**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**x QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934 for the quarterly period ended March 31, 2010**

 

**or**

 

**o TransitionReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 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.) |
|                                      |       |                 |
| **65  Middlesex Road**                    |       |                 |
| **Tyngsboro,  Massachusetts**             | ** ** | **01879**            |
| (Address of  principal executive offices) |       | (Zip code)           |

 

**(978) 694-9121**

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

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

 

Indicateby check mark whether the registrant is a shell company (as defined in rule 12b-2of the Exchange Act.) o Yes xNo

 

Thenumber of shares of the Registrant’s common stock, par value $.01 per share,outstanding as of May 6, 2010 was 182,681,995.

 

 

** **

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

 
| ** **                          | ** **                                                                                                                                                                                           | ** ** | **Page**   |
|-------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                          | ** **                                                                                                                                                                                           | ** ** | ** ** |
| PART I.  Financial Information |                                                                                                                                                                                                 |       |
|                                |                                                                                                                                                                                                 |       |
| Item 1.                             | Financial Statements                                                                                                                                                                                 |       |       |
|                                |                                                                                                                                                                                                 |       |       |
|                                | Consolidated  Balance Sheets at March 31, 2010 and December 31, 2009                                                                                                                       |       | 1          |
|                                |                                                                                                                                                                                                 |       |       |
|                                | Unaudited  Consolidated Statements of Operations for the three months ended  March 31, 2010 and 2009, and for the period from May 8, 1997 (date  of inception) through March 31, 2010 |       | 2          |
|                                |                                                                                                                                                                                                 |       |       |
|                                | Unaudited  Consolidated Statements of Cash Flows for the three months ended  March 31, 2010 and 2009 and for the period from May 8, 1997 (date  of inception) through March  31, 2010 |       | 3          |
|                                |                                                                                                                                                                                                 |       |       |
|                                | Unaudited Consolidated Statements of Stockholders’  Equity for the year ended December 31, 2009 and the three months ended  March 31, 2010                                            |       | 5          |
|                                |                                                                                                                                                                                                 |       |       |
|                                | Notes to Unaudited Consolidated Financial Statements                                                                                                                                                 |       | 6          |
|                                |                                                                                                                                                                                                 |       |       |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                          |       | 26         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 3.                             | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                                                          |       | 45         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 4.                             | Controls and Procedures                                                                                                                                                                              |       | 45         |
|                                |                                                                                                                                                                                                 |       |       |
| PART II. Other  Information    |                                                                                                                                                                                                 |       |
|                                |                                                                                                                                                                                                 |       |
| Item 1.                             | Legal Proceedings                                                                                                                                                                                    |       | 46         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 1A.                            | Risk Factors                                                                                                                                                                                         |       | 46         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 2.                             | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                                         |       | 46         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 3.                             | Defaults  Upon Senior Securities                                                                                                                                                                     |       | 46         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 4.                             | (Removed and  Reserved)                                                                                                                                                                              |       | 46         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 5.                             | Other Information                                                                                                                                                                                    |       | 46         |
|                                |                                                                                                                                                                                                 |       |       |
| Item 6.                             | Exhibits                                                                                                                                                                                             |       | 47         |
|                                |                                                                                                                                                                                                 |       |       |
| Signatures                          |                                                                                                                                                                                                 |       | 48         |

 

iii

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**PART 1 — FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**BEACON POWER CORPORATION ANDSUBSIDIARIES (A Development Stage Company)**

**Consolidated Balance Sheets**

** **
| ** **                                                                                                                                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                               | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                               |       |               |       |                  |       |
| Current  assets:                                                                                                                                                         |       |               |       |                  |       |
| Cash  and cash equivalents                                                                                                                                               |       | $                  | 17,507,912 |                  | $          | 22,605,147 |   |
| Accounts  receivable, net                                                                                                                                                |       | 70,485             |       | 46,907                |       |
| Unbilled  costs on contracts in progress                                                                                                                                 |       | 617,192            |       | 577,356               |       |
| Prepaid  expenses and other current assets                                                                                                                               |       | 734,119            |       | 636,887               |       |
| Total  current assets                                                                                                                                                    |       | 18,929,708         |       | 23,866,297            |       |
| Property  and equipment, net                                                                                                                                             |       | 24,169,638         |       | 24,373,941            |       |
| Restricted  cash                                                                                                                                                         |       | 212,560            |       | 212,557               |       |
| Deferred  financing costs and other assets                                                                                                                               |       | 4,341,311          |       | 1,549,685             |       |
| Total  assets                                                                                                                                                            |       | $                  | 47,653,217 |                  | $          | 50,002,480 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                            |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                    |       |               |       |                  |       |
| Accounts  payable                                                                                                                                                        |       | $                  | 960,762    |                  | $          | 1,154,613 |   |
| Accrued  compensation and benefits                                                                                                                                       |       | 1,148,196          |       | 1,764,053             |       |
| Other  accrued expenses                                                                                                                                                  |       | 1,855,477          |       | 1,543,507             |       |
| Advance  billings on contracts                                                                                                                                           |       | 41,741             |       | 35,418                |       |
| Accrued  contract loss                                                                                                                                                   |       | 237,937            |       | 257,698               |       |
| Deferred  rent — current                                                                                                                                            |       | 144,996            |       | 138,558               |       |
| Current  portion of long term debt                                                                                                                                       |       | 620,989            |       | 608,105               |       |
| Total  current liabilities                                                                                                                                               |       | 5,010,098          |       | 5,501,952             |       |
| Long  term liabilities:                                                                                                                                                  |       |               |       |                  |       |
| Deferred  rent — long term                                                                                                                                          |       | 707,050            |       | 746,518               |       |
| Long  term debt, net of unamortized discount                                                                                                                             |       | 3,517,894          |       | 3,676,569             |       |
| Total  long term liabilities                                                                                                                                             |       | 4,224,944          |       | 4,423,087             |       |
| Commitments  and contingencies (Note 6)                                                                                                                                  |       |               |       |                  |       |
| Stockholders’  equity:                                                                                                                                              |       |               |       |                  |       |
| Preferred  Stock, $.01 par value; 10,000,000 shares authorized; no shares issued or  outstanding                                                                         |       | —             |       | —                |       |
| Common  stock, $.01 par value; 400,000,000 shares authorized 182,263,728 and  171,641,622 shares issued at March 31, 2010 and December 31, 2009,  respectively |       | 1,822,637          |       | 1,716,416             |       |
| Deferred  stock compensation                                                                                                                                             |       | —             |       | —                |       |
| Additional  paid-in-capital                                                                                                                                              |       | 248,803,976        |       | 245,029,557           |       |
| Deficit  accumulated during the development stage                                                                                                                        |       | (211,495,599       | )          | (205,955,693          | )          |
| Treasury  stock, 421,692 shares at cost                                                                                                                                  |       | (712,839           | )          | (712,839              | )          |
| Total  stockholders’ equity                                                                                                                                         |       | 38,418,175         |       | 40,077,441            |       |
| Total  liabilities and stockholders’ equity                                                                                                                         |       | $                  | 47,653,217 |                  | $          | 50,002,480 |   |

 

See notes tounaudited consolidated financial statements.

 

1

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**BEACONPOWER CORPORATION AND SUBSIDIARIES**

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

** **
|                                                            | ** ** | ** **                             | ** ** | ** **                  | ** ** | **Cumulative  from**     | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
|                                                            | ** ** | ** **                             | ** ** | ** **                  | ** ** | **May 8,  1997**    | ** ** |
|                                                            | ** ** | ** **                             | ** ** | ** **                  | ** ** | **(date  of inception)** | ** ** |
|                                                            | ** ** | **Three  months ended March 31,** | ** ** | **through  March 31,** | ** ** |
|                                                            | ** ** | **2010**                               | ** ** | **2009**                    | ** ** | **2010**                 | ** ** |
| Revenue                                                         |       | $                                      | 235,480    |                        | $          | 110,935                  |       | $ | 5,992,579 |   |
| Cost  of goods sold (exclusive of items shown separately below) |       | 183,093                                |       | 172,033                     |       | 6,353,838                |       |
| Gross  profit                                                   |       | 52,387                                 |       | (61,098                     | )          | (361,259                 | )          |
| Operating  expenses:                                            |       |                                   |       |                        |       |                     |       |
| Operations  and maintenance                                     |       | 966,982                                |       | 777,137                     |       | 3,898,297                |       |
| Research  and development                                       |       | 2,072,437                              |       | 2,191,054                   |       | 92,685,324               |       |
| Selling,  general and administrative                            |       | 1,945,535                              |       | 1,897,462                   |       | 67,110,046               |       |
| Loss  on contract commitments                                   |       | —                                 |       | 132,500                     |       | 3,042,624                |       |
| Depreciation  and amortization                                  |       | 529,837                                |       | 423,888                     |       | 8,124,623                |       |
| Restructuring  charges                                          |       | —                                 |       | —                      |       | 2,159,280                |       |
| Loss  on impairment of assets                                   |       | —                                 |       | —                      |       | 4,663,916                |       |
| Total  operating expenses                                       |       | 5,514,791                              |       | 5,422,041                   |       | 181,684,110              |       |
| Loss  from operations                                           |       | (5,462,404                             | )          | (5,483,139                  | )          | (182,045,369             | )          |
| Other  income (expense):                                        |       |                                   |       |                        |       |                     |       |
| Interest  income                                                |       | 8,848                                  |       | 10,521                      |       | 5,597,872                |       |
| Interest  expense                                               |       | (86,350                                | )          | (67,301                     | )          | (1,366,663               | )          |
| Gain  on sale of investment                                     |       | —                                 |       | —                      |       | 3,562,582                |       |
| Other  income (expense)                                         |       | —                                 |       | —                      |       | (237,827                 | )          |
| Total  other income (expense), net                              |       | (77,502                                | )          | (56,780                     | )          | 7,555,964                |       |
| Net  loss                                                       |       | (5,539,906                             | )          | (5,539,919                  | )          | (174,489,405             | )          |
| Preferred  stock dividends                                      |       | —                                 |       | —                      |       | (36,825,680              | )          |
| Accretion  of convertible preferred stock                       |       | —                                 |       | —                      |       | (113,014                 | )          |
| Loss  to common shareholders                                    |       | $                                      | (5,539,906 | )                           | $          | (5,539,919               | )          | $ | (211,428,099 | ) |
| Loss  per share, basic and diluted                              |       | $                                      | (0.03      | )                           | $          | (0.05                    | )          |   |   |
| Weighted-average  common shares outstanding                     |       | 175,527,292                            |       | 109,003,136                 |       |                     |       |

 

See notes to unaudited consolidated financial statements.

 

2

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

 
|                                                                         | ** ** | ** **                             | ** ** | ** **         | ** ** | **Cumulative  from**     | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|--------------------------|------------|
|                                                                         | ** ** | ** **                             | ** ** | ** **         | ** ** | **May 8,  1997**    | ** ** |
|                                                                         | ** ** | ** **                             | ** ** | ** **         | ** ** | **(date  of inception)** | ** ** |
|                                                                         | ** ** | ** **                             | ** ** | ** **         | ** ** | **through**              | ** ** |
|                                                                         | ** ** | **Three  months ended March 31,** | ** ** | **March 31,** | ** ** |
|                                                                         | ** ** | **2010**                               | ** ** | **2009**           | ** ** | **2010**                 | ** ** |
| Cash  flows from operating activities:                                       |       |                                   |       |               |       |                     |       |
| Net  loss                                                                    |       | $                                      | (5,539,906 | )                  | $          | (5,539,919               | )          | $ | (174,489,405 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                                   |       |               |       |                     |       |
| Depreciation  and amortization                                               |       | 529,837                                |       | 423,888            |       | 8,124,625                |       |
| Loss  (gain) on sale of fixed assets                                         |       | —                                 |       | —             |       | 210,012                  |       |
| Impairment  of assets, net                                                   |       | —                                 |       | —             |       | 4,551,147                |       |
| Interest  expense relating to issuance of warrants                           |       | 13,620                                 |       | 10,037             |       | 441,874                  |       |
| Non-cash  charge for change in option terms                                  |       | —                                 |       | —             |       | 346,591                  |       |
| Non-cash  charge for settlement of lawsuit                                   |       | —                                 |       | —             |       | 821,160                  |       |
| Amortization  of deferred consulting expense, net                            |       | —                                 |       | —             |       | 1,160,784                |       |
| Amortization  of deferred stock compensation                                 |       | —                                 |       | —             |       | 3,699,721                |       |
| Options  and warrants issued for consulting services                         |       | —                                 |       | —             |       | 1,585,654                |       |
| Services  and interest expense paid in preferred stock                       |       | —                                 |       | —             |       | 11,485                   |       |
| Gain  on sale of investments                                                 |       | —                                 |       | —             |       | (3,562,582               | )          |
| Stock-based  compensation                                                    |       | 127,116                                |       | 279,012            |       | 4,996,763                |       |
| Deferred  rent                                                               |       | (33,030                                | )          | (26,593            | )          | (577,955                 | )          |
| Cash  received from landlord for build-out credit                            |       | —                                 |       | —             |       | 1,430,000                |       |
| Changes  in operating assets and liabilities:                                |       |                                   |       |               |       |                     |       |
| Accounts  receivable                                                         |       | (23,578                                | )          | (8,091             | )          | (70,485                  | )          |
| Unbilled  costs on government contracts                                      |       | (39,836                                | )          | (41,886            | )          | (617,192                 | )          |
| Prepaid  expenses and other current assets                                   |       | (97,232                                | )          | 51,893             |       | (833,780                 | )          |
| Accounts  payable                                                            |       | (193,851                               | )          | (3,013,188         | )          | 960,762                  |       |
| Accrued  compensation and benefits                                           |       | (615,857                               | )          | (396,664           | )          | 1,148,196                |       |
| Advance  billings on contracts                                               |       | 6,323                                  |       | 3,047              |       | 41,741                   |       |
| Accrued  interest                                                            |       | —                                 |       | —             |       | 275,560                  |       |
| Accrued  loss on contract commitments                                        |       | (19,761                                | )          | 124,836            |       | 237,937                  |       |
| Other  accrued expenses and current liabilities                              |       | 311,970                                |       | (1,411,110         | )          | 1,864,147                |       |
| Net  cash used in operating activities                                       |       | (5,574,185                             | )          | (9,544,738         | )          | (148,243,240             | )          |
| Cash  flows from investing activities:                                       |       |                                   |       |               |       |                     |       |
| Purchase  of investments                                                     |       | —                                 |       | —             |       | (1,190,352               | )          |
| Sale  of investments                                                         |       | —                                 |       | —             |       | 4,752,934                |       |
| Restricted  cash                                                             |       | (3                                     | )          | (21                | )          | (212,560                 | )          |
| Increase  in other assets                                                    |       | —                                 |       | —             |       | (412,072                 | )          |
| Purchases  and manufacture of property and equipment                         |       | (321,892                               | )          | (1,053,935         | )          | (36,372,662              | )          |
| Sale  of property and equipment                                              |       | —                                 |       | —             |       | 202,674                  |       |
| Net  cash used in investing activities                                       |       | (321,895                               | )          | (1,053,956         | )          | (33,232,038              | )          |
| Cash  flows from financing activities:                                       |       |                                   |       |               |       |                     |       |
| Initial  public stock offering, net of expenses                              |       | —                                 |       | —             |       | 49,341,537               |       |
| Stock  offerings, net of expenses                                            |       | 1,520,548                              |       | 1,764,852          |       | 104,851,172              |       |
| Payment  of dividends                                                        |       | —                                 |       | —             |       | (1,159,373               | )          |
| Shares  issued under employee stock purchase plan                            |       | —                                 |       | —             |       | 399,590                  |       |
| Exercise  of employee stock options                                          |       | —                                 |       | (100               | )          | 2,304,091                |       |
| Issuance  of debt                                                            |       | —                                 |       | —             |       | 4,615,155                |       |
| Repayment  of debt                                                           |       | (159,411                               | )          | —             |       | (319,198                 | )          |
| Warrants  issued in relation to lease                                        |       | —                                 |       | —             |       | 716,614                  |       |
|                                                                              |            |                                        |            |                    |            |                          |            |  |  |  |

 

3

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|                                                 | ** ** | ** **                             | ** ** | ** **         | ** ** | **Cumulative  from**     | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|--------------------------|------------|
|                                                 | ** ** | ** **                             | ** ** | ** **         | ** ** | **May 8,  1997**    | ** ** |
|                                                 | ** ** | ** **                             | ** ** | ** **         | ** ** | **(date  of inception)** | ** ** |
|                                                 | ** ** | ** **                             | ** ** | ** **         | ** ** | **through**              | ** ** |
|                                                 | ** ** | **Three  months ended March 31,** | ** ** | **March 31,** | ** ** |
|                                                 | ** ** | **2010**                               | ** ** | **2009**           | ** ** | **2010**                 | ** ** |
| Cash  paid for financing costs and other assets      |       | (2,795,268                             | )          | (200,435           | )          | (4,361,062               | )          |
| Issuance  of preferred stock                         |       | —                                 |       | —             |       | 32,868,028               |       |
| Repayment  of subscription receivable                |       | —                                 |       | —             |       | 5,000,000                |       |
| Proceeds  from capital leases                        |       | —                                 |       | —             |       | 495,851                  |       |
| Repayment  of capital leases                         |       | —                                 |       | —             |       | (1,031,395               | )          |
| Warrant  exercises                                   |       | 2,232,976                              |       | —             |       | 2,325,359                |       |
| Repurchase  company stock                            |       | —                                 |       | —             |       | (613,179                 | )          |
| Proceeds  from notes payable issued to investors     |       | —                                 |       | —             |       | 3,550,000                |       |
| Net  cash provided by (used in) financing activities |       | 798,845                                |       | 1,564,317          |       | 198,983,190              |       |
| (Decrease)  increase in cash and cash equivalents    |       | (5,097,235                             | )          | (9,034,377         | )          | 17,507,912               |       |
| Cash  and cash equivalents, beginning of period      |       | 22,605,147                             |       | 14,357,475         |       | —                   |       |
| Cash  and cash equivalents, end of period            |       | $                                      | 17,507,912 |               | $          | 5,323,098                |       | $ | 17,507,912 |   |
| Supplemental  disclosure of cash flow information:   |       |                                   |       |               |       |                     |       |
| Cash  paid for interest                              |       | $                                      | 81,974     |               | $          | 58,045                   |       | $ | 879,014 |   |
| Cash  paid for taxes                                 |       | $                                      | —     |               | $          | —                   |       | $ | 32,750 |   |
| Assets  acquired through capital lease               |       | $                                      | —     |               | $          | —                   |       | $ | 535,445 |   |
| Warrants  issued in relation to loan (non-cash)      |       | $                                      | —     |               | $          | —                   |       | $ | 227,946 |   |

 

See notes to unaudited consolidated financial statements.

 

4

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**BEACON POWER CORPORATION ANDSUBSIDIARIES (A Development Stage Company)Consolidated Statements of Stockholders’ Equity (Unaudited)**

** **
| ** **                                         | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **          | ** ** | ** **             | ** **   | ** ** | ** ** | **Total**   | ** ** |
|----------------------------------------------------|------------|-------------------|------------|-------------|------------|----------------|------------|---------------------|------------|------------------------|--------------|------------|------------|-------------|------------|
| ** **                                         | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Retained**   | ** ** | **Treasury  Stock** | ** ** | **Stockholders’** | ** **   |
| **Description**                                    | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Deficit**         | ** ** | **Shares**             | ** **   | **Amount** | ** ** | **Equity**  | ** ** |
| Balance, December 31, 2008                    |       | 107,433,190       |       | $           | 1,074,332  |           | $          | 212,145,254         |       | $                      | (186,895,207 | )          | 421,692    |        | $          | (712,839 | ) | $ | 25,611,540 |   |
| Issuance  of officer restricted stock units        |       | 63,272            |       | 631         |       | (631           | )          | —              |       | —                 |         | —     |       | —      |       |
| Shares  issued through ESPP                        |       | 200,102           |       | 2,001       |       | 121,768        |       | —              |       | —                 |         | —     |       | 123,769     |       |
| Stock-based  compensation                          |       | —            |       | —      |       | 902,279        |       | —              |       | —                 |         | —     |       | 902,279     |       |
| Issuance  of stock for cash, net of issuance costs |       | 63,712,933        |       | 637,131     |       | 31,770,825     |       | —              |       | —                 |         | —     |       | 32,407,956  |       |
| Warrant  exercises                                 |       | 232,125           |       | 2,321       |       | 90,062         |       | —              |       | —                 |         | —     |       | 92,383      |       |
| Net  loss                                          |       | —            |       | —      |       | —         |       | (19,060,486         | )          | —                 |         | —     |       | (19,060,486 | )          |
| Balance, December 31, 2009                    |       | 171,641,622       |       | 1,716,416   |       | 245,029,557    |       | (205,955,693        | )          | 421,692                |         | (712,839   | )          | 40,077,441  |       |
| Stock-based  compensation                          |       | —            |       | —      |       | 127,116        |       | —              |       | —                 |         | —     |       | 127,116     |       |
| Issuance  of stock for cash, net of issuance costs |       | 4,500,000         |       | 45,000      |       | 1,475,548      |       | —              |       | —                 |         | —     |       | 1,520,548   |       |
| Warrant  exercises                                 |       | 6,122,106         |       | 61,221      |       | 2,171,755      |       | —              |       | —                 |         | —     |       | 2,232,976   |       |
| Net  loss                                          |       | —            |       | —      |       | —         |       | (5,539,906          | )          | —                 |         | —     |       | (5,539,906  | )          |
| Balance, March 31, 2010                       |       | 182,263,728       |       | $           | 1,822,637  |           | $          | 248,803,976         |       | $                      | (211,495,599 | )          | 421,692    |        | $          | (712,839 | ) | $ | 38,418,175 |   |

 

See notes to unaudited consolidated financial statements.

 

5

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

 

**Note1.  Nature of Business and Operations**

 

*Natureof Business*

 

Beacon Power Corporation(collectively the “Company,” “Beacon,” “we,” “our,” or “us”) (a developmentstage company) was incorporated on May 8, 1997 as a wholly ownedsubsidiary of SatCon Technology Corporation. Since our inception, we have been primarily engaged in the developmentof flywheel devices that store and recycle energy on a highly efficientbasis.  In 2000, we completed an initialpublic offering of our common stock and raised approximately $49.3 million, netof offering expenses. Since our initial public offering, we have raisedapproximately $107 million as of March 31, 2010, through the sale of ourstock and exercise of warrants. Because we have not yet generated a significantamount of revenue from our principal operations, we are accounted for as adevelopment stage company under the Financial Accounting Standards Board’sAccounting Standards Codification (ASC) Topic 915.

 

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

 

On July 2,2009 we announced that we had been notified by the Department of Energy (DOE)of a conditional commitment for a loan guarantee of approximately $43 million. Theloan, which would be funded by the U.S. Treasury’s Federal Financing Bank, isexpected to provide debt financing for 62.5% of the estimated $69 million totalproject cost of our planned 20 megawatt (MW) plant in Stephentown, New York.This plant is under construction and we expect to complete it within 12 to 18months from the date of financial closing. Our equity contribution to theproject is expected to be $26 million. We expect to close on this loan duringthe second quarter of 2010.  In November 2009,the DOE announced that it has awarded us a stimulus grant valued at $24 millionfor use in construction of our second 20 MW flywheel energy storage plant, tobe located in the Chicago, Illinois area. The grant was made to cover approximately 50% of the project’s totalcost.

 

*Operations*

 

We are focused oncommercializing our Smart Energy MatrixTM flywheel system to provide frequencyregulation services and to sell turnkey systems.  In the future, as thenumber of our merchant regulation facilities increases and we developsustainable cash flows from operations and the sale of turnkey plants, weexpect to fund additional plants from a combination of cash flow fromoperations, non-recourse project financing and project equity.

 

We currently have 3megawatts (MW) of our Smart Energy MatrixTM operating and generating frequencyregulation revenue within the New England Independent System Operator region(ISO-NE) under its Alternative Technologies Regulation pilot program.We plan to increase our revenues by buildingadditional facilities, including 1) the 20 MW plant in Stephentown, New York,where we have broken ground and are in the process of finalizing the $43million Department of Energy (DOE) loan guarantee; 2)  a 20 MW plant in either Chicago, Illinois, oranother location in the PJM Interconnection region (PJM) for which we have beenawarded the $24 million DOE Smart Grid stimulus grant; and 3) a 20 MW facilityin Glenville, New York, for which we have secured site control and filed forinterconnection. We have filed interconnection applications for both the sitein Chicago and an alternate site in the PJM region.  Based on our successful Phase I DOE loanapplication, we have been invited by the DOE to submit a Phase II applicationfor the Glenville facility and are in the process of doing so.

 

We are also identifyingother plant locations for future merchant facilities, as well as marketing oursystems to domestic and foreign utilities that lack open-bid markets with theobjective of selling our plants on a turnkey basis.  Additionally, we are exploring otherpotential flywheel applications, including the sale of systems forwind/diesel/flywheel energy storage hybrid power systems on islands and remotegrids.

 

We have experienced netlosses since our inception and, as of March 31, 2010, had an accumulateddeficit of approximately $211.5 million.  We do not expect to havepositive EBITDA (earnings before interest, taxes, depreciation andamortization) or positive cash flow from operations until we have deployed asufficient number of merchant plants and/or sell turnkey systems. We will needto

 

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raise additional capitalfrom a combination of equity and/or project financing, the sale of our systemsand/or other sources to build regulation facilities, support operations at ourTyngsboro and other facilities, implement our business plan and continue as agoing concern.  Of the $17.5 million cashon hand as of March 31, 2010, $12 million represents our expected cashinvestment towards the construction of the Stephentown plant under the terms ofthe DOE loan, and thus is not available for our general corporate operatingpurposes. Based on our projected cash usage rates exclusive of the anticipatedborrowings from the DOE loan and our equity contribution to the Stephentownproject, we have sufficient cash to fund our operations into the third quarterof 2010. We estimate that we will need toraise an additional $18 - $20 million during the remainder of 2010 through theissuance of equity securities or debt in order to fund operations and havesufficient working capital to continue to execute our business plan into 2011,including ordering long-lead items required by our production plan for 2011.  Additional funding will be required in 2011.

 

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

 

**Basis ofPresentation.**

 

The accompanyingunaudited consolidated financial statements have been prepared using accountingprinciples generally accepted in the United States of America except thatcertain information and footnote disclosures normally included in consolidatedfinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted in this Form 10-Q.  Wesuggest that the consolidated financial statements presented herein be read inconjunction with our consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2009.  In our management’s opinion, all adjustments consisting of normalrecurring accruals considered necessary for a fair presentation have beenincluded in the accompanying unaudited financial statements.  Operatingresults for the three months ended March 31, 2010 are not necessarilyindicative of the results that may be expected for the full year ending December 31,2010.

 

*GoingConcern*

 

Theaccompanying consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business.  As shown in our consolidated financialstatements, we had minimal revenues, and incurred significant losses ofapproximately $211.5 million since our inception including losses during thethree months ending March 31, 2010, of approximately $5.5 million.  We have approximately $17.5 million of cashand cash equivalents on hand at March 31, 2010, which we believe, incombination with the DOE loan which is expected to close during the secondquarter of 2010, is adequate to complete the construction of the Stephentownfacility and finance our operations into the third quarter of 2010.  Since our cash requirements for operation andconstruction of frequency regulation facilities beyond that point far exceedthe cash generated from operations, we may be unable to continue as a goingconcern.  The consolidated financialstatements do not include any adjustments relating to the recoverability andclassification of liabilities that might be necessary should we be unable tocontinue as a going concern.

 

Werecognize that our continuation as a going concern is dependent upon ourability to generate sufficient cash flow to allow us to satisfy our obligationson a timely basis.  The generation of sufficientcash flow is dependent, in the short term, on our ability to raise additionalcapital from a combination of equity and/or project financing; and in the longterm, on the successful operation of our merchant plants and on our sales ofsystems on a turnkey basis.  We believethat the successful achievement of these initiatives should provide us withsufficient resources to meet our long-term cash requirements.

 

*Reclassification of prior periodamounts*

 

Certain prior period amountshave been reclassified to be consistent with current period reporting.

 

*Consolidation*

 

The accompanyingconsolidated financial statements include the accounts of Beacon PowerCorporation and our subsidiary, Beacon Power Securities Corporation. In September 2008,we established two wholly-owned subsidiaries, Tyngsboro Regulation Services LLCand Tyngsboro Holding LLC.  In July 2009, we established twoadditional wholly-owned subsidiaries, Stephentown Holding LLC and StephentownRegulation Services, LLC. As of March 31, 2010, these entities remaininactive. The frequency regulation service revenue and costs from the ISO-NEpilot program are accounted for as part of Beacon Power Corporation. Allsignificant inter-company accounts and transactions have been eliminated inconsolidation.

 

*Lossper Share — Basic and Diluted*

 

Basic and dilutedlosses per share have been computed using the weighted-average number of sharesof common stock outstanding during each period. Warrants, options and othersecurities exercisable for common shares are used in the calculation of fullydiluted earnings per share (EPS) only if their conversion to common shareswould decrease income or increase loss per share from continuingoperations.  Since the three month periods ended March 31, 2010 and2009, reflect losses, including the potential 

 

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conversion of warrantsand options in the diluted EPS calculation would decrease loss per share.Accordingly, they are considered anti-dilutive and are not included in thecalculation of loss per share.

 

**Summaryof Significant Accounting Policies**

 

*Use ofEstimates*

 

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

 

*LeaseObligation and Deferred Rent*

 

In July 2007,we signed a seven-year operating lease with escalating payments on a 103,000square foot facility in Tyngsboro, Massachusetts. As part of this leaseagreement, we issued to the landlord 150,000 shares of our common stock and awarrant exercisable for 500,000 shares of our common stock in return for lowercash payments under the lease. (See Note 6: Commitments and Contingencies.)  Additionally, the landlord has reimbursed usfor certain leasehold improvements we have made. In accordance with theFinancial Accounting Standards Board’s (FASB’s) Accounting StandardsCodification (ASC) Topic 840, “*Leases,*” thesereimbursements have been credited to “Deferred Rent”, and we have recorded rentexpense on a straight line basis. The current portion of the deferred rent isincluded in current liabilities, and the remainder is shown on the balancesheet as “Deferred rent — long term.”

 

*Propertyand Equipment*

 

Property andequipment in service is stated at cost and depreciated using the straight-linemethod over the estimated useful lives of the assets. Property and equipmentare defined as tangible items with unit costs exceeding our capitalizationthreshold that are used in the operation of the business, are not intended forresale and which have a useful life of one year or more. The cost of fixedassets is defined as the purchase price of the item, as well as all of thecosts necessary to bring it to the condition and location necessary for itsintended use.  These costs include labor,overhead, capitalized interest and, if applicable, exit costs. Exit costs forwhich we are obligated are accounted for in accordance with ASC Topic 410, “*Asset Retirement and Environmental Obligations*.”  No overhead is generally applied forinternally-constructed projects not directly related to our core business(e.g., leasehold improvements). Interest costs incurred during the constructionof major construction projects (such as the construction of our frequencyregulation plants) are capitalized in accordance with ASC Topic 835, Subtopic20, “*Interest — Capitalization of Interest*.”  The interest is capitalized until theunderlying asset is ready for its intended use, and is considered an integralpart of the total cost of acquiring a qualifying asset.  Thus, the capitalized interest costs areincluded in the calculation of depreciation expense once the constructed assetsare in service. Repair and maintenance costs are expensed as incurred.  Materials used in our development efforts areconsidered research and development materials, and are expensed as incurred inaccordance with ASC Topic 730, “Research and Development.”

 

Capital assets areclassified as “Construction in Progress” (CIP) when initially acquired, andreclassified to the appropriate asset account when placed into service, withthe exception of land, which is capitalized upon purchase. Depreciation expenseis not recorded on assets not yet placed into service.

 

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

 

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*Deferred financing costs andother assets*

 

Deferredfinancing costs represent legal, due diligence and other direct costs incurredto raise capital or obtain debt.  Directcosts include only “out-of-pocket” or incremental costs directly related to theeffort, such as a finder’s fee and fees paid to outside consultants foraccounting, legal or engineering investigations or for appraisals.  These costs will be capitalized if theefforts are successful, or expensed when unsuccessful.  Indirect costs are expensed as incurred.Deferred financing costs related to debt are amortized over the life of thedebt. Deferred financing costs related to issuing equity are charged to Paid inCapital.  Other assets represent advancepayments to suppliers for custom materials used in the manufacture of ourflywheels or frequency regulation facilities and capitalized patent costs.

 

*Loss onContract Commitments*

 

Our contracts havebeen primarily for the development of demonstration units of new products,design of a frequency regulation plant, design of a flywheel for use by theNavy in their electric ships, and other work that supports our core researchand development efforts.  Most of thesecontracts have been structured on a cost-share basis for which the expectedcost share has been recorded as a contract loss.  The “cost” basis allowable on these contractsis based on government-allowable overhead rates, which differ from overheadrates required by GAAP.  In particular,most of our stock compensation expense is not an allowable cost for thepurposes of calculating government-allowable rates.  As a consequence, we may incur losses on ourfinancial statements even for contracts granted on a cost-plus-fixed feebasis.  We establish reserves for anticipatedlosses on contract commitments if, based on our cost estimates to complete thecommitment, we determine that the cost to complete the contract will exceed thetotal expected contract revenue.  Eachquarter, we perform an estimate-to-complete analysis, and any changes to ouroriginal estimates are recognized in the period in which they are determined.

 

*Stock-BasedCompensation*

 

We account forstock-based compensation for employees in accordance with ASC Topic 718, “*Compensation-Stock Compensation*.” Under the fair valuerecognition provision of ASC Topic 718, stock-based compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as an expense as it is earned over the requisite service period,which is the vesting period. The fair value of the options on their grant dateis measured using the Black-Scholes option-pricing model, which we believeyields a reasonable estimate of the fair value of the grants made. Thevaluation provisions of ASC Topic 718 apply to grants issued since January 1,2006 (the effective date) and to grants that were outstanding as of that datethat are subsequently modified. Estimated compensation expense for grants thatwere outstanding as of the effective date will be recognized over the remainingvesting period.

 

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

 

*Restructuringand Asset Impairment Charges*

 

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

 

In certain instances, wemay determine that it is in the best interest of the Company to move and re-deployall or part of a Smart Energy MatrixTM system installed at a givenlocation.  When such a decision has beenmade, we will determine which costs are associated with the movable (fungible)components, and which costs are non-fungible. We will record a period expensefor the net book value associated with the non-fungible components.

 

No asset impairmentcharges were considered necessary for the three months ended March 31,2010 or 2009.

 

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*RevenueRecognition*

 

Although we have recorded revenues for our research and developmentcontracts and frequency regulation service from the ISO-NE pilot program, andsold photovoltaic inverters, our operations have not yet reached a level thatwould qualify us to emerge from the development stage.  Therefore we continue to be accounted for asa development stage company under ASC Topic 915, “Development Stage Entities.”

 

·                  *Frequency Regulation Revenue*

 

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

 

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

 

We recognize contractrevenue using the percentage-of-completion method. We use labor hours as thebasis for the percentage of completion calculation, which is measuredprincipally by the percentage of labor hours incurred to date for each contractto the estimated total labor hours for each contract at completion. Changes to totalestimated contract costs or losses, if any, are recognized in the period inwhich they are determined. Changes in project performance and conditions,estimated profitability, and final contract settlements may result in futurerevisions to contract costs and revenue. Revenues recognized in excess of amounts billed are classified ascurrent assets, and included in “Unbilled costs on contracts in progress” inour balance sheets.  Amounts billed to clients in excess of revenuesrecognized to date are classified as current liabilities under “Advancebillings on contracts.”  Changes in project performance and conditions,estimated profitability, and final contract settlements may result in futurerevisions to contract costs and revenue.

 

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

 

·                  *Inverter Sales*

 

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

 

*Costof Goods Sold*

 

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

 

*Fair Value of Financial Instruments*

 

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

 

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

 

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

 

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·                  Level three—unobservableinputs developed using estimates and assumptions which are developed by thereporting entity and reflect those assumptions that a market participant woulduse.

 

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

 

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

 

***Recently IssuedAccounting Pronouncements and Regulations***

 

In January 2010, theFASB issued Accounting Standards Update (ASU) No. 2010-06, “*Fair Value Measurements and Disclosures (Topic 820): ImprovingDisclosures about Fair Value Measurements.*” This ASU requires somenew disclosures and clarifies some existing disclosure requirements about fairvalue measurement as set forth in Codification Subtopic 820-10. The FASB’sobjective is to improve these disclosures and, thus, increase the transparencyin financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic820-10 to now require:

 

·                  A reporting entity should discloseseparately the amounts of significant transfers in and out of Level 1 and Level2 fair value measurements and describe the reasons for the transfers; and

 

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

 

Level 1 inputs are quotedprices (unadjusted) in active markets for identical assets or liabilities thatthe reporting entity has the ability to access at the measurement date.  Level 2 inputs are inputs other than quotedprices included within Level 1 that are observable for the asset or liability,either directly or indirectly. Level 3 inputs are unobservable inputs for theasset or liability.

 

In addition, ASU 2010-06clarifies the requirements of the following existing disclosures:

 

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

 

·                  A reporting entity should providedisclosures about the valuation techniques and inputs used to measure fairvalue for both recurring and nonrecurring fair value measurements.

 

ASU 2010-06 is effectivefor interim and annual reporting periods beginning after December 15, 2009which for us was January 1, 2010 except for the disclosures aboutpurchases, sales, issuances, and settlements in the roll forward of activity inLevel 3 fair value measurements. Those disclosures are effective for fiscalyears beginning after December 15, 2010, and for interim periods withinthose fiscal years. Early application is permitted.  We do not expect any significant changes toour financial accounting and reporting as a result of the issuance of ASU2010-06.

 

In October 2009, theFASB issued Accounting Standards Update (ASU) 2009-14, “*Software(Topic 985)—Certain Revenue Arrangements That Include Software Elements*,”which changes the accounting model for revenue arrangements that include bothtangible products and software elements. Under this guidance, tangible productscontaining software components and non-software components that functiontogether to deliver the tangible product’s essential functionality are excludedfrom the software revenue guidance in Subtopic 985-605, “*Software-RevenueRecognition*.” In addition, hardware components of a tangible productcontaining software components are always excluded from the software revenueguidance. ASU 2009-14 will be effective for our Company prospectively forrevenue arrangements entered into or materially modified in fiscal yearsbeginning on or after June 15, 2010. Early adoption is permitted. Althoughour flywheel systems do contain a software component, because it is a tangibleproduct, we do not expect this standard to impact our reporting for the sale ofturnkey plants in the future.

 

In October 2009, theFASB issued ASU 2009-13, “*Revenue Recognition (Topic605)—Multiple-Deliverable Revenue Arrangements*,” which addresses theaccounting for multiple-deliverable arrangements to enable vendors to accountfor products or services (deliverables) separately rather than as a combinedunit. Specifically, this guidance amends the criteria in Subtopic 605-25, “*Revenue Recognition-Multiple-Element Arrangements*,” forseparating consideration in multiple-deliverable arrangements. This guidanceestablishes a selling price hierarchy for determining the selling price of adeliverable, which is based on: (a) vendor-specific objective evidence; (b) third-partyevidence; or (c) estimates. This guidance also eliminates the residualmethod of allocation and 

 

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requires that arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. ASU 2009-13 will apply to usprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010. Early adoption ispermitted. In the future, should we sell turnkey plants, this standard mayimpact our reporting for such transactions.

 

***Recently AdoptedAccounting Pronouncements and Regulations***

 

On February 24,2010, the FASB issued Accounting Standards Update  (“ASU”) No. 2010-09“**Subsequent Events - Amendments to CertainRecognition and Disclosure Requirements****” (“ASU 2010-09”)***,*which amends FASB ASC Topic 855, “**Subsequent Events”*,*sothat SEC filers no longer are required to disclose the date through whichsubsequent events have been evaluated in originally issued and revisedfinancial statements.  ASU No. 2010-09 was effective immediately andwe adopted this new requirement in the first quarter of 2010.

 

In December 2009,the FASB issued ASU 2009-17, “*Consolidations (Topic 810)- Improvements to Financial Reporting by Enterprises Involved with VariableInterest Entities*”, which codifies FASB Statement No. 167, “*Amendments**to FASB Interpretation No. 46(R*)”and changes how a reporting entity determines when an entity that is notcontrolled through voting (or similar rights) should be consolidated. Thedetermination of whether a reporting entity is required to consolidate anotherentity is based on, among other things:

 

a)              The power to direct the activities of a variableinterest entity that most significantly impact the entity’s economicperformance, and

 

b)             The obligation to absorb losses of the entity thatcould potentially be significant to the variable interest entity or the rightto receive benefits from the entity that could potentially be significant tothe variable interest entity.

 

ASU 2009-17 also requiresa reporting entity to provide additional disclosures about its involvement withvariable interest entities and any significant changes in risk exposure due tothat involvement. A reporting entity will be required to disclose how itsinvolvement with a variable interest entity affects the reporting entity’sfinancial statements.  ASU 2009-17 iseffective at the start of a reporting entity’s first fiscal year beginningafter November 15, 2009 which for us was January 1, 2010.  Early application is not permitted. In thefuture, should we become fractional owners of certain merchant frequencyregulation plants, this standard may impact our reporting for such entities.

 

In December, the FASBissued ASU 2009-16, *Transfers and Servicing(Topic 860) - Accounting for Transfers of Financial Assets,* whichformally codifies FASB Statement No. 166, *Accountingfor Transfers of Financial Assets.*ASU 2009-16 represents a revisionto the provisions of former FASB Statement No. 140, *Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities,* and will require moreinformation about transfers of financial assets, including securitizationtransactions, and where entities have continuing exposure to the risks relatedto transferred financial assets. Among other things, ASU 2009-16:

 

·                  Eliminates the concept of a “qualifyingspecial-purpose entity”;

 

·                  Changes the requirements forderecognizing financial assets; and

 

·                  Enhances information reported to users offinancial statements by providing greater transparency about transfers of financialassets and an entity’s continuing involvement in transferred financial assets.

 

ASU 2009-16 is effectiveat the start of a reporting entity’s first fiscal year beginning after November 15,2009 which was January 1, 2010 for us. Early application is not permitted.Our business plan anticipates the use of project financing to fund theconstruction of our merchant frequency regulation plants. This standard willimpact our reporting for any such transactions.

 

**Note3.  Accounts Receivable**

 

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

 

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|                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|--------------------|------------|-----------------------|------------|
|                             | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Accounts  receivable, trade      |       | $                  | 70,485     |                  | $          | 46,907 |   |
| Allowance  for doubtful accounts |       | —             |       | —                |       |
| Accounts  receivable, net        |       | $                  | 70,485     |                  | $          | 46,907 |   |

 

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

 

Some of ourresearch and development contracts contain holdback provisions that allow ourcustomers to withhold 10% from each invoice payment. Our accounts receivablebalance includes holdbacks of approximately $19,000 and $17,000 as of March 31,2010 and December 31, 2009, respectively.  These holdbacks arepayable once work has been satisfactorily completed and the final reports havebeen delivered and approved.  We believethe remaining holdbacks will be collected upon completion of the contracts andcollected within one year, and therefore have not recorded any reserve againstthis amount.

 

**Note4.  Property and Equipment**

 

Details of ourproperty and equipment follow:

 

|                                                | ** ** | **Estimated** | ** ** | **As  of:**        | ** ** |
|-----------------------------------------------------|------------|---------------|------------|--------------------|------------|
|                                                | ** ** | **Useful**    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|                                                | ** ** | **Lives**     | ** ** | **2010**           | ** ** | **2009** | ** ** |
| Construction  in Progress                           |       | Varied        |       | $                  | 8,135,336  |   | $ | 7,941,125 |   |
| Land                                                |       |          |       | 192,487            |       | 192,487 |   |
| Smart  Energy 25 flywheels                          |       | 20 years      |       | 6,241,732          |       | 6,241,732 |   |
| Smart  Energy MatrixTM installations - fungible |       | 20 years      |       | 1,571,649          |       | 1,686,038 |   |
| Machinery  and equipment                            |       | 5 - 10 years  |       | 3,286,189          |       | 3,096,175 |   |
| Service  vehicles                                   |       | 5 years       |       | 16,763             |       | 16,763 |   |
| Furniture  and fixtures                             |       | 7 years       |       | 700,624            |       | 700,624 |   |
| Office  equipment and software                      |       | 3 years       |       | 1,077,992          |       | 1,025,936 |   |
| Leasehold  improvements                             |       | Lease term    |       | 7,804,607          |       | 7,804,607 |   |
| Equipment  under capital lease obligations          |       | Lease term    |       | 563,783            |       | 563,783 |   |
| Total                                               |       |          |       | $                  | 29,591,162 |   | $ | 29,269,270 |   |
| Less  accumulated depreciation and amortization     |       |          |       | (5,421,524         | )          | (4,895,329 | ) |
| Property  and equipment, net                        |       |          |       | $                  | 24,169,638 |   | $ | 24,373,941 |   |

 

InNovember 2008, we deployed 1 MW of capacity under the ISO-NE AlternativeTechnologies pilot program (pilot program) with a system installed inside ourTyngsboro facility. We deployed a second MW of capacity under the pilot programin July 2009, and a third MW in December 2009. Both of theseadditional MWs are installed outside and adjacent to our facility in Tyngsboro.The Smart Energy 25 flywheels shown above represent the cost of the flywheelsand electronic control modules in use for this pilot program.  In addition, the “Smart Energy MatrixTMinstallations — fungible” shown above represent the cost of ancillaryequipment, such as chillers, installed outside our facility. This equipment isconsidered fungible because it can be relocated to other sites.

 

Under the terms of our Tyngsboro facility lease,we will incur certain exit costs at termination of our lease.  Estimated exit costs of approximately$243,000 relating to certain non-fungible equipment included in the SmartEnergy MatrixTM system operating outside of our facility were expensed in 2008and carried in accrued expenses.  Machinery and equipment and leasehold improvements include approximately$54,000 in estimated exit costs as of March 31, 2010 and December 31,2009 that are being depreciated over the remaining life of the assets.  In addition, we have paid the Town ofStephentown, New York, $75,000, to be held in escrow to cover any land clearingor exit costs at that site.  This amounthas been included in “Deferred financing costs and other assets” on our balancesheets.

 

13

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InJuly 2008, we purchased land in Stephentown, New York, for theconstruction of a frequency regulation system, the cost of which is reflectedas “Land” in the schedule shown above. On August 31, 2009, we purchased an option to lease land inGlenville, New York, where we expect to build another 20 MW facility.  During the lease option period, we haveagreed to negotiate in good faith a ground lease to be entered into upon ourunilateral exercise of the lease option. Key terms of the ground lease were substantially delineated in theexecuted option of the lease.  The leaseoption expires on August 28, 2010 but may be extended for up to twoadditional consecutive six-month periods. In consideration for this option, we are paying the landlord anon-refundable fee of $4,550 per month in lease commitments.

 

Thecomponents of “Construction in progress,” which represent costs related toassets that have not yet been placed into service and for which no depreciationexpense has been taken, were as follows:

 

|                                                                                           | ** ** | **As  of:**        | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------|------------|
|                                                                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|                                                                                           | ** ** | **2010**           | ** ** | **2009** | ** ** |
| Materials  to build production flywheels                                                       |       | $                  | 4,492,203  |   | $ | 5,665,670 |   |
| Smart  Energy MatrixTM in progress                                                         |       | 3,299,739          |       | 1,955,481 |   |
| Deposits  and other costs related to the acquisition of land for frequency regulation  systems |       | 43,049             |       | 43,002 |   |
| Machinery  and equipment                                                                       |       | 295,325            |       | 260,840 |   |
| Leasehold  improvements                                                                        |       | 5,020              |       | 16,132 |   |
| Construction  in progress                                                                      |       | $                  | 8,135,336  |   | $ | 7,941,125 |   |

 

Asof March 31, 2010 and December 31, 2009, approximately $7,792,000 and$7,621,000, respectively, of the total shown as CIP represents completedflywheels not yet in service, materials to build flywheels and other costsrelated to the Smart Energy MatrixTM installations under construction outsideour Tyngsboro and Stephentown sites.  TheSmart Energy MatrixTM in progress costs included in CIP at March 31, 2010and December 31, 2009 include approximately $0 and $1,023,000 for fungiblecomponents we expect to deploy at our site in Stephentown, New York, andapproximately $3,300,000 and $933,000 in site costs related to Stephentown andGlenville, respectively.

 

**Note5.  Deferred Financing Costs and OtherAssets**

 

Details of our deferred financing costs and other assets are as follows:

 

|                                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
|                                                            | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Prepaid  financing costs associated with the DOE loan guarantee |       | $                  | 1,489,835  |                  | $          | 1,124,300 |   |
| Deferred  finance charges associated with the MassDev loan      |       | 71,331             |       | 74,573                |       |
| Supplier  prepayments                                           |       | 2,637,473          |       | 235,879               |       |
| Patents,  net of amortization                                   |       | 142,672            |       | 114,933               |       |
| Total                                                           |       | $                  | 4,341,311  |                  | $          | 1,549,685 |   |

 

As of March 31, 2010, patents totaledapproximately $143,000, of which approximately $102,000 represents deferredcosts for patents that have not yet been issued and which are not yet beingamortized. Amortization expense for the three months ended March 31, 2010was $399.   Accumulated amortization asof March 31, 2010 and December 31, 2009 was $563 and $164,respectively.

 

**Note 6. Commitments and Contingencies**

 

The followingtable summarizes our purchase obligations and the aggregate maturities andpayments due for our contractual obligations as of March 31, 2010 and forthe subsequent five years:

 

14

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|                                                 | ** ** | **Description  of Commitment** | ** ** |
|------------------------------------------------------|------------|--------------------------------|------------|
|                                                 | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **Total** | ** ** |
| Period  ending:                                      |       |                           |       |   |   |   |   |
| March 31,  2010                                 |       | $                              | —     |   | $ | 28,175,356 |   | $ | 28,175,356 |   |
| December 31,  2010                              |       | 547,187                        |       |   |   | 547,187 |   |
| December 31,  2011                              |       | 753,188                        |       |   |   | 753,188 |   |
| December 31,  2012                              |       | 778,937                        |       |   |   | 778,937 |   |
| December 31,  2013                              |       | 804,689                        |       |   |   | 804,689 |   |
| December 31,  2014                              |       | 618,000                        |       |   |   | 618,000 |   |
| Total  Commitments                                   |       | $                              | 3,502,001  |   | $ | 28,175,356 |   | $ | 31,677,357 |   |
| Non-cancellable  purchase obligations                |       |                           |       | $ | 13,473,343 |   |   |   |
| Less  advance payments to suppliers                  |       |                           |       | (2,637,743 | ) |   |   |
| Non-cancellable  obligations net of advance payments |       |                           |       | $ | 10,835,870 |   |   |   |

 

As of March 31,2010, we had purchase commitments with our suppliers of approximately $28.2million. Of this amount, approximately $13.5 million represents firm,non-cancelable commitments, against which we have made advance paymentstotaling $2.6 million, leaving a net non-cancelable obligation of approximately$10.8 million as of March 31, 2010. Total purchase commitments include approximately $25.6 million formaterials required to build the flywheels, electronic control modules and otherancillary equipment needed for Stephentown, of which $14.7 million arecancelable as of March 31, 2010. The remaining commitments are for otherequipment needed for Stephentown, costs associated with closing the DOE loan,equipment and other operating expenses. We have an additional $2.8 million conditional material purchasecommitment to a second source supplier who is working to meet our qualificationrequirements.

 

In July 2007, wesigned a seven-year lease on our current corporate headquarters, and relocatedall of our operations to this facility in January 2008.  Our 103,000-square-foot facility is locatedat 65 Middlesex Road, Tyngsboro, Massachusetts. We believe our facility has a capacity of approximately 600 flywheelsper year, and with further capital spending for equipment our capacity willincrease to approximately 1,000 flywheels per year.

 

We provided ourlandlord with an irrevocable letter of credit securing our performance underthe lease with a balance at March 31, 2010 of $200,000, which is reducedperiodically over the lease term.  This letter of credit is secured by acash deposit, which is included in restricted cash in the accompanyingconsolidated balance sheets.  In additionto our rent payments, we are responsible for real estate taxes and alloperating expenses of the Tyngsboro facility. Rent expense was approximately $147,000 during the three months ended March 31,2010 and 2009.

 

*LegalProceedings*

 

We may from time to timebe subject to legal proceedings, often likely to involve routine litigationincidental to our business.  The outcome of any legal proceeding is notwithin our complete control, may often be difficult to predict and may be resolvedover a very long period of time.  Estimating probable losses associatedwith any legal proceedings or other loss contingency is very complex andrequires the analysis of many factors, including assumptions about potentialactions by third parties.  A loss contingency is recorded as a liabilityin the consolidated financial statements when it is both (i) probable andknown that a liability has been incurred and (ii) the amount of the lossis reasonably estimable.  If the reasonable estimate of the loss is arange and no amount within the range is a better estimate, the minimum amountof the range is recorded as a liability.  If a loss contingency is notprobable or not reasonably estimable, a liability is not recorded in theconsolidated financial statements. There are no material legal proceedingspending.

 

15

----

 

**Note7.  Accrued Contract Loss**

 

Ourcontract loss reserves are as follows:

 
|                    | ** ** | **Three  months ended March 31,** | ** ** |
|-------------------------|------------|----------------------------------------|------------|
|                    | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| Beginning  balance      |       | $                                      | 257,698    |   | $ | 132,526 |   |
| Charges  for the period |       | —                                 |       | 132,500 |   |
| Reductions              |       | (19,761                                | )          | (7,664 | ) |
| Ending  balance         |       | $                                      | 237,937    |   | $ | 257,362 |   |

 

During the first quarterof 2009, we recorded a contract loss on the Tehachapi contract of approximately$133,000, which represents the difference between our overhead applied based ona “full production” rate, and the contract bid rate.  No additions to our contract loss reservewere necessary for the quarter ended March 31, 2010.

 

**Note8.  Long-Term Debt**

 

Long-term debt was asfollows, which approximates fair value:

 

|                                                   | ** ** | **As  of:**        | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|
|                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|                                                   | ** ** | **2010**           | ** ** | **2009** | ** ** |
| 6.5%  Note Payable to MassDev, due September 2015 |       | $                  | 4,295,957  |   | $ | 4,455,368 |   |
| Less  unamortized discount (warrants)                  |       | (157,074           | )          | (170,694 | ) |
| Total                                                  |       | 4,138,883          |       | 4,284,674 |   |
| Less  current portion of long term debt                |       | (620,989           | )          | (608,105 | ) |
| Net  long-term debt                                    |       | $                  | 3,517,894  |   | $ | 3,676,569 |   |

 

On June 30, 2008, weentered into an agreement with Massachusetts Development Finance Agency (“MassDev”)pursuant to which MassDev agreed to lend to the Company up to $5 million. Thisloan derives from a funding collaboration between the Emerging Technology Fundof MassDev and the Massachusetts Technology Collaborative Business ExpansionInitiative. The loan proceeds were used to help fund the expansion of ourproduction facility.

 

The MassDev loan isevidenced by a promissory note under which we were able to request advances ofup to $5 million total for the purchase of equipment and installation ofcertain building improvements at our Tyngsboro, Massachusetts facility. Theinitial advance on the loan was made in October 2008 for approximately$3.6 million. The final advance was made in October 2009 for approximately$1.0 million. The approximately $0.4 million balance of the loan commitment hasexpired. The note will mature 84 months after the initial advance and bears afixed annual interest rate of 6.5%.

 

Payments to MassDev beganin November 2008. The payments were interest only during the first twelvemonths. In October, 2009, and thereafter, the balance of the principaloutstanding under the note is being amortized in equal monthly installments ofprincipal and interest over the remaining term of the note. Based on the amountoutstanding as of December 31, 2009, principal payments required under theloan over the next five years, excluding discount due to warrants, are asfollows:

 

|                      | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
| Period  ending:           |       |       |       |
| December 31,  2010   |       | $          | 500,914    |   |
| December 31,  2011   |       | 704,402    |       |
| December 31,  2012   |       | 751,674    |       |
| December 31,  2013   |       | 803,313    |       |
| December 31,  2014   |       | 857,882    |       |
| December 31,  2015   |       | 677,772    |       |
| Total  payments remaining |       | $          | 4,295,957  |   |

 

16

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Pursuant to the note, weentered into a security agreement which grants to MassDev an exclusive firstpriority security interest in all equipment and tenant improvementssubstantially funded with the proceeds of the loan with an approximate carryingvalue of $4,800,000 and $5,126,000 at March 31, 2010, and December 31,2009, respectively. We also entered into a collateral assignment of leaseagreement as additional security for the repayment of borrowings.  This agreement grants MassDev all rights,title and interest in and to our lease for the Tyngsboro facility in the eventthat we default on our obligations.

 

As partial considerationfor the loan, on June 30, 2008, we issued MassDev two warrants. Eachwarrant provides for the purchase of 85,979 shares of our common stock at anexercise price of $1.89 per share, subject to any adjustments as set forth inthe warrants. The warrants are exercisable for seven years commencing on June 30,2008 and provide for registration rights for the resale of the shares issuedupon their exercise. MassDev assigned one of the warrants to the MassachusettsTechnology Park Corporation (“MTPC”), as part of MTPC’s participation under theMassachusetts Technology Collaborative Business Expansion Initiative.  The Black-Scholes fair value of the warrantsis shown as a discount against the loan, and is being amortized over the lifeof the loan using the effective interest method at an imputed interest rate of1.124%.  The amortization of thisdiscount resulted in approximately $14,000 and $10,000 charged to interestexpense during the three months ended March 31, 2010 and 2009,respectively.  The effective interestrate of the loan, including the cost of the warrants and other deferred loancosts, is approximately 8.55%.

 

**Note9.  Sale of Stock**

 

OnFebruary 19, 2009, we entered into a common stock purchase agreement withSeaside 88, LP, valued at up to $18 million. This agreement was amended on June 19, 2009.  The original agreement required Seaside tobuy $1 million of common stock once each month for up to 18 months, beginningon February 20, 2009, and on the 20th day of each month thereafter (or thenext closest business day,) at a purchase price reflecting a 20% discount tothe volume weighted average trading price over the five-day trading periodimmediately before the purchase.  Theamended agreement maintained the $18 million aggregate maximum purchase price,but accelerated the purchase to 1.5 million shares twice per month at a 14%discount to the 10-day volume weighted average trading price.  The agreement was structured in threetranches, or segments, of six closings each. The first tranche ended with the July 6,2009 stock purchase.  The second trancheended with the October 5, 2009 closing date, and we exercised our optionto extend the agreement for a third tranche, meaning that there were 18closings over the term of the agreement. In December 2009, we issuedadditional shares of stock through a public offering.  As part of the underwriting conditions forthat offering, we exercised our option to delay the Seaside purchasesoriginally scheduled for December and January for a period of 60 days.   The Seaside purchases resumed on February 5,2010 and the final purchase under this agreement was completed on March 5,2010.

 

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

 
| **Transaction date**     | ** ** | **Aggregate  value** | ** ** | **Common  Shares Sold** | ** ** | **Sale  Price  per Share** | ** ** | **Volume  Weighted  Average  Price  (VWAP)*** | ** ** | **Net  Proceeds** | ** ** |
|--------------------------|------------|----------------------|------------|-------------------------|------------|----------------------------|------------|-----------------------------------------------|------------|-------------------|------------|
| February 20,  2009  |       | $                    | 1,000,000  |                    | 2,656,184  |                       | $          | 0.37648                                       |       | $                 | 0.470600   |   | $ | 889,767 |   |
| March 20,  2009     |       | 1,000,000            |       | 2,896,200               |       | $                          | 0.34528    |                                          | $          | 0.431600          |       | 931,072 |   |
| April 20,  2009     |       | 1,000,000            |       | 1,912,777               |       | $                          | 0.52280    |                                          | $          | 0.653500          |       | 914,855 |   |
| May 20,  2009       |       | 1,000,000            |       | 1,647,772               |       | $                          | 0.60688    |                                          | $          | 0.758600          |       | 946,098 |   |
| June 22,  2009      |       | 1,193,895            |       | 1,500,000               |       | $                          | 0.79593    |                                          | $          | 0.925500          |       | 1,094,839 |   |
| July 6,  2009       |       | 1,118,430            |       | 1,500,000               |       | $                          | 0.74562    |                                          | $          | 0.867000          |       | 1,059,504 |   |
| July 20,  2009      |       | 932,670              |       | 1,500,000               |       | $                          | 0.62178    |                                          | $          | 0.723000          |       | 860,444 |   |
| August 5,  2009     |       | 939,255              |       | 1,500,000               |       | $                          | 0.62617    |                                          | $          | 0.728100          |       | 873,826 |   |
| August 20,  2009    |       | 895,260              |       | 1,500,000               |       | $                          | 0.59684    |                                          | $          | 0.694000          |       | 833,089 |   |
| September 8,  2009  |       | 989,295              |       | 1,500,000               |       | $                          | 0.65953    |                                          | $          | 0.766900          |       | 923,819 |   |
| September 21,  2009 |       | 940,155              |       | 1,500,000               |       | $                          | 0.62677    |                                          | $          | 0.728800          |       | 874,043 |   |
| October 5,  2009    |       | 925,575              |       | 1,500,000               |       | $                          | 0.61705    |                                          | $          | 0.717500          |       | 864,430 |   |
| October 20,  2009   |       | 941,955              |       | 1,500,000               |       | $                          | 0.62797    |                                          | $          | 0.730200          |       | 880,144 |   |
|                          |            |                      |            |                         |            |                            |            |                                               |            |                   |            |  |  |  |  |

 

17

----

 
| **Transaction date**    | ** ** | **Aggregate  value** | ** ** | **Common  Shares Sold** | ** ** | **Sale  Price  per Share** | ** ** | **Volume  Weighted  Average  Price  (VWAP)*** | ** ** | **Net  Proceeds** | ** ** |
|-------------------------|------------|----------------------|------------|-------------------------|------------|----------------------------|------------|-----------------------------------------------|------------|-------------------|------------|
| November 5,  2009  |       | 864,300              |       | 1,500,000               |       | $                          | 0.57620    |                                          | $          | 0.670000          |       | 802,336 |   |
| November 20,  2009 |       | 829,605              |       | 1,500,000               |       | $                          | 0.55307    |                                          | $          | 0.643100          |       | 668,557 |   |
| February 5,  2010  |       | 585,150              |       | 1,500,000               |       | $                          | 0.39010    |                                          | $          | 0.453600          |       | 541,245 |   |
| February 22,  2010 |       | 541,500              |       | 1,500,000               |       | $                          | 0.36100    |                                          | $          | 0.419800          |       | 498,905 |   |
| March 5,  2010     |       | 529,350              |       | 1,500,000               |       | $                          | 0.35290    |                                          | $          | 0.410300          |       | 486,719 |   |
| Total  Investment       |       | $                    | 16,226,395 |                    | 30,112,933 |                       |       |                                          |       |              | $          | 14,943,692 |   |
|                         |            |                      |            |                         |            |                            |            |                                               |            |                   |            |  |  |  |  |

 

Becausethe stock was sold to Seaside at a price below $1.85 per share, certainwarrants issued in November 2005 were adjusted according to the terms ofthose warrants, as discussed in Note 10 below.

 

**Note10.  Stock Warrants**

 

We haveoutstanding various series of warrants to purchase our common stock. Holders ofthe warrants are not entitled to receive dividends, vote, receive notice of anymeetings of stockholders or otherwise have any right as stockholders withrespect to their warrant shares. The following schedule shows warrantsoutstanding as of March 31, 2010:

 
| **Description**                                         | ** ** | **Grant  Date** | ** ** | **Expiration  Date** | ** ** | **Strike  Price** | ** ** | **Issued  and  Outstanding As  of March 31,  2010** | ** ** |
|---------------------------------------------------------|------------|-----------------|------------|----------------------|------------|-------------------|------------|----------------------------------------------------------|------------|
| May 24,  2005 Financing                            |       | 5/24/2005       |       | 5/25/2010            |       | $                 | 1.0080     |                                                     | 800,000    |   |
| November 8,  2005 Financing (Investors)            |       | 11/8/2005       |       | 5/9/2011             |       | $                 | 1.0400     |                                                     | 6,291,118  |   |
| February 15,  2007 Shelf Issue                     |       | 2/15/2007       |       | 2/15/2012            |       | $                 | 1.3300     |                                                     | 6,261,786  |   |
| GFI  Tyngsboro Lease                                    |       | 7/23/2007       |       | 7/22/2014            |       | $                 | 1.7700     |                                                     | 500,000    |   |
| September 10,  2007 Shelf Issue (Investors)        |       | 9/10/2007       |       | 3/11/2013            |       | $                 | 1.9900     |                                                     | 6,122,449  |   |
| September 10,  2007 Shelf Issue (Placement Agents) |       | 9/10/2007       |       | 3/11/2013            |       | $                 | 1.9900     |                                                     | 153,061    |   |
| October 31,  2007 Shelf Issue                      |       | 10/31/2007      |       | 5/1/2013             |       | $                 | 2.9700     |                                                     | 5,431,805  |   |
| June 30,  2007 Massachusetts Development Loan      |       | 6/30/2008       |       | 6/30/2015            |       | $                 | 1.8900     |                                                     | 171,958    |   |
| October 15,  2008 Shelf Issue                      |       | 10/15/2008      |       | 4/16/2014            |       | $                 | 1.2000     |                                                     | 8,700,000  |   |
| December 24,  2008 Shelf Issue                     |       | 12/24/2008      |       | 6/25/2014            |       | $                 | 0.7400     |                                                     | 8,966,000  |   |
| Series W  - December 9, 2009 Public Offering  |       | 12/9/2009       |       | 12/9/2014            |       | $                 | 0.7000     |                                                     | 19,050,000 |   |
| Series X  - December 9, 2009 Public Offering  |       | 12/9/2009       |       | 8/31/2010            |       | $                 | 0.3749     | *                                                        | 12,695,769 |   |
| Total  warrants outstanding                             | ** ** | ** **      | ** ** | ** **           | ** ** | ** **        |       | 75,143,946                                               |       |

 

----

*  These warrants were issued with a floatingexercise price, calculated at 85% of the five day volume weighted average priceof our common stock at the time of exercise, but in no event less than $0.272per share.  The exercise price for thesewarrants as of March 31, 2010, based on this calculation, was $0.3749.

 

The followingshows changes to the warrants outstanding from December 31, 2009, through March 31,2010:

 

18

----

 

|                                                                                                        | ** ** | **# Warrants** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------|------------|
| Warrants  outstanding as of December 31, 2009                                                          |       | 81,089,664     |       |
| Adjustments  to 11/8/05 warrants due to Seaside pricing during the three months ended  March 31, 2010: |       | 176,388        |       |
| Series X  warrants exercised                                                                           |       | (6,122,106     | )          |
| Warrants  outstanding as of March 31, 2010                                                             |       | 75,143,946     |       |

 

Warrants withactivity during the three months ended March 31, 2010, are describedbelow:

 

*November 2005Financing Warrants*

 

As part of afinancing transaction in November 2005, we issued warrants to purchase anaggregate of 2,960,527 shares of our common stock to ten “accredited investors.”In addition, 450,000 warrants were issued to the placement agents.  The per-share exercise price for the warrantshares was $2.21. Each investor warrant is exercisable at any time until May 9,2011.  The placement agent warrantsexpired on November 8, 2008.  Theterms of the investor warrants include anti-dilution provisions which requireus to adjust the exercise price and the number of shares of our common stock tobe issued upon exercise of the warrants under certain circumstances, whichinclude:

 

(1)                Subdivisions, stock dividends or combinations of ourcommon stock

 

(2)                Reclassifications, exchanges, substitutions, orin-kind distributions that result in a change in the number and/or class of thesecurities issuable upon exercise of the warrants

 

(3)                Reorganizations, mergers and similar transactions; and

 

(4)                Issuance of additional shares of our common stock, orsecurities convertible into our common stock, at a price per share lower thanthe closing stock price on the date of this transaction, which was $1.85.

 

Based on thewarrants’ anti-dilution provisions, the exercise price and the number ofwarrants were adjusted as shown below.

 

| ** **                                     | ** ** | **# Warrants** | ** ** | **Exercise  Price** | ** ** |
|------------------------------------------------|------------|----------------|------------|---------------------|------------|
| Original  Warrant                              |       | 2,960,527      |       | $                   | 2.21       |   |
| Adjustments  based on anti-dilution provision: |       |           |       |                |       |
| Financing  February 2007                  |       | 327,294        |       | $                   | 1.99       |   |
| Financing  October 2008                   |       | 248,808        |       | $                   | 1.85       |   |
| Financing  December 2008                  |       | 404,796        |       | $                   | 1.66       |   |
| Seaside  2/20/09 purchase                      |       | 72,542         |       | $                   | 1.63       |   |
| Seaside  3/20/09 purchase                      |       | 75,260         |       | $                   | 1.60       |   |
| Seaside  4/20/09 purchase                      |       | 51,764         |       | $                   | 1.58       |   |
| Seaside  5/20/09 purchase                      |       | 53,092         |       | $                   | 1.56       |   |
| Seaside  6/22/09 purchase                      |       | 27,063         |       | $                   | 1.55       |   |
| Seaside  7/06/09 purchase                      |       | 27,411         |       | $                   | 1.54       |   |
| Seaside  7/20/09 purchase                      |       | 27,766         |       | $                   | 1.53       |   |
| Seaside  8/5/09 purchase                       |       | 28,132         |       | $                   | 1.52       |   |
| Seaside  8/20/09 purchase                      |       | 28,504         |       | $                   | 1.51       |   |
| Seaside  9/8/09 purchase                       |       | 28,886         |       | $                   | 1.50       |   |
| Seaside  9/21/09 purchase                      |       | 29,274         |       | $                   | 1.49       |   |
| Seaside  10/5/09 purchase                      |       | 29,669         |       | $                   | 1.48       |   |
| Seaside  10/20/09 purchase                     |       | 30,072         |       | $                   | 1.47       |   |
| Seaside  11/05/09 purchase                     |       | 30,484         |       | $                   | 1.46       |   |
| Seaside  11/20/09 purchase                     |       | 30,905         |       | $                   | 1.45       |   |
| Public  offering 12/9/09                       |       | 1,602,481      |       | $                   | 1.07       |   |
| Seaside  2/05/10 purchase                      |       | 57,686         |       | $                   | 1.06       |   |

 

19

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| ** **                | ** ** | **# Warrants** | ** ** | **Exercise  Price** | ** ** |
|---------------------------|------------|----------------|------------|---------------------|------------|
| Seaside  2/22/10 purchase |       | 58,786         |       | $                   | 1.05       |   |
| Seaside  3/5/10 purchase  |       | 59,916         |       | $                   | 1.04       |   |
| Adjusted  Warrant:        |       | 6,291,118      |       | $                   | 1.04       |   |

 

*December 2009Series W and Series X Warrants*

 

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

 

The following Series Xwarrants were exercised as of March 31, 2010:

 

| **Date of Exercise**    | ** ** | **#  of Shares** | ** ** | **Exercise  Price** | ** ** | **Proceeds** | ** ** |
|-------------------------|------------|------------------|------------|---------------------|------------|--------------|------------|
| December 28,  2009 |       | 180,000          |       | $                   | 0.3966     |         | 71,388     |   |
| December 29,  2009 |       | 52,125           |       | $                   | 0.4047     |         | 21,095     |   |
| January 7,  2010   |       | 533,206          |       | $                   | 0.4168     |         | 222,240    |   |
| January 29,  2010  |       | 100,000          |       | $                   | 0.3626     |         | 36,260     |   |
| February 2,  2010  |       | 100,000          |       | $                   | 0.3698     |         | 36,980     |   |
| February 3,  2010  |       | 200,000          |       | $                   | 0.3924     |         | 78,480     |   |
| March 1,  2010     |       | 100,000          |       | $                   | 0.3392     |         | 33,920     |   |
| March 11,  2010    |       | 700,000          |       | $                   | 0.3477     |         | 243,390    |   |
| March 11,  2010    |       | 1,000,000        |       | $                   | 0.3477     |         | 347,700    |   |
| March 12,  2010    |       | 2,300,000        |       | $                   | 0.3640     |         | 837,200    |   |
| March 12,  2010    |       | 300,000          |       | $                   | 0.3640     |         | 109,200    |   |
| March 12,  2010    |       | 375,000          |       | $                   | 0.3640     |         | 136,500    |   |
| March 12,  2010    |       | 125,000          |       | $                   | 0.3640     |         | 45,500     |   |
| March 26,  2010    |       | 7,875            |       | $                   | 0.3515     |         | 2,768      |   |
| March 26,  2010    |       | 23,625           |       | $                   | 0.3515     |         | 8,304      |   |
| March 29,  2010    |       | 25,000           |       | $                   | 0.3635     |         | 9,088      |   |
| March 29,  2010    |       | 75,000           |       | $                   | 0.3635     |         | 27,263     |   |
| March 30,  2010    |       | 10,775           |       | $                   | 0.3674     |         | 3,959      |   |
| March 30,  2010    |       | 32,325           |       | $                   | 0.3674     |         | 11,876     |   |
| March 31,  2010    |       | 28,575           |       | $                   | 0.3705     |         | 10,587     |   |
| March 31,  2010    |       | 85,725           |       | $                   | 0.3705     |         | 31,761     |   |
|                    |       | 6,354,231        |       |                |       | 2,325,459    |       |

 

**Note11.  Revenue and Cost of Goods Sold**

 

A breakdown of our salesand the related cost of sales for the three months ended March 31, 2009and 2008, respectively, are as follows:

 

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| ** **             | ** ** | **Three  months ended March 31, 2010** | ** ** | **Three  months ended March 31, 2009** | ** ** |
|------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **             | ** ** | **Revenue**                                 | ** ** | **Cost  of  Goods  Sold**                   | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Goods  Sold** | ** ** | **Margin** | ** ** |
| ** **             | ** ** | **(in thousands)**                          | ** ** |
| Frequency  regulation  |       | $                                           | 143        |                                        | $          | 104 |   | $ | 39 |   | $ | 64 |   | $ | 130 |   | $ | (66 | ) |
| Contract               |       | 79                                          |       | 79                                          |       | — |   | 44 |   | 42 |   | 2 |   |
| Inverters  and related |       | 13                                          |       | —                                      |       | 13 |   | 3 |   | — |   | 3 |   |
| Total                  |       | $                                           | 235        |                                        | $          | 183 |   | $ | 52 |   | $ | 111 |   | $ | 172 |   | $ | (61 | ) |

 

From November 2008(when the ISO-NE pilot program began) until late April 2009, we werebilled for all of the energy stored on our flywheels, rather than for our netenergy usage.  Further, we were billed ata retail rate.  However, since late April 2009,our energy costs have decreased substantially as we have been billed thewholesale rate for our net energy used, plus retail transmission anddistribution charges.  The gross marginfor frequency regulation for the first quarter of 2009 was negative, due to theenergy costs paid from January through March 2009.  Cost of energy during the first quarter of2010 was approximately $104,000, of which approximately $75,000, or 72%,represents retail transmission and distribution (T&D) charges billed by thelocal service provider.  Because ourStephentown facility will be connected to the grid at the transmission level,we will not incur T&D charges, and so we expect our gross margin to beconsiderably higher than in our Tyngsboro installation.

 

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

 

**Note12.  Stock-Based Compensation**

 

**Descriptionof Plans**

 

*StockOption Plan*

 

Our Third Amendedand Restated 1998 Stock Incentive Plan allows for the granting of stock optionsto purchase up to 23,000,000 shares of our common stock.  Options may begranted to our employees, officers, directors, consultants and advisors. Under the terms of the option plan, incentive stock options are to begranted at the fair market value of our common stock at the date of grant, andnonqualified stock options are to be granted at a price determined by our Boardof Directors.  In general, our Board has authorized vesting periods of oneto three years and terms of varying length but in no case more than 10years.  Our stock option program is a long-term retention program that isintended to attract, retain and provide incentives for talented employees, officersand directors, and to align stockholder and employee interests.  Weconsider our option program critical to our operation and productivity;essentially all of our employees participate.  At March 31, 2010 wehad 13,384,483 shares reserved for issuance under this plan.

 

*EmployeeStock Purchase Plan*

 

Our Employee StockPurchase Plan (the “ESPP”) allows substantially all of our employees topurchase shares of our common stock at a discount through payrolldeductions.  Participating employees may purchase our common stock at apurchase price equal to 85% of the lower of the fair market value of our commonstock at the beginning of an offering period or on the exercise date. Employees may designate up to 10% of their base compensation for the purchaseof common stock under this plan.  The ESPP provides for the purchase of upto 2,000,000 shares of our common stock.  At March 31, 2010, we had1,518,841 shares reserved for issuance under this plan.

 

21

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*RestrictedStock Unit Arrangements*

 

Our Third Amendedand Restated 1998 Stock Incentive Plan permits the grant of restricted stockunits (“RSUs”) to our employees, officers, directors and other serviceproviders.  We use RSUs to (i) alignour employees’ interests with those of the Company, (ii) motivate ouremployees 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,rather than in cash, but with the number of such RSUs calculated on adiscounted basis to compensate for the reduced liquidity as compared tocash.  With respect to the RSUs that are granted in lieu of cash bonuses,the number of RSUs granted are based on performance, and are automaticallyconverted into shares of common stock in four equal tranches in the fiscal yearfollowing the year of performance. Certain other RSUs are granted to ourofficers as a form of equity incentive, are not tied to performance, and vestover a three-year period in equal quarterly installments.  There are alsoother performance-based restricted stock units (PSUs) granted to our officersthat cliff-vest upon the achievement of certain earnings-based milestones andupon the Company achieving a level of revenue such that it is no longer treatedas a development stage company for accounting purposes, both such vestingevents subject to the recipient officer being employed by us during the periodending with the milestones. The unvested portion of any RSU or PSU grant issubject to forfeiture upon the holder’s resignation or termination forcause.  As of March 31, 2010 and December 31,2009, certain RSUs granted under the officer employment agreements were vestedbut stock could not be issued under the terms of the RSU agreements because thetrading window was closed to insiders as of the respective vesting dates.

 

Restricted stockunit activity as of December 31, 2009 and for the three months ended March 31,2010 is as follows:

 

|                                                 | ** ** | **Three  months  ended March 31,** | ** ** | **Year  ended  December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|
|                                                 | ** ** | **2010**                                | ** ** | **2009**                           | ** ** |
|                                                 | ** ** | **(number of shares)**                  | ** ** |
| Shares  issued related to vested RSUs:               |       |                                    |       |                               |       |
| Based  on prior year grants                          |       | —                                  |       | 46,352                             |       |
| Based  upon current year executive officer agreement |       | —                                  |       | 16,920                             |       |
|                                                 |       |                                    |       |                               |       |
| Vested  RSUs not yet converted to stock (i)          |       | 26,714                                  |       | 16,376                             |       |
|                                                 |       |                                    |       |                               |       |
| RSU’s  granted but not vested:                  |       |                                    |       |                               |       |
| Related  to 2008 executive officer agreement         |       | 14,112                                  |       | 18,810                             |       |
| Related  to 2009 executive officer agreement         |       | 39,473                                  |       | 45,113                             |       |
| Related  to performance-based executive plan (ii)    |       | 1,265,823                               |       | 1,265,823                          |       |

 

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

 

(ii)          Vesting of the performance-based RSUs(PSUs) is subject to the achievement of performance requirements. We did notmeet the award conditions as of December 31, 2009, and our executivemanagement does not believe it is probable that the award will be earned in2010 based on our current business plan.Accordingly, no compensation expense was recorded forthis grant in 2009 or 2010. On April 26, 2010 we entered into LetterAgreements with our executive officers, under which the outstanding PSUs wereterminated due to the inability to meet the performance goals. Pursuant to thetermination of these agreements, the shares of our stock reserved for issuanceupon conversion of the PSUs became available for future issuance under the ourThird Amended and Restated 1998 Stock Incentive Plan.

 

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**StockOption Plan Schedules**

 

Stock optionactivity for the three months ended March 31, 2010 is as follows:

 
|                                 | ** ** | ** **     | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** |
|--------------------------------------|------------|----------------|------------|---------------|------------|---------------|------------|
|                                 | ** ** | ** **     | ** ** | **Average**   | ** ** | **Average**   | ** ** |
|                                 | ** ** | **Number  of** | ** ** | **Exercise**  | ** ** | **Fair**      | ** ** |
|                                 | ** ** | **Shares**     | ** ** | **Price**     | ** ** | **Value**     | ** ** |
| Outstanding,  December 31, 2009 |       | 12,000,028     |       | $             | 1.18       |          |       |   |
| Granted                              |       | 65,000         |       | $             | 0.42       |          | $          | 0.26 |   |
| Exercised                            |       | —         |       | $             | —     |          |       |   |
| Canceled,  forfeited or expired      |       | (26,667        | )          | $             | (0.89      | )             |       |   |
| Outstanding,  March 31, 2010    |       | 12,038,361     |       | $             | 1.13       |          |       |   |
|                                      |            |                |            |               |            |               |            |  |  |

 

The following tablesummarizes information about stock options outstanding at March 31, 2010:

 
| ** **    | ** ** | ** **      | ** ** | **Weighted-**     | ** ** | ** **    |       |            | ** ** | **Vested**    | ** ** |
|---------------|------------|-----------------|------------|-------------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **    | ** ** | ** **      | ** ** | **Average**       | ** ** | **Weighted-** | ** ** | ** **      | ** ** | **Weighted-** | ** ** |
| ** **    | ** ** | **Number**      | ** ** | **Remaining**     | ** ** | **Average**   | ** ** | **Number**      | ** ** | **Average**   | ** ** |
| **Exercise**  | ** ** | **of  Options** | ** ** | **Contractual**   | ** ** | **Exercise**  | ** ** | **of  Options** | ** ** | **Exercise**  | ** ** |
| **Price**     | ** ** | **Outstanding** | ** ** | **Life  (Years)** | ** ** | **Price**     | ** ** | **Vested**      | ** ** | **Price**     | ** ** |
| $0.26 - $0.74 |       | 4,508,852       |       | 5.70              |       | $             | 0.65       |            | 3,875,293  |          | $          | 0.67 |   |
| $0.80 - $1.46 |       | 5,536,789       |       | 6.40              |       | $             | 1.07       |            | 4,665,218  |          | $          | 1.03 |   |
| $1.51 - $2.19 |       | 1,535,470       |       | 5.48              |       | $             | 1.82       |            | 1,509,626  |          | $          | 1.82 |   |
| $2.50 - $3.10 |       | 130,000         |       | 0.10              |       | $             | 2.64       |            | 130,000    |          | $          | 2.64 |   |
| $4.10 - $5.27 |       | 222,250         |       | 0.91              |       | $             | 4.40       |            | 222,250    |          | $          | 4.40 |   |
| $6.00 - $9.31 |       | 105,000         |       | 0.51              |       | $             | 6.40       |            | 105,000    |          | $          | 6.40 |   |
| Total         |       | 12,038,361      |       |              |       |          |       | 10,507,387      |       |          |       |

 

**StockCompensation**

 

We account for ourstock compensation in accordance with ASC Topic 718. We use the Black-Scholesoption pricing model to determine the fair value of stock options and employeestock purchase plan shares. The valuations determined using this model areaffected by our stock price as well as assumptions we make regarding a numberof complex and subjective variables, including our stock price volatility,expected life of the option, risk-free interest rate and expected dividends, ifany.

 

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

 

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

 

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

 

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termination date toexercise his vested options.  They werenot exercised within that time, and consequently the options were forfeited. 

 

The only option grantsmade during the first quarter of 2009 were those to the consultant as discussedabove, and the measurement date for those options had not occurred as of March 31,2009.  Accordingly, no grants were valuedduring this three month period.  Theassumptions used to value stock option grants for the three months ended March 31,2010 were as follows:

 
|                                                                                      | ** ** | **Three  months ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
|                                                                                      | ** ** | **2010**                                | ** ** |
| Risk-free  interest rate                                                                  |       | 1.49% - 1.65%                           |       |
| Expected  life of option                                                                  |       | 3.5 years                               |       |
|                                                                                      |       |                                    |       |
| Expected  dividend payment rate, as a percentage of the stock price on the date of  grant |       | 0%                                      |       |
| Assumed  volatility                                                                       |       | 90%                                     |       |
| Expected  forfeitures                                                                     |       | 8.3%                                    |       |

 

Stock-based compensationexpense recognized on our consolidated statement of operations for the threemonths ended March 31, 2010, and 2009, are as follows:

 
|                                           | ** ** | **Three  months ended March 31,** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|
|                                           | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| Operations  and maintenance                    |       | $                                      | 15,072     |   | $ | 34,497 |   |
| Research  and development                      |       | 39,282                                 |       | 107,693 |   |
| Selling,  general and administrative           |       | 72,763                                 |       | 136,821 |   |
| Total  stock compensation expense              |       | $                                      | 127,117    |   | $ | 279,011 |   |
|                                           |       |                                   |       |   |   |
| Components  of stock compensation expense:     |       |                                   |       |   |   |
| Compensation  expense related to RSUs          |       | $                                      | 5,083      |   | $ | 8,054 |   |
| Compensation  expense related to stock options |       | 122,034                                |       | 270,957 |   |
| Total  stock compensation expense              |       | $                                      | 127,117    |   | $ | 279,011 |   |

 

As of March 31,2010, there was approximately $190,000 of unrecognized compensation cost,adjusted for estimated forfeitures, related to unvested stock-based paymentsgranted to our employees and directors. Total unrecognized compensation costwill be adjusted for future changes in estimated forfeitures and recognizedover the remaining vesting periods of the stock option grants.

 

**Note 13.****PotentialDelisting of the Company’s Stock**

 

On September 16,2009, we received a letter from the Nasdaq Stock Market indicating that ourcommon stock was subject to delisting on March 15, 2010 if therequirements of Rule 5550(a)(2), which requires a minimum bid price of$1.00 per share, were not met.  On March 16,2010, we received a letter from the Nasdaq Stock Market, notifying us thatNasdaq has granted us an additional 180 days to regain compliance with the$1.00 minimum share price rule. The Company’s securities will continue to belisted on the Nasdaq Capital Market until at least September 13, 2010. If,at any time before September 13, 2010, the bid price of the Company’scommon stock closes at $1.00 per share or more for a minimum**of 10 consecutive business days, Nasdaqwill provide us written notification that we comply with the rule.However, there can be no assurance thatwe will be able to meet The Nasdaq Stock Market’s minimum bid pricerequirements within the extended grace periods and we therefore may lose oureligibility for quotation on The Nasdaq Stock Market.

 

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**Note14.  Subsequent Events**

 

In April 2010, we entered into two new land option agreements.  The first of these is a two-year option thatprovides the right to purchase either of two properties in the Chicago area,but not both, for $1 million. Both properties are zoned industrial, and containcertain improvements relevant to our planned use, including equipment requiredfor physical interconnection to 138 KVA transmission lines.  One property is located in a suburb ofChicago and the other in the city of Chicago. In consideration for this option, we will pay the owner $2,000 permonth.  If we elect to purchase the land,the option payments will be applied to the purchase price.   A second option agreement was executed withan economic development agency of the State of Pennsylvania for a propertysituated in Hazle Township, Luzerne County, Pennsylvania. Under the terms ofthis two-year option, we will pay $2,500 per month for each of four six-monthoption periods, or until the option is converted to a lease. The option allowsus to lease the property for 21 years at the rate of $3,250 per month.  The site covered by this option is located inan economic development zone, which provides an exclusion for the payment of statesales tax on equipment used to build the plant. We expect to build the plantfor which we have received a $24 million grant award on one of the two siteslocated in the Chicago area.  The site inLuzerne County, Pennsylvania is an alternative site for the DOE grant plant, orif unused for that purpose, can be used to build an additional plant.

 

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

 

**NoteRegarding Forward Looking Statements**

 

This QuarterlyReport on Form 10-Q contains forward-looking statements concerning, amongother things, our expected future revenues, operations and expenditures,sources and uses of capital and estimates of the potential markets for ourproducts and services.  Such statements made may fall within the meaningof the Private Securities Litigation Reform Act of 1995, as amended.  Allsuch forward-looking statements are necessarily only estimates of futureresults and the actual results we achieve may differ materially from theseprojections due to a number of factors as discussed in the section entitled “RiskFactors” of this Form 10-Q. New risks can arise and it is not possible formanagement to predict all such risks, nor can management assess the impact ofall such risks on our business or the extent to which any factor, orcombination of factors, may cause actual results to differ materially fromthose contained in any forward-looking statement.  Given these risks anduncertainties, investors should not place undue reliance on forward-lookingstatements as a prediction of actual results.  All forward-lookingstatements speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to revise or update publicly any forward-lookingstatement in order to reflect any event or circumstance that may arise afterthe date of this Quarterly Report on Form 10-Q, other than as required bylaw.

 

**Overview**

 

We design,manufacture and operate flywheel-based energy storage systems that we aredeploying in company-owned merchant plants that sell frequency regulationservices in open-bid markets (which we refer to as our “sale of services” or “merchantplant” model). We also intend to sell systems on a turnkey equipment basis indomestic and overseas markets that lack open-bid auction mechanisms.  We may also share ownership of some plantswith utilities or other investors; enter into bilateral contracts withutilities that provide or purchase regulation services to satisfy theirobligations to pay for or provide regulation services; and/or participate inpilot programs to demonstrate our technology. Our flywheel systems supportstable, reliable and efficient electricity grid operation. We expect the marketfor our systems to benefit from increased electricity demand and the rapidexpansion of intermittent renewable resources, including wind and solar.

 

Our Smart Energy 25 flywheel system includes theflywheel and its associated power electronics. A Smart Energy MatrixTM is anarray of ten Smart Energy 25 flywheel systems that provides 1 MW of energystorage. A frequency regulation installation includes one or more Smart EnergyMatricesTM, along with ancillary equipment and site work. A typical full-scaleinstallation would have a capacity of 20 MW, capable of +/- 20 MW, or a 40 MWregulation range.

 

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

 

·                  Availabilityof grants, loans or other funding sources (including funds received frominvestors for the purchase of all or part of certain systems)

 

·                  Comparativemarket pricing available for frequency regulation in different markets

 

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·                  Our abilityto receive appropriate revenues and payments within the market rules ofeach regional market

 

·                  Our abilityto interconnect at transmission voltage and obtain grid interconnectionapprovals

 

·                  Availabilityand cost of land

 

·                  Ability tosecure all necessary environmental and other permits and approvals

 

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

 

OnNovember 18, 2008, we began to provide 1MW of frequency regulation servicethrough the ISO-NE pilot program. We added a second MW of capacity in July 2009,and third in December 2009.  Ourflywheel system has been on-line for 97% of the time, on average, since January 1,2009, and is earning revenue from frequency regulation services.

 

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

 

The decision to expandour workforce comes following a series of positive events in 2009, includingmore than a full year of operation on the New England grid; a $43-millionconditional loan guarantee commitment from the U.S. Department of Energy (DOE);and the award of a $24-million DOE smart grid stimulus grant. We also raised$20 million in equity investment in December 2009, a portion of which willprovide the remaining capital required to close the DOE loan.

 

Frominception through March 31, 2010, we have incurred losses of approximately$211.5 million. We currently do not expect to become cash flow positive untilwe have deployed a sufficient number of merchant plants and/or sold turnkeysystems.

 

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

 

Wehave also recently initiated market development efforts in Texas (ERCOT), whichis not regulated by FERC. ERCOT is not subject to FERC Order No. 890,which mandated that non-generation resources like ours be allowed to compete inthese open-bid markets. However, we expect that as ERCOT continues to expandits wind resources in Texas, and issues related to increasing wind penetrationand grid stability become better understood, the potential benefits of applyingour technology in ERCOT to help balance frequency and maintain grid stabilityand reliability will increase. We are currently evaluating whether market rule modificationswill be needed to allow us to enter the ERCOT market on an economicallyattractive basis.

 

Forthe sale of plants on a turnkey basis, our market focus in the United States ison geographic regions that lack open-bid markets for regulation services.  Within this market segment, our primary focuswill be on utilities that are experiencing or expect to experience increasedrequirements for regulation capacity due to the current or projected impacts ofincreased deployment of variable wind generation in their balancing areas. Oursecondary focus will be on the largest cooperative and government-owned utilities.Internationally, we are actively investigating the most suitable countries formarket entry, both for the sale of services via merchant plants and for theoutright sale of plants.

 

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Our Smart Energy MatrixTM stores excess energywhen power on the grid exceeds demand and injects it back to the grid whendemand exceeds generated power. Our systems respond up to 100 times faster thanfossil fuel generators that provide frequency regulation. Certain ISOs haveimplemented or are considering tariff changes that would provide additional orenhanced payment mechanisms to compensate resources, such as ours, for fasterregulation response.

 

Our flywheel systems also make it easier for thegrid to integrate intermittent renewable energy sources, such as wind and solarpower, whose variability increases the need for regulation.  Because our flywheels only recycleelectricity already generated, they do not consume fossil fuel or producecarbon dioxide (CO2) greenhousegas emissions or other air pollutants, such as nitrogen oxide or sulfurdioxide. In addition, the energy conversion efficiency of our flywheels doesnot significantly degrade over time or as a function of the number ofcharge/discharge cycles incurred. We believe that our low operating costs willallow us to participate with a very favorable profit margin in the open-bidmarkets, and utilities in non-open bid markets will also find the attributes ofour system attractive and will purchase our systems on a turnkey basis.

 

In2009 we began marketing and business development activities outside of theUnited States, including the development of relationships with strategicpartners in preparation for selling systems on a turnkey basis.  In order to be able to participate in some ofthese markets, we have initiated an engineering design program that will allowour system to operate at 50 Hz.

 

Growthin both the US and international markets are expected from a combination ofadditional factors, including:

 

·      Greateruse of renewable energy sources — especially wind and solar generation

 

·      Long-termgrowth in the demand for electricity

 

·      Increasedoperating costs for conventional generation

 

·      Governmentregulations and market forces aimed at reducing CO2 emissions.

 

We believe that ouroperating cost structure will be significantly lower than most incumbentfrequency regulation service providers. Our Smart Energy 25 flywheel has beendesigned to operate with low energy losses, minimal mechanical maintenance for20 or more years and no significant degradation in energy conversionefficiency. In particular, our technology is different from most frequencyregulation providers in that it does not use fossil fuel, which is the largestvariable cost for most competing frequency regulation providers.

 

Sinceour Smart Energy MatrixTM does not burn fuel, the environmental benefits of ourtechnology are significant. An internally-commissioned study suggests that ourtechnology’s ability to reduce carbon dioxide (CO2) may reduceCO2 emissions by up to 89%.  We believe that the cleaner performance ofour flywheel systems (as contrasted to frequency regulation services suppliedby fossil fuel resources) can be expected to offer significant value toregulators, grid operators, and utilities facing increasing demands to lower CO2 emissions.  If the federal government implements acarbon-reduction program in the form of a cap-and-trade program or carbon tax,we believe that the resulting costs to carbon-intensive regulation providerswill increase faster than our carbon-related costs, which are associated withthe purchase of a small amount of electrical make-up energy.

 

Insome states, additional environmentally related revenues may be available inthe form of renewable energy credits or other credits.  For example, Massachusetts recently passedlegislation that provides alternative compliance payments for qualifyingflywheel storage units when they inject energy into the ISO-NE grid.  In 2009, we began earning alternative energy credits under theMassachusetts Alternative Energy Portfolio Standard (APS) program, and sellingthem to utilities or other retail electricity suppliers that need to meetmandated APS requirements, thus creating a limited source of incrementalrevenue.

 

**Regulatoryand Market Affairs**

 

Since 2008, we have made progress with several of the ISOs by workingwith them directly to implement changes to market rules to allow energystorage technologies to participate on a non-discriminatory basis in theirregulation markets. The ISOs have demonstrated a heightened commitment to workcollaboratively with us to integrate our technology into their grids.  In addition to market rule changes,several ISOs are evaluating or proposing changes to their regulation dispatch signalsin order to ensure that our Smart Energy systems are deployed most efficientlyand effectively for the benefit of the power grid. These changes would takebetter advantage of our flywheel’s fast-response capability, while recognizingthat our resource has limited energy 

 

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storagecapacity. The proposed market rule changes, coupled with more efficientregulation dispatch signals, will allow our resource to maximize its regulationrevenue while minimizing our consumption and cost of electricity. The currentstatus of each open-bid ISO market is as follows:

 

·                  New YorkISO: We believe that NYISO presents the most favorable grid operating regionfor the first full-scale commercial deployment of our systems. After extensivecollaboration with us and with market stakeholders, on March 11, 2009,NYISO submitted new tariff and market rules for Limited Energy StorageResources (LESRs) to provide frequency regulation to the New York power grid.The LESR tariff and market rule changes were approved by FERC on May 15,2009, with an effective implementation date of May 12, 2009.  The NYISO regulation services market is nowfully open to flywheel energy storage. The new rules recognize the uniqueoperating characteristics of our technology and remedy key aspects of thepreviously existing regulation tariff for generators that would otherwise limitour technology.  NYISO’s regulationdispatch method for LESRs will take advantage of the LESRs’ fast response ratesand maximize their deployment. The energy level in our flywheels will beactively managed by NYISO to maintain regulation capability to the extentpossible by charging/discharging as necessary. The new LESR tariff will also allow us to net our electricity costs atwholesale rates.  We believe the newtariff and dispatch mechanisms will provide a highly effective and efficientmethod for integrating our flywheels into the NYISO regulation market.

 

·                  ISO NewEngland: On November 18, 2008, ISO-NE launched an Alternative TechnologiesRegulation pilot program to comply with FERC Order No. 890.  The purpose of the Alternative TechnologiesRegulation pilot program is to evaluate the performance of new technologieslike ours that had been ineligible to participate in ISO-NE’s regulationmarket, determine how these technologies can best be used to meet New England’sregulation requirements, allow program participants to operate in a realisticmarket environment where they can evaluate their market viability, and provideoperating experience that ISO-NE can use to formulate permanent market rules.  On February 2, 2010, ISO-NE beganworking with stakeholders to develop a proposal for permanent market rules foralternative technologies. ISO-NE expects to continue to develop its rules proposalduring the second quarter of 2010 and then take its proposal through the normalNew England Power Pool (NEPOOL) stakeholder process during the thirdquarter.  Once a proposal is approved byNEPOOL, it will be submitted to FERC for approval. Until new permanent market rules forenergy storage are implemented we will continue to earn revenue through thepilot program.  We began participating inthe pilot program with a 1 MW resource located inside our plant in Tyngsboro inNovember 2008,  added another 1 MWoutside our Tyngsboro facility in July 2009 and added a third MW in December 2009.  Until April 2009, the pilot resource wassent a regulation signal that was similar to one for a traditional generatorand therefore did not recognize that our technology provides regulation in adifferent manner than a traditional generator. After discussions with ISO-NE, in May 2009, we convinced the ISO toimplement a regulation dispatch signal for our pilot project that betterrecognizes our system’s unique capabilities and is similar to the dispatchmethod developed by NYISO. This new dispatch signal has improved the economicsof our energy storage resources.  We arecontinuing to work with ISO-NE to implement a NYISO- style dispatch signal inthe permanent rules at the conclusion of the pilot program. In addition,as also discussed above, we are working to have opportunity cost paymentsincluded in the permanent market rules so that the payments made for ourresource are comparable to those made to other parties that provide a similarservice. However, there are no guarantees that these changes will be implementedin the final rules.

 

·                  CaliforniaISO: CAISO is in the process of opening its frequency regulation market toenergy storage technologies and we are actively participating in thisprocess.   In February 2009, FERCordered CAISO to make modifications to its tariff to ensure that non-generationresources are treated comparably to other resources in the CAISO regulationmarket.  We are actively engaged in thisFERC proceeding and in the stakeholder process at CAISO.  Through this process, we continue to workwith CAISO and its stakeholders to promote the lessons learned and bestpractices from other ISOs for integrating energy storage into the regulationmarket.  CAISO has announced that itexpects to initiate a stakeholder process focused specifically on LESRparticipation in the regulation market in the second quarter of 2010.  In addition, as part of an overall evaluationof their Ancillary Services market in 2010, they plan to consider whether itwould be beneficial to create a separate fast regulation product. In addition,the current definition contained in the Western Electricity CoordinatingCouncil (WECC) Reliability Standards for Regulating Reserves only refers togeneration resources.  WECC has aproposal which eliminates this “generator” definitional issue and will allow storageto provide regulation.  Their proposal iscurrently pending at FERC.

 

·                  Midwest ISO:On February 25, 2008, FERC approved the creation of an Ancillary ServicesMarket (ASM) in the Midwest ISO to begin operating on January 6,2009.  As part of its approval, FERCrequired MISO to make further changes to its ASM to remove barriers to newtechnologies to provide regulation service. On April 25, 2008, MISO fully complied with FERC’s directives byfiling a request for an entirely new regulation resource category specificallydesigned for stored energy resources (“SER”), including our flywheeltechnology.  FERC approved this tariff onDecember 18, 2008.  This 

 

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was the first such tariff in the United Statesdesigned specifically to accommodate energy storage-based regulationresources.  In May 2009, MISO, withthe support of its market stakeholders, submitted to FERC additional tariffmodifications to enhance the dispatch algorithm for SERs to better utilizetheir regulation capabilities and maximize their revenues in the MISOmarket.  On December 31, 2009, FERCapproved these tariff modifications.  Thenew MISO market rules for SERs took effect on January 1, 2010.

 

·                  PJMInterconnection: PJM amended its tariff language to comply with FERC Order No. 890and stated that its current rules allow non-generation resources like oursto fully participate in its regulation market. PJM’s market rules allow usto enter the market. In the summer of 2009 PJM adopted a regulation dispatchsignal for energy storage resources that takes partial advantage of our system’sfast-response capability, maximizes benefits to PJM’s grid and pays us for thebenefits of our resource.  We are alsoworking with PJM and market stakeholders to clarify or amend certain aspects ofPJM’s tariff in order to ensure we can net our energy consumption at wholesalerates and therefore minimize our costs to provide service in PJM.  On April 13, 2010, PJM’s MarketImplementation Committee voted to approve changes to their Station Power tariffdefinition that will allow our resource to net our energy at wholesale. Thesechanges were subsequently endorsed by PJM’s Markets and Reliability Committeeand their Tariff Advisory Committee. The tariff changes are expected to be onthe Consent Agenda at the June 3rd Members Committee and filed at FERC forapproval in June.

 

·                  ERCOT: SinceERCOT is not regulated by the Federal Energy Regulatory Commission, in thepast, we have focused our efforts on the other ISOs.  As the amount of wind generation in Texasincreases and therefore the demand for fast frequency regulation resourcesrises, and as we demonstrate the effectiveness of our system in other ISOs, webelieve our technology will become increasingly attractive in the ERCOT market.Consequently, we have begun to focus our attention on this market. On April 13,2010, ERCOT held an energy storage workshop to begin the process of evaluatingwhether market rule changes will be needed to allow energy storage unitssuch as ours to enter this market on an economic basis. We are activelyparticipating in this initiative.

 

**Discussionof Operations**

 

We have experienced netlosses since our inception and, as of March 31, 2010, had an accumulateddeficit of approximately $211.5 million.  We are focused oncommercializing our Smart Energy MatrixTM flywheel system for frequencyregulation and the sale of turnkey systems. We do not expect to havepositive EBITDA (earnings before interest, taxes, depreciation andamortization) or positive cash flow from operations until we have deployed asufficient number of merchant plants and/or sold turnkey systems. Moreover, wemust raise additional capital from a combination of equity, debt and/or turnkeysales to execute our business plan and continue as a going concern.  In the future, as the number of our merchantregulation facilities increases and we develop sustainable cash flows fromoperations and the sale of turnkey plants, we expect to fund additional plantsfrom a combination of cash flow from operations, non-recourse project financingand project equity.

 

On November 18,2008, we began operating our first 1 MW Smart Energy MatrixTM on the electricitygrid in Tyngsboro, Massachusetts. The 1 MW system was installed under ISO NewEngland’s Alternative Technologies Regulation pilot program. The pilot programwas approved by FERC as part of ISO New England’s compliance with FERC Order No. 890,which is intended to promote greater competition in electricity markets,strengthen the reliability of the grid, and allow so-called “non-generation”resources (which include our flywheel technology), to participate in frequencyregulation markets on a non-discriminatory basis.  The pilot program allows us to generaterevenue for regulation services while ISO-NE develops permanent market rules thatwill govern application of the technology. We added a second megawatt ofcapacity in Tyngsboro in July 2009, and a third megawatt in December 2009,all of which are currently earning revenue through the pilot program. We planto redeploy a portion of these systems to the Stephentown site as part of ourin-kind equity contribution required under the terms of the DOE loan guaranteeprogram. We expect to continue to operate megawatts in the ISO-NE pilot programuntil permanent market rules for energy storage are finalized.

 

On July 2,2009, we announced the conditional commitment by the U.S. Department of Energy(DOE) for a loan guarantee of approximately $43 million. The loan, which wouldbe funded by the U.S. Treasury’s Federal Financing Bank, is expected to providedebt financing for 62.5% of the estimated $69 million total project cost of ourplanned 20 MW plant in Stephentown, New York. Of the $26 million not financedby the loan, we have already incurred approximately $14 million in eligibleproject expenditures, which will be considered part of our equity contribution tothe project.  A significant portion ofthis in-kind contribution will come from the redeployment of a portion of ourstorage assets from Tyngsboro to the Stephentown site. The remaining $12million was raised through the sale of units comprised of common stock andwarrants on December 9, 2009. We are in the process of finalizing theadministrative aspects of the loan, which we expect to close during the secondquarter of 2010. We expect to complete the 20 MW facility in Stephentown, NewYork, within 12 to 18 months from the date of closing of the DOE loan.

 

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

 

In April 2010, we entered into two new land option agreements.  The first of these is a two-year option thatprovides the right to purchase either of two properties in the Chicago area,but not both, for $1 million. Both properties are zoned industrial, and containcertain improvements relevant to our planned use, including equipment requiredfor physical interconnection to 138 KVA transmission lines.  One property is located in a suburb ofChicago and the other in the city of Chicago. In consideration for this option, we will pay the owner $2,000 permonth. If we elect to purchase the land, the option payments will be applied tothe purchase price.   A second optionagreement was executed with an economic development agency of the State ofPennsylvania for a property situated in Hazle Township, Luzerne County, Pennsylvania.Under the terms of this two-year option, we will pay $2,500 per month for eachof four six-month option periods, or until the option is converted to a lease.The option allows us to lease the property for 21 years at the rate of $3,250per month.  The site covered by thisoption is located in an economic development zone, which provides an exclusionfor the payment of state sales tax on equipment used to build the plant. Weexpect to build the plant for which we have received a $24 million grant awardon one of the two sites located in the Chicago area.  The site in Luzerne County, Pennsylvania isan alternative site for the DOE grant plant, or if unused for that purpose, canbe used to build an additional plant.

 

In October 2009, theNew York State Public Service Commission (PSC) granted us a Certificate ofPublic Convenience and Necessity (CPCN) and approved our petition for lightenedregulation of the planned 20 MW flywheel frequency regulation plant inStephentown, New York.  After receivingthe PSC decisions, we applied for and received the building permit and begansite preparation in November 2009 for the Stephentown plant, which will belocated on approximately half of the seven acres of land that we purchased in2008.  Prior to the start of winter, wecleared and rough-graded the site, and added drainage. Plant construction hasresumed in April 2010.

 

Ourinterconnection request for the 20 MW plant includes NYSEG as the transmissionprovider.  Before we can enter into an interconnectionagreement with NYISO, we were required to complete a System Impact Study, whichis now complete, and a Facilities Study, which is currently in process.  The purpose of these studies is to confirmthat our facility can be safely and reliably interconnected with the grid, andto identify any utility upgrades or other equipment that may be needed beforeconstruction can begin. Construction and development of this site is alsosubject to certain state and local permitting processes. After executing aninterconnection agreement, necessary upgrades to grid equipment to permit suchinterconnection will begin, in a timeline roughly parallel to our constructionof the facility. We expect the plant to be partially on-line and to beginearning some revenue in the fourth quarter of 2010, although this will require expeditingthe interconnection process with NYSEG and NYISO.  NYSEG has agreed to allow us perform thedesign engineering and procurement of materials for the upgrade of theirsubstation in order to help speed the interconnection process.

 

On June 10, 2009, weannounced that we and the New York State Energy Research and DevelopmentAuthority (NYSERDA) were in the process of negotiating a statement of workrelating to a grant to pay for a portion of the interconnection and otheraspects of the Stephentown facility. As of this filing, we have received thecontract documents, and are waiting for NYSERDA to complete their execution.The value of the fixed price contract, if executed by NYSERDA, is expected tobe $2 million.

 

The first 20 MW plant will cost approximately $69 million, of whichapproximately $50 million is direct equipment and facility costs. The remainderof the cost estimate includes contingency, legal, consulting and administrativecosts.  Some of these costs are eitherunique to the DOE loan guarantee process or are greater than we expect will beincurred in the construction of subsequent similar facilities. The secondmerchant plant is estimated to cost approximately $48 million excluding thecost of land, of which the DOE grant announced in November 2009 willprovide approximately $24 million. This represents a 30% reduction from theexpected total cost of our first plant in New York. In volume production, weare on schedule to meet our cost reduction targets.

 

In 2010 and 2011, we will continue to havecapital needs that will require additional funding through a combination ofequity, debt and/or cash proceeds from the sale of plants to fund operations aswe continue to build and deploy flywheel plants. The amount of debt and equityrequired will depend on the mix of merchant plants and plants sold on a turnkeybasis.  Our deployment plans are affected by the timing of anumber of factors and activities, including but not limited to the following:

 

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·                  Closing the DOE loan and the receipt offunds from the NYSERDA grant and the DOE stimulus grant

 

·                  Corporate or project financing and itsavailability

 

·                  Equity transactions and the amountsthereof

 

·                  Sale of turnkey plants and the amount ofassociated margin and terms and conditions of those sales

 

·                  Receipt of environmental and site-relatedpermits and approvals

 

·                  Receipt of grid interconnectionapprovals.

 

Since ourinception in 1997 we have funded our development primarily through the sale ofcommon stock.  In November 2000, wecompleted our initial public offering, raising approximately $49.3 million netof offering expenses. Since our initial public offering, we have raisedapproximately $107 million as of March 31, 2010, through the sale of ourstock and exercise of warrants.During the remainder of 2010 and beyond, we will needadditional funding to expand our manufacturing capabilities and to build andinstall frequency regulation facilities in accordance with our businessplan.  To execute our business plan, weexpect to raise an additional approximately $18 - $20 million in 2010 from thesale of common stock and anticipated warrant exercises.

 

Ourprofit and losses as well as uses of cash may fluctuate significantly fromquarter to quarter due to fluctuations in revenues, costs of development, costsof materials to build flywheels and other components of our Smart Energy MatrixTM and the market pricefor regulation services. In addition, our cash may fluctuate by period due tothe timing of capital expenditures for expanding manufacturing capabilitiesand/or construction of frequency regulation facilities and the related timing ofproject financing or equity raises. These fluctuations in cash requirementscould put additional pressure on our cash position. There can be no assurancethat we will be able to raise the required capital on a timely basis or thatsufficient funds will be available to us on terms that we deem acceptable, ifthey are available at all. See “— Liquidity and Capital Resources” below formore information concerning our access to and uses for capital.

 

*Revenues*

 

Ourrevenue during the three months ended March 31, 2010 and 2009 cameprimarily from three sources:

 

·                  Frequencyregulation service revenue from the ISO-NE pilot program

 

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

 

·                  Sales of inverters,accessories and APS credits.

 

Our business plananticipates earning revenue primarily from the provision of frequencyregulation service and the sale of  turnkey flywheel systems.  We earnrevenue from the sale of APS certificates or similar “clean energy”credits.  However, such credits have notbeen material. In the past, we have also earned revenue from research anddevelopment contracts with government agencies, and we continue to pursuesimilar contracts. In addition, we have a small inventory of inverters andaccessories that we sell, although that revenue is insignificant.

 

ISO-NE has a three-partpayment model for regulation service:

 

1.               Payment for the resource’s MWs ofcapacity that are scheduled to perform regulation, referred to as “Time-On-Regulation.”

 

2.               Payment based on the degree to which aresource changes its output, referred to as “Regulation Service” or “Mileage.”  Fast-response resources receive highermileage payments than slower-responding resources.

 

3.               Payment to compensate generators for lost revenue as aconsequence of providing frequency regulation rather than conventional powergeneration, referred to as “Opportunity Cost.”

 

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Revenues we are currently receiving from this pilotprogram are less than those that we expect to receive under permanent marketrules, principally because under ISO-NE’s pilot program rules, we are noteligible for opportunity cost payments, which represent approximately one-thirdof the revenue received by conventional regulating generators. We believe thatwhen ISO-NE adopts its permanent market rules they will include a paymentcomponent for regulation pricing approximately equal to opportunity cost. Thismethodology is used in all other ISO markets, and would send the correct marketsignals to suppliers of lower cost technologies, such as flywheels.

 

Because our Smart EnergyMatrixTM responds up to 100 times faster than fossil fuel generators providingfrequency regulation service, we believe that our technology will benefit frompayment mechanisms that reward faster response. Under ISO-NE’s pilot program, our resources are receiving higher thanaverage mileage payments based on their fast response. Other ISOs areconsidering changing their tariffs to provide higher revenues for fasterperformance. If such performance-based tariffs are approved, we would expect tobenefit by receiving more mileage revenue per megawatt of capacity, compared toslower competing resources.

 

In recent months, theFederal Energy Regulatory Commission (FERC) has shown increasing support forthe concept of paying fast-response regulation resources on the basis of actualsystem performance rather than nominal capacity. We will continue to be engagedin this dialogue in an effort to encourage the expansion of performance-basedtariffs. Currently, ISO-NE is the only grid operator that utilizes aperformance-based tariff that rewards resources for speed. Shouldperformance-based regulation tariffs be widely adopted, the economics of ourplants may be enhanced and our addressable markets may expand.

 

*Cost ofGoods Sold*

 

Costof goods sold on research and development contracts is being recorded on thepercentage-of-completion method and consists primarily of direct labor andmaterial, subcontracting and associated overhead costs.  Cost of goods sold for frequency regulationservices consists of the cost of energy. Cost of goods sold does not reflectthe true cost of any inverter sales, because our inverter inventory was fullywritten-off during a prior year.

 

*Operationsand Maintenance*

 

Operations andmaintenance (O&M) expenses are related to manufacturing, materialshandling, purchasing, Smart Energy MatrixTM operations, and expensednon-fungible costs associated with certain installations. Since our currentproduction levels are still well below our facility’s full capacity, O&Mcosts for the quarters ended March 31, 2010 and 2009 include a significantamount of unabsorbed overhead.  Inaddition, costs associated with running the 3 MW resource for the ISO-NE pilotprogram and certain non-fungible costs associated with certain Smart EnergyMatrixTM installations are also included in O&M. O&M expenses willincrease in 2010 as we ramp up our production capacity and begin to operate andmaintain the Stephentown facility.

 

*Researchand Development*

 

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

 

*Selling,General and Administrative Expenses*

 

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

 

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*Loss onContract Commitments*

 

In April 2008, wewere awarded a subcontract to provide a flywheel energy storage system insupport of a wind integration research and development project in Tehachapi,California, sponsored by the California Energy Commission.  We will receive approximately $250,000 tooffset R&D expenses and will contribute an additional $87,000 ofengineering resources for the project, bringing the R&D total toapproximately $337,000.  Accordingly, werecorded a charge of approximately $87,000 to the contract loss reserve during2008 to reflect the expected “cost share” portion of the Tehachapi contract.During the first quarter of 2009, we increased the loss reserve for theTehachapi contract by $132,500, bringing the total contract loss toapproximately $219,000.  This increase isbased on the difference between the overhead rate that was bid on this fixedprice contract and our forecasted overhead rate.  No additions were considered necessary to theloss reserve through the quarter ended March 31, 2010.

 

During the fourth quarterof 2009, we began work on the Pacific Northwest National Laboratory (PNNL)contract. According to the terms of the contract, we expect to incur R&Dcosts of approximately $210,000, and to receive approximately $104,000 tooffset those costs.  Accordingly, werecorded a charge of approximately $106,000 for our “cost share” portion ofthis contract.  The PNNL contract expiredon April 30, 2010.  We believe wehave successfully completed the terms of the contract as of that date.

 

OnFebruary 3, 2009, we announced that we entered into a contract with NAVSEAto evaluate the use of flywheel energy storage for multiple shipboard applicationsthat we expect will lead to a conceptual design of a flywheel system for futurenaval surface combatants and possible retrofit into existing navy ships.  The value of the initial research anddevelopment work is estimated at $900,000, $500,000 of which has already beenappropriated.  Subsequent phases involvework estimated at up to an additional $2.1 million.  This contract was awarded on a “cost plusfixed fee” basis.  Based on ourevaluation of the expected costs for the portion of the contract which has beenappropriated, no reserve for contract loss was considered necessary as of March 31,2010.

 

*Depreciationand Amortization*

 

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

 

*Interestand Other Income/Expense, net*

 

Our non-operatingincome and expenses are primarily attributable to interest income resultingfrom cash on hand.

 

**CriticalAccounting Policies and Estimates**

 

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

 

*RevenueRecognition*

 

Although we have shippedproducts and recorded contract and frequency regulation service revenues, ouroperations have not yet reached a level that would qualify us to emerge fromthe development stage.  Therefore wecontinue to be accounted for as a development stage company under Financial AccountingStandards Board’s (FASB’s) Accounting Standards Codification (ASC) Topic 915,*“Development Stage Entities.”*

 

·                  *Frequency Regulation Service Revenue*

 

Revenue from servicetransactions is recognized when it has been earned and is realized or realizable.Revenue from services is earned either as the services are performed or whenthey are complete, and is considered realizable once the customer has committedto pay for the services and the customer’s ability to pay is not in doubt.  Frequency regulation 

 

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service revenue iscalculated on an hourly basis, as services are provided, based on formulasspecific to the tariffs in effect at the applicable ISO at bid award rates thatare published by the ISO. In general, we recognize as revenue the amountsreported by the ISO.

 

·                  *Government Contract Revenue Recognized on the Percentage-of-CompletionMethod*

 

Werecognize contract revenues using the percentage-of-completion method. We uselabor hours as the basis for the percentage-of-completion calculation, which ismeasured principally by the percentage of labor hours incurred to date for eachcontract to the estimated total labor hours for each contract at completion.Changes to total estimated contract costs or losses, if any, are recognized inthe period in which they are determined. Revenues recognized in excess of amounts billed are classified ascurrent assets, and included in “Unbilled costs on contracts in process” in ourbalance sheets.  Amounts billed toclients in excess of revenues recognized to date are classified as currentliabilities under “Advance billings on contracts.”  Changes in project performance andconditions, estimated profitability, and final contract settlements may resultin future revisions to construction contract costs and revenue.

 

Allof our research and development contracts are subject to cost review by therespective contracting agencies. Our reported results from these contractscould change adversely as a result of these reviews.

 

·                  *Product Sales*

 

We recognize revenues inaccordance with accounting principles generally accepted in the United Statesof America.  Generally, revenue isrecognized on transfer of title, typically when products are shipped, and all relatedcosts are estimable.  For sales todistributors, we make an adjustment to defer revenue until products aresubsequently sold by distributors to their customers.

 

*Loss onContract Commitments*

 

Ourcontracts have been primarily for the development of demonstration units of newproducts, the design of a frequency regulation facility or alternative uses forour flywheels.  As such, the work hassupported our core research and development efforts.  We establish reserves for anticipated losseson contract commitments if, based on our cost estimates to complete thecommitment, we determine that the cost to complete the contract will exceed thetotal expected contract revenue. Excluding the NAVSEA contract, most of our contracts have been grantedon a cost-share basis, for which the expected cost-share is recorded as acontract loss. Additionally, each quarter we perform an evaluation of expectedcosts to complete our in-progress contracts and adjust the contract lossreserve accordingly.

 

*Fixed Assets*

 

Propertyand equipment in service is stated at cost and depreciated using thestraight-line method over the estimated useful lives of the assets. Propertyand equipment are defined as tangible items with unit costs exceeding ourcapitalization threshold that are used in the operation of the business, arenot intended for resale and which have a useful life of one year or more. Thecost of fixed assets is defined as the purchase price of the item, as well asall of the costs necessary to bring it to the condition and location necessaryfor its intended use.  These costsinclude material, labor, overhead, capitalized interest and, if applicable,exit costs. Exit costs for which we are obligated are accounted for inaccordance with ASC 410, “*Asset Retirement andEnvironmental Obligations*.” No overhead is generally applied forinternally-constructed projects not directly related to our core business(e.g., leasehold improvements).  Interestcosts incurred during the construction of major capital projects (such as theconstruction of our frequency regulation plants) are capitalized in accordancewith ASC Topic 835, Subtopic 20, “*Interest — Capitalizationof Interest*.”  The interest iscapitalized until the underlying asset is ready for its intended use, and isconsidered an integral part of the total cost of acquiring a qualifying asset.Thus, the capitalized interest costs are included in the calculation ofdepreciation expense once the constructed assets are in service. Repair andmaintenance costs are expensed as incurred. Materials used in our development efforts are considered research anddevelopment materials, and are expensed as incurred in accordance with ASC 730,“*Research and Development*.”

 

35

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Capitalassets are classified as “Construction in Progress” when initially acquired,and reclassified to the appropriate asset account when placed into service,with the exception of land, which is capitalized upon purchase. Depreciationexpense is not recorded on assets not yet placed into service.

 

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

 

*Impairmentof Long-Lived Assets*

 

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

 

In certain instances, wemay determine that it is in the best interest of the Company to re-deploy allor part of a Smart Energy MatrixTM system installed at a given location.  When such a determination has been made, wewill determine which costs are associated with the movable (fungible)components, and which costs are non-fungible. We will record a period expensefor the net book value associated with the non-fungible components.

 

Based on our analysis, noasset impairment charges were considered necessary as of March 31, 2010 or2009.

 

*Fair Value of Financial Instruments*

 

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

 

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

 

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

 

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

 

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

 

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

 

*Other assets and deferredfinancing costs*

 

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

 

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**Resultsof Operations**

 

***Comparison of Three Months ended March 31, 2010 and2009***

* *
| ** **                                | ** ** | **Three  months ended March 31,** | ** ** |
|-------------------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **2010**                               | ** ** | **2009** | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                                | ** ** | **(in thousands)**                     | ** ** |
| Revenue                                   |       | $                                      | 235        |   | $ | 111 |   | $ | 124 |   | 112 | % |
| Cost  of goods sold                       |       | 183                                    |       | 172 |   | (11 | ) | -6 | % |
| Gross  margin                             |       | 52                                     |       | (61 | ) | 113 |   | 185 | % |
| Operations  and maintenance               |       | 967                                    |       | 777 |   | (190 | ) | -24 | % |
| Research  and development                 |       | 2,072                                  |       | 2,191 |   | 120 |   | 5 | % |
| Selling,  general and administrative      |       | 1,946                                  |       | 1,897 |   | (49 | ) | -3 | % |
| Loss  on contract commitments             |       | —                                 |       | 133 |   | 133 |   | 100 | % |
| Depreciation  and amortization            |       | 530                                    |       | 424 |   | (106 | ) | -25 | % |
| Interest  and other income (expense), net |       | (77                                    | )          | (57 | ) | (20 | ) | 35 | % |
| Net  loss                                 |       | $                                      | (5,540     | ) | $ | (5,540 | ) | $ | — |   | 0 | % |

 

*Revenue*

 

Thefollowing table provides details of our revenues for the three months ended March 31,2010 and 2009.

 
| ** **                             | ** ** | **Percent**  | ** ** | **Three  months ended March  31,** | ** ** | **Cumulative  Contract  Value  Earned as  of March** | ** ** | **Total  Contract** | ** ** | **Remaining  Value** | ** ** |
|----------------------------------------|------------|--------------|------------|------------------------------------|------------|------------------------------------------------------|------------|---------------------|------------|----------------------|------------|
| ** **                             | ** ** | **complete** | ** ** | **2010**                           | ** ** | **2009**                                             | ** ** | **31,  2010**       | ** ** | **Value**            | ** ** | **(Backlog)** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | **(dollars in thousands)**         | ** ** |
| **Frequency regulation:**              |       |         |       | $                                  | 143        |                                                 | $          | 64                  |       |                 |       |   |   |   |   |
| **Contracts:**                         |       |         |       |                               |       |                                                 |       |                |       |                 |       |   |   |
| NYSERDA  PON 800                       |       | 86.8         | %          | $                                  | —     |                                                 | $          | —              |       | $                    | 55         |   | $ | 63 |   | $ | 8 |   |
| NAVSEA                                 |       | 100.0        | %          | —                             |       | 29                                                   |       | 500                 |       | 500                  |       | — |   |
| Tehachapi                              |       | 74.4         | %          | 25                                 |       | 15                                                   |       | 186                 |       | 250                  |       | 64 |   |
|                                   |       |         |       |                               |       |                                                 |       |                |       |                 |       |   |   |
| Pacific  Northwest Laboratories        |       | 71.5         | %          | 54                                 |       | —                                               |       | 74                  |       | 104                  |       | 30 |   |
| Total  Contract Revenue                |       |         |       | $                                  | 79         |                                                 | $          | 44                  |       | $                    | 815        |   | $ | 917 |   | $ | 102 |   |
| **Other (inverters and accessories):** |       |         |       | 13                                 |       | 3                                                    |       |                |       |                 |       |   |   |
| Total                                  |       |         |       | $                                  | 235        |                                                 | $          | 111                 |       |                 |       |   |   |   |   |

 

Revenue for the threemonths ended March 31, 2010 increased by approximately $124,000, or 112%,due primarily to an increase in frequency regulation revenue of $79,000 and anincrease in research and development contract revenue of approximately $35,000.The frequency regulation revenue was earned through our participation in theISO-NE Pilot Program that began in November 2008.

 

Revenues we are currentlyreceiving from this pilot program are less than those that we expect to receiveunder permanent market rules. Under pilot program market rules, we are noteligible for opportunity cost payments, which represent approximately one-thirdof the revenue received by conventional regulating generators. Even so, we arecurrently running the Tyngsboro system at positive gross margins, due to recentreductions in certain operating costs. We are encouraging ISO-NE to developpermanent market rules that will provide an additional payment componentfor alternative technologies that would be approximately equal to opportunitycost. The trend at other ISOs has been to incorporate features in their tariffsthat intrinsically compensate all resources, including energy storageproviders, for opportunity cost.

 

37

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Until April 2009,the pilot resource was sent a regulation signal that was similar to one for atraditional generator and therefore did not recognize that our technologyprovides regulation in a different manner than a traditional generator. The traditional generator signal led to long periods of constant injections orwithdrawals because it did not incorporate the amount of energy stored in thedevice in the dispatch algorithm.  After discussions with ISO-NE, in May 2009,we convinced the ISO to implement a regulation dispatch signal for our pilot projectthat better recognizes our system’s unique capabilities and is similar to thedispatch method developed by NYISO which incorporates our energy level in thedispatch signal. We are continuing to work with ISO-NE to implement a NYISO-style dispatch signal in the permanent rules at the conclusion of thepilot program.  All ISO’s either will allow us to dispatch our resourcebased on its stored energy level (NYISO, MISO, PJM), or are consideringincorporating this feature in their permanent market design (CAISO).

 

This new dispatch signalhas improved the economics of our energy storage resources, but still does notgive us the same capacity utilization that we expect under the NYISO dispatchsystem.   The lower capacity for the current assets is a combinationof the ISO-NE pilot signal and our current operational strategy in NewEngland.  ISO-NE is the only market with a ‘pay-for-performance’ aspect totheir compensation formula.  In order to maximize our total revenue (andoffset for the lower price) from ISO-NE we have selected dispatch parametersthat result in a low regulation capacity value but increase the amount ofregulation service provided.  This trade-off between capacity and “Mileage”payments is unique to ISO-NE.  New York’s compensation mechanism iscompletely based off of the regulation capacity value, and we will pursue anoperational strategy to maximize that value at our Stephentown plant.

 

We had 3 MW of capacityin service in the first quarter of 2010, as compared to 1 MW in the first quarterof 2009.  We provided approximately 136,300 Megawatt hours (MWh)of regulation service in the first quarter of 2010, or approximately 44,000 MWhper MW of capacity in service, as compared to approximately 39,000 MWh in thefirst quarter of 2009, an increase of 12.8%. Although our productivity improved, our revenue per MW capacity droppedfrom approximately $64,000 in the first quarter of 2009 to approximately$48,000 in the same period in 2010, due to a reduction in the average clearingprice for frequency regulation.

 

Contractrevenue for the three months ended March 31, 2010 was approximately$79,000, an increase of $35,000 or 80%, over the contract revenue for the firstquarter of 2009.  The increase isprimarily due to work completed on the PNNL and Tehachapi contracts.

 

*Cost ofGoods Sold*

 

Cost of goods sold for the three months ended March 31, 2010, and2009 are as follows:

 
| ** **            | ** ** | **Three  months ended March 31, 2010** | ** ** | **Three  months ended March 31, 2009** | ** ** |
|-----------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **            | ** ** | **Revenue**                                 | ** ** | **Cost  of  Goods Sold**                    | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Goods Sold** | ** ** | **Margin** | ** ** |
| ** **            | ** ** | **(in thousands)**                          | ** ** |
| Frequency  regulation |       | $                                           | 143        |                                        | $          | 104 |   | $ | 39 |   | $ | 64 |   | $ | 130 |   | $ | (66 | ) |
| Contract              |       | 79                                          |       | 79                                          |       | — |   | 44 |   | 42 |   | 2 |   |
| Inverters  and other  |       | 13                                          |       | —                                      |       | 13 |   | 3 |   | — |   | 3 |   |
| Total                 |       | $                                           | 235        |                                        | $          | 183 |   | $ | 52 |   | $ | 111 |   | $ | 172 |   | $ | (61 | ) |

 

Costof goods sold, inclusive of our frequency regulation services, research anddevelopment contracts, and inverter and other sales increased fromapproximately $172,000 in the first three months of 2009 to approximately$183,000 during the equivalent period of 2010. Our total cost of goods sold for regulation for the first quarter of2010 was lower than for the same period in 2009, despite tripling the frequencyregulation capacity in service during that period. During the first threemonths of 2010 and 2009, cost of goods sold includes approximately $104,000 and$130,000, respectively, for the cost of energy associated with the generationof frequency regulation revenue under the ISO-NE pilot program.  This significant improvement was primarilydriven by a change in our ability to net our energy consumption and pay thewholesale rate for our net energy usage, as explained in detail further below.Consequently, our average gross margin on frequency regulation services duringthe first quarter of 2010 was 27%, as opposed to a negative gross margin of103% for the first quarter of 2009.

 

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During the first sixmonths of the pilot program (which included the first quarter of 2009), ourelectricity costs for operating the Smart Energy MatrixTM in Tyngsboro wereunusually high.  Our connection to thegrid for the pilot program was made through National Grid distribution lines,rather than directly to the ISO through transmission lines, due to cost andtime factors.  Consequently, from November 2008through late April 2009, we paid the retail price for our grosswithdrawals from the grid instead of paying the wholesale price for the netelectricity (withdrawals minus injections), plus retail transmission anddistribution charges.  In late April 2009,ISO-NE and our local distribution company implemented a change that reduced ourcost of electricity by netting the electricity withdrawn and injected into thegrid, and billing for that net usage at the wholesale rate.  In addition, a new regulation dispatch signalimplemented by ISO-NE in May 2009 reduced the net amount of electricity weneed to purchase.  While we are stillpaying retail transmission and distribution charges, the reduction in energycosts resulting from the adjustment that allows us to net our energy costs hasenabled us to earn positive gross margins since May 2009.

 

The cost ofelectricity will be even further reduced for our 20 MW facilities, as we planto be connected to transmission-level (rather than to distribution-level) powerlines, and thus will not be subject to transmission and distribution fees.Those fees have represented approximately 72% of our cost of energy during thefirst quarter of 2010. Pro forma gross margin for frequency regulation servicesfor the first quarter of 2010, calculated without transmission or distributioncharges, would have been approximately 80%.

 

Quarterover quarter, the increase in cost of goods sold associated with contracts wasproportional to our increase in contract revenue.

 

*Operations and Maintenance Expense*

 

For the threemonths ended March 31, 2010, operations and maintenance expenses increasedby approximately $190,000, or 24%, in comparison to the equivalent period in2009. See the table below for explanations of the factors which wereresponsible for the most significant changes.

 
| ** **                        | ** ** | **Three  months  ended March  31,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                        | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **(in thousands)**                  | ** ** | ** **                                                                                                                                                                                                                                                                                                                                         | ** ** |
| Period  Ended March 31, 2009 |       | $                                        | 777        |                                                                                                                                                                                                                                                                                                                                               |       |   |
| Expense  materials                |       | 34                                       |       | Increased spending for  small tools and equipment, tooling and non-recurring expenses, and production  supplies.                                                                                                                                                                                                                                   |       |
| Salaries  and benefits            |       | 8                                        |       | Primarily due to  increase in cost of benefits, particularly employee health insurance.                                                                                                                                                                                                                                                            |       |
| Subcontractors  and consultants   |       | (171                                     | )          | 2009 costs were higher  due to contractor costs associated with completing non-fungible costs of the  3 MW system in Tyngsboro.                                                                                                                                                                                                                    |       |
| Legal                             |       | (28                                      | )          | In 2009, legal and tax  advice represents primarily costs associated with the set up of our frequency  regulation operations in New York.                                                                                                                                                                                                          |       |
| Allocations  and overhead         |       | 86                                       |       | During the first  quarter of 2010, the manufacturing staff was focused on process improvement  and setup for volume manufacturing. Consequently, there was less overhead  capitalized than in the first quarter of 2009. Additionally, there were fewer  direct labor hours spent monitoring and modifying the flywheels in service in  Tyngsboro. |       |
|                                   |            |                                          |            |                                                                                                                                                                                                                                                                                                                                                    |            |  |

 

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|                              |   | **Three  months  ended March  31,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                                            |   |
|-----------------------------------|--------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Stock  Compensation               |   | (19                                      | )          | We use the accelerated  method of calculating stock compensation expense, which results in higher  compensation expense in the year of grant and lesser amounts in the  succeeding years. Option grants in 2009 were significantly lower than in  prior years, and there was only one grant made in the first quarter of 2010  (to an O&M new hire). Thus, stock compensation expense is lower than in  the first quarter of 2009. |   |
| Occupancy                         |   | 273                                      |       | Increase due primarily  to the cost of repair the roof at our Tyngsboro facility, and lease option  costs for the property in Glenville.                                                                                                                                                                                                                                                                                               |   |
| Travel                            |   | 13                                       |       | Increase in travel.                                                                                                                                                                                                                                                                                                                                                                                                                    |   |
| Other                             |   | (6                                       | )          |                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |
| Period  Ended March 31, 2010 |   | $                                        | 967        |                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |   |
|                                   |        |                                          |            |                                                                                                                                                                                                                                                                                                                                                                                                                                        |        |  |

 

*Research and Development Expense*

 

For the threemonths ended March 31, 2010, research and development expenses decreasedby approximately $120,000, or 5%, in comparison to the equivalent period in2009. See the table below for explanations of the factors which wereresponsible for the most significant changes.

 
| ** **                        | ** ** | **Three months  ended March  31,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Period  Ended March 31, 2009 |       | $                                            | 2,191      |                                                                                                                                                                                                                                                                                                                                                                                                                      |       |   |
| Expense  materials                |       | (90                                          | )          | In 2009, the materials  cost included in R&D are primarily the cost of redesigning and replacing  motors as part of the motor-stator redesign needed to reduce the operating  temperature of the flywheels and engineering efforts to reduce the cost of  the flywheels. In the first quarter of 2010, expense materials for R&D  primarily relates to work developing lower cost components for our flywheels.   |       |
| Salaries  and benefits            |       | 13                                           |       | Increase represents  more hours charged to R&D by manufacturing staff in 2010 than in 2009.  The manufacturing staff has been working with engineering to improve the  tools and procedures used to manufacture the flywheels as part of our cost  reduction efforts.                                                                                                                                                 |       |
| Allocations  and overhead         |       | (51                                          | )          | The increase in  overhead allocation in 2010 from 2009 is a result in the increase in the  level of production and contract activity, resulting in an increase in  overhead capitalized.                                                                                                                                                                                                                                  |       |
| Stock  Compensation               |       | (68                                          | )          | We use the accelerated  method of calculating stock compensation expense, which results in higher  compensation expense in the year of grant and lesser amounts in the  succeeding years. Option grants in 2009 were significantly lower than in  prior years, there were no new grants to R&D employees in the first  quarter of 2010. Thus, stock compensation expense is lower than in the first  quarter of 2009. |       |
|                                   |            |                                              |            |                                                                                                                                                                                                                                                                                                                                                                                                                           |            |  |

 

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| Occupancy                         |   | 68 |   | Increase due to cost to  repair the roof at our Tyngsboro facility. |   |
|-----------------------------------|--------|----|--------|---------------------------------------------------------------------|--------|
| Travel                            |   | 11 |   | Increase in travel.                                                 |   |
| Other                             |   | (2 | )      |                                                                |   |
| Period  Ended March 31, 2010 |   | $  | 2,072  |                                                                |   |   |
|                                   |        |    |        |                                                                     |        |  |

 

*Selling,General and Administrative Expense*

 

Selling,general and administrative expenses totaled approximately $1,946,000 and $1,897,000for the three months ended March 31, 2010 and 2009, respectively, whichrepresents an increase of approximately $49,000, or 3%, period over period.

 

Significantchanges in spending are explained in the table shown below.

 
| ** **                          | ** ** | **Three months  ended March  31,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                |       |                                         |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |       |
| Period  Ended March 31, 2009   |       | $                                            | 1,897      |                                                                                                                                                                                                                                                                                                                                                                                                                              |       |   |
| Stock  Compensation                 |       | (64                                          | )          | We use the accelerated  method of calculating stock compensation expense, which results in higher  compensation expense in the year of grant and lesser amounts in the  succeeding years. Option grants in 2009 were significantly lower than in  prior years. Grants in the first quarter of 2010 were limited to 3 SG&A  new hire grants. Thus, stock compensation expense is lower than during the  first quarter of 2009. |       |
| Legal,  audit and professional fees |       | (16                                          | )          | Reduction in use of  outside legal services.                                                                                                                                                                                                                                                                                                                                                                                      |       |
| Salaries  and benefits              |       | 39                                           |       | Three G&A employees  were hired during the first quarter of 2010, primarily to support the  administrative cost of building the Stephentown project and planning for  future construction projects.                                                                                                                                                                                                                           |       |
| Taxes                               |       | 20                                           |       | Increase in Delaware  franchise tax.                                                                                                                                                                                                                                                                                                                                                                                              |       |
| Small  tools and equipment          |       | 14                                           |       | Increase represents  primarily the cost of computer equipment for new hires.                                                                                                                                                                                                                                                                                                                                                      |       |
| Subcontractors  and consultants     |       | 6                                            |       | Increased use of  consultants, especially in regards to international marketing efforts.                                                                                                                                                                                                                                                                                                                                          |       |
| Hiring  Expense                     |       | 24                                           |       | Cost associated with  recruiting new hires during the first quarter 2010. There were no new hires  in the first quarter of 2009.                                                                                                                                                                                                                                                                                                  |       |
| Travel                              |       | 15                                           |       | Increase in travel.                                                                                                                                                                                                                                                                                                                                                                                                               |       |
| Other                               |       | 11                                           |       |                                                                                                                                                                                                                                                                                                                                                                                                                              |       |
| Period  Ended March 31, 2010   |       | $                                            | 1,946      |                                                                                                                                                                                                                                                                                                                                                                                                                              |       |   |

 

*Loss onContract Commitments*

 

Ourcontracts have been primarily for the development of demonstration units of newproducts and the design of a frequency regulation plant. As such, the work hassupported our core research and development efforts.  Most of these contracts have been structuredon a cost-share basis, for which the expected cost-share has been recorded as acontract loss.  The NAVSEA contract,which we were awarded on January 28, 2009, is a cost-plus-fixed feecontract.

 

41

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Eachquarter we perform an estimate-to-complete analysis, and any changes to ouroriginal estimates are recognized in the period in which they aredetermined.  In 2008, we recorded acontract loss of approximately $86,600, which represents our expected “costshare” portion of the Tehachapi contract. During the first quarter of 2009, werecorded an additional contract loss on the Tehachapi contract of approximately$132,000, which represents the difference between our overhead rate based on “fullproduction”, and the contract bid rate. No loss reserve adjustments were considered necessary during the quarterended March 31, 2010.

 

*Depreciationand Amortization*

 

Depreciation andamortization expense increased from approximately $424,000 during the threemonths ended March 31, 2009, to approximately $530,000 for the same periodin 2010, an increase of approximately $106,000, or 25%. The increase indepreciation and amortization results primarily from the capitalization offlywheel and related equipment that was placed into service in July and December of2009, as well as machinery and equipment purchased in the fourth quarter of2009.  As of March 31, 2010, we hadapproximately $8.1 million in “Construction in progress,” of whichapproximately$4.5 million is for flywheels or materials to build flywheels andapproximately $3.3 million are costs related to the construction of SmartEnergy MatrixTM systems.

 

*Interestand Other Income (Expense), net*

 

Average cashbalances during the first three months of 2010 were approximately $12 millionhigher, on average, than during the same period in 2009. However, interestrates were significantly lower in 2010. As a result of the lower interestrates, interest income for the first three months of 2010 was approximately$2,000 lower than during the first three months of 2009.

 

Interest expensefor the three months ended March 31, 2010 and 2009 was as follows:

 
| ** **               | ** ** | **Three  months ended March 31,** | ** ** |
|--------------------------|------------|----------------------------------------|------------|
| ** **               | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| Interest  incurred       |       | $                                      | 81,974     |   | $ | 58,045 |   |
| Loan  discount amortized |       | 13,620                                 |       | 10,037 |   |
| Interest  capitalized    |       | (9,244                                 | )          | (781 | ) |
| Net  interest expense    |       | $                                      | 86,350     |   | $ | 67,301 |   |

 

Interest expenseand the loan discount amortization increased due to the final drawdown on theMassDev loan which was made during the fourth quarter of 2009.  These increases were partially offset byhigher interest capitalized on the Stephentown project.

 

*NetLoss*

 

As a result of thechanges discussed above, the net loss for the three months ended March 31,2010 was approximately $5,540,000 which is essentially flat compared to the netloss during the same period in 2009.

 

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**Liquidityand Capital Resources**

** **
| ** **                                 | ** ** | **Three  months ended March 31,** | ** ** |
|--------------------------------------------|------------|----------------------------------------|------------|
| ** **                                 | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                     | ** ** |
| Cash  and cash equivalents                 |       | $                                      | 17,508     |   | $ | 5,323 |   |
| Working  capital                           |       | 13,920                                 |       | 1,658 |   |
| Cash  provided by (used in)                |       |                                   |       |   |   |
| Operating  activities                      |       | (5,574                                 | )          | (9,545 | ) |
| Investing  activities                      |       | (322                                   | )          | (1,054 | ) |
| Financing  activities                      |       | 799                                    |       | 1,564 |   |
| Net  decrease in cash and cash equivalents |       | $                                      | (5,097     | ) | $ | (9,035 | ) |
| Current  ratio                             |       | 3.8                                    |       | 1.4 |   |

 

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

 

We deployed one megawatt of frequency regulation capacity in 2008, anddeployed two additional megawatts in 2009. In 2010, we plan to re-deploy part of the three megawatts from the pilotprogram at the site of our planned 20 MW plant in Stephentown, New York. Thisplant will cost approximately $69 million. We broke ground in November 2009,and we expect to complete the production of most of the flywheels needed forthat plant in 2010.  Although we expectto begin to generate revenue from part of that facility late in 2010, we do notexpect to complete construction until the end of the second quarter of2011.  We also expect to begin preparations for our second and third plantswhich will begin construction in 2011. However the number of megawatts we willbe able to deploy in 2011 is dependent on obtaining sufficient funding.

 

We have experienced netlosses since our inception and, as of March 31, 2010, had an accumulateddeficit of approximately $211.5 million.  We do not expect to havepositive EBITDA (earnings before interest, taxes, depreciation andamortization) or positive cash flow from operations until we have deployed asufficient number of merchant plants and/or sell turnkey systems. We will needto raise additional capital from a combination of equity and/or projectfinancing, the sale of our systems and/or other sources to build regulationfacilities, support operations at our Tyngsboro and other facilities, implementour business plan and continue as a going concern.

 

Our first 20 MW plant is being financed by $26million of cash and in-kind assets that we will contribute to the project and a$43 million loan guaranteed by DOE. In 2010 and 2011, we will continue to havecapital needs to fund operations and the ongoing deployment of frequencyregulation facilities.Of the $17.5 million cash on hand as of March 31, 2010, $12 millionrepresents our expected cash investment towards the construction of theStephentown plant under the terms of the DOE loan, and thus is not availablefor our general corporate operating purposes. Based on our projected cash usagerates, exclusive of the anticipated borrowings from the DOE loan and our equitycontribution to the Stephentown project, we have sufficient cash to fund our operationsinto the third quarter of 2010. We estimatethat we will need to raise an additional $18 - $20 million during the remainderof 2010 through the issuance of equity securities or debt in order to fundoperations and have sufficient working capital to continue to execute ourbusiness plan into 2011, including ordering long-lead items required by ourproduction plan for 2011.  Additionalfunding will be required in 2011.

 

The amount of debt and equity required will depend on themix of merchant plants and plants sold on a turnkey basis.  Our deployment plans are affected by thetiming of a number of factors and activities, including but not limited to thefollowing:

 

·                  Closing the DOE loan and the receipt offunds from the NYSERDA grant and the DOE stimulus grant

 

·                  Corporate or project financing and itsavailability

 

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·                  Equity transactions and the amountsthereof

 

·                  Sale of turnkey plants and the amount ofassociated margin and terms and conditions of those sales

 

·                  Receipt of environmental and site-relatedpermits and approvals

 

·                  Receipt of grid interconnection approvals.

 

The timing of thefirst disbursement of the DOE loan is directly affected by the timing of theexecution of an interconnection agreement with NYISO; hence the ramp up of cashburn will be affected by the same timing.

 

In November 2009,we were notified by the Department of Energy that we have been awarded astimulus grant of $24 million for use in construction of a 20 MW plant to belocated in the Chicago area.  The grantfor the Chicago facility results from one of our applications for the DOE SmartGrid demonstration project funding, known as Funding Opportunity RegulationAncillary Services projects.  The grantaward is for 50% of the project’s estimated cost.

 

**OperatingActivities**

 

Net cash used inoperating activities was approximately $5,574,000 and $9,545,000 for the threemonths ended March 31, 2010 and 2009, respectively.  The primarycomponent of the negative cash flows from operations is from our netlosses.  For the three months ended March 31, 2010, we had a net lossof approximately $5,540,000.  Adjustments to reconcile net loss to cash flowin 2010 include non-cash stock compensation of approximately $127,000,depreciation and amortization of approximately $530,000, interest expense onwarrants of approximately $14,000, partially offset by a net increase indeferred rent of approximately ($33,000) and changes in operating assets andliabilities of approximately ($672,000).

 

During the sameperiod in 2009, we also had a net loss of approximately $5,540,000. Adjustments to reconcile net loss to cash flow for the period include non-cashstock compensation of approximately $279,000, depreciation and amortization ofapproximately $424,000,  interest expenseon warrants of approximately $10,000, partially offset by a net increase indeferred rent of approximately ($27,000) and changes in operating assets andliabilities of approximately ($4,691,000).

 

**InvestingActivities**

 

Net cash used ininvesting activities was approximately $322,000 and $1,054,000 for the threemonths ending March 31, 2010 and 2009, respectively.  The principal use of cash in 2010 was thepurchase and manufacture of property and equipment in the amount ofapproximately $322,000.  For the threemonths ended March 31, 2009, the principal use of cash was the purchase ofproperty and equipment in the amount of approximately $1,054,000.

 

**FinancingActivities**

 

Net cash providedby financing activities was approximately $799,000 and $1,564,000 for the firstthree months of 2010 and 2009, respectively. In 2010, funds were provided by the sale of stock to Seaside of approximately$1,520,000 and the exercise of warrants of approximately $2,233,000, offset partially by cash paid for financingcosts (primarily for the DOE loan) of approximately $2,795,000 andapproximately $159,000 in repayment of the MassDev loan.  For the first threemonths of 2009, funds were provided by the sale of stock to Seaside ofapproximately $1,765,000, offset partially by cash paid for financing costs ofapproximately $201,000 related to the due diligence for the DOE Loan GuaranteeProgram for which we had applied.

 

The followingtable summarizes our commitments and debt at March 31, 2010:

 

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| ** **                                                     | ** ** | **Description  of Commitment** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                     | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **MassDev  Loan** | ** ** | **Total** | ** ** |
| Period  ending:                                                |       |                           |       |   |   |   |   |   |   |
| March 31,  2010                                           |       | $                              | —     |   | $ | 28,175,356 |   | $ | — |   | $ | 28,175,356 |   |
| December 31,  2010                                        |       | 547,187                        |       |   |   | 500,914 |   | 1,048,101 |   |
| December 31,  2011                                        |       | 753,188                        |       |   |   | 704,402 |   | 1,457,590 |   |
| December 31,  2012                                        |       | 778,937                        |       |   |   | 751,674 |   | 1,530,611 |   |
| December 31,  2013                                        |       | 804,689                        |       |   |   | 803,313 |   | 1,608,002 |   |
| December 31,  2014                                        |       | 618,000                        |       |   |   | 857,882 |   | 1,475,882 |   |
| December 31,  2015                                        |       | —                         |       |   |   | 677,772 |   | 677,772 |   |
| Total  Commitments                                             |       | $                              | 3,502,001  |   | $ | 28,175,356 |   | $ | 4,295,957 |   | $ | 35,973,314 |   |
| Non-cancellable  purchase obligations:                         |       |                           |       | $ | 13,473,343 |   |   |   |   |   |
| Advance  payments to suppliers                                 |       |                           |       | (2,637,473 | ) |   |   |   |   |
| Non-cancellable  purchase obligations net of advance payments: |       |                           |       | $ | 10,835,870 |   |   |   |   |   |

 

As of March 31,2010, we had purchase commitments with our suppliers of approximately $28.2million. Of this amount, approximately $13.5 million represents firm,non-cancelable commitments, against which we have made advance paymentstotaling $2.6 million, leaving a net non-cancelable obligation of approximately$10.8 million as of March 31, 2010. Total purchase commitments include approximately $25.6 million formaterials required to build the flywheels, electronic control modules and otherancillary equipment needed for Stephentown, of which $14.7 million arecancelable as of March 31, 2010. The remaining commitments are for otherequipment needed for Stephentown, costs associated with closing the DOE loan,equipment and other operating expenses. We have an additional $2.8 million conditional material purchasecommitment to a second source supplier that is working to meet ourqualification requirements.

 

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

 

Our cashequivalents and investments, all of which have maturities of less than ninetydays, could expose us to interest rate risk. At March 31, 2010, we had approximately $976,000 of cashequivalents that were held in a non-interest bearing checking account.  Also at March 31, 2010, we hadapproximately $16.7 million of cash equivalents that were held ininterest-bearing money market accounts at high-quality financial institutions,some of which are invested in off-shore securities. The fair value of theseinvestments approximates their cost. A 10% change in interest rates wouldchange the investment income realized on an annual basis by approximately$4,000, which we do not believe is material. The funds invested in money market accounts may not be covered underFDIC Insurance, and therefore may be at some risk of loss. However, the moneymarket accounts are invested primarily in government funds, such as TreasuryBills.  Approximately $15.6 million ofour cash on hand at March 31, 2010 was invested in mutual funds at abrokerage firm that has purchased supplementary insurance through Lloyd’s ofLondon. This insurance coverage provides protection above the SecuritiesInvestor Protection Corporation (SIPC) coverage in the event that the brokerbecomes insolvent.  SIPC protects againstthe loss of securities up to a total of $500,000 (of which $100,000 may be incash) per client.  The supplementalinsurance provided by the broker would cover investments at that brokerage firmup to a maximum of $1 billion, including up to $1.9 million per client for thecash portion of any remaining shortfall. SIPC and the supplemental insurance do not cover market losses; however,management believes the risk of substantial market losses is low because ourfunds are invested primarily in government funds.

 

**Item 4.  Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

As of the end of the period covered by this report, wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures.  Based on theevaluation, both the Chief Executive Officer and the Chief Financial Officerconcluded that our disclosure controls and procedures, as defined in Rules 13a— 15(e) and 15d — 15(e) promulgated under the Securities Exchange Actof 1934, were effective as of  March 31,2010.

 

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*InternalControl over Financial Reporting*

 

There was no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgatedunder the Securities Act of 1934) that materially affected, or is reasonablylikely to materially affect, such internal control over financial reportingduring the quarter ended  March  31,2010.

 

**Part II — OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

None.

 

**Item 1A.  Risk Factors**

 

In addition toother information set forth in this report, you should carefully consider thefactors described in Part I, Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2009, filed with the SEC on March 15,2010.  Those factors could materiallyaffect our business, financial condition or future results. The risks describedin such reports are not the only risks we face. Additional risks anduncertainties not currently known to us or that we currently deem to be immaterialmay also have a materially adverse effect on our business, financial conditionand/or operating results.

 

**Item2.  Unregistered Sales of Equity Securities and Use of Proceeds**

 

None.

 

**Item 3.  Defaults Upon Senior Securities**

 

None.

 

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

 

**Item 5.  Other Information**

 

None.

 

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**Item6.  Exhibits**

 
| **Exhibit  Number** | ** ** | **Ref** | ** ** | **Description  of Document**                                                                                                                                |
|---------------------|------------|---------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |    |       |                                                                                                                                                        |
| 3.1                 |       | (1)     |       | Sixth Amended and  Restated Certificate of Incorporation,                                                                                                   |
|                |       |    |       |                                                                                                                                                        |
| 3.2                 |       | (1)     |       | Certificate of  Amendment of Certificate of Incorporation, dated June 25, 2007.                                                                        |
|                |       |    |       |                                                                                                                                                        |
| 3.3                 |       | (1)     |       | Certificate of  Amendment of the Sixth Amended and Restated Certificate of Incorporation,  dated June 26, 2007.                                        |
|                |       |    |       |                                                                                                                                                        |
| 3.4                 |       | (2)     |       | Certificate of  Amendment of the Sixth Amended and Restated Certificate of Incorporation,  dated June 11, 2009                                         |
|                |       |    |       |                                                                                                                                                        |
| 3.5                 |       | (3)     |       | Amended and Restated  Bylaws, as amended.                                                                                                                   |
|                |       |    |       |                                                                                                                                                        |
| 3.6                 |       | (4)     |       | Certificate of  Designations of Series A Junior Participating Preferred Stock, filed  with the Secretary of State of Delaware on October 4, 2002. |
|                |       |    |       |                                                                                                                                                        |
| 31.1                |       | +       |       | Certification of  Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                              |
|                |       |    |       |                                                                                                                                                        |
| 31.2                |       | +       |       | Certification of  Principal Financial and Accounting Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                               |
|                |       |    |       |                                                                                                                                                        |
| 32.1                |       | +       |       | Certification of  Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 |
|                |       |    |       |                                                                                                                                                        |
| 32.1                |       | +       |       | Certification of  Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 |

 

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(1) Incorporated byreference from Form 10-K filed on March 17, 2008 (File No. 000-31973).

(2) Incorporated byreference from the Form 10-Q filed on August 6, 2009 (File No. 000-31973).

(3) Incorporated byreference from the Form 8-K filed on October 1, 2007 (File No. 000-31973).

(4) Incorporated byreference from the 100K filed on March 30, 2006 (File No. 000-31973.)

+ Filed herewith.

 

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**SIGNATURES**

 

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

 
|                    |                     | BEACON POWER  CORPORATION                            |
|-------------------------|--------------------------|------------------------------------------------------|
|                    |                     |                                                 |
| Date:    |  May  10, 2010 |                                                 | By: | /s/ F. William Capp |
|                    |                     |                                                 | F. William Capp |
|                    |                     |                                                 | President and Chief  Executive Officer |
|                    |                     |                                                 | Principal Executive  Officer |
|                    |                     |                                                 |   |
|                    | May 10, 2010        |                                                 | By: | /s/ James M. Spiezio |
|                    |                     | James M. Spiezio                                     |
|                    |                     | Vice President of Finance,  Chief Financial Officer, |
|                    |                     | Treasurer and Secretary                              |
|                    |                     | Principal Financial  Officer                         |

 

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