**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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

**or**

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

**Commission File Number: 000-31973**

 

**Beacon Power Corporation**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                             |   | **04-3372365**       |
|------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of         |   | (I.R.S. Employer     |
| incorporation or  organization)          |   | Identification  No.) |
|                                     |   |                 |
| **234 Ballardvale Street**               |   | ** **           |
| **Wilmington, Massachusetts**            |   | **01887-1032**       |
| (Address of principal executive offices) |   | (Zip code)           |

 

**(978) 694-9121**

(Registrant’s telephone number, including area code)

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.  x Yes  o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)
| Large accelerated filer o | Accelerated  filer o | Non-accelerated  filer x |
|---------------------------|----------------------|--------------------------|

 

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

The number of shares of the Registrant’s common stock, par value $.01 per share, outstanding as of August 4, 2006 was 58,713,303.

 

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**BEACON POWER CORPORATION AND SUBSIDIARY**

**(A Development Stage Company)**

**Table of Contents**
| ** **                     | **Page**                                                                                              |
|--------------------------------|-------------------------------------------------------------------------------------------------------|
| PART I. Financial  Information |                                                                                                  |
|                           |                                                                                                  |
|                           | Item 1. Financial  Statements.                                                                        |   |
|                           |                                                                                                  |   |
|                           |                                                                                                  | Consolidated Balance  Sheets at June 30, 2006 (unaudited) and December 31, 2005 (audited). | 1 |
|                           |                                                                                                  |   |   |
|                           |                                                                                                  | Unaudited  Consolidated Statements of Operations for the three months ended June 30,  2006 and 2005, the six months ended June 30, 2006 and 2005 and for the period  from May 8, 1997 (date of inception) to June 30, 2006. | 2 |
|                           |                                                                                                  |   |   |
|                           |                                                                                                  | Unaudited  Consolidated Statements of Cash Flows for the six months ended June 30, 2006  and 2005 and for the period from May 8, 1997 (date of inception) to June 30,  2006. | 3 |
|                           |                                                                                                  |   |   |
|                           |                                                                                                  | Notes to  Unaudited Consolidated Financial Statements. | 5 |
|                           |                                                                                                  |   |   |
|                           | Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations. | 12 |
|                           |                                                                                                  |   |   |
|                           | Item 3.  Quantitative and Qualitative Disclosures about Market Risk.                                  | 20 |
|                           |                                                                                                  |   |   |
|                           | Item 4. Controls and  Procedures.                                                                     | 20 |
|                           |                                                                                                  |   |
| PART II. Other  Information    |                                                                                                  |
|                           |                                                                                                  |
|                           | Item 1. Legal  Proceedings.                                                                           | 21 |
|                           |                                                                                                  |   |
|                           | Item  1A. Risk Factors.                                                                               | 21 |
|                           |                                                                                                  |   |
|                           | Item 2. Unregistered  Sales of Equity Securities and Use of Proceeds.                                 | 21 |
|                           |                                                                                                  |   |
|                           | Item 3.  Defaults Upon Senior Securities.                                                             | 21 |
|                           |                                                                                                  |   |
|                           | Item 4.  Submission of Matters to a Vote of Security Holders.                                         | 21 |
|                           |                                                                                                  |   |
|                           | Item 5. Other  Information.                                                                           | 21 |
|                           |                                                                                                  |   |
|                           | Item  6. Exhibits.                                                                                    | 22 |
|                           |                                                                                                  |   |
| Signatures                     | 24                                                                                                    |
|                                |                                                                                                       |  |  |  |

 

i

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**PART1 – FINANCIAL INFORMATION**

**Item 1. FinancialStatements**

**BEACON POWER CORPORATION AND SUBSIDIARY**

**(A Development Stage Company)**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                   | ** ** | **June 30,**         | ** ** | **December 31,**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2006 (unaudited)** | ** ** | **2005 (audited)** | ** ** |
| **Assets**                                                                                                                                                                   | ** ** | ** **                | ** ** | ** **              | ** ** |
| Current assets:                                                                                                                                                              |       |                      |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                   |       | $                         | 10,227,461 |                    | $          | 13,890,162 |   |
| Accounts  receivable, trade, net                                                                                                                                             |       | 176,737                   |       | 588,440                 |       |
| Unbilled costs  on contracts in progress                                                                                                                                     |       | 207,249                   |       | 437,759                 |       |
| Prepaid expenses  and other current assets                                                                                                                                   |       | 478,643                   |       | 777,385                 |       |
| Total current  assets                                                                                                                                                        |       | 11,090,090                |       | 15,693,746              |       |
| Property and equipment,  net                                                                                                                                                 |       | 259,003                   |       | 212,296                 |       |
| Restricted cash                                                                                                                                                              |       | 219,568                   |       | 219,568                 |       |
| Total assets                                                                                                                                                                 |       | $                         | 11,568,661 |                    | $          | 16,125,610 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                               | ** ** | ** **                | ** ** | ** **              | ** ** |
| Current liabilities:                                                                                                                                                         |       |                      |       |                    |       |
| Accounts payable                                                                                                                                                             |       | $                         | 135,905    |                    | $          | 137,290 |   |
| Accrued  compensation and benefits                                                                                                                                           |       | 474,161                   |       | 151,318                 |       |
| Other accrued  expenses                                                                                                                                                      |       | 604,776                   |       | 844,742                 |       |
| Advance billings  on contracts                                                                                                                                               |       | 324,548                   |       | 74,820                  |       |
| Accrued contract  loss                                                                                                                                                       |       | 560,842                   |       | 548,614                 |       |
| Restructuring  reserve                                                                                                                                                       |       | 530,439                   |       | 713,469                 |       |
| Total current  liabilities                                                                                                                                                   |       | 2,630,671                 |       | 2,470,253               |       |
|                                                                                                                                                                         |       |                      |       |                    |       |
| Commitments (Note 5)                                                                                                                                                         |       |                      |       |                    |       |
|                                                                                                                                                                         |       |                      |       |                    |       |
| Stockholders’ equity:                                                                                                                                                   |       |                      |       |                    |       |
| Preferred Stock,  $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding                                                                              |       | —                    |       | —                  |       |
| Common stock,  $.01 par value; 110,000,000 shares authorized; 59,134,995 and 58,700,036  shares issued and outstanding at June 30, 2006 and December 31, 2005,  respectively |       | 591,350                   |       | 587,000                 |       |
| Deferred stock  compensation                                                                                                                                                 |       | (262,834                  | )          | (1,063,145              | )          |
| Additional  paid-in-capital                                                                                                                                                  |       | 153,662,065               |       | 153,089,842             |       |
| Deficit accumulated  during the development stage                                                                                                                            |       | (144,339,752              | )          | (138,245,501            | )          |
| Treasury stock,  421,692 shares at cost                                                                                                                                      |       | (712,839                  | )          | (712,839                | )          |
| Total  stockholders’ equity                                                                                                                                             |       | 8,937,990                 |       | 13,655,357              |       |
| Total liabilities and stockholders’ equity                                                                                                                              |       | $                         | 11,568,661 |                    | $          | 16,125,610 |   |

 

Seenotes to unaudited consolidated financial statements.

1

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**BEACON POWER CORPORATION AND SUBSIDIARY**

**(A Development Stage Company)**

**Consolidated Statements ofOperations (Unaudited)**
| ** **                                  | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** **                    | ** ** | ** ** | ** ** | **Cumulative from**          | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|-------------------------------|------------|------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** **                    | ** ** | ** ** | ** ** | **May 8, 1997**         | ** ** |
| ** **                                  | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** **                    | ** ** | ** ** | ** ** | **(date of inception)** | ** ** |
| ** **                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** | **through June 30** | ** ** |
| ** **                                  | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006**                      | ** ** | **2005**   | ** ** | **2006**                          | ** ** |
| Revenue                                     |       | $                                                   | 209,439    |                                              | $          | 318,304                       |       | $          | 498,034    |                              | $          | 954,438 |   | $ | 2,861,170 |   |
| Cost of goods  sold                         |       | 206,418                                             |       | 333,956                                           |       | 451,343                       |       | 1,004,464  |       | 3,484,452                         |       |
| Gross profit                                |       | 3,021                                               |       | (15,652                                           | )          | 46,691                        |       | (50,026    | )          | (623,282                          | )          |
| Operating  expenses:                        |       |                                                |       |                                              |       |                          |       |       |       |                              |       |
| Selling, general and administrative         |       | 1,627,718                                           |       | 1,108,571                                         |       | 3,557,250                     |       | 2,280,949  |       | 42,147,443                        |       |
| Research and development                    |       | 1,086,553                                           |       | 150,293                                           |       | 2,147,998                     |       | 636,531    |       | 57,431,776                        |       |
| Loss on sales and contract commitments      |       | 687,786                                             |       | 508,859                                           |       | 687,786                       |       | 1,056,566  |       | 2,598,058                         |       |
| Depreciation and amortization               |       | 27,189                                              |       | 22,918                                            |       | 48,418                        |       | 41,109     |       | 4,269,415                         |       |
| Restructuring charges                       |       | —                                              |       | —                                            |       | —                        |       | —     |       | 2,159,280                         |       |
| Loss on impairment of assets                |       | —                                              |       | —                                            |       | —                        |       | —     |       | 4,663,916                         |       |
| Total operating expenses                    |       | 3,429,246                                           |       | 1,790,641                                         |       | 6,441,452                     |       | 4,015,155  |       | 113,269,888                       |       |
| Loss from  operations                       |       | (3,426,225                                          | )          | (1,806,293                                        | )          | (6,394,761                    | )          | (4,065,181 | )          | (113,893,170                      | )          |
| Other income  (expense):                    |       |                                                |       |                                              |       |                          |       |       |       |                              |       |
| Interest income                             |       | 149,578                                             |       | 17,123                                            |       | 295,083                       |       | 32,010     |       | 4,340,002                         |       |
| Interest expense                            |       | —                                              |       | —                                            |       | —                        |       | —     |       | (1,093,703                        | )          |
| Gain on sale of  investment                 |       | —                                              |       | —                                            |       | —                        |       | —     |       | 3,562,582                         |       |
| Other income  (expense)                     |       | 4,046                                               |       | 24,389                                            |       | 5,427                         |       | 23,389     |       | (249,269                          | )          |
| Total other income (expense), net           |       | 153,624                                             |       | 41,512                                            |       | 300,510                       |       | 55,399     |       | 6,559,612                         |       |
| Net loss                                    |       | (3,272,601                                          | )          | (1,764,781                                        | )          | (6,094,251                    | )          | (4,009,782 | )          | (107,333,558                      | )          |
| Preferred stock  dividends                  |       | —                                              |       | —                                            |       | —                        |       | —     |       | (36,825,680                       | )          |
| Accretion of  convertible preferred stock   |       | —                                              |       | —                                            |       | —                        |       | —     |       | (113,014                          | )          |
| Loss to common  shareholders                |       | $                                                   | (3,272,601 | )                                                 | $          | (1,764,781                    | )          | $          | (6,094,251 | )                                 | $          | (4,009,782 | ) | $ | (144,272,252 | ) |
| Loss per share,  basic and diluted          |       | $                                                   | (0.06      | )                                                 | $          | (0.04                         | )          | $          | (0.10      | )                                 | $          | (0.09 | ) |   |   |
| Weighted-average common  shares outstanding |       | 58,950,147                                          |       | 44,801,287                                        |       | 58,825,782                    |       | 44,299,825 |       |                              |       |

 

Seenotes to unaudited consolidated financial statements.

2

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**BEACON POWER CORPORATION ANDSUBSIDIARY**

**(A Development Stage Company)**

**Consolidated Statements of Cash Flows (Unaudited)**
| ** **                                                                   | ** ** | ** **                                        | ** ** | ** **                     | ** ** | **Cumulative from**          | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                        | ** ** | ** **                     | ** ** | **May 8, 1997**         | ** ** |
| ** **                                                                   | ** ** | ** **                                        | ** ** | ** **                     | ** ** | **(date of inception)** | ** ** |
| ** **                                                                   | ** ** | **Six months ended June 30,** | ** ** | **through June 30,** | ** ** |
| ** **                                                                   | ** ** | **2006**                                          | ** ** | **2005**                       | ** ** | **2006**                          | ** ** |
| Cash flows from  operating activities:                                       |       |                                              |       |                           |       |                              |       |
| Net loss                                                                     |       | $                                                 | (6,094,251 | )                              | $          | (4,009,782                        | )          | $ | (107,333,558 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                              |       |                           |       |                              |       |
| Depreciation and amortization                                                |       | 48,418                                            |       | 41,109                         |       | 4,269,416                         |       |
| Loss on sale of fixed assets                                                 |       | —                                            |       | 87,365                         |       | 196,169                           |       |
| Impairment of assets                                                         |       | (40,389                                           | )          | (111,754                       | )          | 4,491,638                         |       |
| Restricted cash                                                              |       | —                                            |       | —                         |       | (219,568                          | )          |
| (Expenses paid) restructuring charge                                         |       | (183,030                                          | )          | (171,773                       | )          | 530,439                           |       |
| Interest expense relating to issuance of warrants                            |       | —                                            |       | —                         |       | 371,000                           |       |
| Non-cash charge for change in option terms                                   |       | —                                            |       | —                         |       | 346,591                           |       |
| Non-cash charge for settlement of lawsuit                                    |       | —                                            |       | —                         |       | 303,160                           |       |
| Amortization of deferred consulting expense, net                             |       | —                                            |       | —                         |       | 1,160,784                         |       |
| Amortization of deferred stock compensation                                  |       | 800,311                                           |       | 483,313                        |       | 3,436,887                         |       |
| 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                                                     |       | 548,771                                           |       | —                         |       | 548,771                           |       |
| Changes in  operating assets and liabilities:                                |       |                                              |       |                           |       |                              |       |
| Accounts receivable                                                          |       | 411,703                                           |       | (75,310                        | )          | (176,737                          | )          |
| Inventory                                                                    |       | —                                            |       | 222,593                        |       | —                            |       |
| Unbilled costs under government contracts                                    |       | 230,510                                           |       | (241,790                       | )          | (207,249                          | )          |
| Prepaid expenses and other current assets                                    |       | 298,742                                           |       | 369,689                        |       | (578,303                          | )          |
| Accounts payable                                                             |       | (1,385                                            | )          | (239,708                       | )          | 135,905                           |       |
| Accrued compensation and benefits                                            |       | 322,843                                           |       | 46,579                         |       | 474,161                           |       |
| Advance billings on contracts                                                |       | 249,728                                           |       | —                         |       | 324,548                           |       |
| Accrued interest                                                             |       | —                                            |       | —                         |       | 275,560                           |       |
| Accrued loss on contract commitments                                         |       | 12,228                                            |       | 455,339                        |       | 560,842                           |       |
| Other accrued expenses and current liabilities                               |       | (239,966                                          | )          | 174,775                        |       | 613,446                           |       |
| Net cash used in operating activities                                        |       | (3,635,767                                        | )          | (2,969,355                     | )          | (92,441,541                       | )          |
| Cash flows from  investing activities:                                       |       |                                              |       |                           |       |                              |       |
| Purchase of investments                                                      |       | —                                            |       | (500,000                       | )          | (1,190,352                        | )          |
| Sale of investments                                                          |       | —                                            |       | —                         |       | 4,752,934                         |       |
| Increase in other assets                                                     |       | —                                            |       | —                         |       | (412,072                          | )          |
| Purchases of property and equipment                                          |       | (95,354                                           | )          | (39,713                        | )          | (8,589,758                        | )          |
| Sale of property and equipment                                               |       | 40,618                                            |       | 28,800                         |       | 239,215                           |       |
| Net cash used in investing activities                                        |       | (54,736                                           | )          | (510,913                       | )          | (5,200,033                        | )          |
| Cash flows from  financing activities:                                       |       |                                              |       |                           |       |                              |       |
| Initial public stock offering, net of expenses                               |       | —                                            |       | —                         |       | 49,341,537                        |       |
| Private stock offering, net of expenses                                      |       | —                                            |       | 1,977,380                      |       | 17,108,477                        |       |
| Payment of dividends                                                         |       | —                                            |       | —                         |       | (1,159,373                        | )          |
| Shares issued under employee stock purchase plan                             |       | 10,302                                            |       | 1,738                          |       | 142,367                           |       |
| Exercise of employee stock options                                           |       | 17,500                                            |       | 189,833                        |       | 2,166,722                         |       |
| Cash paid for financing costs                                                |       | —                                            |       | (232,332                       | )          | —                            |       |
| Issuance of preferred stock                                                  |       | —                                            |       | —                         |       | 32,868,028                        |       |
| Repayment of  subscription receivable                                        |       | —                                            |       | —                         |       | 5,000,000                         |       |
|                                                                              |            |                                                   |            |                                |            |                                   |            |  |  |  |

 

3

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| Proceeds from capital leases                        |   | —     |       | —     |   | 495,851     |   |
|-----------------------------------------------------|--------|------------|------------|------------|--------|-------------|--------|
| Repayment of capital leases                         |   | —     |       | —     |   | (1,031,395  | )      |
| Repurchase company stock                            |   | —     |       | (87,914    | )      | (613,179    | )      |
| Proceeds from notes payable issued to investors     |   | —     |       | —     |   | 3,550,000   |   |
| Net cash provided by (used in) financing activities |   | 27,802     |       | 1,848,705  |   | 107,869,035 |   |
| (Decrease)  increase in cash and cash equivalents   |   | (3,662,701 | )          | (1,631,563 | )      | 10,227,461  |   |
| Cash and cash  equivalents, beginning of period     |   | 13,890,162 |       | 5,097,188  |   | —      |   |
| Cash and cash  equivalents, end of period           |   | $          | 10,227,461 |       | $      | 3,465,625   |   | $ | 10,227,461 |   |
| Supplemental  disclosure of cash flow information:  |   |       |       |       |   |        |   |
| Cash paid for interest                              |   | $          | —     |       | $      | —      |   | $ | 488,126 |   |
| Cash paid for taxes                                 |   | $          | —     |       | $      | —      |   | $ | 32,750 |   |
| Assets acquired through capital lease               |   | $          | —     |       | $      | —      |   | $ | 535,445 |   |

 

Seenotes to unaudited consolidated financial statements.

4

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**BEACON POWER CORPORATION AND SUBSIDIARY**

**(A Development Stage Company)**

**Notesto Consolidated Financial Statements**

**Note 1.  Nature ofBusiness and Operations**

*Nature of Business*

BeaconPower Corporation (the “Company”, “Beacon”, “we”, “our”, or “us”) (a developmentstage company) was incorporated on May 8, 1997. Since our inception, we have been primarily engaged in the developmentof flywheel devices for storing and transmitting energy kinetically.  During 2000 we completed an initial publicoffering of our common stock and raised approximately $49.3 million net ofoffering expenses, and during 2005 we raised approximately $17 million viaprivate placements of our common stock. We expect to generate revenues in the future from the commercializationof our flywheel energy storage systems to supply frequency regulation servicesto the electricity grid.  In addition, webelieve as the commercialization of our technologies continues otherapplications for our flywheel systems will develop that will provide additionalrevenues. Because we have not yet generated a significant amount of revenuefrom our expected principal operations, we are accounted for as a developmentstage company under Statement of Financial Accounting Standards No. 7.

*Operations*

Wehave experienced net losses since our inception and, as of June 30, 2006, hadan accumulated deficit of approximately $144 million.  We are focused on the development andcommercialization of our Smart Energy MatrixTM flywheel system for frequencyregulation and completion of our research and development contracts.  The completion of development and deploymentof our Smart Energy MatrixTM flywheel system will require substantial additionaloutlays of capital.

We do not expectto become profitable or cash-flow positive until at least 2009 and must raiseadditional equity to execute our business plan and continue as a goingconcern.  Based on our planned cash usagerates we believe that we have adequate cash to fund operations into the earlypart of the first quarter of 2007.  Weexpect to raise capital to execute our business plan by issuing and sellingadditional common stock in equity financing. We expect these financing activities to begin later this year.

**Note 2.  Basis ofPresentation and Summary of Significant Accounting Policies**

**Basis of Presentation**

Theaccompanying unaudited consolidated financial statements have been preparedusing accounting principles generally accepted in the United States of Americaexcept that certain information and footnote disclosures normally included inconsolidated financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted in this Form10-Q.  We suggest that the consolidatedfinancial statements presented herein be read in conjunction with ourconsolidated financial statements and notes thereto included in our AnnualReport on Form 10-K/A, for the year ended December 31, 2005.  In our management’s opinion, all adjustments,consisting of normal recurring accruals, considered necessary for a fairpresentation, have been included in the accompanying unaudited financialstatements.  Operating results for thesix months ended June 30, 2006 are not necessarily indicative of the resultsthat may be expected for the full year ending December 31, 2006.

*Going Concern*

Theaccompanying consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business.  As shown in our consolidated financialstatements, we have had minimal revenues, and incurred losses of approximately$144 million since our inception, including losses during the six months endingJune 30, 2006 of approximately $6.1 million. We have approximately $10.2 million of cash and cash equivalents on handat June 30, 2006.  Since our operatingcash requirements far exceed any cash generated from operations, we may beunable to continue as a going concern.  Theconsolidated financial statements contained herein do not include anyadjustments relating to the recoverability and classification of liabilitiesthat might be necessary should we be unable to continue as a going concern.

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 ofsufficient cash flow is dependent, in the short term, on our ability to obtainadditional equity financing, and in the long term, on the successful expansionof our share of the frequency regulation market based on our Smart EnergyMatrixTM flywheel systems that are now under development.

5

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*Consolidation*

 

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

*Loss per Share – Basic andDiluted*

Basic and dilutedloss per share have been computed using the weighted-average number of sharesof common stock outstanding during each period. Warrants, options and othersecurities exercisable for common shares are used in the calculation offully-diluted EPS only if their conversion to common shares would decreaseincome or increase loss per share from continuing operations.  Since both the quarter and six months endedJune 30, 2006 reflect losses, including the potential conversion of warrantsand options in the diluted EPS calculation would decrease loss per share, thusthey are considered anti-dilutive and are not included in the calculation ofearnings per share.

**Summary of Significant Accounting Policies**

*Use of Estimates*

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

*Stock-Based Compensation*

Duringthe first quarter of 2006, we adopted the provisions of and accounted forstock-based compensation in accordance with, the Financial Accounting StandardsBoard’s Statement of Financial Accounting Standards No. 123—revised 2004 (“SFAS123R”), “Share-Based Payment” which replaced Statement of Financial AccountingStandards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” andsupersedes APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued toEmployees.” Under the fair value recognition provisions of SFAS 123R,stock-based compensation cost is measured at the grant date based on the fairvalue of the award and is recognized as an expense as it is earned over therequisite service period, which is the vesting period. To implement thisstandard, we elected the modified-prospective transition method, under whichprior periods are not revised for comparative purposes. The valuationprovisions of SFAS 123R apply to new grants and to grants that were outstandingas of the effective date and are subsequently modified. Estimated compensationexpense for grants that were outstanding as of the effective date will berecognized over the remaining vesting period using the compensation costestimated for the SFAS 123 pro forma disclosures.

Theadoption of SFAS 123R had a material impact on our consolidated financialposition, results of operations and cash flows. See Note 8 for furtherinformation regarding our stock-based compensation assumptions and expenses,including pro forma disclosures for prior periods as if we had recordedstock-based compensation expense.

**Note 3. Accounts Receivable**

Our trade accounts receivable includeamounts due from customers and are reported net of a reserve for uncollectibleaccounts as follows:
|                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Accounts  receivable, trade         |       | $                 | 189,966    |                  | $          | 601,669 |   |
| Reserve for  uncollectible accounts |       | (13,229           | )          | (13,229               | )          |
| Accounts receivable,  trade, net    |       | $                 | 176,737    |                  | $          | 588,440 |   |

 

6

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

 

**Note 4.  Property andEquipment**

Detailsof our property and equipment follows:

|                                                 | ** ** | **Estimated** | ** ** | ** **       | ** ** | ** **            | ** ** |
|-------------------------------------------------|------------|---------------|------------|------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **Useful**    | ** ** | **June 30** | ** ** | **December 31,** | ** ** |
| ** **                                      | ** ** | **Lives**     | ** ** | **2006**         | ** ** | **2005**              | ** ** |
| Machinery and  equipment                        |       | 5  years      |       | $                | 648,844    |                  | $          | 570,424 |   |
| Service vehicles                                |       | 5  years      |       | 16,763           |       | 16,762                |       |
| Furniture and  fixtures                         |       | 7  years      |       | 255,940          |       | 255,940               |       |
| Office equipment                                |       | 3  years      |       | 1,449,328        |       | 1,433,947             |       |
| Leasehold  improvements                         |       | Lease  term   |       | 533,352          |       | 533,352               |       |
| Equipment under  capital lease obligations      |       | Lease  term   |       | 918,285          |       | 918,285               |       |
| Total                                           |       |          |       | $                | 3,822,512  |                  | $          | 3,728,710 |   |
| Less accumulated  depreciation and amortization |       |          |       | (3,563,509       | )          | (3,516,414            | )          |
| Property and  equipment, net                    |       |          |       | $                | 259,003    |                  | $          | 212,296 |   |

 

**Note 5.  Commitmentsand Contingencies**

The following table summarizes our commitments at June 30, 2006:
|                                         | ** ** | **Six months ending   December 31,** | ** ** | **Year ending  December 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------|------------|----------------|------------|------------|------------|
| **Description of Commitment** | ** ** | **2006**                                                 | ** ** | **2007**                                | ** ** | **Thereafter** | ** ** | **Total**  | ** ** |
| Operating leases                        |       | 264,706                                                  |       | 397,059                                 |       | —         |       | 661,765    |       |
| Purchase  obligations                   |       | 1,300,411                                                |       | —                                  |       | —         |       | 1,300,411  |       |
| Total Commitments                       |       | 1,565,117                                                |       | 397,059                                 |       | —         |       | 1,962,176  |       |

 

Welease office, light manufacturing and assembly space under an operating leasethrough September 30, 2007. We have provided the lessor with an irrevocableletter of credit securing our performance under this lease with a balance atJune 30, 2006 of $219,568, which is reduced annually during the leaseterm.  This letter of credit is securedby a cash deposit, which is included in restricted cash in the accompanyingconsolidated balance sheets.

AtJune 30, 2006 we had firm, non-cancelable purchase commitments with oursuppliers to acquire components for the development of the Smart Energy MatrixTMflywheel system and to satisfy contractual obligations for our research anddevelopment programs in the amount of approximately $1.3 million.

*LegalProceedings.*

Wemay from time to time be subject to legal proceedings, often likely to involveroutine litigation incidental to our business. The outcome of any legal proceeding is not within our complete control,may often be difficult to predict and is resolved over very long periods oftime.  Estimating probable lossesassociated with any legal proceedings or other loss contingencies is verycomplex and requires the analysis of many factors including assumptions aboutpotential actions by third parties.  Aloss contingency is recorded as a liability in the consolidated financialstatements when it is both (i) probable or known that a liability has beenincurred and (ii) the amount of the loss is reasonably estimable.  If the reasonable estimate of the loss is a rangeand no amount within the range is a better estimate, the minimum amount of therange is recorded as a liability.  If aloss contingency is not probable or not reasonably estimable, a liability isnot recorded in the consolidated financial statements.

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**Note 6. ****Restructuring and Asset Impairment Charges**

We periodically evaluate all of ourproperty and equipment as required by Statement of Financial AccountingStandards No. 144 “Accounting for the Impairment or Disposal of Long-LivedAssets.” In 2002, we incurred a restructuring and impairment charge of $6.5million of which $4.3 million represented impaired capital equipment andleasehold improvements, $0.3 million related to severance costs and $1.9million related to a reserve against future lease payments and related facilitycosts.  The reserve against future leasepayments is classified as “Restructuring Reserve” in the current liabilitiessection of the balance sheet.

At June 30, 2006, the restructuringreserves are as follows:
|                         | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Beginning  balance      |       | $                                                 | 713,469    |   | $ | 1,062,644 |   |
| Charges for the  period |       | —                                            |       | — |   |
| Payments                |       | (183,030                                          | )          | (171,773 | ) |
| Ending balance          |       | $                                                 | 530,439    |   | $ | 890,871 |   |

 

**Note 7.  Stock Warrants**

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

 

We have outstanding three series ofwarrants to purchase Beacon common stock. The exercise price and the number ofshares of our common stock to be issued upon exercise of the warrants will beadjusted under certain circumstances, including:

·                                          subdivisions,stock dividends or combinations of our common stock;

·                                          reclassifications,exchanges, substitutions, or in-kind distributions that result in a change inthe number and/or class of the securities issuable upon exercise of thewarrants;

·                                          reorganizations,mergers and similar transactions; and

·                                          issuance ofadditional shares of our common stock or securities convertible into our commonstock at a price per share less than the exercise price in effect immediatelyprior to the issuance of the additional securities, only with respect to theNovember 2005 Financing warrants.

 

Holders of the warrants are not entitledto receive dividends, vote, receive notice of any meetings of stockholders orotherwise have any right as stockholders.

*Class F Preferred Stock Financing Warrant*

Thewarrant, originally issued in connection with our Class F Preferred Stockfinancing, is exercisable for 1,333,333 shares of our common stock at anexercise price of $2.25 per share.  Inconnection with the Investment Agreement among us, Perseus Capital, L.L.C. andPerseus 2000 Expansion, L.L.C., dated April 22, 2005, we extended, by twoyears, the term of the warrant.  Theholder of this warrant, Perseus Capital, L.L.C., may exercise the warrant atany time prior to its expiration on May 23, 2007.

*April 2005 Financing Warrant*

In connection with the investment byPerseus 2000 Expansion, L.L.C., we issued a warrant for 800,000 shares of ourcommon stock, at an exercise price of $1.008.

8

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*November 2005 Financing Warrants*

 

Aspart of a financing transaction, we issued warrants to purchase an aggregate of2,960,527 shares of our common stock to ten “accredited investors.”  Each warrant is exercisable for a period offive years and the per share exercise price for the warrant shares is $2.21,subject to adjustment upon the occurrence of certain specified events,including the issuance of additional shares of our common stock or securitiesconvertible into our common stock at a price per share less than the exerciseprice in effect immediately prior to the issuance of the additional securities.

**Note 8.  Stock BasedCompensation**

**Descriptionof Plans**

*StockOption Plan*

OurThird Amended Restated 1998 Stock Incentive Plan provides for the granting ofstock options to purchase up to 23,000,000 shares of our common stock.  Options may be granted to our employees,officers, directors, consultants and advisors. Under the terms of the option plan, incentive stock options (“ISOs”) areto be granted at the fair market value of our common stock at the date ofgrant, and nonqualified stock options (“NSOs”) are to be granted at a pricedetermined by the Board of Directors.  Ingeneral, the Board has authorized vesting periods of one to three years andterms of varying length but in no case more than 10 years.  Our stock option program is a long-termretention program that is intended to attract, retain and provide incentivesfor talented employees, officers and directors, and to align stockholder andemployee interests.  We consider ouroption program critical to our operation and productivity; essentially all ofour employees participate.  At June 30,2006 we had 11,160,307 shares reserved for issuance under this plan.

*EmployeeStock Purchase Plan*

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

*RestrictedStock Unit Arrangements*

OurThird Amended Restated 1998 Stock Incentive Plan permits the grant ofrestricted stock units (“RSUs”) to (i) align our employees’ interests withthose of the Company, (ii) motivate our employees to achieve key productdevelopment milestones and thus create stockholder value, (iii) retain keyemployees by providing equity to such employees and (iv) conserve cash, bypaying bonuses in the form of RSUs, rather than in cash, but with the number ofsuch RSUs calculated on a discounted basis to compensate for the reducedliquidity as compared to cash.  Withrespect to the RSUs that are granted in lieu of cash bonuses, the number ofRSUs granted are based on performance, and are automatically converted intoshares of common stock in four equal tranches in the fiscal year following theyear of performance. Certain other RSUs are granted to our officers as a formof equity incentive, are not tied to performance, and vest over three-yearperiods in equal quarterly installments. The unvested portion of any RSU grant is subject to forfeiture upon theholder’s resignation or termination for cause. There are also other performance-based RSU’s granted to our officersthat cliff-vest upon certain milestones based on achieving earnings targets, onthe Company no longer being treated as a development stage company foraccounting purposes, and on the officer being employed during the period endingwith the milestones.

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** StockOption Plan Schedules**

 

Stockoption activity for the first six months of 2006 is as follows:
|                                 | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** |
|---------------------------------|------------|--------------------|------------|---------------|------------|---------------|------------|
| ** **                      | ** ** | ** **         | ** ** | **Average**   | ** ** | **Average**   | ** ** |
| ** **                      | ** ** | **Number of** | ** ** | **Exercise**  | ** ** | **Fair**      | ** ** |
| ** **                      | ** ** | **Shares**         | ** ** | **Price**     | ** ** | **Value**     | ** ** |
| Outstanding,  December 31, 2005 |       | 5,581,803          |       | $             | 1.18       |          |       |   |
| Granted                         |       | 693,683            |       | $             | 1.67       |          | $          | 1.11 |   |
| Exercised                       |       | (25,000            | )          | $             | 0.70       |          |       |   |
| Canceled, forfeited or expired  |       | —             |       | $             | —     |          |       |   |
| Outstanding, June 30,  2006     |       | 6,250,486          |       | $             | 1.19       |          |       |   |
|                                 |            |                    |            |               |            |               |            |  |  |

 

Thefollowing table summarizes information about stock options outstanding at June30, 2006:
|                         | ** ** | ** **          | ** ** | **Weighted**          | ** ** | ** **    | ** ** | ** **          | ** ** | **Vested**    | ** ** |
|-------------------------|------------|---------------------|------------|-----------------------|------------|---------------|------------|---------------------|------------|---------------|------------|
| ** **              | ** ** | ** **          | ** ** | **Average**           | ** ** | **Weighted-** | ** ** | ** **          | ** ** | **Weighted-** | ** ** |
| ** **              | ** ** | **Number**          | ** ** | **Remaining**         | ** ** | **Average**   | ** ** | **Vested**          | ** ** | **Average**   | ** ** |
| ** **              | ** ** | **of Options** | ** ** | **Contractual**       | ** ** | **Exercise**  | ** ** | **Number**          | ** ** | **Exercise**  | ** ** |
| **Exercise Price** | ** ** | **Outstanding**     | ** ** | **Life (Years)** | ** ** | **Price**     | ** ** | **of Options** | ** ** | **Price**     | ** ** |
| $.255-$.74              |       | 3,314,886           |       | 8.10                  |       | $             | 0.70       |                | 3,314,886  |          | $          | 0.70 |   |
| $.87 - $1.24            |       | 1,284,896           |       | 5.35                  |       | $             | 0.92       |                | 1,284,896  |          | $          | 0.92 |   |
| $1.51-$2.19             |       | 1,193,454           |       | 8.69                  |       | $             | 1.63       |                | 422,258    |          | $          | 2.10 |   |
| $2.50-$3.10             |       | 130,000             |       | 3.92                  |       | $             | 2.64       |                | 130,000    |          | $          | 2.64 |   |
| $4.10-$5.27             |       | 222,250             |       | 4.67                  |       | $             | 4.40       |                | 222,250    |          | $          | 4.40 |   |
| $6.00 - $9.31           |       | 105,000             |       | 4.31                  |       | $             | 6.40       |                | 105,000    |          | $          | 6.40 |   |
| Total                   |       | 6,250,486           |       |                  |       |          |       | 5,479,290           |       |          |       |

 

**StockCompensation**

Beginningon January 1, 2006, we adopted SFAS 123R. See Note 2 for a description of ouradoption of SFAS 123R. We currently use the Black-Scholes option pricing modelto determine the fair value of stock options and employee stock purchase planshares. The determination of the fair value of stock-based payment awards onthe date of grant using an option-pricing model is affected by our stock priceas well as assumptions regarding a number of complex and subjective variables.These variables include our stock price volatility, expected life of theoption, risk-free interest rate and expected dividends, if any.

Weestimate the volatility of our common stock by using historicalvolatility.  We estimate the expectedterm and use a risk-free interest rate based on U.S. Treasury issues withremaining terms similar to the expected term on the options. We do notanticipate paying any cash dividends in the foreseeable future and thereforeuse an expected dividend yield of zero in the option valuation model. We arerequired to estimate forfeitures at the time of grant and revise thoseestimates in subsequent periods. All stock-based payment awards are amortizedas they are earned over the requisite service periods of the awards, which aregenerally the vesting periods.

Priorto the adoption of SFAS 123R, we recognized the estimated compensation cost ofrestricted stock units over the vesting term. The estimated compensation costis based on the fair value of our common stock using the closing stock price onthe last day of the fiscal year in which the compensation is earned. We willcontinue to recognize the compensation cost, net of estimated forfeitures, overthe vesting term.

10

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The assumptions used tovalue stock option grants for the six months ended June 30, 2006 are asfollows:
|                                                                                           | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                          | ** ** |
| Risk-free  interest rate                                                                  |       | 4.68%  - 4.99%                                    |       |
| Expected life of  option                                                                  |       | 3  years                                          |       |
| Expected  dividend payment rate, as a percentage of the stock price on the date of  grant |       | 0%                                                |       |
| Assumed  volatility                                                                       |       | 106%  - 108%                                      |       |
| Expected forfeitures                                                                      |       | 10%                                               |       |

 

Stock-basedcompensation expense as a result of FAS 123R recognized on our consolidatedstatement of operations for the three and six months ended June 30, 2006 is asfollows:
|                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                        | ** ** | **2006**                                      | ** ** |
| Selling, general  and administrative |       | $                                               | 164,665    |                                          | $          | 430,549 |   |
| Research and  development            |       | 13,903                                          |       | 89,882                                        |       |
| Total                                |       | $                                               | 178,568    |                                          | $          | 520,431 |   |

 

Forcomparison purposes, the following table sets forth the pro forma amounts ofnet income and net income per share, for the three and six month periods endedJune 30, 2005, that would have resulted if we had accounted for our employeestock plans under the fair value recognition provisions of SFAS 123R at thattime:
|                                              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                        | ** ** | **2005**                                      | ** ** |
| Net loss to  common shareholders as reported |       | $                                               | (1,764,781 | )                                             | $          | (4,009,782 | ) |
| Pro forma  compensation expense              |       | —                                          |       | 82,686                                        |       |
| Net loss–pro  forma                     |       | $                                               | (1,764,781 | )                                             | $          | (4,092,468 | ) |
| Loss per share–as  reported             |       | $                                               | (0.04      | )                                             | $          | (0.09 | ) |
| Loss per share–pro  forma               |       | $                                               | (0.04      | )                                             | $          | (0.09 | ) |

 

Asof June 30, 2006, there was approximately $453,000 of unrecognized compensationcost, adjusted for estimated forfeitures, related to non-vested stock-basedpayments granted to our employees and directors. Total unrecognizedcompensation cost will be adjusted for future changes in estimated forfeituresand recognized over the remaining vesting periods of the stock option grants.Additionally, as of June 30, 2006, there was $157,000 of unamortized deferredcompensation, related to our restricted stock unit program, which will berecognized over the remainder of 2006.

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

**Note Regarding ForwardLooking Statements:**

This QuarterlyReport on Form 10-Q contains forward-looking statements concerning, among otherthings, our expected future revenues, operations and expenditures, andestimates of the potential markets for our products and services.  Such statements made may fall within themeaning of the Private Securities Litigation Reform Act of 1995, asamended.  All such forward-lookingstatements are necessarily only estimates of future results and the actualresults we achieve may differ materially from these projections due to a numberof factors as discussed in the section entitled “Risk Factors” of this Form10-Q.

**CriticalAccounting Policies and Estimates**

Thepreparation of financial statements requires management to make estimates andjudgments that may significantly affect the reported amounts of assets,liabilities, revenues, expenses and related disclosures. On an ongoing basis,management evaluates our estimates and assumptions including, but not limitedto, those related to revenue recognition, asset impairments, inventoryvaluation, warranty reserves and other assets and liabilities.  Management bases its estimates on historicalexperience and various other assumptions that it believes to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from these estimates under differentassumptions or conditions.

*RevenueRecognition*

Although we haveshipped products and recorded contract revenues, our operations have not yetreached a level that would qualify us to emerge from the developmentstage.  Therefore we continue to beaccounted for as a development stage company under Statement of FinancialAccounting Standards No. 7 “Accounting and Reporting by Development StageEnterprises.”

We recognize revenuesin accordance with accounting principles generally accepted in the UnitedStates of America.  Generally, revenue isrecognized on transfer of title, typically when products are shipped and allrelated costs are estimable.  For salesto distributors, we make an adjustment to defer revenue until they aresubsequently sold by distributors to their customers.

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

Werecognize contract revenues using the percentage-of-completion method, basedprimarily on contract costs incurred to date compared with total estimatedcontract costs.  Changes to totalestimated contract costs or losses, if any, are recognized in the period inwhich they are determined.  Revenuesrecognized in excess of amounts billed are classified as current assets, andincluded in “Unbilled costs on contracts in process” in our balancesheets.  Amounts billed to clients inexcess of revenues recognized to date are classified as current liabilitiesunder “Advance billings on contracts.” Changes in project performance and conditions, estimated profitability,and final contract settlements may result in future revisions to constructioncontract costs and revenue.

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

*Loss on Contract Commitments*

Each quarter, we perform an evaluation ofexpected costs to complete our in-progress contracts that we account for usingthe percentage-of-completion method.  Inthe event that the total expected costs to complete a contract exceed theexpected total contract revenue, we immediately record a loss on the contractto the extent that the expected loss exceeds the expected revenue from thecontract.

*WarrantyReserves*

Ourwarranties require us to repair or replace defective products returned to usduring the applicable warranty period at no cost to the customer. We record anestimate for warranty-related costs based on actual historical return rates,anticipated return rates, and repair costs at the time of sale. A significantincrease in product return rates, or a significant increase in the costs torepair products, could have a material adverse impact on future operatingresults for the period or periods in which such returns or additional costsmaterialize and thereafter.

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*IncomeTaxes*

Deferredtax assets and liabilities are determined based on differences between the financialreporting and income tax basis of assets and liabilities as well as netoperating loss and tax credit carryforwards and are measured using the enactedtax rates and laws that will be in effect when the differences reverse.  Deferred tax assets are reduced by a 100%valuation allowance to reflect the uncertainty associated with their ultimaterealization.

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

*Long-Lived Assets*

In accordance withStatement of Financial Accounting Standards No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets,” our long-lived assets arereviewed to determine whether any events or changes in circumstances indicatethat the carrying value of any of such assets may not be recoverable.  The conditions to be considered includewhether or not the asset is in service, has become obsolete, or whetherexternal market circumstances indicate that the carrying amount may not berecoverable.  When appropriate, werecognize a loss for the difference between the estimated fair value of theasset and the carrying amount.  The fairvalue of the asset is measured using either available market prices orestimated discounted cash flows.

*Sarbanes-Oxley Compliance*

Companies that areconsidered “accelerated filers” as defined in Exchange Act Rule 12b-2 wererequired to comply with the provisions of Section 404 of the Sarbanes-Oxley Actof 2002 (SOX) as of the fiscal year ending on or after November 15, 2004.  Non-accelerated and foreign private issuersmust comply with SOX by the first fiscal year ending on or after July 15,2007.  We are a “small business issuer”and hence are considered to be a “non-accelerated filer” and are not requiredto comply with Sarbanes-Oxley Section 404 until 2007.  However, we are in the process of reviewing,documenting and testing our controls over financial reporting in order to befully prepared to comply with the requirements of Sarbanes-Oxley as of 2007.

**Overview**

We design,develop, configure and expect to begin offering for sale, advanced products andservices to support more reliable and cost-effective electricity gridoperation. The focus of our development has been to establish apatent-protected technology that can provide highly reliable energy storagesolutions for the worldwide electricity grid at competitive costs. Ourcommercial market strategy is to become a global provider of frequencyregulation services to operators of the electricity grid. In addition, webelieve that as the commercialization of our technologies continues additionalapplications for our flywheel systems may develop that could have significantcommercial applications.  In 2005 we wereawarded development contracts by the California Energy Commission (CEC) and NewYork State Energy Research and Development Authority (NYSERDA) to demonstratethe viability of our flywheel technologies for frequency regulation by gridoperators. The demonstration units are scale-power prototypes of the SmartEnergy MatrixTM flywheel system.  Both unitsare installed and are undergoing field trials. We believe these demonstration units will validate the capability of oursystems to provide frequency regulation services to the electricity grid. Anancillary benefit of these contracts is that the funds received subsidize aportion of our core research and development efforts, and any lossesattributable to these contracts would have been costs incurred as part of ouron-going research and development efforts.

We may continue topursue additional Government development and design contracts for a variety offlywheel-related applications.

We must raiseadditional funds to execute our business plan. Based on our rate of expenditure of cash and the additional expendituresexpected to support our business plan, we estimate that we have sufficient cashto fund operations into the early part of the first quarter of 2007. We need toobtain additional investments during 2006 to fund:

·                  our continuationas a going concern;

·                  ongoing researchand development of the 25kWh flywheel and the Smart Energy MatrixTM flywheelsystem;

·                  the ramp up ofour manufacturing and assembly capacity;

·                  the build-out offacilities to provide frequency regulation services to the electricity grid;

·                  working capitalrequirements; and

·                  theidentification and development of new business opportunities.

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Weare continuing to develop the 25kWh flywheel, which is the core component ofthe Smart Energy MatrixTM flywheel system. In order to complete development of the Smart Energy MatrixTM flywheelsystem, build and operate a one to three megawatt flywheel-based commercialfrequency regulation plant and have sufficient working capital to continue toexecute our business plan, we will need to raise $20 to $30 million.

As part of our new business development, we will continue to evaluatepossible acquisitions of enterprises or technologies that we would considersynergistic from a market, technology or product perspective.

Frominception through June 30, 2006, we have incurred losses of approximately$144.3 million. We expect to continue to incur losses as we expand our productdevelopment and begin to increase our manufacturing and assembly capacity.

*Revenues*

Wehave been awarded fixed price research and development contracts fromgovernment agencies and are pursuing similar contracts from other governmentagencies.  We have determined that wewill recognize revenues using the percentage of completion method for suchcontracts.  We are continuing to evaluatemarkets for our flywheel systems but we have not yet recognized revenues fromthese products.  We have placeddevelopment prototype flywheels with potential customers and shippedpre-production units.  These flywheelproducts were provided to potential customers without charge or on ademonstration basis to allow us access to field test information and todemonstrate the application of our technologies.  We have available for sale our Smart Power M5TM inverter system inthe solar renewable energy market through domestic distributors who in turnsell our products to installers who then make sales to residential homeownersor commercial customers.  We willrecognize revenues on our inverter products when they are sold by ourdistributors to their customers. Although we are continuing to support our inverter product, we do notbelieve that inverters will be a significant portion of our business going forwardand we are uncertain as to when or at what price we will be able to sell theremainder of our inventories.

*Costof Goods Sold*

Costof goods sold on fixed price research and development contracts arepredominantly being recorded on the percentage of completion method and consistof direct labor and material, subcontracting, and associated overhead costs.

In2004, we established a reserve for our entire inverter product inventory as aresult of lower than anticipated customer demand and uncertainty of our abilityto sell those inventories.  During 2005and into 2006 we continue to have very limited sales of our inverterproducts.  The costs related to thesesales are not fully reflected in cost of goods sold as a result of theinventory being reserved in a prior year. Therefore our cost of goods sold does not accurately reflect the costsassociated with these revenues.

*Selling, General and Administrative Expenses*

Oursales and marketing expenses consist primarily of compensation and benefits forsales and marketing personnel and related business development expenses.  In 2006 we added a director of businessdevelopment to investigate additional applications for our technologies.  We expect sales and marketing expenses tocontinue to increase as we expand efforts to define new markets for ourproducts.  We continue to rely on our engineeringpersonnel to provide technical specifications and product overviews to ourpotential customer base.  General andadministrative expenses consist primarily of compensation and benefits relatedto our corporate staff, professional fees, insurance and travel. We expect ourselling, general and administrative expenses to increase in 2006 over 2005 dueprimarily to the implementation and reporting expenses associated withcompliance with Section 404 of the Sarbanes-Oxley Act of 2002, fundraisingactivities, marketing and business development expenses associated withflywheel products and compensation costs associated with equity-basedcompensation.

*Research and Development*

Ourcost of research and development consists primarily of the cost of compensationand benefits for research and development, and support staff, as well as materialsand supplies used in the engineering design and development process.  These costs are expected to increase in 2006as compared to 2005 as we accelerate the development of the 25kWh flywheel forfrequency regulation applications and record compensation costs associated withequity based compensation.

14

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*Loss on Contract Commitments*

Wewill establish reserves for anticipated losses on contract commitments if,based on cost estimates to complete the commitment, we determine that a losswill be incurred.  We recorded a $1.5million charge during 2005 for anticipated losses on our research anddevelopment contracts and an additional charge of approximately $688,000through June 30, 2006.  The increase inthe estimated costs to complete these contracts in 2006 is due, in part, to therevision of labor and overhead rates based upon current forecasts. Thecontracts relate primarily to the development of demonstration units of newproducts.  There is an inherentdifficulty in estimating costs to develop new products. We believe that theongoing costs of completing these contracts will directly provide benefits tothe Company in our development of the 25kWh flywheel.

Weexpect to recognize probable losses on contract commitments early in a product’scommercial introduction prior to being able to realize expected decreases incost per unit through engineering design changes, operating efficiencies, andvolume purchasing discounts.  Ongovernment contracts, we have, and will continue, on a quarterly basis, toevaluate our estimated costs to complete and modify reserves when appropriate.

*Depreciation and Amortization*

Ourdepreciation and amortization is primarily related to depreciation on capitalexpenditures and the amortization of lease and leasehold costs related to ourfacilities.  We have intellectualproperty in the form of patents on our flywheel vacuum system, our heat pipecooling systems, DC output paralleling, metal hub, low-loss motor, co-mingledrims and earthquake-tolerant bearings on our flywheel products, andanti-islanding software, drawings, source code, and production know-how on our Smart Power M5TM inverter system, andexpect to obtain other patents during 2006 and beyond.  These costs were being amortized during 2004,but we recorded impairment charges to write down these assets to zero on thebalance sheet at December 31, 2004.  Theseimpairment charges were made due to the uncertainty of realizing any futurevalue from this property mainly due the lack of substantial revenues to date.

*Interestand Other Income/Expense, net*

Ournon-operating income and expenses are primarily attributable to interest incomeresulting from cash on hand and gains or losses on the sale of our impairedassets.

15

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**Results of Operations**

**Comparison of Six Months ended June 30, 2006 and 2005**
|                                         | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | **(in thousands)**                           | ** ** |
| Revenues                                |       | $                                                 | 498        |   | $ | 954 |   | $ | (456 | ) | 48% |   |
| Cost of goods  sold                     |       | 451                                               |       | 1,004 |   | (553 | ) | 55% |   |
| Gross margin                            |       | 47                                                |       | (50 | ) | 97 |   | 194% |   |
| Selling, general  and administrative    |       | 3,557                                             |       | 2,281 |   | 1,276 |   | 56% |   |
| Research and  development               |       | 2,148                                             |       | 636 |   | 1,512 |   | 238% |   |
| Loss on sales  and contract commitments |       | 688                                               |       | 1,057 |   | (369 | ) | 35% |   |
| Depreciation and  amortization          |       | 49                                                |       | 41 |   | 8 |   | 20% |   |
| Interest and  other income, net         |       | 301                                               |       | 55 |   | 246 |   | 442% |   |
| Net loss                                |       | $                                                 | (6,094     | ) | $ | (4,010 | ) | $ | (2,084 | ) | 52% |   |

 

*Revenue*

Thefollowing table provides details of our revenues for the six months ended June30, 2006 and 2005.

*Dollars in thousands*

 
|                                | ** ** | **Percent**  | ** ** | **Six months ended June 30,** | ** ** | **Revenue from** | ** ** | **Total Contract** | ** ** |
|--------------------------------|------------|--------------|------------|---------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|
| **Contract Name**         | ** ** | **complete** | ** ** | **2006**                                          | ** ** | **2005**              | ** ** | **inception**           | ** ** | **Value** | ** ** |
| CEC                            |       | 87%          |       | $                                                 | 145        |                  | $          | 700                     |       | $ | 1,074 |   | $ | 1,233 |   |
| NYSERDA PON 846                |       | 82%          |       | 198                                               |       | 122                   |       | 528                     |       | 646 |   |
| Bechtel Bettis                 |       | 100%         |       | —                                            |       | 71                    |       | 98                      |       | 98 |   |
| NYSERDA PON 800                |       | 60%          |       | 23                                                |       | 11                    |       | 38                      |       | 63 |   |
| Air Force  Research Laboratory |       | 9%           |       | 68                                                |       | —                |       | 67                      |       | 750 |   |
| Total Contract Revenue         |       |         |       | $                                                 | 434        |                  | $          | 904                     |       | $ | 1,805 |   | $ | 2,790 |   |
| M5 and  accessories            |       |         |       | 64                                                |       | 50                    |       |                    |       |   |   |
| Total                          |       |         |       | $                                                 | 498        |                  | $          | 954                     |       |   |   |   |   |

 

Inthe six months ended June 30, 2006, we recorded revenue from flywheel relatedresearch and development contracts calculated using the percentage ofcompletion method of approximately $434,000 and recorded $64,000 from the saleof Smart Power M5TM invertersystems and related products.  In thesame period for 2005, we recorded research and development contract revenue ofapproximately $904,000 and approximately $50,000 from the sale of our Smart Power M5TM inverter systems andrelated products.  Contract revenue waslower in 2006 compared to 2005 by approximately 470,000 or 52% primarily theresult of the completion of the majority of the milestones on our largestcontracts, CEC and NYSERDA, in 2005, offset by higher inverter revenues ofapproximately $14,000.

*Costof Goods Sold*

Costof goods sold for the six months ending June 30, 2006 includes costs incurredin performance of our research and development contracts calculated using thepercentage of completion method in the amount of approximately $434,000 and thecost of materials, labor, overheads and warranty accruals for inverter productssold in the amount of approximately $17,000. In 2005, cost of goods sold included costs for our flywheel development contracts in the amount of approximately$981,000, and materials, labor and warranty accruals for shipments of our SmartPower M5TM inverter product sold in the quarter of approximately $23,000.

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*Selling, General and Administrative Expense*
|                                 | ** ** | **Amount**              | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Six months ended  June 30, 2005 |       | $                       | 2,281      |   |
| Increases:                      |       |                    |       |
| Stock  compensation expense     |       | 910                     |       |
| Subcontractors  and consultants |       | 156                     |       |
| Public company  expenses        |       | 60                      |       |
| Office equipment  upgrades      |       | 50                      |       |
| Salaries and  benefits          |       | 48                      |       |
| Travel                          |       | 40                      |       |
| Other                           |       | 12                      |       |
| Six months ended June  30, 2006 |       | $                       | 3,557      |   |

 

Selling,general and administrative expenses totaled approximately $3,557,000 and$2,281,000 for the six months ended June 30, 2006 and 2005, respectively. Theincrease of approximately $1,276,000 or 56% was primarily the result ofexpensing stock compensation due to the implementation of FAS 123R and ofissuing restricted stock units of approximately $910,000, higher subcontractorand consultant expenses of $156,000, additional public company expense of$60,000 primarily relating to our preparations for the requirements of Section404 of the Sarbanes Oxley Act of 2002, office equipment upgrades ofapproximately $50,000, additional salaries and benefits because of new hires of$48,000, additional travel related expenses primarily due to our fundraisingactivities of $40,000 and other various items of approximately $12,000.  We expect our selling, general andadministrative expenses to be somewhat higher over the remainder of 2006 thanduring the same period in 2005 due primarily to stock option expensing,additional costs expected in the implementation and reporting expensesassociated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002,fundraising activities and increased marketing and business developmentexpenses associated with flywheel products.

*Research and Development Expense*
|                                                  | ** ** | **Amount**              | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Six months ended  June 30, 2005                  |       | $                       | 637        |   |
| Increases:                                       |       |                    |       |
| Stock  compensation                              |       | 386                     |       |
| Salaries and  benefits for new hires             |       | 325                     |       |
| Engineering and  manufacturing overheads applied |       | 321                     |       |
| Expense  materials                               |       | 178                     |       |
| Software and  office expenses                    |       | 82                      |       |
| Consultants                                      |       | 56                      |       |
| Other                                            |       | 163                     |       |
| Six months ended June  30, 2006                  |       | $                       | 2,148      |   |

 

Theincrease for the six months ended June 30, 2006 compared to the equivalentperiod in 2005 of approximately $1,511,000, or 237%, is primarily due toFAS123R stock compensation expense of approximately $386,000, increasedheadcount related expenses due to the hiring of engineering personnel ofapproximately $325,000, lower overheads applied to contracts of approximately$321,000, increased expenses for development materials of approximately$178,000, higher software and office expenses of approximately $82,000,increased usage of consultants of $56,000, and other costs including higherfacility charges and miscellaneous expenses of approximately $163,000.  We expect the cost of research anddevelopment for the remainder of 2006 to be higher than in the same periodduring 2005 due to increased headcount and development material required forthe 25kWh flywheel development and other related development activities on theSmart Energy MatrixTM flywheel system.

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*Losson Contract Commitments*

Werecorded contract commitment losses in the first quarter of 2005 at the time wesigned our CEC and NYSERDA research and development contracts for expected costoverruns related to material, labor and overheads.   These costs were originally planned for usto provide as cost share under these contracts. During the six months ended June 30, 2006, the company revised itsestimated cost to complete its various contract obligations, and recorded anadditional provision for contract loss of $688,000.  This increase represents additional labor andmaterial expected to be needed to complete the contracts of $275,000,additional costs based upon updating our labor and overhead rates of $368,000,and other costs of $45,000.

*Depreciation and Amortization*

Theincrease in depreciation expense for the first six months of 2006 as comparedto the first six months of 2005 of approximately $7,000, or 18%, is primarilyattributable to depreciation on new assets acquired during the latter half of2005 and upgrades to our office equipment. We expect depreciation during the remainder of 2006 will be higher than2005 due to capital expenditures relating to production capability for theSmart Energy MatrixTM flywheel system.

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

Theincrease from 2005 to 2006 of approximately $245,000, or 442%, is primarilyattributable to increases in interest income due to higher cash balances thanduring the same period in 2005.

*NetLoss*

Asa result of the changes discussed above, the net loss for the six months endedJune 30, 2006 was approximately $6,094,000 which compares to a net loss duringthe same period in 2005 of approximately $4,010,000, an increase in net loss ofapproximately $2,084,000 or 52%.

**Liquidity and Capital Resources**
|                                            | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                           | ** ** |
| Cash and cash  equivalents                 |       | $                                                 | 10,227     |   | $ | 3,466 |   |
| Working capital                            |       | 8,459                                             |       | 2,041 |   |
| Cash provided by  (used in)                |       |                                              |       |   |   |
| Operating activities                       |       | (3,636                                            | )          | (2,969 | ) |
| Investing activities                       |       | (55                                               | )          | (511 | ) |
| Financing activities                       |       | 28                                                |       | 1,849 |   |
| Net decrease in  cash and cash equivalents |       | $                                                 | (3,663     | ) | $ | (1,631 | ) |
| Current ratio                              |       | 4.2                                               |       | 1.9 |   |

 

Ourcash requirements depend on many factors, including but not limited to,research and development activities, continued efforts to commercialize ourproducts, facilities costs, and general and administrative expenses.  Since we are still in the development stageand have not yet begun our expected principal operations of providing frequencyregulation services to the electricity grid, we do not generate enough cashfrom operations to satisfy our working capital requirements.  We expect to make significant expenditures tofund our operations, develop technologies and explore opportunities to find anddevelop additional markets to sell our products.  Over the last three years we have takensignificant actions to reduce our cash expenditures for product development,infrastructure and production readiness by significantly reducing headcount,development spending and capital expenditures. We have focused our activity on market analysis in terms of size ofmarkets, competitive aspects and advantages that our products couldprovide.  We expect to use more cashresources during 2006 as we continue to work on our government research anddevelopment contracts and mobilize our engineering team to develop the 25kWhflywheel and the Smart Energy MatrixTM flywheel system.

We must raiseadditional equity to execute our business plan. Based on our rate of expenditure of cash and the additional expendituresexpected to support our business plan we have sufficient cash to fundoperations into the early part of the first quarter of 2007. We need to obtainadditional investments during 2006 to fund:

18

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·                  our continuationas a going concern;

·                  ongoing research and development ofthe 25kWh flywheel and the Smart Energy MatrixTM flywheel system;

·                  the ramp up of our manufacturing andassembly capacity;

·                  the build out of facilities toprovide frequency regulation services to the electricity grid;

·                  working capital requirements; and

·                  theidentification and development of new business opportunities.

Weare continuing to develop the 25kWh flywheel, which is the core component ofthe Smart Energy MatrixTM flywheel system. In order to complete development of the Smart Energy MatrixTM flywheelsystem, build and operate a one to three megawatt flywheel-based commercialfrequency regulation plant and have sufficient working capital to continue toexecute our business plan, we will need to raise $20 to $30 million.

**Operating Activities**

Netcash used in operating activities was approximately $3,636,000 and $2,969,000for the six months ended June 30, 2006 and 2005, respectively.  The primary component to the negative cashflow from operations is from net losses. For the six months ending June 30, 2006, we had a net loss ofapproximately $6,094,000.  Adjustments toreconcile net loss to cash flow include non-cash stock compensation of approximately$1,349,000, depreciation and amortization of approximately $48,000 offset byfacility-related cash payments charged against restructuring reserves ofapproximately $183,000 and a reduction to our impairment reserve resulting fromthe disposition of fixed assets of approximately $40,000.  Changes in operating assets and liabilitiesgenerated approximately $1,284,000 and approximately $712,000 of cash during2006 and 2005, respectively.

**InvestingActivities**

Netcash used in investing activities was $55,000 and approximately $511,000 forthe six months ending June 30, 2006 and 2005, respectively.  The principal use of cash in 2006 was thepurchase of property and equipment in the amount of approximately $95,000,offset by the sale of property and equipment of approximately $41,000.  The principal uses of cash in 2005 were fromthe purchase of an investment in NxtPhase T&D Corporation of approximately$500,000 and a purchase of approximately $40,000, offset by proceeds from thesale of property and equipment of approximately $29,000.

**FinancingActivities**

Netcash used by financing activities was approximately $28,000 and approximately$1,849,000 for the first six months of 2006 and 2005, respectively.  For 2006 the primary sources of cash wereapproximately $18,000 from the exercise of employee stock options andapproximately $10,000 from employee purchases of shares from our employee stockpurchase plan.  For the first six monthsof 2005, cash generated by financing activities included approximately$1,977,000 from the issuance of common stock pursuant to an investment agreementwith Perseus 2000 Expansion, $190,000 related to the exercise of stock optionsand approximately $2,000 from the employee stock purchase plan, offset by cashpaid for financing costs of $232,000 and approximately $88,000 for therepurchase of our stock.

As part of our new business development, we may evaluate possibleacquisitions of enterprises or technologies that we consider synergistic from amarket, technology or product perspective. We may make investments in companiesfor strategic business reasons if sufficient cash is available.  Because our primary motivation in makingthese investments may not be to realize a profit on the investment itself, butrather to expand our business prospects, these investments may lack anyfinancial return to the Company and may result in a loss of principal and maylack liquidity.

Inasmuch as we arenot expecting to become cash flow positive until at least 2009, our ability tocontinue as a going concern will depend on our ability to raise additionalcapital.  We may not be able to raisethis capital at all, or if it we are able to do so, it may be on terms that areadverse to existing shareholders.  Webelieve that debt financing will not be available to us to meet our cash requirementsfor 2006 or 2007.

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**Item3.  Quantitative and QualitativeDisclosure About Market Risk**

Our cashequivalents, which have maturities of less than three months, may expose ourassets to interest rate risk but not to market risk of principal.  At June 30, 2006, we had approximately$60,000 of cash equivalents that were held in non-interest bearingaccounts.  Also at June 30, 2006, we hadapproximately $429,000 of cash equivalents that were held in interest bearingchecking accounts, $7,000,000 invested in short-term highly-rated bonds and approximately$2,738,000 invested in interest-bearing money market accounts at high-qualityfinancial institutions.  Our exposure tomarket risk through financial instruments is not material.

**Item 4.  Controls and Procedures**

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

In addition, our management, with the participation of ourprincipal executive officer and principal financial officer, has evaluatedwhether any change in our internal control over financial reporting (as definedin Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred duringthe period covered by this Quarterly Report on Form 10-Q.  Based on that evaluation, the principalexecutive officer and principal financial officer have concluded that there hasbeen no change in our internal control over financial reporting during theperiod covered by this Quarterly Report on Form 10-Q that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

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**Part II –OTHER INFORMATION**

 

**Item 1.  LegalProceedings**

None

**Item 1A.  Risk Factors**

**We intend to bring our frequency regulationservices to market through participation in the energy auction markets, wherethe amount of frequency regulation required is a percentage of power produced.If changes in the percentage occur due to regulatory modifications and are notoffset by a proportionate increase in energy consumption our business plancould be adversely affected.**

Theregulatory landscape is in constant flux, and we are aware that a NorthAmerican Electric Reliability Council (NERC) subcommittee is in the process ofdeveloping a new NERC standard that may reduce the amount of frequencyregulation required by lowering the ratio of frequency regulation to powergenerated. There is not yet a consensus on the potential changes to thestandard.  The new NERC standard may notbe adopted as currently proposed. Among other obstacles that these potentialchanges face, there is opposition by some powerful stakeholders in the utilityindustry due to the possible negative impact on overall grid reliability.However, if adopted, the changes potentially could be harmful to us by: a)reducing the amount of frequency regulation required by Independent SystemOperators in such a way as to reduce the total size of the US frequencyregulation market, b) lowering the price of frequency regulation as aconsequence of any potential lower demand that might result from a change inregulatory standards, and c) increasing our cost of providing the service.  Any combination of these things couldadversely impact our ability to access the markets for frequency regulation ordo so on a profitable or sustainable basis.

Othermarket-expanding developments may partially counterbalance the uncertaintyposed by the above possible changes in the NERC standard.  For example, efforts by some states toincrease the amount of renewable energy that is produced for the grid from windand solar power may expand the market for frequency regulation services. Fromconversations with grid operators, we believe that the constant changes inenergy output that derive from natural and constant changes in wind speed andcloud cover will require increased frequency regulation.

Otherthan the aforementioned risk, there have not been any material changes duringthe quarter ended June 30, 2006 to the risk factors set forth in Part I, Item1A in our Annual Report on Form 10-K for the year ended December 31, 2005 filedwith the SEC on March 30, 2006.

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

None

**Item 3.  Defaults Upon Senior Securities**

None.

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

None.

**Item 5.  Other Information**

None.

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**Item 6.  Exhibits**

 
| Exhibit    | ** ** | ** ** | ** ** | ** **                                                                                                                                             |
|------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Ref**    | ** ** | **Description of Document**                                                                                                                            |
|       |       |       |       |                                                                                                                                                   |
| 3.1        |       | (1)        |       | Sixth Amended and Restated Certificate of Incorporation.                                                                                               |
|       |       |       |       |                                                                                                                                                   |
| 3.2        |       | (1)        |       | Amended and Restated Bylaws.                                                                                                                           |
|       |       |       |       |                                                                                                                                                   |
| 3.3        |       | (2)        |       | Certificate of Designation of Series A Junior  Participating Preferred Stock, filed with The Secretary of State of Delaware  on October 4, 2002.       |
|       |       |       |       |                                                                                                                                                   |
| 4.1        |       | (4)        |       | Form of specimen stock certificate.                                                                                                                    |
|       |       |       |       |                                                                                                                                                   |
| 10.1       |       | (3)        |       | Employment Agreement dated May 8, 2006 between the  Company and F. William Capp.                                                                       |
|       |       |       |       |                                                                                                                                                   |
| 10.2       |       | (3)        |       | Employment Agreement dated May 8, 2006 between the  Company and James M. Spiezio.                                                                      |
|       |       |       |       |                                                                                                                                                   |
| 10.3       |       | (3)        |       | Employment Agreement dated May 8, 2006 between the  Company and Matthew L. Lazarewicz.                                                                 |
|       |       |       |       |                                                                                                                                                   |
| 10.4       |       | (3)        |       | Performance-based Restricted Stock Unit Agreement  dated May 8, 2006 between the Company and F. William Capp.                                          |
|       |       |       |       |                                                                                                                                                   |
| 10.5       |       | (3)        |       | Performance-based Restricted Stock Unit Agreement dated  May 8, 2006 between the Company and James M. Spiezio.                                         |
|       |       |       |       |                                                                                                                                                   |
| 10.6       |       | (3)        |       | Performance-based Restricted Stock Unit Agreement  dated May 8, 2006 between the Company and Matthew L. Lazarewicz.                                    |
|       |       |       |       |                                                                                                                                                   |
| 10.7       |       | (3)        |       | Restricted Stock Unit and Option Agreement dated May  8, 2006 between the Company and F. William Capp.                                                 |
|       |       |       |       |                                                                                                                                                   |
| 10.8       |       | (3)        |       | Restricted Stock Unit and Option Agreement dated May  8, 2006 between the Company and James M. Spiezio.                                                |
|       |       |       |       |                                                                                                                                                   |
| 10.9       |       | (3)        |       | Restricted Stock Unit and Option Agreement dated May  8, 2006 between the Company and Matthew L. Lazarewicz.                                           |
|       |       |       |       |                                                                                                                                                   |
| 31.1       |       | +          |       | Certification of Principal Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               |
|       |       |       |       |                                                                                                                                                   |
| 31.2       |       | +          |       | Certification of Principal Financial and Accounting  Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                |
|       |       |       |       |                                                                                                                                                   |
| 32.1       |       | +          |       | Certification of Principal Executive Officer  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|       |       |       |       |                                                                                                                                                   |
| 32.2       |       | +          |       | Certification of Principal Financial Officer  pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |

 

22

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----

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

(2) Incorporated by reference from the 10-K filed on March 30, 2006 (FileNo. 001-16171).

(3) Incorporated by reference from the Form 10-Q filed on May 9, 2006(File No. 000-31973).

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

+ Filed herewith.

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.
|                       |   | BEACON POWER CORPORATION                             |
|-----------------------|--------|------------------------------------------------------|
|                  |   |                                                 |
| Date: August 9,  2006 |   | By:                                                  | /s/ F. William Capp |   |
|                  |   | F. William Capp                                      |
|                  |   | President and  Chief Executive Officer               |
|                  |   |                                                 |
|                  |   |                                                 |
| August 9, 2006        |   | By:                                                  | /s/ James M. Spiezio |   |
|                  |   | James M. Spiezio                                     |
|                  |   | Vice President  of Finance, Chief Financial Officer, |
|                  |   | Treasurer and  Secretary                             |
|                  |   | Principal  Financial Officer                         |

 

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