to common shares would decrease income or increaseloss per share from continuing operations. Since both the quarter and nine months ended September 30, 2006 reflectlosses, including the potential conversion of warrants and options in thediluted EPS calculation would decrease loss per share. Thus, they areconsidered anti-dilutive and are not included in the calculation of earningsper share.

**Summary of Significant Accounting Policies**

*Use ofEstimates*

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

*Stock-BasedCompensation*

During the first quarterof 2006, we adopted the provisions of, and accounted for, stock-basedcompensation in accordance with the Financial Accounting Standards Board’sStatement of Financial Accounting Standards No. 123R (“SFAS 123R”), “Share-BasedPayment”. Under the fair value recognition provisions of SFAS 123R, stock-basedcompensation cost is measured at the grant date based on the fair value of theaward and is recognized as an expense as it is earned over the requisiteservice period, which is the vesting period. To implement this standard, weelected the modified-prospective transition method, under which prior periodsare not revised for comparative purposes. The valuation provisions of SFAS 123Rapply to new grants and to grants that were outstanding as of the effectivedate and are subsequently modified. Estimated compensation expense for grantsthat were outstanding as of the effective date will be recognized over theremaining vesting period using the compensation cost estimated for the SFAS 123pro forma disclosures.

The adoption of SFAS123R had a material impact on our consolidated financial position, results ofoperations and cash flows. See Note 8 for further information regarding ourstock-based compensation assumptions and expenses, including pro formadisclosures for prior periods as if we had recorded stock-based compensationexpense during such periods.

**Note 3.  Accounts Receivable**

Ourtrade accounts receivable include amounts due from customers and are reportednet of a reserve for uncollectible accounts as follows:

|                                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Accounts  receivable, trade         |       | $                      | 188,050    |                  | $          | 601,669 |   |
| Reserve for  uncollectible accounts |       | (13,746                | )          | (13,229               | )          |
| Accounts receivable,  trade, net    |       | $                      | 174,304    |                  | $          | 588,440 |   |

 

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Two of our research anddevelopment contracts contain holdback provisions that allow our customers towithhold 10% from each invoice payment. At September 30, 2006 and December 31,2005 we had approximately $55,000 and $49,000, respectively, of holdbacks inour accounts receivable balance.  Theseholdbacks are payable once work has been satisfactorily completed and the finalreport has been received and approved. We believe these holdbacks will be collectedupon completion of the contracts, and therefore have not recorded any reserveagainst these amounts.

**Note 4.  Property and Equipment**

Details of our propertyand equipment follow:
| ** **                                      | ** ** | ** **                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **Estimated Useful Lives** | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Machinery and  equipment                        |       | 5  years                             |       | $                      | 674,141    |                  | $          | 570,424 |   |
| Service vehicles                                |       | 5  years                             |       | 16,763                 |       | 16,762                |       |
| Furniture and  fixtures                         |       | 7  years                             |       | 255,940                |       | 255,940               |       |
| Office equipment                                |       | 3  years                             |       | 1,471,201              |       | 1,433,947             |       |
| Leasehold  improvements                         |       | Lease  term                          |       | 533,352                |       | 533,352               |       |
| Equipment under  capital lease obligations      |       | Lease  term                          |       | 918,285                |       | 918,285               |       |
| Total                                           |       |                                 |       | $                      | 3,869,682  |                  | $          | 3,728,710 |   |
| Less accumulated  depreciation and amortization |       |                                 |       | (3,587,843             | )          | (3,516,414            | )          |
| Property and  equipment, net                    |       |                                 |       | $                      | 281,839    |                  | $          | 212,296 |   |

 

**Note 5.  Commitmentsand Contingencies**

The followingtable summarizes our commitments at September 30, 2006:
| ** **                              | ** ** | **Remainder of year  ending December 31,** | ** ** | **Year ending  December 31,** | ** ** | ** ** | ** ** | ** **     | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------|------------|-----------------------------------------|------------|------------|------------|----------------|------------|
| **Description of Commitment** | ** ** | ** **                                                     | ** ** | **2006**                                | ** ** | **2007**   | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Operating leases                        |       | $                                                              | 132,353    |                                    | $          | 397,059    |       | $              | —     |   | $ | 529,412 |   |
| Purchase  obligations                   |       | 1,215,792                                                      |       | —                                  |       | —     |       | 1,215,792      |       |
| Total Commitments                       |       | $                                                              | 1,348,145  |                                    | $          | 397,059    |       | $              | —     |   | $ | 1,745,204 |   |
|                                         |            |                                                                |            |                                         |            |            |            |                |            |  |  |  |  |  |  |

 

We lease office, lightmanufacturing and assembly space under an operating lease that expires September30, 2007. We have provided the lessor with an irrevocable letter of creditsecuring our performance under this lease with a balance at September 30, 2006 of$219,568, which is reduced annually during the lease term.  This letter of credit is secured by a cashdeposit, which is included in restricted cash in the accompanying consolidatedbalance sheets.

At September 30, 2006 wehad firm, non-cancelable purchase commitments with our suppliers to acquirecomponents for the development of the Smart Energy 25 flywheel system (a keycomponent to the Smart Energy Matrix), and to satisfy contractual obligationsfor our research and development programs in the amount of approximately $1.2million.

*Legal Proceedings*

We may from time to timebe subject to legal proceedings, often likely to involve routine litigationincidental to our business.  The outcomeof any legal proceeding is not within our complete control, may often bedifficult to predict and may be resolved over very long periods of time.  Estimating probable losses associated withany legal proceedings or other loss contingencies is very complex and requiresthe analysis of many factors including assumptions about potential actions bythird parties.  A loss contingency isrecorded as a liability in the consolidated financial statements when it isboth (i) probable or known that a liability has been incurred and (ii) theamount of the loss is reasonably estimable. If the reasonable estimate of the loss is a range and no amount withinthe range is a better estimate, the minimum amount of the range is recorded asa liability.  If a loss contingency isnot probable or not reasonably estimable, a liability is not recorded in theconsolidated financial statements.

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**Note 6. **Restructuring and AssetImpairment Charges

Weperiodically evaluate all of our property and equipment as required byStatement of Financial Accounting Standards No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets.” In 2002, we incurred arestructuring and impairment charge of $6.5 million of which $4.3 millionrepresented impaired capital equipment and leasehold improvements, $0.3 millionrelated to severance costs and $1.9 million related to a reserve against futurelease payments and related facility costs. The reserve against future lease payments is classified as “RestructuringReserve” in the current liabilities section of the balance sheet.

AtSeptember 30, 2006, the restructuring reserves are as follows:

|                         | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------|------------|---------------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| Beginning  balance      |       | $                                                       | 713,469    |   | $ | 1,062,644 |   |
| Charges for the  period |       | —                                                  |       | — |   |
| Payments                |       | (274,545                                                | )          | (257,660 | ) |
| Ending balance          |       | $                                                       | 438,924    |   | $ | 804,984 |   |

 

**Note7.  Stock Warrants**

Thefollowing schedule shows warrants outstanding as of September 30, 2006:
| **Description**               | ** ** | **Grant Date** | ** ** | **Expiration Date** | ** ** | **Strike Price** | ** ** | **Issued and Outstanding** | ** ** |
|-------------------------------|------------|---------------------|------------|--------------------------|------------|-----------------------|------------|--------------------------------------|------------|
| Class F  Financing (extended) |       | 5/23/2000           |       | 5/23/2007                |       | $                     | 2.250      |                                 | 1,333,333  |   |
| April 2005  Financing         |       | 5/24/2005           |       | 5/24/2010                |       | $                     | 1.008      |                                 | 800,000    |   |
| November 2005  Financing      |       | 11/8/2005           |       | 11/8/2010                |       | $                     | 2.210      |                                 | 2,960,527  |   |
| Total warrants  outstanding   |       |                |       |                     |       |                  |       | 5,093,860                            |       |

 

Wehave outstanding three series of warrants to purchase our common stock. Theexercise price and the number of shares of our common stock to be issued uponexercise of the warrants will be adjusted under certain circumstances,including:

·         Subdivisions, stock dividends orcombinations of our common stock

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

·         Reorganizations, mergers and similartransactions; and

·         Issuance of additional shares of ourcommon stock or securities convertible into our common stock at a price pershare less than the exercise price in effect immediately prior to the issuanceof the additional securities, only with respect to the November 2005 Financingwarrants.

Holdersof the warrants are not entitled to receive dividends, vote, receive notice ofany meetings of stockholders or otherwise have any right as stockholders withrespect to their warrant shares.

*Class F Preferred Stock FinancingWarrant*

The warrant, originallyissued in connection with our Class F Preferred Stock financing, is exercisablefor 1,333,333 shares of our common stock at an exercise price of $2.25 pershare.  In connection with the InvestmentAgreement among us, Perseus Capital, L.L.C. and Perseus 2000 Expansion, L.L.C.,dated April 22, 2005, we extended by two years the term of the warrant.  The holder of this warrant, Perseus Capital,L.L.C., may exercise the warrant at any time prior to its expiration on May 23,2007.

*April 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.

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*November 2005Financing Warrants*

As part of a financingtransaction, we issued warrants to purchase an aggregate of 2,960,527 shares ofour common stock to ten “accredited investors.” Each warrant is exercisable for a period of five years and the per shareexercise price for the warrant shares is $2.21, subject to adjustment upon theoccurrence of certain specified events, including the issuance of additionalshares of our common stock or securities convertible into our common stock at aprice per share less than the exercise price in effect immediately prior to theissuance of the additional securities.

**Note8.  Stock Based Compensation**

**Description of Plans**

*Stock Option Plan*

Our Third Amended andRestated 1998 Stock Incentive Plan allows for the granting of stock options topurchase up to 23,000,000 shares of our common stock.  Options may be granted to our employees,officers, directors, consultants and advisors.  Under the terms of the option plan, incentivestock options (“ISOs”) are to be granted at the fair market value of our commonstock at the date of grant, and nonqualified stock options (“NSOs”) are to begranted at a price determined by the Board of Directors.  In general, the Board has authorized vestingperiods of one to three years and terms of varying length but in no case more than10 years.  Our stock option program is along-term retention program that is intended to attract, retain and provideincentives for talented employees, officers and directors, and to alignstockholder and employee interests.  Weconsider our option program critical to our operation and productivity;essentially all of our employees participate. At September 30, 2006 we had 11,110,307 shares reserved for issuance underthis plan.

*Employee Stock Purchase Plan*

Our Employee Stock Purchase Plan (the “ESPP”) allows substantially all of our employees to purchase shares of our common stock at a discount through payroll deductions.  Participating employees may purchase our common stock at a purchase price equal to 85% of the lower of the fair market value of the common stock at the beginning of an offering period or on the exercise date.  Employees may designate up to 15% of their base compensation for the purchase of common stock under this plan.  The ESPP provides for the purchase of up to 2,000,000 shares of our common stock.  At September 30, 2006, we had 1,874,631 shares reserved for issuance under this plan.

*Restricted Stock UnitArrangements*

Our Third Amended and Restated1998 Stock Incentive Plan permits the grant of restricted stock units (“RSUs”)to (i) align our employees’ interests with those of the Company, (ii) motivateour employees to achieve key product development milestones and thus createstockholder value, (iii) retain key employees by providing equity to suchemployees and (iv) conserve cash, by paying bonuses in the form of RSUs, ratherthan in cash, but with the number of such RSUs calculated on a discounted basisto compensate for the reduced liquidity as compared to cash.  With respect to the RSUs that are granted inlieu of cash bonuses, the number of RSUs granted are based on performance, andare automatically converted into shares of common stock in four equal tranchesin the fiscal year following the year of performance. Certain other RSUs aregranted to our officers as a form of equity incentive, are not tied toperformance, and vest over three-year periods in equal quarterlyinstallments.  There are also otherperformance-based RSU’s granted to our officers that cliff-vest upon theachievement of certain earnings-based milestones and upon the Company achievinga level of revenue such that it is no longer treated as a development stagecompany for accounting purposes, both such vesting events subject to therecipient officer being employed during the period ending with the milestones.The unvested portion of any RSU grant is subject to forfeiture upon the holder’sresignation or termination for cause.

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**Stock Option Plan Schedules**

Stock option activityfor the first nine months of 2006 was as follows:

|                                  | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** |
|----------------------------------|------------|--------------------|------------|---------------|------------|---------------|------------|
| ** **                       | ** ** | ** **         | ** ** | **Average**   | ** ** | **Average**   | ** ** |
| ** **                       | ** ** | **Number of** | ** ** | **Exercise**  | ** ** | **Fair**      | ** ** |
| ** **                       | ** ** | **Shares**         | ** ** | **Price**     | ** ** | **Value**     | ** ** |
| Outstanding,  December 31, 2005  |       | 5,581,803          |       | $             | 1.18       |          |       |   |
| Granted                          |       | 743,683            |       | $             | 1.56       |          | $          | 1.11 |   |
| Exercised                        |       | (40,000            | )          | $             | 0.72       |          |       |   |
| Canceled,  forfeited or expired  |       | —             |       | $             | —     |          |       |   |
| Outstanding, September  30, 2006 |       | 6,285,486          |       | $             | 1.24       |          |       |   |
|                                  |            |                    |            |               |            |               |            |  |  |

 

The following tablesummarizes information about stock options outstanding at September 30, 2006:

|                           | ** ** | ** **          | ** ** | **Weighted-**         | ** ** | ** **    | ** ** | ** **          | ** ** | **Vested**    | ** ** |
|---------------------------|------------|---------------------|------------|-----------------------|------------|---------------|------------|---------------------|------------|---------------|------------|
| ** **                | ** ** | ** **          | ** ** | **Average**           | ** ** | **Weighted-** | ** ** | ** **          | ** ** | **Weighted-** | ** ** |
| ** **                | ** ** | **Number**          | ** ** | **Remaining**         | ** ** | **Average**   | ** ** | **Vested**          | ** ** | **Average**   | ** ** |
| ** **                | ** ** | **of Options** | ** ** | **Contractual**       | ** ** | **Exercise**  | ** ** | **Number**          | ** ** | **Exercise**  | ** ** |
| **Exercise Price**   | ** ** | **Outstanding**     | ** ** | **Life (Years)** | ** ** | **Price**     | ** ** | **of Options** | ** ** | **Price**     | ** ** |
| $.255 - $  .74  |       | 3,299,886           |       | 7.85                  |       | $             | 0.70       |                | 3,299,886  |          | $          | 0.70 |   |
| $  .87  - $1.26 |       | 1,334,896           |       | 5.28                  |       | $             | 0.93       |                | 1,284,896  |          | $          | 0.92 |   |
| $1.51 - $2.19             |       | 1,193,454           |       | 8.43                  |       | $             | 1.88       |                | 591,092    |          | $          | 2.04 |   |
| $2.50 - $3.10             |       | 130,000             |       | 3.67                  |       | $             | 2.64       |                | 130,000    |          | $          | 2.64 |   |
| $4.10 - $5.27             |       | 222,250             |       | 4.42                  |       | $             | 4.40       |                | 222,250    |          | $          | 4.40 |   |
| $6.00 - $9.31             |       | 105,000             |       | 4.06                  |       | $             | 6.40       |                | 105,000    |          | $          | 6.40 |   |
| Total                     |       | 6,285,486           |       |                  |       |          |       | 5,633,124           |       |          |       |

 

**Stock Compensation**

Beginning on January 1,2006, we adopted SFAS 123R. See Note 2 for a description of our adoption ofSFAS 123R. We currently use the Black-Scholes option pricing model to determinethe fair value of stock options and employee stock purchase plan shares. Thevaluations determined using such model are affected by our stock price as wellas assumptions regarding a number of complex and subjective variables, includingour stock price volatility, expected life of the option, risk-free interestrate and expected dividends, if any.

We estimate thevolatility of our common stock by using historical volatility.  We estimate the expected term of the share oroption grant, and determine a risk-free interest rate based on U.S. Treasuryissues with remaining terms similar to the expected term of the stock oroptions. We do not anticipate paying any cash dividends in the foreseeablefuture and therefore use an expected dividend yield of zero in our valuationmodel. We are required to estimate forfeitures at the time of grant and revisethose estimates in subsequent periods. All stock-based payment awards areamortized as they are earned over the requisite service periods of the awards,which are generally the vesting periods.

Prior to the adoption ofSFAS 123R, we recognized the estimated compensation cost of restricted stockunits over the vesting term. The estimated compensation cost is based on thefair value of our common stock using the closing stock price on the last day ofthe fiscal year in which the compensation is earned. We will continue torecognize the compensation cost, net of estimated forfeitures, over the vestingterm.

Restricted stock units(RSUs) are valued at the stock price at date of grant, and expensed ratablyover the performance period or vesting period, as appropriate.  The number of performance-based RSUs forwhich stock compensation expense is calculated is based upon management’sassessment of the likelihood of achieving the performance targets.

The assumptions used tovalue stock option grants for the nine months ended September 30, 2006 are asfollows:

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| ** **                                                                                | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                                | ** ** |
| Risk-free  interest rate                                                                  |       | 4.68%  - 5.01%                                          |       |
| Expected life of  option                                                                  |       | 3  years                                                |       |
| Expected  dividend payment rate, as a percentage of the stock price on the date of  grant |       | 0%                                                      |       |
| Assumed  volatility                                                                       |       | 106%  - 108%                                            |       |
| Expected forfeitures                                                                      |       | 10%                                                     |       |

 

Stock-based compensationexpense recognized on our consolidated statement of operations for the threeand nine months ended September 30, 2006 is as follows: 
| ** **                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                             | ** ** | **2006**                                            | ** ** |
| Selling, general  and administrative            |       | $                                                    | 356,645    |                                                | $          | 1,299,306 |   |
| Research and  development                       |       | 158,324                                              |       | 564,744                                             |       |
| Total stock  compensation expense               |       | $                                                    | 514,969    |                                                | $          | 1,864,050 |   |
|                                            |       |                                                 |       |                                                |       |
| Components of  stock compensation expense:      |       |                                                 |       |                                                |       |
| Amortization of deferred compensation from RSUs |       | 120,151                                              |       | 920,461                                             |       |
| Compensation expense related to other RSUs      |       | 235,999                                              |       | 264,339                                             |       |
| Compensation expense related to stock options   |       | 158,819                                              |       | 679,250                                             |       |
| Total stock  compensation expense               |       | $                                                    | 514,969    |                                                | $          | 1,864,050 |   |

 

For comparison purposes,the following table sets forth the pro forma amounts of net income and netincome per share, for the three and nine month periods ended September 30,2005, that would have resulted if we had accounted for our employee stock plansunder the fair value recognition provisions of SFAS 123R at that time:
| ** **                                   | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                             | ** ** | **2005**                                            | ** ** |
| Net loss to  common shareholders as reported |       | $                                                    | (2,143,442 | )                                                   | $          | (6,153,223 | ) |
| Pro forma  compensation expense              |       | 22,626                                               |       | 105,312                                             |       |
| Net loss—pro  forma                     |       | $                                                    | (2,166,068 | )                                                   | $          | (6,258,535 | ) |
| Loss per  share—as reported             |       | $                                                    | (0.04      | )                                                   | $          | (0.13 | ) |
| Loss per share—pro  forma               |       | $                                                    | (0.04      | )                                                   | $          | (0.14 | ) |

 

As of September 30,2006, there was approximately $364,000 of unrecognized compensation cost,adjusted for estimated forfeitures, related to non-vested stock-based paymentsgranted to our employees and directors. Total unrecognized compensation costwill be adjusted for future changes in estimated forfeitures and recognizedover the remaining vesting periods of the stock option grants. Additionally, asof September 30, 2006, there was $36,000 of unamortized deferred compensation,related to our restricted stock unit program, which will be recognized over theremainder of 2006.

**Note9.  Shelf Registration**

On September 1, 2006, we filed a $40 million universal shelf registrationwith the Securities and Exchange Commission.

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**Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

**Note Regarding Forward Looking Statements:**

This Quarterly Report on Form 10-Qcontains forward-looking statements concerning, among other things, ourexpected future revenues, operations and expenditures, and estimates of thepotential markets for our products and services.  Such statements made may fall within themeaning of the Private Securities Litigation Reform Act of 1995, asamended.  All such forward-lookingstatements are necessarily only estimates of future results and the actualresults we achieve may differ materially from these projections due to a numberof factors as discussed in the section entitled “Risk Factors” of this Form10-Q. New risks can arise and it is not possible for management to predict allsuch risks, nor can management assess the impact of all such risks on ourbusiness or the extent to which any factor, or combination of factors, maycause actual results to differ materially from those contained in anyforward-looking statement.  Given theserisks and uncertainties, investors should not place undue reliance onforward-looking statements as a prediction of actual results.  All forward-looking statements speak only asof the date of this Quarterly Report on Form 10-Q.  We undertake no obligation to revise orupdate publicly any forward-looking statement in order to reflect any event or circumstancethat may arise after the date of this Quarterly Report on Form 10-Q, other thanas required by law.

**Critical Accounting Policies andEstimates**

The preparation offinancial statements requires management to make estimates and judgments thatmay significantly affect the reported amounts of assets, liabilities, revenues,expenses and related disclosures. On an ongoing basis, management evaluates ourestimates and assumptions including, but not limited to, those related torevenue recognition, asset impairments, inventory valuation, warranty reservesand other assets and liabilities. Management bases its estimates on historical experience and variousother assumptions that it believes to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities that are not readily apparent from othersources.  Actual results may differ fromthese estimates under different assumptions or conditions.

*Revenue Recognition*

Although we have shipped products and recorded contractrevenues, 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 Statement of Financial Accounting Standards No. 7 “Accounting andReporting by Development Stage Enterprises.”

We recognize revenue in accordance with accountingprinciples generally accepted in the United States of America.  Generally, revenue is recognized on transferof title, typically when products are shipped and all related costs areestimable.  For sales to distributors, wemake an adjustment to defer revenue until our products are subsequently sold bydistributors to their customers.

*Research and Development ContractRevenue Recognized on the Percentage-of-Completion Method*

We recognize contractrevenue using the percentage-of-completion method, based primarily on contractcosts incurred to date compared with total estimated contract costs.  Changes to total estimated contract costs or losses,if any, are recognized in the period in which they are determined.  Revenues recognized in excess of amountsbilled are classified as current assets, and included in “Unbilled costs oncontracts in process” in our balance sheets. Amounts billed to clients in excess of revenues recognized to date areclassified as current liabilities under “Advance billings on contracts.”  Changes in project performance andconditions, estimated profitability, and final contract settlements may resultin future revisions to construction contract costs and revenue.

All of our research anddevelopment contracts are subject to cost review by the government agencies.Our reported results from these contracts could change adversely as a result ofthese reviews.

*Loss on Contract Commitments*

Eachquarter, we perform an evaluation of expected costs to complete our in-progresscontracts that we account for using the percentage-of-completion method.  In the event that the total expected cost tocomplete a contract exceeds the expected total contract revenue, we immediatelyrecord a loss on the contract to the extent that the expected loss exceeds theexpected revenue from the contract.

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*Warranty Reserves*

Our warranties requireus to repair or replace defective products returned to us during the applicablewarranty period at no cost to the customer. We record an estimate forwarranty-related costs based on actual historical return rates, anticipatedreturn rates, and repair costs at the time of sale. A significant increase inproduct return rates, or a significant increase in the costs to repairproducts, could have a material adverse impact on future operating results forthe period or periods in which such returns or additional costs materialize andthereafter.

*Income Taxes*

Deferred tax assets andliabilities are determined based on differences between the financial reportingand income tax basis of assets and liabilities as well as net operating lossand tax credit carryforwards, and are measured using the enacted tax rates andlaws that will be in effect when the differences reverse.  Deferred tax assets are reduced by a 100%valuation allowance to reflect the uncertainty associated with their ultimaterealization.

Significant managementjudgment is required in determining the provision for income taxes, thedeferred tax assets and liabilities and any valuation allowance recordedagainst deferred tax assets.  Thevaluation allowance is based on our estimates of taxable income and the periodover which our deferred tax assets will be recoverable.  In the event that actual results differ fromthese estimates or we adjust these estimates in future periods, we may need toestablish an additional valuation allowance or reduce our current valuationallowance, which could materially impact our tax provision.

*Long-Lived Assets*

In accordance with Statement of Financial AccountingStandards No. 144 “Accounting for the Impairment or Disposal of Long-LivedAssets,” we review our long-lived assets to determine whether any events orchanges in circumstances indicate that the carrying value of any of such assetsmay not be recoverable.  The conditionsto be considered include whether or not the asset is in service, has becomeobsolete, or whether external market circumstances indicate that the carryingamount may not be recoverable.  Whenappropriate, we recognize a loss for the difference between the estimated fairvalue of the asset and the carrying amount. The fair value of the asset is measured using either available marketprices or estimated discounted cash flows.

*Sarbanes-Oxley Compliance*

Companies that are considered “accelerated  filers” as defined in Exchange Act Rule 12b-2were required to comply with the provisions of Section 404 of theSarbanes-Oxley Act of 2002 (SOX) as of the first fiscal year ending on or afterNovember 15, 2004.  Non-accelerated andforeign private issuers must comply with SOX by the first fiscal year ending onor after December 15, 2007.  We are a “smallbusiness issuer” and hence are considered to be a “non-accelerated filer” and arenot required to comply with Sarbanes-Oxley Section 404 until 2007.  However, we are in the process of reviewing,documenting and testing our controls over financial reporting in order to befully prepared to comply with the requirements of Sarbanes-Oxley as of 2007.

**Overview**

We design, develop, configure and expect to beginoffering for sale, advanced products and services to support more reliable andcost-effective electricity grid operation. The focus of our development hasbeen to establish a patent-protected technology that can provide highlyreliable energy storage solutions for the worldwide electricity grid atcompetitive costs. Our commercial market strategy is to become a globalprovider of frequency regulation services to operators of the electricity grid.In addition, we believe that, as the commercialization of our technologies continues,additional applications for our flywheel systems may develop that could havesignificant commercial applications.  In2005 we were awarded development contracts by the California Energy Commission(CEC) and New York State Energy Research and Development Authority (NYSERDA) todemonstrate the viability of our flywheel technologies for frequency regulationby grid operators. The demonstration units are scale-power prototypes of theSmart Energy MatrixTM flywheel system. Both units are installed and are undergoing formal field trials.  We believe these demonstration units will validatethe capability of our systems to provide frequency regulation services to theelectricity grid. An ancillary benefit of these contracts is that the fundsreceived subsidize a portion of our core research and development efforts, andany losses attributable to these contracts would have been costs incurred aspart of our on-going research and development efforts.

We may continue to pursue additional development anddesign contracts for a variety of flywheel-related applications.

We must raise additional funds to execute our business plan.  Based on our rate of expenditure of cash andthe additional expenditures expected to support our business plan, we estimatethat we have sufficient cash to fund operations into the early part of the firstquarter of 2007. We need to obtain additional investments to fund:

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·                  Ourcontinuation as a going concern

·                  Ongoingresearch and development of the Smart Energy 25 flywheel and the Smart EnergyMatrixTM multi-flywheel system

·                  Theramp up of our manufacturing and assembly capacity

·                  Thebuild-out of facilities to provide frequency regulation services to theelectricity grid

·                  Workingcapital requirements; and

·                  The identificationand development of new business opportunities.

We are continuing to develop the Smart Energy 25 flywheel, which is thecore component of the Smart Energy MatrixTM flywheel system.  In order to complete development of the SmartEnergy MatrixTM flywheel system, build, operate and receive fees for frequencyregulation services of at least one megawatt from our flywheel-based commercialfrequency regulation system and have sufficient working capital to continue toexecute our business plan through 2007, we will need to raise approximately $20million of funding. Also, we will need to raise additional amounts beyond theforegoing $20 million through a combination of debt and equity to finance thevarious additional frequency regulation facilities that are contemplated by ourbusiness plan.

As part of our newbusiness development, we will continue to evaluate possible acquisitions ofenterprises or technologies that we would consider synergistic from a market,technology or product perspective.

From inception through September30, 2006, we have incurred losses of approximately $148 million. We expect tocontinue to incur losses as we expand our product development and begin toincrease our manufacturing and assembly capacity.

*Revenues*

We have been awardedfixed price research and development contracts from government agencies and arepursuing similar contracts from other government agencies related to ourflywheel technologies.  We havedetermined that we will recognize revenues using the percentage of completionmethod for such contracts.  We arecontinuing to evaluate markets for our flywheel systems but we have not yetrecognized revenues from these products. We have placed development prototype flywheels with potential customersand shipped pre-production units.  Theseflywheel products were provided to potential customers without charge or on ademonstration basis to allow us access to field test information and todemonstrate the application of our technologies.  We have available for sale in the solarrenewable energy market our SmartPower M5TM inverter system.  Ourinverter systems are sold through domestic distributors who sell our productsto installers who then make sales to residential homeowners or commercialcustomers.  We recognize revenues on ourinverter products when they are sold by our distributors to theircustomers.  Although we are continuing tosupport our inverter product, we do not believe that inverters will be asignificant portion of our business going forward and we are uncertain as towhen or at what price we will be able to sell the remainder of our inventories.

*Cost of Goods Sold*

Cost of goods sold onfixed price research and development contracts are predominantly being recordedon the percentage of completion method and consist of direct labor andmaterial, subcontracting, and associated overhead costs.

In 2004, we establisheda reserve for our entire inverter product inventory as a result of lower thananticipated customer demand and uncertainty of our ability to sell thoseinventories.  During 2005 and into 2006we continue to have very limited sales of our inverter products.  The costs related to these sales are notfully reflected in cost of goods sold as a result of the inventory beingreserved in a prior year.  Therefore ourcost of goods sold does not accurately reflect the costs associated with theserevenues.

*Selling,General and Administrative Expenses*

Our sales and marketingexpenses consist primarily of compensation and benefits for sales and marketingpersonnel and related business development expenses.  In 2006 we added a director of businessdevelopment to investigate additional applications for our technologies.  We expect sales and marketing expenses tocontinue to increase as we expand efforts to define new markets for ourproducts.  We continue to rely on ourengineering personnel to provide technical specifications and product overviewsto our potential customer base.  Generaland administrative expenses consist primarily of compensation and benefitsrelated to our corporate staff, professional fees, insurance and travel. Weexpect our selling, general and administrative expenses to increase in 2006over 2005 due primarily to the implementation and reporting expenses associatedwith compliance with Section 404 of the Sarbanes-Oxley Act of 2002, fundraisingactivities, marketing and business development expenses associated withflywheel products and compensation costs associated with equity-basedcompensation.

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*Researchand Development*

Our cost of research anddevelopment consists primarily of the cost of compensation and benefits forresearch and development, and support staff, as well as materials and suppliesused in the engineering design and development process.  These costs are expected to increase in 2006as compared to 2005 as we accelerate the development of the Smart Energy 25flywheel for frequency regulation applications and record compensation costsassociated with equity based compensation.

*Losson Contract Commitments*

We establish reservesfor anticipated losses on contract commitments if, based on cost estimates tocomplete the commitment, we determine that a loss will be incurred.  We recorded a $1.5 million charge during 2005for anticipated losses on our research and development contracts and anadditional charge of approximately $967,000 through September 30, 2006. Approximately$240,000 of this charge relates to the cost share portion of a contract awardedto Beacon during the third quarter of 2006from the U.S. Department of Energy (DOE), to be administered by Sandia NationalLaboratories, to design a 20-megawatt Smart Energy Matrix frequency regulationpower plant.  The remainder of the chargerelates to a revision of our labor and overhead rates and otherestimated costs to complete our remaining contracts based upon currentforecasts.  These remaining contractsrelate primarily to the development of demonstration units of newproducts.  There is an inherentdifficulty in estimating costs to develop new products. We believe that workperformed under these contracts will provide direct benefits to the Company inour development of the Smart Energy 25 flywheel.

We expect to recognizeprobable losses on contract commitments early in a product’s commercialintroduction prior to being able to realize expected decreases in cost per unitthrough engineering design changes, operating efficiencies, and volumepurchasing discounts.  With respect to governmentcontracts, we have evaluated, and will continue on a quarterly basis toevaluate, our estimated costs to complete and modify reserves when appropriate.

*Depreciationand Amortization*

Our depreciation andamortization is primarily related to depreciation on capital expenditures andthe amortization of lease and leasehold costs related to our facilities.  We own intellectual property in the form ofpatents on our flywheel vacuum system, our heat pipe cooling systems, DC outputparalleling, metal hub, low-loss motor, co-mingled rims and earthquake-tolerantbearings on our flywheel products, and anti-islanding software, drawings,source code, and production know-how on our Smart Power M5TM inverter system, and expect to obtain otherpatents during 2006 and beyond.  Thesecosts were being amortized during 2004, but we recorded impairment charges towrite down these assets to zero on the balance sheet at December 31, 2004.  These impairment charges were made due to theuncertainty of realizing any future value from this property mainly due thelack of substantial revenues to date. Accordingly, all costs incurred during 2005 and 2006 related to thedevelopment of intellectual property have also been expensed as incurred.

*Interest and OtherIncome/Expense, net*

Our non-operating incomeand expenses are primarily attributable to interest income resulting from cashon hand and gains or losses on the sale of our impaired assets.

**Resultsof Operations**

*Comparisonof Nine Months ended September 30, 2006 and 2005*

|                                         | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                 | ** ** |
| Revenue                                 |       | $                                                       | 775        |   | $ | 1,259 |   | $ | (484 | ) | 38 | % |
| Cost of goods  sold                     |       | 689                                                     |       | 1,352 |   | (663 | ) | 49 | % |
| Gross margin                            |       | 86                                                      |       | (93 | ) | 179 |   | 192 | % |
| Selling, general  and administrative    |       | 5,273                                                   |       | 4,130 |   | 1,143 |   | 28 | % |
| Research and  development               |       | 3,462                                                   |       | 994 |   | 2,468 |   | 248 | % |
| Loss on sales  and contract commitments |       | 967                                                     |       | 1,057 |   | (90 | ) | 9 | % |
| Depreciation and  amortization          |       | 73                                                      |       | 62 |   | 11 |   | 18 | % |
| Interest and  other income, net         |       | 430                                                     |       | 183 |   | 247 |   | 135 | % |
| Net loss                                |       | $                                                       | (9,259     | ) | $ | (6,153 | ) | $ | (3,106 | ) | 50 | % |

 

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*Revenue*

The following tableprovides details of our revenues for the nine months ended September 30, 2006and 2005.
| ** **                         | ** ** | **Percent**  | ** ** | **Nine months ended September 30,** | ** ** | **Cumulative  Contract  Value** | ** ** | **Total  Contract** | ** ** |
|------------------------------------|------------|--------------|------------|---------------------------------------------------------|------------|---------------------------------|------------|---------------------|------------|
| **Dollars in thousands** | ** ** | **complete** | ** ** | **2006**                                                | ** ** | **2005**                        | ** ** | **Earned**          | ** ** | **Value** | ** ** |
| CEC                                |       | 91%          |       | $                                                       | 192        |                            | $          | 975                 |       | $ | 1,121 |   | $ | 1,233 |   |
| NYSERDA PON 846                    |       | 85%          |       | 217                                                     |       | 128                             |       | 547                 |       | 646 |   |
| Bechtel Bettis                     |       | 100%         |       |                                                    |       | 71                              |       | 98                  |       | 98 |   |
| NYSERDA PON 800                    |       | 80%          |       | 29                                                      |       | 14                              |       | 50                  |       | 63 |   |
| Air Force  Research Laboratory     |       | 26%          |       | 197                                                     |       | —                          |       | 197                 |       | 750 |   |
| Sandia DOE  Earmark                |       | 3%           |       | 25                                                      |       | —                          |       | 25                  |       | 752 |   |
| Total Contract Revenue             |       |         |       | $                                                       | 660        |                            | $          | 1,188               |       | $ | 2,038 |   | $ | 3,542 |   |
| M5 and  accessories                |       |         |       | 115                                                     |       | 71                              |       |                |       |   |   |
| Total                              |       |         |       | $                                                       | 775        |                            | $          | 1,259               |       | $ | 2,038 |   | $ | 3,542 |   |

 

In the nine monthsended September 30, 2006, we recorded revenue from flywheel-related researchand development contracts calculated using the percentage of completion methodof approximately $660,000 and recorded $115,000 from the sale of Smart Power M5TM inverter systems andrelated products.  In the same period for2005, we recorded research and development contract revenue of approximately$1,188,000 and approximately $71,000 from the sale of our Smart Power M5TM inverter systems andrelated solar products.  Contract revenuewas lower in 2006 compared to 2005 by approximately $528,000 or 44% primarilyas the result of the completion of the majority of the milestones on ourlargest contracts, CEC and NYSERDA, in 2005, offset by higher inverter revenuesof approximately $44,000.

Duringthe third quarter of 2006, we were awardeda contract from the U.S. Department of Energy (DOE), to be administered bySandia National Laboratories, to design a 20-megawatt Smart Energy Matrixfrequency regulation power plant. This project directly supports our plan todevelop a commercial-scale flywheel-based frequency regulation facility in theU.S during 2007. The contract, valued at $752,500 over a 12-month time period,will provide funding for a portion of our expected development costs.

Under the contract, we will develop a design specification package for a20-megawatt flywheel-based frequency regulation power plant; complete acomparison study contrasting the features, costs and benefits of flywheelregulation versus conventional technology solutions; perform an analysis tooptimize the unique performance advantages of flywheels in providing frequencyregulation; determine the comparative advantages of plant sizes between one and40 megawatts; and identify, study and rank potential plant locations.

*Cost of Goods Sold*

Cost of goods sold forthe nine months ending September 30, 2006 includes costs incurred inperformance of our research and development contracts calculated using thepercentage of completion method in the amount of approximately $660,000 and thecost of materials, labor, overheads and warranty accruals for inverter productssold in the amount of approximately $30,000 In 2005, cost of goods sold included costs for our flywheel development contracts in the amount ofapproximately $1,307,000, and materials, labor and warranty accruals forshipments of our Smart Power M5TM inverter products sold in the nine monthperiod of approximately $45,000.

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*Selling, General and Administrative Expense*

|                                       | ** ** | **Amount**              | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Nine months  ended September 30, 2005 |       | $                       | 4,130      |   |
| Reductions:                           |       |                    |       |
| Subcontractors  and consultants       |       | (391                    | )          |
| Legal and  professional fees          |       | (120                    | )          |
| Increases:                            |       |                    |       |
| Stock  compensation expense           |       | 1,299                   |       |
| Public company  expenses              |       | 135                     |       |
| Salaries and  benefits                |       | 68                      |       |
| Audit fees                            |       | 47                      |       |
| Office equipment  upgrades            |       | 36                      |       |
| Other                                 |       | 69                      |       |
| Nine months ended  September 30, 2006 |       | $                       | 5,273      |   |

 

Selling, general andadministrative expenses totaled approximately $5,273,000 and $4,130,000 for thenine months ended September 30, 2006 and 2005, respectively. The increase ofapproximately $1,143,000 or 28% was primarily the result of expensing stockcompensation due to the implementation of FAS 123R and the issuance of restrictedstock units of approximately $1,299,000, additional public company expense of $135,000 primarily relating to ourpreparations for the requirements of Section 404 of the Sarbanes Oxley Act of2002, additional salaries and benefits because of new hires of $68,000,  additional audit fees of $47,000, officeequipment upgrades of approximately $36,000, and other various items ofapproximately $69,000. These increases were offset by a reduction in the use ofsubcontractors and consultants of $391,000 and a reduction in legal fees of$120,000.  Legal and consulting fees in2005 included costs incurred in an attempt to acquire another company that wasnot consummated. We expect our selling, general and administrative expenses tobe somewhat higher over the remainder of 2006 than during the same period in2005 due primarily to stock option expensing, additional costs expected in theimplementation and reporting expenses associated with compliance with Section404 of the Sarbanes-Oxley Act of 2002, fundraising activities and increasedmarketing and business development expenses associated with flywheel products.

*Research and Development Expense*

|                                                  | ** ** | **Amount**              | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Nine months  ended September 30, 2005            |       | $                       | 994        |   |
| Increases:                                       |       |                    |       |
| Expense  materials                               |       | 730                     |       |
| Salaries and  benefits                           |       | 565                     |       |
| Stock  compensation expense                      |       | 565                     |       |
| Engineering and  manufacturing overheads applied |       | 177                     |       |
| Consultants and  subcontractors                  |       | 134                     |       |
| Facility costs                                   |       | 126                     |       |
| Software  maintenance                            |       | 72                      |       |
| Travel                                           |       | 43                      |       |
| Other                                            |       | 56                      |       |
| Nine months ended  September 30, 2006            |       | $                       | 3,462      |   |

 

The increase for the ninemonths ended September 30, 2006 compared to the equivalent period in 2005 ofapproximately $2,468,000, or 248%, is primarily due to  increased expenses for development materialsof approximately $730,000, increased headcount related expenses resulting from hiringof engineering personnel to support our flywheel development of approximately$565,000, FAS123R stock compensation expense of approximately $565,000, loweroverheads applied to contracts of approximately $177,000, increased usage ofconsultants of $134,000, higher facility charges of $126,000, higher software maintenanceexpenses of approximately $72,000, increased travel costs of $43,000,  and other miscellaneous expenses ofapproximately $56,000.  We expect thecost of research and development for the remainder of 2006 to be higher than inthe same period during 2005 due to increased headcount and development materialrequired for the 25kWh flywheel development as well as the Smart Energy MatrixTMflywheel system.

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*Loss on Contract Commitments*

We recorded contractcommitment losses in the first quarter of 2005 at the time we signed our CECand NYSERDA research and development contracts for expected cost overrunsrelated to material, labor and overheads.  These costs were originally planned for us to provide as cost share underthese contracts. An additional loss of approximately $240,000 was recordedduring the third quarter of fiscal 2006 related to our expected cost shareportion of the Sandia contract. Additionally, during the nine months ended September 30, 2006, werevised our estimated cost to complete various contractual obligations andrecorded an additional provision for contract loss of approximately $727,000.  This increase represents additional labor,material and travel costs of $314,000 expected to be needed to complete thecontracts, additional costs of $368,000 related to updating our labor andoverhead rates, and other costs of $45,000.

*Depreciationand Amortization*

The increase indepreciation expense for the first nine months of 2006 as compared to the firstnine months of 2005 of approximately $11,000, or 17%, is primarily attributableto depreciation on new assets acquired during the latter half of 2005 andupgrades to our office equipment.  Weexpect depreciation during the remainder of 2006 will be higher than 2005 dueto capital expenditures relating to the increase of production capacity forflywheel development and manufacturing.

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

The increase from 2005to 2006 of approximately $246,000, or 134%, is primarily attributable toincreases in interest income due to higher cash balances than during the sameperiod in 2005.  This increase was offsetby the write-back of an officer loan reserve in 2005 of approximately$102,000.  This loan reserve adjustmentwas included as Other Income during the nine months ended September 30, 2005.

*Net Loss*

As a result of thechanges discussed above, the net loss for the nine months ended September 30,2006 was approximately $9,259,000 which compares to a net loss during the sameperiod in 2005 of approximately $6,153,000, an increase in net loss ofapproximately $3,106,000 or 50%.

**Liquidityand Capital Resources**

|                                            | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                                 | ** ** |
| Cash and cash  equivalents                 |       | $                                                       | 8,164      |   | $ | 3,385 |   |
| Working capital                            |       | 5,798                                                   |       | 2,318 |   |
| Cash provided by  (used in)                |       |                                                    |       |   |   |
| Operating activities                       |       | (5,663                                                  | )          | (5,322 | ) |
| Investing activities                       |       | (102                                                    | )          | (1,011 | ) |
| Financing activities                       |       | 39                                                      |       | 4,620 |   |
| Net decrease in  cash and cash equivalents |       | $                                                       | (5,726     | ) | $ | (1,713 | ) |
| Current ratio                              |       | 2.9                                                     |       | 2.1 |   |

 

Our cash requirementsdepend on many factors, including but not limited to, research and developmentactivities, continued efforts to commercialize our products, facilities costs,and general and administrative expenses. Since we are still in the development stage and have not yet begun ourexpected principal operations of providing frequency regulation services to theelectricity grid, we do not generate enough cash from operations to satisfy ourworking capital requirements.  We expectto make significant expenditures to fund our operations, develop technologiesand explore opportunities to find and develop additional markets to sell ourproducts.  Over the last three years wehave taken significant actions to reduce our cash expenditures for productdevelopment, infrastructure and production readiness by significantly reducingheadcount, development spending and capital expenditures.  We have focused our activity on marketanalysis in terms of size of markets, competitive aspects and advantages thatour products could provide.  We expect touse more cash resources during 2006 as we continue to work on our governmentresearch and development contracts and mobilize our engineering team to developthe Smart Energy 25 flywheel and the Smart Energy MatrixTM multi-flywheelsystem.

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We must raise additional equity to execute our business plan.  Based on our rate of expenditure of cash andthe additional expenditures expected to support our business plan, we havesufficient cash to fund operations into the early part of the first quarter of2007. We need to obtain additional investments to fund:

·                  Ourcontinuation as a going concern

·                  Ongoingresearch and development of the Smart Energy 25 flywheel and the Smart EnergyMatrixTM multi-flywheel system

·                  Theramp up of our manufacturing and assembly capacity

·                  Thebuild out of facilities to provide frequency regulation services to theelectricity grid

·                  Workingcapital requirements; and

·                  The identificationand development of new business opportunities.

We are continuing to develop the Smart Energy 25 flywheel, which is thecore component of the Smart Energy MatrixTM flywheel system.  In order to complete development of the SmartEnergy MatrixTM flywheel system, build, operate and receive fees for frequencyregulation services of at least one megawatt from our flywheel-based commercialfrequency regulation system and have sufficient working capital to continue toexecute our business plan through 2007, we will need to raise approximately $20million of funding. Also, we will need to raise additional amounts beyond theforegoing $20 million through a combination of debt and equity to finance thevarious additional frequency regulation facilities that are contemplated by ourbusiness plan.

**Operating Activities**

Net cash used inoperating activities was approximately $5,663,000 and $5,321,000 for the ninemonths ended September 30, 2006 and 2005, respectively.  The primary component to the negative cashflow from operations is from net losses. For the nine months ending September 30, 2006, we had a net loss ofapproximately $9,259,000.  Adjustments toreconcile net loss to cash flow in 2006 include non-cash stock compensation ofapproximately $1,864,000, depreciation and amortization of approximately $73,000,offset by facility-related cash payments charged against restructuring reservesof approximately $274,000 and a reduction to our impairment reserve resultingfrom the disposition of fixed assets of approximately $40,000. Changes inoperating assets and liabilities generated approximately $1,975,000 of cashduring 2006.  During the same period in2005, we had a net loss of $6,153,000. Adjustments to reconcile net loss to cash flow include non-cash stockcompensation of approximately $621,000, facility-related cash payments chargedagainst restructuring reserves of approximately $258,000, a write-back of areserve for a repaid officer’s note of approximately $102,000, proceeds fromthe sale of fixed assets (net of reserve) of $24,000, reduction of the amountof restricted cash of $90,000, and depreciation and amortization ofapproximately $62,000.  Changes in theoperating assets and liabilities generated approximately $442,000 of cashduring the first nine months of 2005.

**Investing Activities**

Net cash used ininvesting activities was approximately $102,000 and $1,011,000 for the ninemonths ending September 30, 2006 and 2005, respectively.  The principal use of cash in 2006 was thepurchase of property and equipment in the amount of approximately $143,000,offset by the sale of property and equipment of approximately $41,000.  The principal uses of cash in 2005 were fromthe purchase of an investment in NxtPhase T&D Corporation of approximately$1,000,000 and a purchase of equipment of approximately $40,000, offset byproceeds from the sale of property and equipment of approximately $29,000.

**Financing Activities**

Net cash provided byfinancing activities was approximately $39,000 and approximately $4,620,000 forthe first nine months of 2006 and 2005, respectively.  For 2006 the primary sources of cash wereapproximately $29,000 from the exercise of employee stock options andapproximately $10,000 from employee purchases of shares from our employee stockpurchase plan.  For the first nine monthsof 2005, cash generated by financing activities included approximately $3,954,000from the issuance of common stock pursuant to an investment agreement withPerseus 2000 Expansion, $656,000 related to the exercise of stock options andapproximately $2,000 from the employee stock purchase plan, offset by expensingof cash paid for financing costs of approximately $327,000 and approximately $319,000for the repurchase of our stock.

As part of our newbusiness development, we may evaluate possible acquisitions of enterprises ortechnologies that we consider synergistic from a market, technology or productperspective. We may make investments in companies for strategic business reasonsif sufficient cash is available.  Becauseour primary motivation in making these investments may not be to realize aprofit on the investment itself, but rather to expand our business prospects,these investments may lack any financial return to the Company, result in aloss of principal and lack liquidity.

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Inasmuch as we are not expecting to become cash flow positive until atleast 2009, our ability to continue as a going concern will depend on ourability to raise additional capital.  Wemay not be able to raise this capital at all, or if we are able to do so, itmay be on terms that are adverse to existing shareholders.  We believe that debt financing will not be availableto us to meet our cash requirements for 2006 or 2007.

**Item 3. Quantitative and Qualitative Disclosure About Market Risk**

Our cashequivalents, which have maturities of less than three months, may expose ourassets to interest rate risk but not to market risk of principal.  At September 30, 2006, we had approximately $160,000of cash equivalents that were held in non-interest bearing accounts.  Also at September 30, 2006, we hadapproximately $200,000 of cash equivalents that were held in interest bearingchecking accounts, $5,500,000 invested in short-term highly-rated bonds andapproximately $2,304,000 invested in interest-bearing money market accounts athigh-quality financial institutions.  Ourexposure to market risk through financial instruments is not material.

**Item 4.  Controls and Procedures**

Our management,with the participation of our principal executive officer and principalfinancial officer, has evaluated the effectiveness of our disclosure controlsand procedures (as defined in Rule 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended) as of the end of the periodcovered by this QuarterlyReport on Form 10-Q.  Based onthat evaluation, the principal executive officer and principal financialofficer have concluded that our disclosure controls and procedures areeffective in enabling us to record, process, summarize and report informationrequired to be included in our periodic SEC filings within the required timeperiod.  Management recognizes that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives, and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. Based on the evaluation of our disclosurecontrols and procedures as of September 30, 2006, our principal executiveofficer and principal financial officer concluded that, as of such date, ourdisclosure controls and procedures were effective at the reasonable assurancelevel.

In addition, our management, with the participation of our principalexecutive officer and principal financial officer, has evaluated whether anychange in our internal control over financial reporting (as defined in Rule13a-15(f) under the Securities Exchange Act of 1934) occurred during the periodcovered by this Quarterly Report on Form 10-Q. Based on that evaluation, the principal executive officer and principalfinancial officer have concluded that there has been no change in our internalcontrol over financial reporting during the period covered by this QuarterlyReport on Form 10-Q that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

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**Part II — OTHER INFORMATION**

**Item 1.  LegalProceedings**

None.

**Item 1A.  Risk Factors**

In addition to the risk factors set forth in Part I, Item 1A of ourAnnual Report on Form 10-K for the year ended December 31, 2005 filed with theSecurities and Exchange Commission on March 30, 2006 and in our QuarterlyReport on Form 10-Q for the quarter ended June 30, 2006 filed with the SEC onAugust 10, 2006, the following risk factors pertain to us:

***Our business plan includesthe design, development, construction, financing and operation of severalfrequency regulation power plants******thatincorporate our Smart Energy Matrix technology in order to provide frequency regulationservices.  We have limited prior experience doing this.  Should wefail in any material aspect of these tasks, it is unlikely that we willrecognize significant revenue under our current business model.***

Our current business plan calls for the design, development,construction, financing and operation of one or more commercial-level frequencyregulation power plants that incorporate our Smart Energy Matrixtechnology.  However, we have limited experience doing these things at acommercial level, although we have designed, developed, constructed andinstalled two one-tenth scale demonstration units at existing utility sites onthe grid and are operating them in demonstration and testing mode. However, wehave never done these things commercially, nor ever obtained project finance(although we have experience in raising corporate finance). We expect thatdoing these things on a commercial level will be complex and challenging and wemay not be successful. If we are not successful, then we will not achieve therevenues planned in our business model.

***Our revenue and sales depend uponthe achievement of the product development and commercialization milestones setforth in our contracts with third parties. Our future revenues will result fromsimilar milestones related to government contracts and from our commercialapplications. These revenues will depend on our ability to deliver flywheelsystems with certain performance and dependability attributes.***

The majority of our revenue is currently derived from contracts withgovernmental entities which tie our payments to our reaching certain productdevelopment and commercialization milestones set forth in those contracts.  We expect that our future revenue fromgovernment sources will similarly be tied to the achievement of milestones. Oncommercial applications for our flywheel systems, our ability to achieverevenues will be dependent on our ability to complete development of oursystems and for these systems to have the performance and dependabilityattributes required for economic viability.  It is uncertain whether and to what degree wewill be able to meet these goals in the future and to the extent we do not meetsuch goals, we expect our revenue to suffer.

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

None.

**Item 3.  Defaults Upon Senior Securities**

None.

**Item 4.  Submission of Matters to a Vote of Security Holders**

On September 22, 2006, we held our annual meeting of shareholders.  At this meeting, stockholders voted on two matters:  (1) to elect William Stanton to serve a one-year term on the Board of Directors; and (2) to ratify the selection of Miller Wachman LLP as the Corporation’s independent auditors for 2006.  The result of the votes was as follows:

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| Matter voted upon:                                                                                                             | ** ** | **Votes For:** | ** ** | **Votes Against** | ** ** | **Abstentions or  Votes Withheld** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|----------------------------------------------|------------|
| 1     Election of William E. Stanton to a  one-year term on the Board of Directors                                   |       | 52,446,466          |       | —                 |       | 540,496                                      |       |
|                                                                                                                                     |       |                |       |                   |       |                                         |       |
| 2     Ratification  of the selection of Miller Wachman LLP as the Corporation’s independent  auditors for 2006. |       | 52,807,742          |       | 112,637                |       | 66,583                                       |       |

 

The total shares outstanding and eligible to vote as of the record date of August 4, 2006 were 58,713,303 shares.  Proxies representing 52,986,962 shares or 90 percent of the eligible voting shares were received and tabulated.

**Item 5.  Other Information**

None.

**Item6.  Exhibits**
| Exhibit    | ** ** | ** ** | ** ** | ** **                                                                                                                                              |
|------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Ref**    | ** ** | **Description of Document**                                                                                                                             |
|       |       |       |       |                                                                                                                                                    |
| 3.1        |       | (1)        |       | Sixth Amended and Restated Certificate of  Incorporation.                                                                                               |
|       |       |       |       |                                                                                                                                                    |
| 3.2        |       | (5)        |       | Amended and Restated Bylaws.                                                                                                                            |
|       |       |       |       |                                                                                                                                                    |
| 3.3        |       | (2)        |       | Certificate of Designation of Series A Junior  Participating Preferred Stock, filed with The Secretary of State of Delaware  on October 4, 2002.        |
|       |       |       |       |                                                                                                                                                    |
| 4.1        |       | (3)        |       | Form of specimen stock certificate.                                                                                                                     |
|       |       |       |       |                                                                                                                                                    |
| 10.1       |       | (4)        |       | Agreement dated August 31, 2006 between the Company  and Sandia National Laboratories.                                                                  |
|       |       |       |       |                                                                                                                                                    |
| 31.1       |       | +          |       | Certification of Principal Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                |
|       |       |       |       |                                                                                                                                                    |
| 31.2       |       | +          |       | Certification of Principal Financial and Accounting  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                 |
|       |       |       |       |                                                                                                                                                    |
| 32.1       |       | +          |       | Certification of Principal Executive Officer  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|       |       |       |       |                                                                                                                                                    |
| 32.2       |       | +          |       | Certification of Principal Financial Officer  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

----

(1)             Incorporatedby reference from the Form S-1 filed on November 16, 2000 (File No. 333-43886).

(2)             Incorporatedby reference from the Form 10-K filed on March 30, 2006 (File No. 001-16171).

(3)             Incorporatedby reference from the Form S-3 filed on December 8, 2005 (File No. 333-130207).

(4)             Incorporatedby reference from the Form 8K filed on September 7, 2006 (File No. 000-31973).

(5)             Incorporatedby reference from the Form 8K filed on August 29, 2006 (File No. 000-31973).

+                    Filedherewith.

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.
|                                                                                                                                                                                                                                                                                                                                                                                                   | BEACON POWER CORPORATION                            |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                   |                                                |   |
|                                                   Date:    October  31, 2006                                                  | By:                                                 | /s/ F. William Capp |
|                                                                                                                                                                                                                                                                                                                                                                                                   | F. William Capp                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                   | President and  Chief Executive Officer              |
|                                                                                                                                                                                                                                                                                                                                                                                                   |                                                |   |
|                                                               October   31, 2006 | 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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