UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                              ---------------------

                                    FORM 10-Q


[ X ]  Quarterly  Report  Pursuant  to Section 13 or 15(d) of the  Securities
     Exchange Act of 1934 for the quarterly period ended June 30, 2005

                                       or

[   ]  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: 001-16171

                            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 the registrant (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 (or for 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. Yes _X_ No ___

   Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes ____ No __X__

     The number of shares of the Registrant's common stock, par value $.01 per
share, outstanding as of August 11, 2005 was 48,855,161.

<PAGE>

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


                                                                          Page
PART I.  Financial Information

     Item 1.  Financial Statements.

         Consolidated Balance Sheets at June 30, 2005 (unaudited) and
         December 31, 2004 (audited)....................................     1

         Unaudited Consolidated Statements of Operations for the three
         months ended June 30, 2005 and 2004, the six months ended June
         30, 2005 and 2004 and for the period from May 8, 1997 (date of
         inception) to June 30, 2005....................................     2

         Unaudited Consolidated Statements of Cash Flows for six months
         ended June 30, 2005 and 2004 and for the period from May 8,
         1997 (date of inception) to June 30, 2005......................     3

         Notes to Unaudited Consolidated Financial Statements...........  5-14

     Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations............................ 15-27

       Item 3. Quantitative and Qualitative Disclosures about Market
         Risk...........................................................    28

       Item 4.  Controls and Procedures.................................    28

PART II.  Other Information

     Item 1.  Legal Proceedings.........................................    29
     Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds   29
     Item 3.  Defaults Upon Senior Securities...........................    29
     Item 4.  Submission of Matters to a Vote of Security Holders.......    29
     Item 5.  Other Information.........................................    29
     Item 6.  Exhibits..................................................    30

Signatures                                                                  32




<PAGE>
<TABLE>
<CAPTION>
                    BEACON POWER CORPORATION AND SUBSIDIARIES
                          (A Development Stage Company)
                           Consolidated Balance Sheets

                                                        June 30, 2005    December 31,
                                                         (unaudited)         2004
                                                        -------------    -------------
Assets
Current assets:
<S>                                                    <C>              <C>
     Cash and cash equivalents .....................   $   3,465,625    $   5,097,188
     Accounts receivable, trade, net ...............         127,415           52,105
     Inventory .....................................            --            222,593
     Unbilled costs on government contracts ........         241,790             --
     Prepaid expenses and other current assets .....         447,707          817,396
                                                        -------------    -------------
         Total current assets                              4,282,537        6,189,282

Property and equipment, net ........................         252,840          258,647
Restricted cash ....................................         310,011          310,011
Investments ........................................         500,000             --
Other assets and prepaid financing costs ...........         559,978          327,646
                                                        -------------    -------------
Total assets .......................................   $   5,905,366    $   7,085,586
                                                        =============    =============

Liabilities and Stockholders' Equity
Current liabilities:
     Accounts payable ..............................   $     149,481    $     389,189
     Accrued compensation and benefits .............         177,188          130,609
     Other accrued expenses ........................         568,344          393,569
     Accrued contract loss .........................         455,339             --
     Restructuring reserve .........................         890,871        1,062,644
                                                        -------------    -------------
         Total current liabilities                         2,241,223        1,976,011
                                                        -------------    -------------
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; 46,666,917 and 43,788,810 shares
     issued and outstanding at June 30, 2005 and
     December 31, 2004, respectively ...............        466,669          437,888
     Deferred stock compensation ...................       (208,470)        (707,167)
     Additional paid-in-capital ....................    136,536,697      134,411,911
     Deficit accumulated during the development stage  (132,943,179)    (128,933,397)
     Treasury stock, 231,146 shares at cost ........       (187,574)         (99,660)
                                                       -------------    -------------
         Total stockholders' equity                       3,664,143        5,109,575
                                                       -------------    -------------
Total liabilities and stockholders' equity .........  $   5,905,366    $   7,085,586
                                                       =============    =============
</TABLE>

       See notes to unaudited consolidated financial statements.

<PAGE>
<TABLE>
<CAPTION>
                    BEACON POWER CORPORATION AND SUBSIDIARIES
                          (A Development Stage Company)
                Consolidated Statements of Operations (Unaudited)

                                                                                                                  Cumulative from
                                                                                                                    May 8, 1997
                                                                                                                      (date of
                                                                                                                     inception)
                                            Three months ended June 30,          Six months ended June 30,        through June 30,
                                              2005              2004              2005              2004                2005
                                          --------------    --------------    --------------    --------------    -----------------
<S>                                          <C>               <C>               <C>               <C>               <C>
Revenue                                      $  318,304        $  126,484        $  954,438        $  183,891        $   1,830,316
Cost of goods sold                              333,956           308,088         1,004,464           383,867            2,462,333
                                          --------------    --------------    --------------    --------------    -----------------
Gross profit                                    (15,652)         (181,604)          (50,026)         (199,976)            (632,017)

Operating expenses:
     Selling, general and
     administrative                           1,108,571         1,212,428         2,280,949         2,288,690           34,536,923
     Research and development                   150,293           921,266           636,531         1,969,506           54,512,076
     Loss on sales and contract
     commitments                                508,859                 -         1,056,566                 -            1,432,540
     Depreciation and amortization               22,918            43,199            41,109            89,785            4,179,075
     Restructuring charges                            -                 -                 -                 -            2,159,280
     Loss on impairment of assets                     -                 -                 -                 -            4,663,916
                                          --------------    --------------    --------------    --------------    -----------------
           Total operating expenses           1,790,641         2,176,893         4,015,155         4,347,981          101,483,810
                                          --------------    --------------    --------------    --------------    -----------------
Loss from operations                         (1,806,293)       (2,358,497)       (4,065,181)       (4,547,957)        (102,115,827)

Other income (expense):
Interest income                                  17,123            31,247            32,010            71,830            3,914,885
Interest expense                                      -                 -                 -                 -          (1,093,703)
Gain on sale of investment                            -                 -                 -                 -            3,562,582
Other income (expense)                           24,389            61,045            23,389            61,195            (204,922)
                                          --------------    --------------    --------------    --------------    -----------------
     Total other income (expense), net           41,512            92,292            55,399           133,025            6,178,842
                                          --------------    --------------    --------------    --------------    -----------------
Net loss                                     (1,764,781)       (2,266,205)       (4,009,782)       (4,414,932)         (95,936,985)

Preferred stock dividends                             -                 -                 -                 -         (36,825,680)
Accretion of convertible preferred
stock                                                 -                 -                 -                 -            (113,014)
                                          --------------    --------------    --------------    --------------    -----------------
Loss to common shareholders                $ (1,764,781)     $ (2,266,205)     $ (4,009,782)     $ (4,414,932)      $ (132,875,679)
                                          ==============    ==============    ==============    ==============    =================
Loss per share, basic and diluted           $    (0.04)       $    (0.05)       $    (0.09)       $    (0.10)
                                          ==============    ==============    ==============    ==============
Weighted-average common shares
outstanding                                  44,801,287        43,273,817        44,299,825        43,197,760
                                          ==============    ==============    ==============    ==============
</TABLE>

          See notes to unaudited consolidated financial statements.

<PAGE>
<TABLE>
<CAPTION>

                    BEACON POWER CORPORATION AND SUBSIDIARIES
                          (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
                                                                    2005           2004          30, 2005
                                                              --------------  --------------  ---------------
Cash flows from operating activities:
<S>                                                           <C>             <C>             <C>
     Net loss .............................................   $ (4,009,782)   $ (4,414,932)   $(95,936,985)
     Adjustments to reconcile net loss to net cash used in
     operating activities:
        Depreciation and amortization .....................         41,109          89,786       4,179,076
        Loss on sale of fixed assets ......................         87,365            --           283,534
        Impairment of assets ..............................       (111,754)         (8,241)      4,542,459
        Restricted cash ...................................           --            45,221        (310,011)
        (Expenses paid) restructuring charge ..............       (171,773)       (171,773)        890,871
        Reserve for officer's note ........................           --              --           102,044
        Interest expense relating to issuance of warrants .           --              --           371,000
        Non-cash charge for change in option terms ........           --              --           346,591
        Non-cash charge for settlement of lawsuit .........           --              --           303,160
        Amortization of deferred consulting expense, net ..           --              --         1,160,784
        Amortization of deferred stock compensation .......        483,313         611,652       2,474,171
        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)
     Changes in operating assets and liabilities:
        Accounts receivable ...............................        (75,310)        (17,459)       (127,415)
        Inventory .........................................        222,593        (570,858)           --
        Unbilled costs under government contracts .........       (241,790)           --          (241,790)
        Prepaid expenses and other current assets .........        369,689         289,923        (649,411)
        Accounts payable ..................................       (239,708)         22,050         149,481
        Accrued compensation and benefits .................         46,579          71,230         177,188
        Accrued interest ..................................           --              --           275,560
        Dividend receivable ...............................           --           (26,594)           --
        Accrued contract loss .............................        455,339         455,339
        Other accrued expenses and current liabilities ....        174,775         155,300         577,014
                                                              ------------    ------------    ------------
          Net cash used in operating activities ...........     (2,969,355)     (3,924,695)    (82,942,783)

Cash flows from investing activities:
     Purchase of investments ..............................       (500,000)           --        (1,690,352)
     Sale of investments ..................................           --              --         4,752,934
     Increase in other assets .............................           --              --          (412,072)
     Purchases of property and equipment ..................        (39,713)        (14,082)     (8,492,266)
     Repurchase company stock .............................        (87,914)           --           (87,914)
     Sale of property and equipment .......................         28,800            --           100,040
                                                              ------------    ------------    ------------
        Net cash used in investing activities .............       (598,827)        (14,082)     (5,829,630)

Cash flows from financing activities:
     Initial public stock offering, net of expenses .......           --              --        49,341,537
     Payment of dividends .................................           --              --        (1,159,373)
     Shares issued under employee stock purchase plan .....          1,738           2,276         129,888
     Exercise of employee stock options ...................        189,833          26,700       1,626,100
     Cash paid for financing costs ........................       (232,332)           --          (559,978)
     Issuance of preferred stock ..........................           --              --        32,868,028
     Stock issued for cash ................................      1,977,380            --         1,977,380
     Repayment of subscription receivable .................           --              --         5,000,000
     Proceeds from capital leases .........................           --              --           495,851
     Repayment of capital leases ..........................           --              --        (1,031,395)
     Proceeds from notes payable issued to investors ......           --              --         3,550,000
                                                              ------------    ------------    ------------
        Net cash provided by (used in) financing activities      1,936,619          28,976      92,238,038

(Decrease) increase in cash and cash equivalents ..........     (1,631,563)     (3,909,801)      3,465,625

Cash and cash equivalents, beginning of period ............      5,097,188       8,909,261            --
                                                              ------------    ------------    ------------
Cash and cash equivalents, end of period ..................   $  3,465,625    $  4,999,460    $  3,465,625
                                                              ============    ============    ============

Supplemental disclosure of non--cash transactions:
     Cash paid for interest ...............................   $       --      $       --      $    488,126
                                                              ============    ============    ============
     Cash paid for taxes ..................................   $       --      $      1,956    $     32,000
                                                              ============    ============    ============
     Assets acquired through capital lease ................   $       --      $       --      $    535,445
                                                              ============    ============    ============
</TABLE>
          See notes to unaudited consolidated financial statements.

<PAGE>
                    BEACON POWER CORPORATION AND SUBSIDIARIES
                          (A Development Stage Company)
              Notes to Unaudited Consolidated Financial Statements


Note 1.  Nature of Business and Operations

Nature of Business. Beacon Power Corporation ("the Company") was incorporated on
May 8, 1997. Beacon Power Corporation and its subsidiaries design, develop,
configure and offer for sale advanced products and services to support more
stable and reliable electricity grid operation. The Company has a single
operating segment, developing alternative sustainable energy storage and power
conversion solutions. The Company's organizational structure has no divisions or
subsidiaries dictated by product lines, geography or customer type. Because the
Company has not yet generated a significant amount of revenue from its principal
operations, it is accounted for as a development stage company under Statement
of Financial Accounting Standards No. 7.

The Company has experienced net losses since its inception and, as of June 30,
2005, had an accumulated deficit of approximately $133 million. It does not
expect to become profitable or cash flow positive until at least 2008 and must
raise additional funds to execute its business plan and continue as a going
concern.

On April 22, 2005, the Company entered into an agreement to acquire NxtPhase T&D
Corporation ("NxtPhase"), a privately held Canadian corporation. Under terms of
the agreement, the Company would, subject to closing conditions, acquire
NxtPhase by issuing approximately 15.7 million new shares of common stock of the
Company to NxtPhase stockholders. The agreement also requires the company,
immediately following closing, to grant restricted stock units for approximately
2.7 million new shares of common stock of the Company to certain of NxtPhase
employees. As of April 22, 2005, the closing bid price of the Company's common
stock as reported on the Nasdaq Small Cap Market was $0.84 per share. The
proposed acquisition is subject to, among other things, approval by the
stockholders of both the Company and NxtPhase, and also requires regulatory and
court approvals. The agreement expires on December 31, 2005 unless the
acquisition of NxtPhase has occurred by that date. This agreement resulted from
introductions made by Perseus, L.L.C., which is an affiliate of both the Company
and NxtPhase.

The Company has been unable to file a registration statement with the Securities
and Exchange Commission, which is necessary to complete the acquisition of
NxtPhase, because its prior independent audit firm, Deloitte and Touche, has
refused to consent to the inclusion of that firm's audit report on the Company's
audited financial statements for 2002 and 2003 in the registration statement.
Because of the delay caused by this refusal, the Company is unsure whether it
will be able to complete the acquisition of NxtPhase by December 31, 2005. If
the acquisition does not occur by then, the acquisition of NxtPhase will not
occur unless the Company and NxtPhase agree to extend their agreement on the
same or different terms than those discussed above. The Company has engaged
Miller Wachman, LLP, its current audit firm, to reaudit its financial statements
for 2002 and 2003, but this work may not be accomplished by them in time to
permit a registration statement to be filed and to be declared effective by the
SEC in order to allow the acquisition of NxtPhase to occur by December 31, 2005
in accordance with the agreement.

NxtPhase develops, manufactures and markets products to improve the stability
and reliability of the generation, transmission and distribution of high voltage
electric power. NxtPhase sensors are gaining market acceptance and are protected
by a portfolio of more than 20 owned or licensed patents. Headquartered in
Vancouver, British Columbia, NxtPhase has sales and manufacturing operations in
the United States and Canada. If it is acquired by the Company, NxtPhase will
operate as a wholly owned subsidiary and will retain the NxtPhase brand name.
Many of NxtPhase's products are in the early stages of development or
production, and as such, NxtPhase does not yet have revenues sufficient to
offset its cost of sales and operating costs. NxtPhase and its predecessor have
incurred losses since their inception.

On April 22, 2005, a fund affiliated with Perseus, L.L.C. committed to invest a
maximum of $3.0 million in the Company and was granted the option to assign to
the Company its right to make a maximum investment of $1,500,000 in NxtPhase T&D
Corporation, to be made in three tranches, which was granted in connection with
a Preferred Stock Purchase Agreement among NxtPhase and certain of its existing
Class A preferred shareholders. The option was granted as part of a proposed
acquisition of NxtPhase by the Company and, if exercised by Perseus, required
the Company to purchase Class A preferred shares of NxtPhase in exchange for
Perseus purchasing shares of the Company's common stock. The $3.0 million
investment in the Company by Perseus is to be made in exchange for approximately
3.6 million shares of the Company's common stock, warrants covering up to 0.8
million shares of the Company's common stock, exercisable at $1.008 per share
and a two year extension of a warrant to purchase 1,333,333 shares of common
stock, exercisable at $2.25 per share, already held by Perseus. The $1.5 million
investment by Perseus to fund NxtPhase is to be made in exchange for the receipt
by Perseus of approximately 1.8 million shares of the Company's common stock and
warrants covering up to 0.4 million shares of the Company's common stock,
exercisable at $1.008 per share, and in exchange for the receipt by the Company
of approximately 0.3 million shares of NxtPhase Class A preferred stock. The
agreement between the Company and Perseus on the NxtPhase related investment
contains unwind language in the event that the proposed acquisition of NxtPhase
does not occur. This would result in the Company exchanging its NxtPhase Class A
preferred stock for shares of its common stock issued to Perseus. On May 24,
2005, Perseus invested $1.4 million in the Company, and also paid $100,000 for
the warrant extension. Subsequent to the end of the quarter, on July 26, 2005,
Perseus invested the remaining $1.5 million of the $3.0 million investment. On
the NxtPhase investment, through June 30, 2005, Perseus invested $.5 million
that was invested by the Company into NxtPhase in exchange for .1 million Class
A preferred stock. Subsequent to the end of the quarter Perseus invested an
additional $.5 million which the Company then invested in NxtPhase T&D for .1
million shares of NxtPhase Class A preferred stock. See Note 6 for more
information.

Based on the Company's current cash usage rates, inclusive of the Perseus
investments, the Company believes it has adequate cash to fund its operations
through approximately December 2005. The Company expects to pursue additional
funding as soon as practicable to further support the combined operations,
working capital, flywheel prototype development and new business development.

The Company has the following products, which are in varying stages of
development, production readiness or low volume production:

     o Smart Energy Matrix - One of the most challenging aspects of today's
     electric grid is the constant balancing of power demand and production to
     maintain a stable frequency. This is referred to as frequency regulation.
     If the amount of power generated and the amount consumed is not in balance
     at all times, imbalances adversely affect grid stability because they
     change the frequency of electricity that end users require (60 hertz in the
     United States). The Company's Smart Energy Matrix is a flywheel-based
     energy storage system combining high power flywheels with power electronics
     that is intended to supply frequency regulation services to regional grid
     operators by supplying and absorbing electricity. It is a long-life,
     environmentally friendly solution for frequency regulation, with no fuel
     consumed and no emissions generated.

     In addition to providing frequency regulation services to the grid itself,
     the Company also believes that the Smart Energy Matrix is well suited to
     provide services to regulate the frequency of distributed generation
     facilities, which, due to differences in scale, typically suffer more
     sudden and dramatic imbalances between power supply and demand than do
     regional grids.

     The Company has been awarded contracts by the New York State Energy
     Research and Development Authority (NYSERDA) and the California State
     Energy Resources Conservation and Development Commission (CEC) to
     demonstrate frequency regulation of electricity on the power grid. The
     demonstrations will be conducted using one-tenth-power prototypes of the
     Company's planned megawatt-level Smart Energy Matrix. Under these
     contracts, the Company is developing and installing a system in each of
     California and New York during 2005 to demonstrate the benefits of using
     flywheel energy storage to provide frequency regulation of the grid; a
     service required by all grid operators. Successful demonstrations of
     frequency regulation with NYSERDA and CEC may also demonstrate the system's
     technical and market feasibility in other large, important, growing markets
     related to the North American grid. The Company has shifted virtually all
     of its development spending towards meeting the requirements of these two
     programs.

     The Company's flywheels are unique in that they focus on high energy (kWh),
     rather than high power (kW). The Company's flywheels can deliver power for
     approximately 15 minutes. High power flywheels, on the other hand, provide
     power for a much shorter period of time, generally less than 30 seconds. In
     addition, on a per-pound basis, the Company's composite flywheel technology
     delivers nearly 10 times the energy of the best steel flywheels.

     To successfully provide frequency regulation on a commercial scale, the
     Company will need to obtain sufficient funding to complete design and
     development of a 25kWh flywheel and its power electronics, integrate and
     test the units in the matrix and establish manufacturing capability. The
     25kWh flywheel is a scaling up of the existing Smart Energy 6 kWh flywheel
     system.

     o Smart Energy system - The Company has produced in limited quantities
     high-energy flywheel-based systems of 2kWh and 6kWh that store electricity
     for telecommunications, cable systems, computer networks, and Internet
     market applications. The Company has sufficient capacity to return to
     production if market demand occurs. These units have a cumulative operating
     time of approximately 500,000 hours.

     o Smart Power(TM) M5 inverter system - The Company's Smart Power M5
     inverter system is an electronic system that converts direct current
     electricity produced by photovoltaic panels into alternating current
     electricity for residential and commercial use. Although it is continuing
     to sell and support this product, the Company does not believe that
     inverters will be a significant portion of its business going forward.
     During the 4th quarter of 2004 the Company recorded a reserve against its
     entire inverter inventory of approximately $1,025,000 and made a provision
     for future inverter warranty expenditures of approximately $28,000.

Smart Energy Matrix

The Company's Smart Energy Matrix is designed to provide frequency regulation
services. Frequency regulation, traditionally a function provided by integrated
utilities, has been a part of the power industry since the industry began. With
deregulation, it is one of the several ancillary services that have become a
separately identified service with its own established market price. Some of the
services are provided under long-term contracts whereas others are provided in a
spot market consisting of a daily auction run by some regional grid operators.
Suppliers of frequency regulation services include those fossil, hydro and other
electricity generators that are willing and able, at short notice, to vary the
supply of electricity in a specified amount during a specified period.

Participating generators sell both electricity in their capacities as
generators, and sell frequency regulation services using some of their reserve
generating capacity. Providing regulation services is qualitatively different
than generating electricity, both because the generator's output constantly
varies in response to continual signals from the grid operator, and because it
is priced differently and sold through a different market. Also, not all
generators provide frequency regulation services. Some, such as nuclear power
plants, are unable to vary their output in the manner needed to participate in
the market. If there is no local competitive market for regulation services,
regulation must be provided by local generators. The outputs of those generators
must be adjusted to provide sufficient reserves for regulation. This adjustment
involves lost potential revenue where output is reduced, or additional cost
where output must be increased to operate in an acceptable power range of the
generator. In addition, the constant up and down of supplying frequency
regulation services is hard on their equipment. Fossil fuel generators suffer
more wear and tear from this process than do hydro generators. These costs are
not optional if the turbines are required to provide regulation. These costs are
simply counted as cost of generating power.

Where local competitive markets exist for frequency regulation, generators have
the option of operating at reduced power and providing regulation or operating
at a power level that maximizes revenue i.e. 100% power instead of reduced power
with reserves for regulation. Many generators prefer to sell electricity and not
provide frequency regulation services, because their net financial return from
such services is less than for generating electricity, due to the higher
operating and maintenance costs that arise from frequency regulation as compared
to steady-state generation of electricity. Despite these disadvantages, many
generators sell such services both to obtain revenues from whatever portion of
their generating capacity is held in reserve, and to offset the amount that that
the generator otherwise has to pay to its regional grid operator for frequency
regulation services that it has not itself provided to the grid.

Frequency regulation services are contracted through some competitive markets
organized by regional transmission organizations, the entities responsible for
organizing and maintaining the proper operation of the electric grid. Only part
of the U.S. electrical power market is open to competition. For example, there
are competitive markets at the PJM Interconnection (serving the Mid-Atlantic
States), New York Independent System Operator (NY ISO), New England Regional
Transmission Organization (NE RTO), and California Independent System Operator
(CAL ISO). The Electricity Reliability Council of Texas Independent System
Operator (ERCOT ISO) is only partially open, using competitive bidding for a
small fraction of its needs. Frequency Regulation within ERCOT is mostly self
provided and not managed through an open market. The Midwest Independent System
Operator (MISO), serving North and South Dakota, Michigan, and Missouri, opened
to competitive bidding in 2005, and the Company understands that MISO will
operate in a manner and scope similar to PJM's frequency regulation auction. On
the other hand, for example, in the southeast United States, Georgia Power must
provide its own frequency regulation and does not obtain competitive bids
because there is no regional transmission organization in this area. The Company
intends to become credentialed and qualified to participate in the competitive
bidding procurement by PJM and other regional transmission operators. The key
qualification for the Company will be to operate a full-size commercial-grade
Smart Energy Matrix for evaluation by the regional transmission operators.

The Company believes its Smart Energy Matrix's characteristics match the
requirements of the frequency regulation market quite well, as it is designed to
quickly draw or absorb excess energy, on very short notice, when generated power
exceeds demand and deliver it when demand exceeds supply. The Company will be
able to provide a faster response than most service providers because the
Company's flywheel systems for supplying or absorbing electricity are inherently
faster acting than generators. The Company can perform either of these steps in
a fraction of the time it takes a fossil fuel generator to increase or reduce
its output. Flywheels actually recycle excess energy when generated power
exceeds load and deliver it when load increases. Using the Company's technology,
frequency regulation can be addressed for the first time as a primary
application - and with higher performance and lower operating costs. Use of the
Smart Energy Matrix also should result in significant environmental benefits,
both in that frequency regulation could be supplied without directly consuming
fuel or generating emissions, and in that fossil fuel generators would be able
to operate more efficiently by reducing their frequency regulation services and
hence reducing the extra emissions that come from ramping a generating facility
up and down to provide those services. Similarly, widespread use of the
Company's Smart Energy Matrix may also mean that the most inefficient and
highest-cost generators, being the greatest producers of emissions, would reduce
their participation in the market to a greater degree than the more efficient
producers. The Smart Energy Matrix equipment can also be sited nearly anywhere
advantageous to the grid, even within distribution systems. If sited in the
distribution systems, additional benefits such as voltage regulation and
uninterruptible power can be offered to enhance the value of the product.

Frequency regulation services are provided through a spot or auction market. In
these auctions, the regional power authority accepts bidders having the lowest
bids up through the highest bids necessary to provide the projected amount of
frequency regulation. All of these successful bidders then receive the same,
highest accepted bid price, known as the market clearing price. Because all
successful bidders receive the market clearing price, if that clearing price
provides a bidder with an adequate margin above its costs, a low cost provider
can be assured of being part of the successful bidders and having an adequate
return on investment by bidding zero. During the several years since the spot
market became open to competition, the market clearing price has been well above
the Company's anticipated cost to supply the service. Bidders in the frequency
regulation auctions are typically fossil fuel generators, and they are
constrained from making low bids in the auctions. Fossil fuel generators have
increasing fuel costs, high operating and maintenance costs arising from ramping
equipment up and down to supply frequency regulation services, and opportunity
costs that arise from having used generating capacity to provide frequency
regulation services rather than to sell electricity to the grid. Although hydro
generators have lower operating and maintenance costs than fossil fuel
producers, they are geographically limited. In contrast to the fossil fuel
generators, the Smart Energy Matrix has much lower operating and maintenance
costs and minimal fuel costs. Consequently, the Company believes that it will
always be a successful bidder of frequency regulation services to any regional
grid operator that uses an auction market.

The Company believes that the increasing trend towards renewable energy will
have an impact on the future of providing frequency regulation in several ways:

1.   The variable output of these renewable assets, i.e. fluctuating wind or sun
     exposure adds to the mismatch  variability between generated power and load
     demand.  Additional  regulation  will be required and demand for regulation
     will increase.
2.   Today's  generator  assets  scheduled for retirement  over the next several
     years tend to be the very  assets that  provide the lowest cost  regulation
     today. Therefore supply of lower cost regulation will decrease.


The Company has identified additional applications for its Smart Energy Matrix
in the distributed generation market. A distributed generation facility is any
electrical power source other than the utilities' power grid, including advanced
generators such as fuel cells, natural gas engines, wind turbines, photovoltaic
arrays and microturbines which usually supply local power to facilities such as
hospitals or manufacturing plants. In distributed generation, demand
fluctuations are a much higher percentage of power production than is
experienced in the power grid, which adversely affects the distributed
generator's ability to match supply and demand. The Company's Smart Energy
Matrix can be used to regulate the frequency of the distributed generation
facility's power in the same way it regulates the frequency of the power grid as
described above. The Smart Energy Matrix, because of its extremely fast response
time, can respond to demand fluctuations better than the distributed generators
and thus provide stability to these micro-grid facilities.

Smart Energy

The Company has offered for sale its Smart Energy flywheel products, which
deliver a low level of power for a long period of time (typically measured in
hours). These products include the 2kWh and 6kWh Smart Energy systems, which
have demonstrated quality performance and reliability at numerous sites. The
Smart Energy products are tailored to the telecommunications, cable systems,
computer networks, and Internet markets. The Company believes that its Smart
Energy products offer life cycle cost advantages and significant performance
improvements over conventional, battery-based back-up power sources. The Company
is not actively marketing these products and does not have orders for its Smart
Energy products or any inventory of finished products and does not have purchase
orders in place with vendors for components. In the event that the Company
identifies potential customers and then receives significant customer orders for
these products, it will need to place orders for components with vendors and
hire and train manufacturing personnel to assemble, inspect and assist in the
installation of deliverable units.

Smart Power M5

The Smart Power M5 inverter system for the photovoltaic energy market converts
direct current generated by solar cells from sunlight into alternating current
required by residential and commercial users for operating electrical devices
and reducing the amount of purchased power when it is connected to a power grid.
Solar cells contain semi-conducting material that converts sunlight into direct
current electricity. The Company's Smart Power M5 inverter system has the
capacity to convert direct current electricity into up to 5,000 watts of
alternating current. The Company has not been successful in selling a
significant number of units of its Smart Power M5 and therefore has shifted
virtually all of its development and sales activities from the Smart Power M5 to
its Smart Energy Matrix. The Company does not believe that inverters will be a
significant portion of its business going forward and is uncertain as to when or
at what price it will be able to sell its inventories. In 2004, the Company
established a reserve for its entire Smart Power M5 inventory in its financial
statements.

Revenues, Cost of Goods Sold and Operations

Revenue. Although the Company has shipped a limited number of commercial
products, and recorded revenues from its development contracts, its operations
have not yet reached a level that would qualify it to emerge from the
development stage. Therefore it continues to be accounted for as a development
stage company under Statement of Financial Accounting Standards No. 7
"Accounting and Reporting by Development Stage Enterprises."

The Company recognizes revenues in accordance with accounting principles
generally accepted in the United States of America. Revenues on its flywheel
development contracts are recognized on the percentage of completion basis.
Revenues on commercial product sales contracts are recognized when products are
delivered to end users. The Company is not currently delivering commercial
flywheel products. The Company has been awarded contracts by the California
State Energy Resources Conservation and Development Commission and the New York
State Energy Research and Development Authority for programs demonstrating the
viability of the Company's flywheel based system for frequency regulation of
electricity on the power grid.

NYSERDA - On February 10, 2005, the Company was awarded a research and
development contract from the New York State Energy Research and Development
Authority (NYSERDA) under a joint initiative between the U.S. Department of
Energy (DOE) Energy Storage Research Program and NYSERDA, entitled "Grid
Frequency Regulation by Recycling Energy in Flywheels," to demonstrate an
advanced energy storage solution for frequency regulation and grid stability in
New York State. Under the contract, the Company will demonstrate a
one-tenth-power prototype of the Company's planned megawatt-level system, known
as the Smart Energy Matrix. The demonstration will integrate the Company's
flywheels and associated power electronics into the distribution power grid. The
contract requires the Company's Smart Energy Matrix to be delivered and
installed during the second half of 2005. The contract is expected to cost
approximately $1.4 million, of which approximately $385,000 consists of
inventories the Company had previously expensed, and this expected cost will be
partially offset by approximately $645,000 of revenue, nearly all of it in 2005.
Through June 30, 2005, the Company has recorded revenue from this project of
$121,539 and determined this project to be approximately 18% complete.

CEC - On February 14, 2005, the Company was awarded a contract with the
California State Energy Resources Conservation and Development Commission (CEC)
entitled "Flywheel Energy Storage System for Grid Frequency Regulation," to
demonstrate a one-tenth power prototype version of its Smart Energy Matrix
advanced energy storage solution for frequency regulation and grid stability. A
successful demonstration of frequency regulation will also serve to demonstrate
the system's technical and market feasibility in the grid stabilization market.
The contract requires the Company's flywheel based system to be delivered and
installed during the second half of 2005. The contract is expected to cost
approximately $1.8 million, of which approximately $140,000 consists of
inventories the company had previously expensed, and this expected cost wii be
partially offset by approximately $1.2 million of revenue, with the majority of
it in 2005. Through June 30, 2005, the Company has recorded revenue from this
project of $700,262 and determined this project to be 58% complete.

For the Company's inverter products, which are sold to distributors, the Company
recognizes revenues based on the sales by its distributors to their customers.

The Company may enter into contracts to research and develop or manufacture
products with a loss anticipated at the date the contract is signed. These
contracts are entered into in anticipation that profits will be obtained from
future contracts for the same or similar products. These loss contracts may
provide the Company with intellectual property rights that, in effect, establish
it as the sole producer of these products. Anticipated losses on these contracts
are recognized at the date the Company becomes contractually obligated. Future
losses on contracts are charged to earnings as soon as these losses are known.
Estimated costs in excess of revenues are classified under current liabilities
as "Accrued contract loss." The Company accounts for its long-term government
contracts using the percentage of completion method. Under this method,
percentage of completion is measured principally by the percentage of labor
hours incurred to date for each contract to the estimated total labor hours for
each contract at completion. Costs incurred in excess of amounts billed are
classified as current assets under "Unbilled costs under government contracts."

Cost of goods sold. The Company costs its products at the lower of cost or
market. Any cost in excess of this measurement is expensed in the period in
which it is incurred. In addition, the Company continuously evaluates inventory
and purchase commitments to insure that levels do not exceed the expected
deliveries for the next twelve months. As the Company is in the early stages of
production, its actual manufacturing costs incurred currently exceed the fair
market value of its products. The Company provides a five-year limited product
warranty for its Smart Power M5 product line and accrues for estimated future
warranty costs in the period in which the revenue is recognized.

Operations. The Company has experienced net losses since its inception and, as
of June 30, 2005, had an accumulated deficit of approximately $133 million. The
Company's business strategy is to continue to seek government contracts to
demonstrate the application of its flywheel technologies and identify and review
possible acquisitions or mergers of companies with complementing technologies or
markets. The Company expects to use the results of its government contracts to
validate its technologies and expand relationships it is developing to gain
market access for the Company's future products for the renewable energy
industry. The Company believes that there is sufficient market interest to begin
full-scale development of its Smart Energy Matrix, however the Company will not
begin full-scale development until it has obtained additional funds. For other
contemplated flywheel-based systems the Company will continue to evaluate market
size, growth potential and competitive advantages that its products could
provide and the probable market penetration that could be achieved. If markets
are identified in which the Company believes its flywheel products will be
successful, and those markets express a tangible interest in the Company's
products, the Company will seek to obtain additional funds to complete prototype
development and production of identified products. To continue as a going
concern the Company must raise additional funds by December, 2005. The Company
does not expect to become profitable or obtain positive operating cash flow
before 2008 and may not achieve positive cash flow even at that point or beyond.

Note 2.  Basis of Presentation and Summary of Significant Accounting Policies

The accompanying unaudited consolidated financial statements have been prepared
using accounting principles generally accepted in the United States of America
except that certain information and footnote disclosure normally included in
consolidated financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted in this Form 10-Q. It is
suggested that these consolidated financial statements presented herein be read
in conjunction with the Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K, for the year ended
December 31, 2004. In the opinion of the Company's management, all adjustments,
consisting of normal recurring accruals considered necessary for a fair
presentation, have been included in the accompanying unaudited financial
statements. Operating results for the six months ended June 30, 2005 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 2005.

Going Concern.

The accompanying unaudited consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
had minimal revenues and incurred losses of approximately $133 million since its
inception including losses in the six months ending June 30, 2005 of
approximately $4,010,000. At June 30, 2005, the Company had approximately
$3,466,000 of cash and cash equivalents on hand. As more fully described in Note
6, after receiving the $1.5 million investment from Perseus on July 11, 2005,
the Company estimates it will have cash to fund its operations through December,
2005. These factors raise substantial doubt about the Company's ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might be necessary if the Company is unable to
continue as a going concern.

The Company recognizes that its continuation as a going concern is dependent
upon its ability to generate sufficient cash flow to allow it to satisfy its
obligations on a timely basis. The generation of sufficient cash flow is
dependent, in the short term, on the Company's ability to obtain additional
funding, and in the long term, on the success of the Company's identified
products to obtain a share of the target market and the establishment of new
markets in which its technologies could provide competitive products. The
Company believes that the successful achievement of these initiatives should
provide it with sufficient resources to meet its cash requirements. In addition,
the Company is also considering a number of other strategic financing
alternatives, and has incurred substantial costs in these efforts; however, no
assurance can be made with respect to the success of these efforts or the
viability of the Company.

There have been no significant additions to or changes in accounting policies of
the Company since December 31, 2004. For a complete description of the Company's
accounting policies, see Note 2 to Consolidated Financial Statements in the
Company's Annual Report on Form 10-K for the year ended December 31, 2004.

Note 3. Inventory

Inventories are stated at the lower of cost (first-in, first-out method) or
market and consist of raw materials, work in process and finished goods held for
resale. Inventory balances include the following amounts:

                                           June 30, 2005   December 31, 2004
                                       ------------------  ------------------
Raw materials ....................   $             --     $          176,349
Work in progress .................                 --                 46,244
Finished goods ...................                 --                   --
                                       ------------------  ------------------
Inventories, net .................   $             --     $          222,593
                                       ==================  ==================

As of June 30, 2005, all inventory is included as part of "Unbilled costs on
government contracts" in the Company's consolidated balance sheet. Any
inventories not associated with the Company's government contracts were
previously reserved.

Note 4.  Property and Equipment

Property and equipment are stated at cost and consist of the following:
<TABLE>
<CAPTION>
                                                                Estimated
                                                                  Useful        June 30,     December 31,
                                                                  Lives           2005           2004
                                                                 ----------   -----------    -----------
<S>                                                              <C>          <C>            <C>
Machinery and equipment ......................................   5 years      $   575,663    $   571,198
Service vehicles .............................................   5 years           16,762         16,762
Furniture and fixtures .......................................   7 years          255,939        296,652
Office equipment .............................................   3 years        1,431,809      1,396,562
Leasehold improvements .......................................   Lease term       533,352        533,352
Equipment under capital lease obligations ....................   Lease term       918,285        918,285
                                                                              -----------    -----------
     Total ...................................................                $ 3,731,810    $ 3,732,811
Less accumulated depreciation and amortization ...............                 (3,478,970)    (3,474,164)
                                                                              -----------    -----------
     Property and equipment, net .............................                $   252,840    $   258,647
                                                                              ===========    ===========
</TABLE>
Note 5.  Commitments

The Company's principal contractual obligations as of June 30, 2005 are as
follows:
<TABLE>
<CAPTION>

                                                       Cash payments due during the
                                                           year ended December 31,
                                  Six months ending     ------------------------------
Description of commitment         December 31, 2005         2006             2007         Thereafter         Total
------------------------------    ------------------    -------------    -------------    -----------    --------------
<S>                                   <C>                 <C>              <C>           <C>             <C>
Operating leases..............        $     255,022       $  529,413       $  397,059              -     $   1,181,494
Non-cancelable purchase
orders........................              203,960                -                -              -           203,960
                                  ------------------    -------------    -------------    -----------    --------------
Total commitments                     $     458,982       $  529,413       $  397,059         $    -     $   1,385,454
                                  ==================    =============    =============    ===========    ==============
</TABLE>

The Company leases office and light manufacturing space under an operating lease
with a term through September 30, 2007. At June 30, 2005, the Company has
provided the lessor with an irrevocable letter of credit with a balance of
$310,011, which is reduced annually during the lease term. This letter of credit
is secured by a cash deposit, which is included in restricted cash in the
accompanying consolidated balance sheets.

The Company has firm non-cancelable purchase commitments with its suppliers to
fulfill its Smart Power M5 production requirements and to satisfy contractual
obligations for its research and development programs in the amount of
approximately $203,960. In the fourth quarter of 2004, the Company fully
reserved all contractual obligations related to its Smart Power M5 purchase
commitments.

Legal Proceedings. The Company may be subject to various legal proceedings, many
involving routine litigation incidental to its business. The outcome of any
legal proceeding is not within the complete control of the Company, is often
difficult to predict and may be resolved over very long periods of time.
Estimating probable losses associated with any legal proceedings or other loss
contingencies are very complex and require the analysis of many factors
including assumptions about potential actions by third parties. Loss
contingencies are recorded as liabilities in the consolidated financial
statements when it is both (1) probable and known that a liability has been
incurred and (2) the amount of the loss is reasonably estimable. If the
reasonable estimate of the loss is a range and no amount within the range is a
better estimate, the minimum amount of the range is recorded as a liability. If
a loss contingency is not probable or not reasonably estimable, a liability is
not recorded in the consolidated financial statements.

On August 16, 2004, Ricardo and Gladys Farnes and TLER Associates, Ltd., a
Bahamas corporation ("TLER," and together with Ricardo and Gladys Farnes, the
"Plaintiffs"), delivered a complaint to the Company naming as defendants the
Company, John Doherty, Richard Lane, and unidentified individuals and
corporations. The case was filed in District Court in Clark County, Nevada on or
about June 1, 2004, and was subsequently removed to the United States District
Court for the District of Nevada. The complaint alleged that in 2001 defendants
(a) forged the signature of plaintiff Ricardo Farnes (a principal of TLER) to a
document purporting to extend the performance period on a purchase order issued
by TLER to the Company and (b) thereafter posted on the internet defamatory and
personal information concerning the Plaintiffs. The Plaintiffs did not allege
any specific amount of damages and instead merely asserted that damages exceeded
$10,000. The Company answered the complaint denying its material allegations.

The Plaintiffs and the Company settled this dispute on July 31, 2005. The
Company paid the Plaintiffs a sum of $5,000 and the parties agreed to file a
stipulation stating, among other things, that the litigation is dismissed with
prejudice. The settlement did not constitute an admission of liability.

Note 6.  Investments

On April 22, 2005, the Company entered into an agreement to acquire NxtPhase T&D
Corporation. See Note 1 for more information.

On April 22, 2005 the Company entered into an Investment Agreement with Perseus
Capital, L.L.C. and Perseus 2000 Expansion, L.L.C. ("Perseus 2000 Expansion"),
and Perseus 2000 Expansion separately entered into a term sheet with NxtPhase.
In each of the Investment Agreement and the NxtPhase term sheet, the respective
companies have the right to require Perseus 2000 Expansion to purchase shares of
such company's capital stock at a price per share as specified in the Investment
Agreement and NxtPhase term sheet, respectively. The Investment Agreement also
provides that if NxtPhase requires Perseus 2000 Expansion to purchase NxtPhase
Class A preferred shares, Perseus 2000 Expansion may assign its obligation to
the Company to purchase such NxtPhase Class A preferred shares, so long as
Perseus 2000 Expansion purchases an equivalent dollar amount of the Company's
common stock, on the terms set forth in the Investment Agreement. The agreement
between the Company and Perseus on the NxtPhase related investment contains
unwind language in the event that the proposed acquisition of NxtPhase does not
occur. This would result in the Company exchanging its NxtPhase Class A
preferred stock for shares of its common stock issued to Perseus.

On June 13, 2005, the Company, NxtPhase and Perseus 2000 Expansion completed the
first tranche of the NxtPhase investment option of $500,000 whereby (a) the
Company purchased 111,111 Class A preferred shares of NxtPhase, (b) Perseus 2000
Expansion purchased 595,238 shares of the Company's common stock and (c) the
Company issued to Perseus 2000 Expansion a warrant to purchase up to 138,636
shares of its common stock, at an exercise price per share of $1.008.

This investment in equity securities is classified as available-for-sale and is
carried on the balance sheet at cost.

Note 7.  Common Stock

Shareholder Rights Agreement. In September 2002, and amended as of December 27,
2002 the Company's board of directors approved a Rights Agreement, under which,
each holder of common stock on October 7, 2002 automatically received a
distribution of one Right for each share of common stock held. Each Right
entitles the holder to purchase 1/100th of a share of the Company's newly issued
preferred stock for $22.50 in the event that any person not approved by the
board of directors acquires more than 15% (35% in the case of one large
shareholder that already owned more than 15%) of the outstanding common stock,
or in the event that the Company is acquired by another company, $22.50 worth of
the common stock of the other company at half its market value (in each case any
rights held by the acquiring person are not exercisable and become void).

Treasury Stock. In May 2005, the board of directors authorized the Company to
purchase 99,146 shares of the Company's common stock from its three executive
officers at an average market price of $0.89 per share. These shares were
originally issued to the officers under the Company's restricted stock unit
deferred compensation program described in Note 10. This decision was driven by
the Company's policies restricting open market trading by senior personnel who
have access to material nonpublic information. As those policies prevent
management from selling shares to the market to generate cash to fund the
withholding tax obligations that arise from the compensation income which is
generated by the restricted stock units, the Company has withheld shares in
sufficient quantity to pay tax liability in connection with this first and
second installment of restricted stock.

Reserved Shares. At June 30, 2005 and December 31, 2004, 11,337,970 and
11,601,803 shares of common stock were reserved for issuance under the Company's
stock option plan and for outstanding warrants, respectively. The following
schedule shows warrants outstanding as of June 30, 2005:

<TABLE>
<CAPTION>
Warrantholder                          Grant Date      Expiration      Strike         Issued and
                                                          Date          Price        Outstanding
---------------------------------    -------------    ------------    -----------    -------------
<S>                                     <C>             <C>          <C>               <C>
Class F (extended)                      5/23/2000       5/23/2007     $  2.25           1,333,333
Consultants                              8/2/2000        8/2/2005     $  6.00              20,000
GE (CR&D)                              10/24/2000      10/24/2005     $  2.10             120,000
Perseus 2000 Expansion, L.L.C.          5/24/2005       5/24/2010     $  1.01             800,000
Perseus 2000 Expansion, L.L.C.          6/10/2005       6/10/2010     $  1.01             138,636
                                     -------------    ------------    -----------    -------------
Total Warrants                                                                          2,411,969
</TABLE>

Note 8.  Related Party Transactions

Loan to Officer. During 2001, the Company advanced approximately $565,000 to an
officer of the Company, Mr. William Stanton, its former CEO and President and
currently a director of and consultant to the Company. This advance is interest
bearing and secured by Mr. Stanton's holdings of the Company's common stock and
was provided to him to allow the exercise of stock options and the payment of
related taxes. In 2004 and 2005, Mr. Stanton was paid approximately $80,000 and
$6,000, respectively, of consulting fees by the Company, of which, Mr. Stanton
paid the Company $21,500 to reduce his outstanding loan balance. Through June
30, 2005, the Company collected approximately $464,000 in principal payments on
this advance. The balance of this loan as of June 30, 2005 is $100,544 and is
fully reserved; however, it has not been cancelled. Mr. Stanton continues to
serve as a director of and consultant to the Company.

On August 5, 2005, Mr. Stanton surrendered options to purchase 76,752 shares of
common stock of the Company which were granted to him on October 13, 2004. The
Company gave Mr. Stanton credit for $100,544 as a result of such surrender,
which equaled the excess of the value of the shares issuable upon exercise of
the options, based on the mid-point of the high and the low trading prices per
share of the Company's common stock on August 5, 2005, over the exercise price
of the options, to repay in full the outstanding principal of and interest on
the loan advanced by the Company to Mr. Stanton as described above.

Perseus Investment. On April 22, 2005, a fund affiliated with Perseus, L.L.C.
committed to invest a maximum of $3.0 million in the Company and was granted the
option to assign to the Company its right to make a maximum investment of
$1,500,000 in NxtPhase T&D Corporation, to be made in three tranches, which was
granted in connection with a Preferred Stock Purchase Agreement among NxtPhase
and certain of its existing Class A preferred shareholders. The option was
granted as part of a proposed acquisition of NxtPhase by the Company and, if
exercised by Perseus, required the Company to purchase Class A preferred shares
of NxtPhase in exchange for Perseus purchasing shares of the Company's common
stock. The $3.0 million investment in the Company by Perseus is to be made in
exchange for approximately 3.6 million shares of the Company's common stock,
warrants covering up to 0.8 million shares of the Company's common stock,
exercisable at $1.008 per share and a two year extension of a 1,333,333 warrant,
exercisable at $2.25 per share, already held by Perseus. The $1.5 million
investment by Perseus to fund NxtPhase is to be made in exchange for the receipt
by Perseus of approximately 1.8 million shares of the Company's common stock and
warrants covering up to 0.4 million shares of the Company's common stock,
exercisable at $1.008 per share, and in exchange for the receipt by the Company
of approximately 0.3 million shares of NxtPhase Class A preferred stock. The
agreement between the Company and Perseus on the NxtPhase related investment
contains unwind language in the event that the proposed acquisition of NxtPhase
does not occur. This would result in the Company exchanging its NxtPhase Class A
preferred stock for shares of its common stock issued to Perseus. On May 24,
2005, Perseus invested $1.4 million in the Company, and also paid $100,000 for
the warrant extension. Subsequent to the end of the quarter, on July 26, 2005,
Perseus invested the remaining $1.5 million of the $3.0 million investment. On
the NxtPhase investment, through the end of the quarter Perseus invested $.5
million that was invested by the Company into NxtPhase in exchange for .1
million Class A preferred stock. Subsequent to the end of the quarter Perseus
invested an additional $.5 million which the Company then invested in NxtPhase
T&D for .1 million shares of NxtPhase Class A preferred stock. See Note 6 for
more information.

Treasury Stock. In May 2005, the board of directors authorized the Company to
purchase 99,146 shares of the Company's common stock from its three executive
officers at market price of $0.89 per share. These shares were issued under the
Company's restricted stock unit deferred compensation program described in Note
10. This decision was driven by the Company's policies restricting open market
trading by senior personnel who have access to material nonpublic information.
As those policies prevent management from selling shares to the market to
generate cash to fund the withholding tax obligations that arise from the
compensation income which is generated by the restricted stock units, the
Company has withheld shares in sufficient quantity to pay tax liability in
connection with this first and second installment of restricted stock.


Note 9. Restructuring Charges

Restructuring and asset impairment charges. The Company's initial products were
focused on the telecommunications industry. As a result of the overall economic
downturn and in particular the significant decline in capital and maintenance
spending in telecommunications as well as the low price of lead-acid batteries,
products competing with those of the Company, the Company has not been
successful in selling products into this market. Therefore, in December, 2003,
the Company recorded a non-cash asset impairment charge of $0.4 million in order
to reduce the carrying amount of its flywheel related patents and patents
pending as the estimated future cash flows anticipated from these assets were
substantially in doubt. Also, in July, 2002, in an effort to reduce its monthly
cash-spending rate, the Company implemented a number of cost-cutting measures to
ensure the availability of resources necessary to pursue its business strategy
for a reasonable period but at a significantly lower cash expenditure rate. As a
result, a substantial portion of the Company's long-term assets were idled,
including machinery and equipment, tooling, office furniture and fixtures, and
equipment and leasehold improvements. The Company evaluated all of its property
and equipment as required by Statement of Financial Accounting Standards No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" and, in 2002,
incurred a restructuring and impairment charge of $6.5 million of which $4.3
million represents impaired capital equipment and leasehold improvements, $.3
million relates to severance costs and $1.9 million relates to a reserve against
future lease payments and related facility costs. The reserve against future
lease payments is classified as "Restructuring Reserve" in the current
liabilities section of the balance sheet.

A summary of the restructuring reserves is as follows:

                                            Six months ended June 30,
                                       ------------------------------------
                                            2005                2004
                                       ----------------    ----------------
Beginning balance                         $  1,062,644        $  1,406,191
Charges for the period                               -                   -
Payments                                     (171,773)           (171,773)
                                       ----------------    ----------------
Ending balance                             $   890,871        $  1,234,418
                                       ================    ================


Note 10.  Stock-Based Compensation

The Company's Second Amended and Restated 1998 Stock Incentive Plan provides for
the granting of stock options to purchase up to 9,000,000 shares of the
Company's common stock. Options with terms of up to 10 years may be granted to
employees, officers, directors and consultants of the Company. Under the terms
of the plan, incentive stock options ("ISOs") are to be granted at fair market
value of the Company's stock at the date of grant, and nonqualified stock
options ("NSOs") are to be granted at a price determined by the Board of
Directors. ISOs and NSOs generally vest ratably over 36 months from the grant
date and have contractual lives of up to 10 years.

The Company accounts for stock based employee compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25
(Accounting for Stock Issued to Employees) and related interpretations. In 2002,
the Company implemented FASB Statement of Financial Accounting Standards No. 148
("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure." SFAS 148 amends current disclosure requirements and requires
prominent disclosures on both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. This statement is effective for financial
reports containing financial statements for interim periods beginning after
December 15, 2002. SFAS 148 also provides alternative methods of transition for
a voluntary change to fair-value based methods of accounting, which the Company
has not adopted at this time.

Deferred compensation expense associated with stock awards to non-employees is
measured using the fair-value method and is amortized over the vesting period
using a calculation under FASB Interpretation No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans."

No stock-based compensation is reflected in net earnings for stock options
granted to employees as all options granted under the plan had an exercise price
equal to or greater than the market price of the underlying stock at the date of
the grant. The following table illustrates the effect on net earnings and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123 "Accounting for Stock-Based Compensation"
to stock-based employee compensation.

<TABLE>
<CAPTION>

                                       Three months ended June 30,                Six months ended June 30,
                                         2005                2004                 2005                 2004
                                   ----------------- -- ----------------    ----------------- -- -----------------
Net loss to common
<S>                                  <C>                 <C>                  <C>                  <C>
shareholders as reported             $  (1,764,781)      $  (2,266,205)       $  (4,009,782)       $  (4,414,932)
Pro forma compensation expense                    -              91,520               82,686              184,387
                                   -----------------    ----------------    -----------------    -----------------
Net loss--pro forma                  $  (1,764,781)      $  (2,357,725)       $  (4,092,468)       $  (4,599,319)
Loss per share--as reported            $     (0.04)        $     (0.05)         $     (0.09)         $     (0.10)
Loss per share--pro forma              $     (0.04)        $     (0.05)         $     (0.09)         $     (0.11)
</TABLE>

Restricted Stock Units

In 2003, the Company put into place a long-term incentive plan (LTIP) for all
executives and employees for 2003 and 2004. Based on the Company's need to
conserve cash and the desire to retain its professional staff, the Company
determined that it would be in the best interest of it, its employees, and its
stockholders to implement a stock-based Deferred Compensation Plan.

The LTIP eliminated the previous cash bonus structure for successful performance
and replaced it with a program whereby the Company establishes goals that are
strategically aligned to the Company's performance and, therefore, shareholder
value. The LTIP agreement is intended to provide employees deferred compensation
in the form of restricted stock units (or "RSUs") at no cost to the recipient,
that can be converted into shares of Company's common stock through establishing
and evaluating quarterly, or in some cases yearly, targets for the employee and,
following each quarter, determining the number of RSUs to accrue and to be
granted in four equal installments in the fiscal year following the fiscal year
with respect to which employee accrued the RSUs. Employees have the right to
convert their RSUs into shares at any time after such grant, subject to a
quarterly vesting schedule. The Company's employees earned 738,921 and 667,151
RSUs for the fiscal years ended December 31, 2004 and 2003, respectively, which
are not available for exercise until satisfaction of the quarterly vesting
period during the following calendar year. The grants are recorded as deferred
stock compensation until they are earned over the vesting schedule, at which
time, the value of the RSUs will be recorded as compensation expense in the
Company's Income Statement. Compensation expense recorded for the six months
ending June 30 was $483,313 and $631,368 for 2005 and 2004, respectively.

Note 11.  Income Taxes

At December 31, 2004 the Company had approximately $81 million of net operating
loss carry forwards which begin to expire in 2012 and additional research and
development tax credits. Valuation allowances have reduced the potential
benefits from the use of these carry forwards to zero as their future
utilization is not assured.

Under the provisions of the Internal Revenue Code, certain substantial changes
in the Company's ownership may limit, in the future, the amount of net operating
loss carry forwards which could be utilized annually to offset future taxable
income and income tax liabilities. The amount of any annual limitation is
determined based upon the Company's value prior to an ownership change. The
Company's agreement to effect a business combination with NxtPhase T&D
Corporation (see Note 6) may limit the value of these tax loss carry-forwards if
that combination occurs, but the Company has not yet made an assessment of this
limitation.

Note 12.  Subsequent Events

On July 15, 2005, pursuant to the investment agreement dated as of April 22,
2005, the Company provided Perseus 2000 Expansion a notice exercising its call
option requiring Perseus 2000 Expansion to purchase an additional 1,785,714
shares of the Company's common stock for $1.5 million. On July 26, 2005, the
Company received $1.5 million from Perseus 2000 Expansion, and issued 1,785,714
shares of the Company's common stock for $0.84 per share. On July 21, 2005, as
part of the investment in NxtPhase T&D Corporation, Perseus 2000 Expansion
invested $500,000 in exchange for 595,238 shares of the Company's common stock
pursuant to the investment agreement. This was the second of three tranches that
will total $1.5 million. As more fully described in Note 6, Perseus 2000
Expansion exercised the option to make its investment in the Company, and the
Company made a similar investment in NxtPhase. The Company subsequently made an
investment in NxtPhase in exchange for 111,111 shares of its Class A preferred
stock.

On August 5, 2005, Mr. Stanton repaid his loan from the Company.  See Note 8.


<PAGE>


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

Note Regarding Forward Looking Statements:

This Quarterly Report on Form 10-Q contains forward-looking statements
concerning, among other things, the Company's expected future revenues,
operations and expenditures and estimates of the potential markets for the
Company's services. Such statements made by the Company fall within the meaning
of the Private Securities Litigation Reform Act of 1995, as amended. All such
forward-looking statements are necessarily only estimates of future results and
the actual results achieved by the Company may differ materially from these
projections due to a number of factors as discussed in the section entitled
"Certain Factors Affecting Future Operating Results" of this Form 10-Q.

Critical Accounting Policies and Estimates

The preparation of financial statements requires management to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues,
expenses and related disclosures. On an ongoing basis, management evaluates the
Company's estimates and assumptions including but not limited to those related
to revenue recognition, asset impairments, inventory valuation, warranty
reserves, contract losses and other assets and liabilities. Management bases its
estimates on historical experience and various other assumptions that it
believes to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.

Revenue Recognition. Although the Company has shipped products, and recorded
contract revenues, its operations have not yet reached a level that would
qualify it to emerge from the development stage. Therefore it continues to be
accounted for as a development stage company under Statement of Financial
Accounting Standards No. 7 "Accounting and Reporting by Development Stage
Enterprises."

The Company recognizes revenues, in accordance with accounting principles
generally accepted in the United States of America. Generally, revenue is
recognized on transfer of title, typically when products are shipped and all
related costs are estimable. For sales to distributors, the Company makes an
adjustment to defer revenue until the products are subsequently sold by
distributors to their customers.

Government Contract Revenue Recognized on the Percentage-of-Completion Method.
The Company recognizes contract revenues using the percentage-of-completion
method, based primarily on contract costs incurred to date compared with total
estimated contract costs. Changes to total estimated contract costs or losses
are recognized in the period in which they are determined. Revenues recognized
and/or costs incurred in excess of amounts billed are classified as current
assets and included in "Unbilled costs on government contracts" and amounts
billed to clients in excess of revenues recognized to date are classified as
current liabilities under "Advance billings on contracts" in the Company's
consolidated balance sheets. Provisions for contract losses are included in
current liabilities as "Accrued contract loss." Changes in project performance
and conditions, estimated profitability, and final contract settlements may
result in future revisions to construction contract costs and revenue.

Inventory Valuation. The Company values its inventory at the lower of actual
cost or the current estimated market value. It regularly reviews inventory
quantities on hand and records a provision for excess and obsolete inventory
based primarily on historical usage for the prior twelve month period and future
sales forecasts. Although the Company makes every effort to ensure the accuracy
of its forecasts of future product demand, any significant unanticipated changes
in demand or technological developments could have a significant impact on the
value of its inventory and its reported operating results.

Warranty Reserves. The Company's warranties require it to repair or replace
defective products returned to it during the applicable warranty period at no
cost to the customer. It records an estimate for warranty-related costs based on
actual historical return rates, anticipated return rates, and repair costs at
the time of sale. A significant increase in product return rates, or a
significant increase in the costs to repair products, could have a material
adverse impact on future operating results for the period or periods in which
such returns or additional costs materialize and thereafter.

Income Taxes. Deferred tax assets and liabilities are determined based on
differences between the financial reporting and income tax bases of assets and
liabilities as well as net operating loss and tax credit carryforwards and are
measured using the enacted tax rates and laws that will be in effect when the
differences reverse. Deferred tax assets are reduced by a valuation allowance to
reflect the uncertainty associated with their ultimate realization.

Significant management judgment is required in determining the provision for
income taxes, the deferred tax assets and liabilities and any valuation
allowance recorded against deferred tax assets. The valuation allowance is based
on the Company's estimates of taxable income and the period over which its
deferred tax assets will be recoverable. In the event that actual results differ
from these estimates or the Company adjusts these estimates in future periods it
may need to establish an additional valuation allowance or reduce its current
valuation allowance which could materially impact its tax provision.

Long-Lived Assets. In accordance with Statement of Financial Accounting
Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets", long-lived assets to be held and used by the Company are reviewed to
determine whether any events or changes in circumstances indicate that the
carrying value of the asset may not be recoverable. The conditions to be
considered include whether or not the asset is in service, has become obsolete,
or whether external market circumstances indicate that the carrying amount may
not be recoverable. When appropriate the Company recognizes a loss for the
difference between the estimated fair value of the asset and the carrying
amount. The fair value of the asset is measured using either available market
prices or estimated discounted cash flows.

Investments. Marketable equity securities not classified as held-to-maturity or
as trading, are classified as available-for-sale, and are carried at fair market
value, with the unrealized gains and losses, net of tax, included in the
determination of comprehensive income and reported in shareholders' equity. The
fair value of substantially all securities is determined by quoted market
prices. The estimated fair value of securities for which there are no quoted
market prices is based on similar types of securities that are traded in the
market.

Overview

The Company's initial product strategy was to develop high energy, composite
flywheels for back-up powering of telecommunications applications. With the
weakening of the telecommunications market, which began in 2001, the Company
recognized that its Smart Energy flywheel products as alternative backup
solutions to the telecommunications industry were not on a path to produce
meaningful revenues. With that recognition, the Company initiated a series of
cost cutting measures throughout 2002 and 2003. The focus of these efforts was
to reduce cash usage while preserving the Company's intellectual properties and
maintaining the integrity of its public company requirements while evaluating
all potential product markets for the Company's technologies and considering
acquisitions or mergers that could lead to increased shareholder value. The
Company has:

(i)  identified promising applications for its Smart Energy Matrix design in the
     electric utility power grid  marketplace.  In the first quarter of 2005 the
     Company was awarded development contracts by CEC and NYSERDA to demonstrate
     the  viability  of  the  Company's  flywheel   technologies  for  frequency
     regulation by grid operators.  The demonstrations will be a one-tenth-power
     prototype of the Smart Energy Matrix;

(ii) pursued  additional  development  and  design  contracts  for a variety  of
     applications  by government  agencies.  The Company has been  successful in
     obtaining  two small  contracts  and is  continuing  its  efforts to obtain
     additional research and development funding; and

(iii) entered  into an  agreement  on April 22,  2005 to  acquire  NxtPhase  T&D
     Corporation ("NxtPhase"), a privately held Canadian supplier of digital and
     fiber optic products for electric power and grid monitoring and control.

On April 25, 2005 a fund affiliated with Perseus, L.L.C. committed to invest $3
million in the Company and an additional $1.5 million in NxtPhase T&D to fund
its operations as part of an acquisition of NxtPhase T&D by the Company. See
Note 6 for more information. The Company has been advised by Perseus and
NxtPhase management that with the above $1.5 million of additional financing,
NxtPhase has sufficient cash to fund its operations through approximately
December, 2005.

The Company expects to pursue additional financing in 2005 to fund:

o  continuing as a going concern;
o  ongoing research and development of the Smart Energy Matrix;
o  completing the NxtPhase transaction;
o  working capital requirements; and
o  developing new business.

In the event that the Company elects to begin full scale development of its
Smart Energy Matrix flywheel system, the amount of funding required would
increase substantially. The Company believes that there is ample market interest
for its Smart Energy Matrix.

From inception through June 30, 2005, the Company has incurred losses of
approximately $133 million. The Company expects to continue to incur losses as
it expands its product development, commercialization program, and establishes
its manufacturing capabilities.

The Company recognized an asset impairment charge in 2003 and restructuring and
asset impairment charges in 2002. The Company, as required by Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," periodically evaluates all of its property and
equipment in light of facts and circumstances and the outlook for future cash
flows. As a result of its ongoing evaluations, in 2003 the Company took a
non-cash charge of approximately $0.4 million representing the impairment of
capitalized costs of internally developed intellectual property including
various patents and patents pending relating to the Company's flywheel
technology. In 2002 the Company took a non-cash charge of $6.5 million of which
$4.3 million represented impaired capital equipment and leasehold improvements,
$1.9 million related to a reserve against future lease payments and related
facility costs and $0.3 million relating to severance costs. These charges
related to a substantial portion of the Company's long-term assets being idled,
including machinery and equipment, tooling, office furniture and fixtures and
leasehold improvements. The portion of the reserve that relates to future lease
payments is classified as "Restructuring reserve" in the current liabilities
section of the balance sheet.


Results of operations:

Comparison of six months ended June 30, 2005 and 2004

<TABLE>
<CAPTION>
                                                              Six months ended June 30,
                                                   2005           2004        $ Change       % Change
                                                ------------   -----------   -----------    -----------
                                                                    (in thousands)
<S>                                                  <C>           <C>           <C>              <C>
Revenues                                             $  954        $  184        $  770           418%
Cost of goods sold                                    1,004           384           620           161%
Selling, general and administrative                   2,281         2,289           (8)             0%
Research and development                                637         1,970       (1,333)            68%
Loss on sales and contract commitments                1,057             -         1,057             0%
Depreciation and amortization                            41            90          (49)            54%
Interest and other income, net                           55           133          (78)            59%
</TABLE>


Revenues. For the six months ending June 30, 2005, the Company's revenues were
as follows:

                                    Percent           Revenue (in
Source                              complete          thousands)
-----------------------------    ---------------    ----------------
CEC Contract                             56.80%           $     700
NYSERDA Contract                         18.82%                 122
Bechtel Bettis Contract                 100.00%                  71
PON 800 Contract                         17.52%                  11
M5 and accessories                          n/a                  50
                                                    ----------------
Total                                                     $     954
                                                    ================

The Company recorded revenue from its development contracts of approximately
$904,000 and revenue from the sale of its Smart Power M5 power conditioning
systems of approximately $50,000. Revenues for the six months ending June 30,
2004 were primarily generated from sales of the Company's Smart Power M5 in the
amount of $103,000 and also from a research and development contract with DARPA
of approximately $81,000.

In the first quarter of 2005, the Company was awarded development contracts with
the California State Energy Resources Conservation and Development Commission
(CEC) and the New York State Energy Research and Development Authority (NYSERDA)
to demonstrate the viability of the Company's flywheel technologies for
frequency regulation. The demonstrations will be conducted using one-tenth-power
prototypes of the Company's planned megawatt-level system known as the Smart
Energy Matrix. Under these contracts, the Company expects to develop and install
a system in both California and New York during 2005 to demonstrate the benefits
of using flywheel energy storage to provide frequency regulation of the grid; a
service required by all grid operators. Successful demonstrations of frequency
regulation with CEC and NYSERDA may also demonstrate the system's technical and
market feasibility in other large, important, growing markets related to the
North American grid. The CEC prototype is complete, and is expected to ship by
the end of August 2005.

Cost of Goods Sold. Cost of goods sold for the six months ending June 30, 2005
includes costs incurred to date for the Company's flywheel development contracts
in the amount of approximately $981,000, sell-through adjustment and warranty
accruals for Smart Power M5 inverter product sold of approximately $23,000. Cost
of goods sold, for the six months ending June 30, 2004, included costs
associated with the sell-through of Smart Power M5 inverters of $283,000, and
costs associated with the revenues recorded on the DARPA flywheel development
contract of approximately $101,000.

Selling, General and Administrative Expenses. The Company's sales and marketing
expenses consist primarily of compensation and benefits for its sales and
marketing personnel and related business development expenses. The Company's
general and administrative expenses consist primarily of compensation and
benefits related to its corporate staff, professional fees, insurance and travel
costs. Selling, general and administrative expenses totaled approximately
$2,281,000 and $2,289,000 for the six months ended June 30, 2005 and 2004,
respectively. The decrease of approximately $8,000 or 0% is primarily the result
of decreases in the cost of personnel and benefits mainly attributable to the
Company's RSU plan, and higher professional fees.

Research and Development. The Company's cost of research and development
consists primarily of the cost of compensation and benefits for research and
development and support staff, as well as materials and supplies used in the
engineering design process exclusive of the Company's development contracts.
These costs decreased for the six months ending June 30, 2005 over the same
period during 2004 due primarily to the allocation of resources from research
and development departments to the Company's flywheel development contracts
presented in cost of goods sold. As a result, the Company expects its cost of
research and development for the duration of these contracts to continue to be
lower compared to 2004. The Company expects costs of development of its flywheel
systems will be more significant during the last quarter of 2005, once its
flywheel development contracts are substantially complete and it begins
development of a full scale prototype of the Smart Energy Matrix and it has
obtained funding to complete this work. Research and development expenses
totaled approximately $637,000 and $1,970,000 for the six months ended June 30,
2005 and 2004, respectively. The decrease of $1,333,000 or 68% is primarily the
result of accounting allocations from research and development expense to its
development contracts.

Loss on Sales and Contract Commitments. The Company has established reserves for
anticipated losses on its government contracts with CEC and NYSERDA. Expected
losses are approximately $1,044,000 ($629,000 for CEC, $341,000 for NYSERDA and
$74,000 for others). The Company agreed, in its government contracts, to provide
cost sharing dollars. The expected losses increased over the second quarter of
2005 due primarily to additional labor costs associated with the projects. The
Company did not accrue such losses during 2004. The Company is continuously
evaluating its loss reserve and will make any necessary adjustments as
appropriate.

Depreciation and Amortization. The Company's depreciation and amortization is
primarily related to depreciation on capital expenditures and the amortization
of lease and leasehold costs related to its facilities. The Company also
amortized the Smart Power M5 intellectual property it acquired from Advanced
Energy Systems in 2004. Depreciation and amortization totaled approximately
$41,000 and $90,000 for the six months ended June 30, 2005 and 2004,
respectively. The decrease of $49,000 or 54% is attributable to the decrease in
the remaining net book values of the Company's assets.

Interest and Other Income/Expense, net. The Company's non-operating income and
expenses are primarily attributable to interest income resulting from cash on
hand, accrued dividends on the Company's holdings in the Series A Preferred
stock of Evergreen Solar, Inc., and proceeds from the sale of certain capital
equipment no longer used. Interest and Other Income/Expense, net for the six
months ended June 30, 2005 was approximately $55,000, compared to approximately
$133,000 for the same period in 2004. The decrease of approximately $78,000
(59%) in 2005 compared to the prior year is the result of lower interest due to
lower cash balances and lower dividends received since the Company sold its
Evergreen investment in 2004.


Liquidity and Capital Resources

                                            Six months ended June 30,
                                        ------------------------------------
                                             2005                2004
                                        ----------------    ----------------
                                 (in thousands)
Cash and cash equivalents                   $     3,466         $     4,999
Working capital                                   2,041               7,241
Cash provided by (used in)
     Operating activities                       (2,969)             (3,925)
     Investing activities                         (599)                (14)
     Financing activities                         1,937                  29
                                        ----------------    ----------------
Net decrease in cash and cash equivalents  $    (1,631)        $    (3,910)
                                        ================    ================
Current ratio                                       1.9                 4.0
                                        ================    ================

The Company's cash requirements depend on many factors, including but not
limited to research and development activities, executing its development
contracts, continued efforts to commercialize products, facilities costs,
general and administrative expenses, costs related to raising additional funding
and costs related to its mergers and acquisitions. The Company expects to make
significant expenditures to fund its operations, develop technologies and
explore opportunities to find and develop additional markets to sell its
products. The Company has taken significant actions to reduce its cash
expenditures for product development and production readiness by reducing
headcount, development spending and capital expenditures over the past three
years. The Company has focused its activities on market analysis in terms of
size of markets, competitive aspects and advantages that its products could
provide. It has continued to do preliminary design of products for markets under
consideration for its flywheel systems. Based on the Company's rate of
expenditure of cash and the additional expenditures expected in support of its
business plan, the Company will need to obtain additional financing by December,
2005 to fund:


o        continuing as a going concern;
o        ongoing research and development primarily related to the Smart Energy
         Matrix;
o        completing the proposed NxtPhase transaction;
o        working capital requirements; and
o        new business development.

If the Company elects to accelerate the development of its Smart Energy Matrix
flywheel systems, the amount of cash required would increase substantially, and
the Company will not begin this development until it has obtained the required
funds.

Net cash used in operating activities was approximately ($2,969,000) and
($3,925,000) for the six months ended June 30, 2005 and 2004, respectively. The
primary component to the negative cash flow from operations is from net losses.
For the first six months of 2005, the Company had a net loss of approximately
($4,010,000). This included employee stock compensation of approximately
$483,000, facility related cash payments charged against restructuring reserves
of approximately ($172,000), proceeds from the sale of fixed assets, net of
reserve of ($24,000) and depreciation and amortization of approximately $41,000.
Changes in operating assets and liabilities generated approximately $712,000 of
cash during the first six months of 2005. For the first six months of 2004, the
Company had a net loss of approximately ($4,415,000). This included employee
stock compensation of approximately $612,000, facility related cash payments
charged against restructuring reserves of approximately ($172,000), a reduction
in restricted cash related to the lease of the Company's facility of
approximately $45,000, and depreciation and amortization of approximately
$90,000. Changes in operating assets and liabilities used approximately
($76,000) of cash during the first six months of 2004.

Net cash used in investing activities was approximately ($599,000) and ($14,000)
for the six months ended June 30, 2005 and 2004, respectively. For the first six
months of 2005 the principal uses of cash in investing activities included
($500,000) to invest in NxtPhase, approximately ($40,000) to purchase capital
equipment, and approximately ($88,000) to repurchase the Company's common stock
from its officers. Sources of investing activities include $29,000 from the sale
of capital equipment. For the first six months of 2004, cash used in investing
activities was approximately ($14,000) for the purchase of capital equipment.

Net cash generated/(used) by financing activities was approximately $1,937,000
and $29,000 for the six months ended June 30, 2005 and 2004, respectively. For
the first six months of 2005, cash generated by financing activities included
approximately $1,977,000 from the issuance of common stock pursuant to an
investment agreement with Perseus 2000 Expansion, $190,000 related to the
exercise of stock options and approximately $2,000 from the employee stock
purchase plan, offset by cash paid for financing costs of ($232,000). For the
first six months of 2004, the cash generated by financing activities of
approximately $29,000 related to the exercise of stock options in the amount of
approximately $27,000 and shares issued under the employee stock purchase plan
of approximately $2,000.

In the event that the Company elects to begin full-scale development of its
Smart Energy Matrix flywheel systems, the amount of cash required will increase
substantially. The Company is not expecting to become profitable or cash flow
positive until at least 2008 and its ability to continue as a going concern will
depend on being able to raise additional cash to fund operations. If the Company
is successful in completing the acquisition of NxtPhase its cash needs will
increase. Many of NxtPhase's products are in the early stages of development or
production, and as such, NxtPhase does not yet have revenues sufficient to
offset its cost of sales and operating costs. NxtPhase and its predecessor have
incurred losses since their inception. The Company may not be able to raise
these funds, or if it is able to do so, it may be on terms that are adverse to
existing stockholders.

On May 24, 2005, pursuant to an investment agreement requiring the investment of
up to a maximum of $3.0 million in the Company by Perseus 2000 Expansion,
Perseus invested $1.4 million in the Company, and also paid $100,000 to extend
an existing warrant for two additional years. Subsequent to the end of the
quarter, on July 11, 2005, Perseus invested the remaining $1.5 million.

Perseus also committed to invest up to $1.5 million in NxtPhase T&D Corporation.
The Company and Perseus agreed that, due to the proposed acquisition of NxtPhase
by the Company, Perseus would be able to assign its investment commitment to the
Company so that Perseus invests up to $1.5 million in the Company and the
Company uses such funds to purchase shares of NxtPhase Class A preferred stock.
Through the end of the quarter, Perseus invested $.5 million in the Company that
was then invested by the Company into NxtPhase in exchange for .1 million shares
of NxtPhase Class A preferred stock. Subsequent to the end of the quarter
Perseus invested an additional $.5 million which the Company then invested in
NxtPhase T&D. See Note 6 for more information.



Certain Factors Affecting Future Operating Results

The following factors, as well as others mentioned in the Company's Annual
Report on Form 10-K for the year ended December 31, 2004, could cause actual
results to differ materially from those indicated by forward-looking statements
made in this Quarterly Report on Form 10-Q:

     FOR THE COMPANY'S BUSINESS STRATEGY TO BE EFFECTIVELY IMPLEMENTED,
DEMONSTRATIONS OF ITS SMART ENERGY MATRIX TO NYSERDA AND CEC NEED TO BE
SUCCESSFUL.

         The Company's business plan focuses on completing the development of
its energy storage solution, the Smart Energy Matrix. As part of this strategy,
the Company has entered into agreements with the New York State Energy Research
and Development Authority (NYSERDA) and the California State Energy Resources
Conservation and Development Commission (CEC) to demonstrate the Smart Energy
Matrix using a one-tenth-power prototype for the provision of frequency
regulation services to the electric grid. These agreements allow the Company to
demonstrate its highly responsive and cost-effective frequency regulation
prototype for the electricity grid which is the first application specifically
designed to provide grid frequency regulation. The Company has shifted virtually
all of its development spending towards meeting the requirements of these two
programs. If the Company is not successful in demonstrating the anticipated
benefits, completing development of the Smart Energy Matrix may be significantly
delayed and its business strategy may be considerably harmed.

         THE COMPANY'S ABILITY TO SUCCESSFULLY COMPLETE DEVELOPMENT OF ITS SMART
ENERGY MATRIX WILL REQUIRE SUBSTANTIAL FUNDS. ITS STOCKHOLDERS MAY BE ADVERSELY
AFFECTED IF THE COMPANY ISSUES DEBT SECURITIES OR ADDITIONAL EQUITY SECURITIES
TO OBTAIN FINANCING.

         The Company will require substantial funds to conduct research and
development activities, market its products and services, and increase its
revenues. The Company anticipates that such funds will be obtained from external
sources and intends to seek additional equity or debt to fund future operations.
The Company estimates that it will require approximately $24.0 million to
complete development of the Smart Energy Matrix and an additional $6.0 million
to provide full power prototypes. If the Company is able to raise sufficient
funding through equity or debt to begin development in the fourth quarter of
2005, it expects the development to be complete by 2008.

         The Company's actual capital requirements will depend on many factors.
If the Company experiences unanticipated cash requirements, it may need to seek
additional sources of funding, which may not be available on favorable terms, if
at all. Such additional funding may only be available on terms that may, for
example, cause dilution to common stockholders, and/or have liquidation
preferences and/or pre-emptive rights. If the Company raises additional funds by
issuing debt securities or additional equity securities, existing stockholders
may be adversely affected because new investors may have rights superior to
current stockholders and current stockholders may be diluted.

         If the Company does not succeed in raising additional funds on
acceptable terms, it may be unable to complete planned development for its
products and services. In addition, the Company could be forced to take
unattractive steps, such as discontinuing product development, limiting the
services it may offer, reducing or foregoing sales and marketing efforts and
attractive business opportunities, or discontinuing operations entirely.

         The Company expects that it will be several years before it will
recognize significant revenues from the products it intends to offer and the
services it intends to provide. A large portion of its expenses are fixed,
including expenses related to facilities, equipment and personnel. In addition,
it expects to spend significant amounts to fund product development based on its
core technologies. The Company also expects to incur substantial expenses to
manufacture its Smart Energy Matrix product in the future. As a result,
operating expenses may increase significantly over the next several years and,
consequently, the Company will need to generate substantial commercial revenue
to achieve profitability. Even if it does achieve profitability, the Company may
not be able to sustain or increase profitability on a consistent basis.

         THE COMPANY FACES SIGNIFICANT TECHNICAL CHALLENGES IN COMPLETING THE
DEVELOPMENT OF ITS SMART ENERGY MATRIX. THE COMPANY MAY FAIL TO DEVELOP ITS
25KWH GENERATION FLYWHEEL SYSTEM, WHICH IS A CRITICAL REQUIREMENT FOR THE
DEVELOPMENT OF THE SMART ENERGY MATRIX, AND EVEN IF IT IS ABLE TO DEVELOP THE
25KWH SYSTEM, IT MAY FAIL TO DEVELOP THE SMART ENERGY MATRIX.

         Although the Company has successfully developed two high energy systems
(the 2kWh and 6kWh) that had similar technical challenges there can be no
assurance that it will be able to successfully develop the 25kWh system.

        The successful development of the Company's new 25kWh flywheel system,
which is the flywheel system that will be used in the Smart Energy Matrix,
involves significant technological and cost challenges, including, among other
possible challenges:

o    it may take longer to develop cost effective  designs for key components of
     the Smart  Energy  Matrix such as the rim,  motor,  power  electronics  and
     bearing system, and the master controller software;
o    development  and production  delays and/or cost increases may occur because
     the  Company  relies  on  single-source  suppliers  to supply  several  key
     components  to meet  its  engineering  requirements,  cost  objectives  and
     development  and  production  schedules  and  the  Company  does  not  have
     contracts with all of these suppliers;
o    The Company's  ability to develop cost  effective  designs on schedule that
     will meet system performance requirements such as:

     o    a rotor-cooling scheme to avoid overheating during operation;
     o    cost effective  bearings to ensure acceptable  vibration levels at all
          speeds; and
     o    a touchdown  bearing  system to stabilize  the rotor  during  abnormal
          conditions such as an earthquake;

o    the ability to ramp up and maintain production rates; and
o    quality and cost control from key suppliers.

         There can be no assurance that the Company will be successful in
meeting these challenges. In addition, even if the Company is able to develop
the new 25kWh flywheel system, it plans to integrate multiple 25kWh flywheels
into a common building or container to produce its Smart Energy Matrix. This
effort will pose significant technological and cost challenges including, among
others:

o    transporting the Smart Energy Matrix safely to customer locations;
o    meeting the technical requirements for interconnection to the utility grid;
     and
o    developing  a  communication  and  control  system  adequate  to  meet  the
     performance standards of the grid managers.

         THE COMPANY HAS A HISTORY OF LOSSES AND ANTICIPATES FUTURE LOSSES AND
WILL HAVE LIMITED REVENUES IN THE NEAR TERM. UNLESS IT RAISES ADDITIONAL CAPITAL
TO OPERATE ITS BUSINESS, IT MAY NOT BE ABLE TO CONTINUE AS A GOING CONCERN AS
ITS CASH BALANCES ARE SUFFICIENT TO FUND OPERATIONS ONLY THROUGH APPROXIMATELY
DECEMBER, 2005.

         The Company has incurred significant losses from operations since its
inception. As shown in its consolidated financial statements, it incurred
significant losses from operations of $9,049,000, $9,138,000, and $20,867,000
and cash decreases of $3,812,000, $8,957,000, and $16,335,000, during the years
ended December 31, 2004, 2003, and 2002, respectively. Additionally, the Company
reported losses of $ 4,010,000 through the six months ending June 30, 2005 and a
decrease in cash of $ 1,632,000 through June 30, 2005. The Company is unsure if
or when it will become profitable.

         The Company had $3,465,625 of cash and cash equivalents on hand at June
30, 2005. Based on its current cash usage rates and additional expenditures
expected in support of its business plan, the Company has adequate cash to fund
operations through approximately December, 2005.

         The Company intends to focus on further development of the Smart Energy
Matrix to provide frequency regulation services, but this product will not
generate revenues in the near-term. The Company expects future revenues to come
from a combination of the sale of services related to its Smart Energy Matrix
and sales of Smart Energy Matrix units. Other than revenue related to the
NYSERDA and CEC agreements in the amount of $1.8 million, the Company has no
revenues to date from its Smart Energy Matrix. The timing of future revenues is
uncertain.

         Miller Wachman, LLP, the Company's independent auditors, has included
an explanatory paragraph related to a going concern uncertainty in their audit
report on the Company's consolidated financial statements for the fiscal year
ended December 31, 2004, which states that "Beacon's recurring losses from
operations and negative cash flows raise substantial doubt about its ability to
continue as a going concern."

         The Company's financial statements have been prepared on the basis of a
going concern, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The Company has not made any
adjustments to its financial statements as a result of the going concern
uncertainty. If the Company cannot continue as a going concern, it may have to
liquidate its assets and may receive significantly less than the values at which
they are carried on its financial statements. Any shortfall in the proceeds from
the liquidation of its assets would directly reduce the amounts that holders of
the Company's common stock could receive in liquidation.

         THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN MAY NEGATIVELY
IMPACT ITS ABILITY TO OBTAIN CUSTOMERS.

         The uncertainty of the Company's ability to continue as a going concern
may negatively impact its ability to successfully attract customers for its
products because of potential customer's perception that the Company may not be
able to provide product support and warranty coverage.

         COMPETITORS IN THE FREQUENCY REGULATION MARKET INCLUDE ESTABLISHED
UTILITIES AND INDEPENDENT SERVICE PROVIDERS WITH FAR GREATER RESOURCES THAN THE
COMPANY.

         The Company believes that it will be able to provide frequency
regulation services using its Smart Energy Matrix at lower cost than other
providers. However, this market is being served by well-known utilities and
independent service providers that use conventional generators. These utilities
and independent service providers are primarily focused on the sale of energy
and generally provide frequency regulation as an ancillary service. Although
these generators typically prefer to sell energy rather than provide frequency
regulation services because, among other things, the sale of energy can provide
higher revenues, the Company will be competing with these established generators
that have far greater resources than it does. Companies that are currently
providing frequency regulation include Allegheny Energy Supply Company,
Commonwealth Chesapeake Company, Dominion Virginia Power, Ingenco Wholesale
Power, NRG Power Marketing and Reliant Energy Services.

         ALTHOUGH THE MARKET FOR FREQUENCY REGULATION SERVICES IS LARGE AND
GROWING, THE COMPANY HAS NOT DEMONSTRATED ITS ABILITY TO SELL INTO THAT MARKET.

         The Company intends to provide frequency regulation services using its
Smart Energy Matrix in the spot or auction markets of regional grid operators,
such as PJM Interconnection. In order to bid in these markets, one must be
qualified to do so. The Company expects to receive the necessary approvals, but
there is no assurance it will be successful.

         Even if the Company successfully qualifies to participate in the
auction markets, if the structure of these markets changes due to regulatory
modifications, the Company's business plan could be adversely affected. The
central financial attraction for the Company in the auction market is that it is
able to bid electronically into each auction. These auctions yield the same
sales price for all successful bidders, a price that historically has been well
above the Company's anticipated costs to supply the service. The Company's
anticipated advantage is that it can be the lowest cost supplier of frequency
regulation services to regional grid operators. If the auction market changes,
the Company may be required to change its business plan and there can be no
assurance that it will be successful in doing so.

         THE COMPANY'S FINANCIAL PERFORMANCE COULD BE ADVERSELY AFFECTED IF IT
IS UNABLE TO RETAIN KEY EXECUTIVE OFFICERS.

         Because its future success depends to a large degree on the management
provided by the executive officers, the Company's competitiveness will depend
significantly on whether it can retain members of its executive team. The
Company has employment agreements with Messrs. Spiezio, Vice President of
Finance, Chief Financial Officer, Treasurer and Secretary; and Lazarewicz, Vice
President and Chief Technical Officer. The employment agreement between the
Company and Mr. Capp, CEO and President, expired on December 31, 2004.
Negotiations between Mr. Capp and the Company are ongoing. There can be no
assurance that an agreement will be reached with Mr. Capp.

         The Company's ability to effectively implement its business plan
depends, to a significant extent, on its ability to retain its executive
officers. There can be no assurance that it will be successful in retaining its
executive officers.

         If the Company cannot reach agreement with Mr. Capp and his employment
is terminated, pursuant to the terms of the expired employment agreement, the
Company is obligated to pay Mr. Capp a monthly amount until December 31, 2005,
equal to the sum of one-twelfth of his base salary at the time of expiration
plus one-twelfth of his bonus for the most recent fiscal year. No monthly
payment is required after December 31, 2005. If the at-will employment continues
after December 31, 2005 but then terminates, no such monthly amount will be
paid. As of December 31, 2004, Mr. Capp's base salary was $240,000 annually.
Based on the closing bid price of The Company's common stock as of December 31,
2004 as reported on the NASDAQ SmallCap Market, Mr. Capp received a bonus in the
amount of $236,800, paid in the form of a grant of 251,391 restricted stock
units, pursuant to the Company's Second Amended and Restated 1998 Stock
Incentive Plan.

         THE COMPANY'S FINANCIAL PERFORMANCE COULD BE ADVERSELY AFFECTED BY ITS
NEED TO RETAIN AND ATTRACT TECHNICAL PERSONNEL.

         The Company's future success depends to a large degree on the technical
skills of its engineering staff and its ability to attract technical personnel.
Competition for skilled technical professionals is intense and the Company may
not be successful in attracting and retaining the talent necessary to design,
develop and manufacture its flywheel products.

         MARKET VOLATILITY MAY AFFECT THE COMPANY'S STOCK PRICE AND THE VALUE OF
AN INVESTMENT IN ITS COMMON STOCK MAY BE SUBJECT TO SUDDEN DECREASES.

         The trading price for the Company's common stock has been, and is
expected to continue to be, volatile. The price at which the Company's common
stock trades depends upon a number of factors, including its historical and
anticipated operating results, market perception of the prospects for companies
in its industry and general market and economic conditions, some of which are
beyond the Company's control such as instability in the global financial markets
due to terrorist attacks, war or other civil disturbances. Factors such as
fluctuations in the Company's financial and operating results, changes in
government regulations affecting product or service approvals or other aspects
of it or its competitors' businesses, announcements of technological innovations
or new commercial products by the Company or its competitors, developments
concerning key personnel and its intellectual property rights, significant
collaborations or strategic alliances and publicity regarding actual or
potential performance of products under development by the Company or its
competitors could also cause the market price of its common stock to fluctuate
substantially. The high and low closing prices per share of the Company's common
stock on the NASDAQ SmallCap Market were $1.50 and $0.14, respectively, in 2002,
$1.54 and $0.16, respectively, in 2003, $1.72 and $0.25, respectively, in 2004,
and $3.18 and $0.62, respectively, in this year through August 11, 2005. The
average daily trading volume of its common stock on the NASDAQ SmallCap Market
was 135,300 shares in 2002, 1,295,400 shares in 2003, 1,259,700 shares in 2004
and 1,580,500 shares this year through June 30, 2005. In the first half of
August 2005 the daily trading volume has been significantly higher; on August 8,
2005, more than 29 million shares were traded. During periods of stock market
price volatility, share prices of many companies in the Company's industry have
often fluctuated in a manner not necessarily related to their individual
operating performance. Because the historical trading prices of its common stock
were dependent on factors relating solely to the Company on a stand-alone basis,
it cannot predict the effect of the plan of arrangement on the trading price of
its common stock after the combination. Accordingly, the Company's common stock
may be subject to greater price volatility than the stock market as a whole.

         THE COMPANY HAS ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION AND CHANGES IN CONTROL IN ITS BOARD OF DIRECTORS AND MANAGEMENT, AND
COULD ADVERSELY AFFECT THE PRICE OF ITS COMMON STOCK.

         Provisions of the Company's Sixth Amended and Restated Certificate of
Incorporation, the Company's amended and restated by-laws, the Company's Rights
Agreement, adopted in September 2002 and subsequently amended, and Delaware law
may have the effect of deterring unsolicited takeovers or delaying or preventing
changes in control of its management, including transactions in which its
stockholders might otherwise receive a premium for their shares over then
current market prices. In addition, these provisions may limit the ability of
stockholders to approve transactions that they may deem to be in their best
interest.

         The Company's Sixth Amended and Restated Certificate of Incorporation
permits its board of directors to issue preferred stock without stockholder
approval upon such terms as the board of directors may determine. The rights of
the holders of the Company's common stock will be subject to, and may be
adversely affected by, the rights of the holders of any preferred stock that may
be issued in the future. The issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from acquiring, a
majority of the Company's outstanding common stock. Although it has no present
intention of issuing any additional preferred stock, an issuance of a
substantial number of preferred shares could adversely affect the price of its
common stock.

         The Company's Sixth Amended and Restated Certificate of Incorporation
also provides for a staggered board of directors divided into three classes.
Such a staggered board of directors will make it more difficult for the
Company's stockholders to change the composition of the board of directors in
any one year, which could have the effect of preventing or delaying a change of
control transaction that is not approved by the Company's board of directors.

         In addition, the Company's Sixth Amended and Restated Certificate of
Incorporation and its amended and restated by-laws provide that:

     o    its  directors  may only be  removed  for cause by a  majority  of the
          outstanding  capital  stock  entitled  to  vote  in  the  election  of
          directors;
     o    its  stockholders  do not have the power to call  special  meetings of
          stockholders; and
     o    the provisions relating to the classified board,  removal of directors
          and calling of special stockholders  meetings may only be amended by a
          66  2/3%  vote of the  outstanding  shares  of  common  stock,  voting
          together as a single class.

         These provisions make it more difficult for the Company's stockholders
to change the composition of the board of directors and approve transactions
they may deem to be in their best interests that are not approved by the board
of directors.

         Pursuant to a Rights Agreement adopted in September 2002 and
subsequently amended, the Company issued rights as a dividend on common stock on
October 7, 2002 each of which entitles the holder to purchase 1/100th of a share
of newly issued preferred stock for $22.50 in the event that any person not
approved by the board of directors acquires more than 15% (35% in the case of
one large shareholder, Perseus Capital, L.L.C. and its affiliates, that already
owned more than 15%) of the Company's outstanding common stock, or in the event
of an acquisition by another company, $22.50 worth of the common stock of the
other company at half its market value (in each case the rights held by the
acquiring person are not exercisable and become void).

         THE COMPANY'S COMMON STOCK MAY BE REMOVED FROM THE NASDAQ SMALLCAP
MARKET, WHICH COULD CAUSE THE PRICE TO FALL FURTHER AND DECREASE ITS LIQUIDITY.

         The Company's common stock trades on The NASDAQ SmallCap Market. To
continue trading on The NASDAQ SmallCap Market, it must comply with The NASDAQ
SmallCap Market's continued listing requirements set forth in Rule 4310(c),
which require, among other things, that the Company maintain a minimum closing
bid price of $1.00 per share.

         On May 13, 2005, NASDAQ informed the Company that unless the bid price
of its common stock closes at $1.00 per share or more for a minimum of 10
consecutive trading days by November 9, 2005, the Company's common stock is
subject to removal from The NASDAQ SmallCap Market. On June 27, 2005, the
Company announced that it had received a letter from NASDAQ stating that because
the closing bid price of its common stock had been at $1.00 per share or greater
for at least 10 consecutive business days, the Company had regained compliance
with Rule 4310(c)(4).

         In addition, NASDAQ's continued listing requirements also require that
the Company maintain stockholders' equity of $2.5 million, market value of
listed securities of $35 million or net income from continuing operations of
$500,000. Because the Company has not yet been able to achieve profitability, it
must either maintain the minimum stockholders' equity amount or market value
amount. Although it is currently in compliance with both minimum amounts, there
is a risk that, unless the Company obtains additional financing in the near
future, it will not be able to maintain these requirements.

         If the Company does not continue to satisfy NASDAQ's continued listing
requirements, its common stock may be delisted from NASDAQ, or delisted
entirely. The delisting of its common stock may result in the trading of the
stock on the over-the-counter markets in the so-called "pink sheets" or the
NASD's electronic bulletin board. Consequently, a delisting of the Company's
common stock from NASDAQ would materially reduce the liquidity of its common
stock, not only in the number of shares that could be bought and sold, but also
through delays in the timing of the transaction and reductions in securities
analysts and media coverage. This may reduce the demand for the Company's stock
and significantly destabilize the price of its stock. In addition, a delisting
would materially adversely affect the Company's ability to raise additional
necessary capital.

         FAILURE TO PROTECT THE COMPANY'S INTELLECTUAL PROPERTY COULD IMPAIR ITS
COMPETITIVE POSITION.

         Although it is unaware of any challenges to its intellectual property,
the Company cannot provide assurance that it has or will be able to maintain a
significant proprietary position on the basic technologies used in its flywheel
systems. The Company's ability to compete effectively against alternative
technologies will be affected by its ability to protect proprietary technology,
systems designs and manufacturing processes. The Company does not know whether
any of its pending or future patent applications under which it has rights will
issue, or, in the case of patents issued or to be issued, that the claims
allowed are or will be sufficiently broad to protect its technology or processes
from competitors. Even if all of its patent applications are issued and are
sufficiently broad, they may be challenged or invalidated. The Company could
incur substantial costs in prosecuting or defending patent infringement suits,
and such suits would divert funds and resources that could be used in its
business. The Company does not know whether it has been or will be completely
successful in safeguarding and maintaining its proprietary rights.

         Further, its competitors or others may independently develop or patent
technologies or processes that are substantially equivalent or superior to those
of the Company. If the Company is found to be infringing on third-party patents,
it does not know whether it will be able to obtain licenses to use such patents
on acceptable terms, if at all. Failure to obtain needed licenses could delay or
prevent the development, manufacture or sale of the Company's systems.

         The Company relies, in part, on contractual provisions to protect trade
secrets and proprietary knowledge. These agreements may be breached, and the
Company may not have adequate remedies for any breach. The Company's trade
secrets may also be known without breach of such agreements or may be
independently developed by competitors or others. The Company's inability to
maintain the proprietary nature of its technology and processes could allow
competitors or others to limit or eliminate any competitive advantages the
Company may have.

         ONGOING COMPLIANCE WITH THE SARBANES-OXLEY ACT OF 2002 MAY REQUIRE
ADDITIONAL PERSONNEL OR SYSTEMS CHANGES. ANY WEAKNESSES IDENTIFIED IN ITS
INTERNAL CONTROLS AS PART OF THE EVALUATION BEING UNDERTAKEN BY THE COMPANY AND
ITS INDEPENDENT PUBLIC ACCOUNTANT PURSUANT TO SECTION 404 OF THE SARBANES-OXLEY
ACT COULD HAVE AN ADVERSE EFFECT ON THE COMPANY'S BUSINESS.

         Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies
evaluate and report on their systems of internal control over financial
reporting. In addition, as of the fiscal year end December 31, 2005, the
Company's independent accountants must report on management's evaluation. The
Company is in the process of documenting and testing its system of internal
control over financial reporting to provide the basis for its report. At this
time, the Company is aware that its financial reporting information systems and
point-of-sale information systems require a significant level of manual controls
to ensure the accurate reporting of its results of operations and financial
position. Upon the completion of its review, certain deficiencies may be
discovered that will require remediation. This remediation may require the
implementation of certain information systems operating protocols and/or
additional manual controls, the costs of which could have a material adverse
effect on its business, financial condition and results of operations. Due to
the ongoing evaluation and testing of the Company's internal controls, there can
be no assurance that there may not be significant deficiencies or material
weaknesses that would be required to be reported.

         The Company's business plan may not have sufficient resources
identified to ensure ongoing compliance with the Sarbanes-Oxley Act of 2002.
Given the limited size of the Company and its cash position, it may not have
sufficient resources to satisfy the segregation of duties required for
compliance with Section 404 of the Sarbanes-Oxley Act of 2002 or to be
compliant, the Company may need to obtain additional funding.

         GOVERNMENT REGULATION MAY IMPAIR THE COMPANY'S ABILITY TO MARKET ITS
PRODUCTS.

         Government regulation of the Company's products, whether at the
federal, state or local level, including any change in regulations, on tariffs,
product buy downs or tax rebates relating to purchase and installation of its
products, may increase the cost and price of its systems, and may have a
negative impact on the Company's revenue and profitability. The Company cannot
provide assurance that its products will not be subject to existing or future
federal and state regulations governing traditional electric utilities and other
regulated entities. The Company expects that its products and their installation
will be subject to oversight and regulation at the local level in accordance
with state and local ordinances relating to building codes, safety and related
matters. The Company does not know the extent to which any existing or new
regulations may impact its ability to distribute, install and service its
products. Once the Company's products reach the commercialization stage,
federal, state or local government entities may seek to impose regulations.

         PRODUCT LIABILITY CLAIMS AGAINST THE COMPANY COULD RESULT IN
SUBSTANTIAL EXPENSES AND NEGATIVE PUBLICITY THAT COULD IMPAIR SUCCESSFUL
MARKETING OF PRODUCTS.

         The Company's business exposes it to potential product liability claims
that are inherent in the manufacture, marketing and sale of electro-mechanical
products, and as such, it may face substantial liability for damages resulting
from the faulty design or manufacture of products or improper use of products by
end users. The Company cannot provide assurance that its product liability
insurance will provide sufficient coverage in the event of a claim. Also, it
cannot predict whether it will be able to maintain such coverage on acceptable
terms, if at all, or that a product liability claim would not materially
adversely affect its business, financial condition or the price of its common
stock. In addition, negative publicity in connection with the faulty design or
manufacture of the Company's products would adversely affect its ability to
market and sell its products.

         SAFETY FAILURES BY THE COMPANY'S FLYWHEEL PRODUCTS OR THOSE OF ITS
COMPETITORS COULD REDUCE MARKET DEMAND OR ACCEPTANCE FOR FLYWHEEL SERVICES OR
PRODUCTS IN GENERAL.

         A serious accident involving either the Company's flywheels or
competitors' similar products could be a significant deterrent to market
acceptance and adversely affect the Company's financial performance. There is
the possibility of accident with any form of energy storage. In particular, if a
metal flywheel fails and the stored energy is released, the flywheel could break
into fragments that could be ejected at a high rate of speed. However, the
Company's flywheels are based on a composite design so that in the event of a
failure, its flywheel is expected to fail in a more benign manner.

         IF IT ACQUIRES NXTPHASE, THE COMPANY WILL ISSUE A FIXED NUMBER OF
SHARES OF ITS COMMON STOCK IN THE PLAN OF ARRANGEMENT, REGARDLESS OF THE STOCK'S
MARKET FLUCTUATIONS PRIOR TO THE EFFECTIVE DATE OF THE PLAN OF ARRANGEMENT. THE
VALUE OF BEACON COMMON STOCK AND OF NXTPHASE SHARES WILL FLUCTUATE AND MAY
DECLINE OR INCREASE, EACH INDEPENDENT OF MOVEMENTS OF VALUE OF THE OTHER
COMPANY.

         Pursuant to the terms of the arrangement agreement, the number of
shares of the Company's common stock to be issued is fixed. There is no
mechanism to adjust the exchange ratio based on changes in the market price of
the Company's common stock or in the value of NxtPhase. Furthermore, neither
NxtPhase nor the Company is permitted to withdraw from the plan of arrangement
solely because of changes in the market price of Beacon common stock or the
value of NxtPhase shares.

         THE COMPANY AND NXTPHASE EXPECT TO INCUR SIGNIFICANT COSTS ASSOCIATED
WITH THE PLAN OF ARRANGEMENT.

         If it acquires NxtPhase, the Company estimates that it will incur
direct transaction costs of approximately $1,170,000, of which $938,000 will be
capitalized for accounting purposes and $232,000 will be expensed as incurred.
The combined company may also incur charges to operations, which they cannot
currently reasonably estimate, in the quarter in which the plan of arrangement
is completed or the following quarters, to reflect costs associated with
integrating the two companies. There can be no assurance that the combined
company will not incur additional charges in subsequent periods due to the
combination.

         THE COMPANY MAY NOT REALIZE ALL OF THE BENEFITS IT EXPECTS FROM
ACQUIRING NXTPHASE.

         If it acquires NxtPhase, the benefits realized by the Company will
depend, in part, on the Company's ability to take advantage of the anticipated
opportunities resulting from offering a diversified set of products and services
for a more reliable and stable grid, from utilizing broader technological and
product engineering skills and from being better positioned to raise capital. It
is possible that the Company will be unable realize all of these benefits.

<page>

Item 3.  Quantitative and Qualitative Disclosure about Market Risk

The Company's cash equivalents and investments, all of which have maturities of
less than one year, may expose the Company to interest rate risk but not to
market risk of principal. At June 30, 2005, the Company had approximately
$60,000 of cash equivalents that were held in non-interest bearing accounts.
Also at June 30, 2005, the Company had approximately $955,000 of cash
equivalents that were held in interest bearing checking accounts and $2,509,000
invested in interest-bearing money market accounts. The Company's exposure to
market risk through financial instruments is not material.

Item 4.  Controls and Procedures

The Company's management, with the participation of its Chief Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of its disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934) as of the end of the period covered by this Quarterly
Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that the Company's disclosure controls
and procedures are effective in enabling the Company to record, process,
summarize, and report information required to be included in its periodic SEC
filings within the required time period.

In addition, the Company's management, with the participation of its Chief
Executive Officer and Chief Financial Officer, has evaluated whether any change
in the Company's internal control over financial reporting (as defined in Rule
13a-15(f) under the Securities Exchange Act of 1934) occurred during the period
covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer have concluded that there
has been no change in the Company's internal control over financial reporting
during the period covered by this Quarterly Report on Form 10-Q that has
materially affected, or is reasonably likely to materially affect, its internal
control over financial reporting.


<PAGE>
                                     PART II

Item 1.  Legal Proceedings

None


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.




<PAGE>


Item 6.  Exhibits

     Exhibit
     Number        Description of Document

          2.1 (1)
                   Arrangement Agreement and Plan of Arrangement, dated April
                   22, 2005, by and among the Company, Beacon Acquisition Co.
                   and NxtPhase T&D Corporation.
          3.1 (2)  Sixth Amended and Restated Certificate of Incorporation of
                   the Company.

          3.2 (2)  Amended and Restated Bylaws of the Company.

          4.1 (2)  Rights Agreement dated September 25, 2002 between the Company
                   and EquiServe Trust Company, N.A.

          4.2 (4)  Amendment No. 1 to Rights Agreement dated December 27,
                   2002 between the Company and EquiServe Trust Company, N.A.

        10.1.1(2)  Securities Purchase Agreement dated May 23, 2000 among the
                   Company, Perseus Capital, L.L.C., DQE Enterprises, Inc.,
                   Micro-Generation Technology Fund, L.L.C., Mechanical
                   Technology Incorporated, GE Capital Equity Investments, Inc.,
                   The Beacon Group Energy Investment Fund II, L.P. and Penske
                   Corporation.

        10.1.2(2)  Warrant of the Company dated August 2, 2000 issued to
                   Kaufman-Peters Company.

        10.1.3(2)  Warrant of the Company dated October 24, 2000 issued to GE
                   Capital Equity Investments, Inc.

        10.1.4(2)  Second Amended and Restated 1998 Stock Incentive Plan of the
                   Company.

        10.1.5(2)  Form of Incentive Stock Option Agreement of the Company.

        10.1.6(2)  Form of Non-Qualified Stock Option Agreement of the Company.

        10.1.7(2)  Form of Non-Qualified Stock Option Agreement of the Company
                   issued to certain consultants on July 24, 2000 and list of
                   holders thereof.

        10.1.8(2)  Amended and Restated License Agreement dated October 23, 1998
                   between the Company and SatCon Technology Corporation.

        10.1.9(2)  Lease dated July 14, 2000 between the Company and BCIA New
                   England Holdings LLC.

       10.1.10(2)  Letter Agreement dated October 24, 2000 among the Company, GE
                   Capital Equity Investments, Inc. and GE Corporate Research
                   and Development.

         10.1.11+  Form of Director and Officer Indemnification Agreement of
                   the Company.

       10.1.12(5)  Employment Agreement dated April 25, 2004 between the Company
                   and Matthew L. Lazarewicz.

       10.1.13(4)  Employment Agreement dated October 25, 2002 between the
                   Company and James M. Spiezio.

       10.1.14(6)  Form of Restricted Stock Unit Agreement of the Company.

       10.1.15(7)  Agreement dated January 31, 2005 between the Company and the
                   New York State Energy Research and Development Authority.

       10.1.16(8)  Agreement dated January 31, 2005 between the Company and
                   California State Energy Resources Conservation and
                   Development Commission.

       10.1.17(5)  Amendment to Employment Agreement dated ___________ between
                   the Company and Matthew L. Lazarewicz.

      10.1.19 (1)  Form of NxtPhase Shareholder Agreement.

      10.1.20 (1)  Investment Agreement dated as of April 22, 2005 among the
                   Company, Perseus Capital, L.L.C. and Perseus 2000 Expansion
                   Fund, L.L.C.

      10.1.21 (9)  Warrant of the Company dated May 24, 2005 issued to Perseus
                   2000 Expansion Fund, L.L.C.

      10.1.22 (9)  Amended and Restated Warrant of the Company dated May 24,
                   2005 issued to Perseus Capital, L.L.C.

      10.1.23 (9)  Registration Rights Agreement dated May 24, 2005 between the
                   Company and Perseus 2000 Expansion Fund, L.L.C.

     10.1.24 (10)  Securities Purchase Agreement between NxtPhase T&D
                   Corporation, the Company and Perseus 2000 Expansion, L.L.C.,
                   dated as of June 13, 2005

     10.1.25 (10)  Joinder Agreement for the Investor Rights Agreement executed
                   by the Company on June 13, 2005

     10.1.26 (10)  Warrant issued by the Company to Perseus 2000 Expansion,
                   L.L.C. on June 13, 2005

     10.1.27 (11)  Securities Purchase Agreement between NxtPhase T&D
                   Corporation, the Company and Perseus 2000 Expansion, L.L.C.,
                   dated as of July 21, 2005

     10.1.28 (11)  Warrant issued by the Company to Perseus 2000 Expansion,
                   L.L.C. on July 21, 2005.

     31.1+         Principal Executive Officer--Certification pursuant to
                   Section 302 of the Sarbanes-Oxley Act of 2002.

     31.2+         Principal Financial Officer--Certification pursuant to
                   Section 302 of the Sarbanes-Oxley Act of 2002.

     32.1+         Principal Executive Officer--Certification pursuant to
                   Section 906 of the Sarbanes-Oxley Act of 2002.

     32.2+         Principal Financial Officer--Certification pursuant to
                   Section 906 of the Sarbanes-Oxley Act of 2002

Incorporated by reference from:
(1)      Form 8-K filed on April 25, 2005 (File No. 001-16171).
(2)      Form S-1 filed on November 16, 2000 (File No. 333-43386).
(3)      Form 8-K filed on October 4, 2002 (File No. 001-16171).
(4)      Form 10-K filed on June 30, 2003 (File No. 001-16171).
(5)      Form 10-K filed on March 31, 2005 (File No. 001-16171).
(6)      Form 10-K/A filed on May 17, 2004 (File No. 001-16171).
(7)      Form 8-K filed on February 14, 2005 (File No. 001-16171).
(8)      Form 8-K filed on February 16, 2005 (File No. 001-16171).
(9)      Form 8-K filed on May 26, 2005 (File No. 001-16171).
(10)     Form 8-K filed on June 17, 2005 (File No. 001-16171).
(11)     Form 8-K filed on July 26, 2005 (File No. 001-16171).
+        Filed herewith.


                                   SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.

                            BEACON POWER CORPORATION

          Date:  August 12, 2005             By:  /s/ F. William Capp
                                                  -------------------
                                                  F. William Capp
                                                  President and Chief Executive
                                                  Officer


                 August 12, 2005              By: /s/ James M. Spiezio
                                                  -------------------
                                                  James M. Spiezio
                                                  Vice President of Finance,
                                                  Chief Financial Officer,
                                                  Treasurer and Secretary
                                                  Principal Financial Officer