**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

----

 

**x****      Quarterly Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934 for thequarterly period ended September 30, 2009**

 

**or**

 

**o****         Transition ReportPursuant to Section 13 or 15(d) of the Securities Exchange Act of1934 (For the transition period from        to       ).**

 

**Commission File Number: 000-31973**

 

**Beacon Power Corporation**

(Exact name of registrant as specified in its charter)

 

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

 

| **65  Middlesex Road**                    |       |       |
|-------------------------------------------|------------|------------|
| **Tyngsboro,  Massachusetts**             | ** ** | **01879**  |
| (Address of  principal executive offices) |       | (Zip code) |

 

**(978) 694-9121**

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

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

 

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

 

Thenumber of shares of the Registrant’s common stock, par value $.01 per share,outstanding as of October 31, 2009 was 129,754,901.

 

 

 

----

 

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

 
| ** **                         | ** ** | ** **                                                                                                                                                                                                             | **Page** |
|------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                               |       |
| PART I. Financial Information |       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 1.    | Financial  Statements                                                                                                                                                                                                  |     |
|                               |       |                                                                                                                                                                                                                   |     |
|                               |       | Consolidated Balance Sheets at September 30, 2009  and December 31, 2008.                                                                                                                                    | 1        |
|                               |       |                                                                                                                                                                                                                   |     |
|                               |       | Unaudited Consolidated Statements of Operations for  the three and nine months ended September 30, 2009 and 2008, and for the  period from May 8, 1997 (date of inception) through September 30,  2009. | 2        |
|                               |       |                                                                                                                                                                                                                   |     |
|                               |       | Unaudited Consolidated Statements of Cash Flows for  the three and nine months ended September 30, 2009 and 2008 and for the  period from May 8, 1997 (date of inception) through September 30,  2009.  | 3        |
|                               |       |                                                                                                                                                                                                                   |     |
|                               |       | Notes to Unaudited Consolidated Financial Statements.                                                                                                                                                                  | 5        |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.                                                                                                                           | 22       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 3.    | Quantitative  and Qualitative Disclosures about Market Risk.                                                                                                                                                           | 43       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 4.    | Controls and  Procedures.                                                                                                                                                                                              | 43       |
|                               |       |
| PART II.  Other Information   |       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 1.    | Legal Proceedings.                                                                                                                                                                                                     | 44       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 1A.   | Risk Factors.                                                                                                                                                                                                          | 44       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds.                                                                                                                                                          | 44       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 3.    | Defaults  Upon Senior Securities.                                                                                                                                                                                      | 44       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 4.    | Submission  of Matters to a Vote of Security Holders.                                                                                                                                                                  | 44       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 5.    | Other Information.                                                                                                                                                                                                     | 44       |
|                               |       |                                                                                                                                                                                                                   |     |
|                               | Item 6.    | Exhibits.                                                                                                                                                                                                              | 44       |
|                               |       |                                                                                                                                                                                                                   |
| Signatures                         |       | 46                                                                                                                                                                                                                     |

 

ii

----

 

**PART 1 — FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

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

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                   | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                   |       |                   |       |                  |       |
| Current  assets:                                                                                                                                                             |       |                   |       |                  |       |
| Cash  and cash equivalents                                                                                                                                                   |       | $                      | 4,335,289  |                  | $          | 14,357,475 |   |
| Accounts  receivable, net                                                                                                                                                    |       | 46,320                 |       | 11,840                |       |
| Unbilled  costs on contracts in progress                                                                                                                                     |       | 386,705                |       | 16,804                |       |
| Prepaid  expenses and other current assets                                                                                                                                   |       | 381,800                |       | 880,729               |       |
| Total  current assets                                                                                                                                                        |       | 5,150,114              |       | 15,266,848            |       |
| Property  and equipment, net                                                                                                                                                 |       | 24,119,619             |       | 23,027,909            |       |
| Restricted  cash                                                                                                                                                             |       | 207,552                |       | 205,020               |       |
| Deferred  financing costs and other assets                                                                                                                                   |       | 1,542,902              |       | 96,033                |       |
| Total  assets                                                                                                                                                                |       | $                      | 31,020,187 |                  | $          | 38,595,810 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                                                        |       |                   |       |                  |       |
| Accounts  payable                                                                                                                                                            |       | $                      | 1,107,711  |                  | $          | 3,825,520 |   |
| Accrued  compensation and benefits                                                                                                                                           |       | 1,613,506              |       | 1,410,038             |       |
| Other  accrued expenses                                                                                                                                                      |       | 1,588,963              |       | 3,253,407             |       |
| Advance  billings on contracts                                                                                                                                               |       | 34,727                 |       | 10,811                |       |
| Accrued  contract loss                                                                                                                                                       |       | 201,268                |       | 132,526               |       |
| Deferred  rent - current                                                                                                                                                     |       | 132,121                |       | 112,808               |       |
| Current  portion of long term debt                                                                                                                                           |       | 576,283                |       | 117,023               |       |
| Total  current liabilities                                                                                                                                                   |       | 5,254,579              |       | 8,862,133             |       |
| Long  term liabilities:                                                                                                                                                      |       |                   |       |                  |       |
| Deferred  rent - long term                                                                                                                                                   |       | 785,986                |       | 885,076               |       |
| Long  term debt, net of unamortized discount                                                                                                                                 |       | 2,811,650              |       | 3,237,061             |       |
| Total  long term liabilities                                                                                                                                                 |       | 3,597,636              |       | 4,122,137             |       |
| Commitments  and contingencies (Note 6)                                                                                                                                      |       |                   |       |                  |       |
| Stockholders’  equity:                                                                                                                                                  |       |                   |       |                  |       |
| Preferred  Stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding                                                                              |       | —                 |       | —                |       |
| Common  stock, $.01 par value; 400,000,000 shares authorized; 127,176,593 and  107,433,190 shares issued at September 30,2009 and December 31,  2008, respectively |       | 1,271,766              |       | 1,074,332             |       |
| Deferred  stock compensation                                                                                                                                                 |       | —                 |       | —                |       |
| Additional  paid-in-capital                                                                                                                                                  |       | 222,902,960            |       | 212,145,254           |       |
| Deficit  accumulated during the development stage                                                                                                                            |       | (201,293,915           | )          | (186,895,207          | )          |
| Treasury  stock, 421,692 shares at cost                                                                                                                                      |       | (712,839               | )          | (712,839              | )          |
| Total  stockholders’ equity                                                                                                                                             |       | 22,167,972             |       | 25,611,540            |       |
| Total  liabilities and stockholders’ equity                                                                                                                             |       | $                      | 31,020,187 |                  | $          | 38,595,810 |   |

 

See notes tounaudited consolidated financial statements.

 

1

----

 

**BEACONPOWER CORPORATION AND SUBSIDIARIES**

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

 
|                                        | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** **                      | ** ** | ** **  | ** **  | **Cumulative  from**     | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|---------------------------------|------------|-------------|-------------|--------------------------|------------|
|                                        | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** **                      | ** ** | ** **  | ** **  | **May 8,  1997**    | ** ** |
|                                        | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** **                      | ** ** | ** **  | ** **  | **(date  of inception)** | ** ** |
|                                        | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** | **through  September 30,** | ** ** |
|                                        | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009**                        | ** ** | **2008**    | ** **  | **2009**                 | ** ** |
| Revenue                                     |       | $                                          | 273,096    |                                      | $          | 4,390                           |       | $           | 665,736     |                     | $          | 52,782 |   | $ | 5,454,414 |   |
| Cost  of goods sold                         |       | 246,844                                    |       | 5,763                                     |       | 704,520                         |       | 9,935       |        | 5,883,784                |       |
| Gross  profit                               |       | 26,252                                     |       | (1,373                                    | )          | (38,784                         | )          | 42,847      |        | (429,370                 | )          |
| Operating  expenses:                        |       |                                       |       |                                      |       |                            |       |        |        |                     |       |
| Operations  and maintenance                 |       | 621,109                                    |       | —                                    |       | 2,167,203                       |       | —      |        | 2,167,203                |       |
| Research  and development                   |       | 1,625,910                                  |       | 3,535,096                                 |       | 5,302,613                       |       | 9,570,674   |        | 89,119,475               |       |
| Selling,  general and administrative        |       | 1,463,545                                  |       | 1,804,595                                 |       | 5,356,356                       |       | 6,108,836   |        | 63,404,962               |       |
| Loss  on contract commitments               |       | —                                     |       | —                                    |       | 132,500                         |       | 86,601      |        | 2,936,562                |       |
| Depreciation  and amortization              |       | 479,121                                    |       | 334,236                                   |       | 1,345,539                       |       | 927,455     |        | 7,101,161                |       |
| Restructuring  charges                      |       | —                                     |       | —                                    |       | —                          |       | —      |        | 2,159,280                |       |
| Loss  on impairment of assets               |       | —                                     |       | —                                    |       | —                          |       | —      |        | 4,663,916                |       |
| Total  operating expenses                   |       | 4,189,685                                  |       | 5,673,927                                 |       | 14,304,211                      |       | 16,693,566  |        | 171,552,559              |       |
| Loss  from operations                       |       | (4,163,433                                 | )          | (5,675,300                                | )          | (14,342,995                     | )          | (16,650,719 | )           | (171,981,929             | )          |
| Other  income (expense):                    |       |                                       |       |                                      |       |                            |       |        |        |                     |       |
| Interest  income                            |       | 434                                        |       | 54,234                                    |       | 12,690                          |       | 310,612     |        | 5,588,177                |       |
| Interest  expense                           |       | 77,931                                     |       | —                                    |       | (65,081                         | )          | —      |        | (1,230,236               | )          |
| Gain  on sale of investment                 |       | —                                     |       | —                                    |       | —                          |       | —      |        | 3,562,582                |       |
| Other  income (expense)                     |       | (7,013                                     | )          | 334                                       |       | (3,322                          | )          | 202         |        | (226,315                 | )          |
| Total  other income (expense), net          |       | 71,352                                     |       | 54,568                                    |       | (55,713                         | )          | 310,814     |        | 7,694,208                |       |
| Net  loss                                   |       | (4,092,081                                 | )          | (5,620,732                                | )          | (14,398,708                     | )          | (16,339,905 | )           | (164,287,721             | )          |
| Preferred  stock dividends                  |       | —                                     |       | —                                    |       | —                          |       | —      |        | (36,825,680              | )          |
| Accretion  of convertible preferred stock   |       | —                                     |       | —                                    |       | —                          |       | —      |        | (113,014                 | )          |
| Loss  to common shareholders                |       | $                                          | (4,092,081 | )                                         | $          | (5,620,732                      | )          | $           | (14,398,708 | )                        | $          | (16,339,905 | ) | $ | (201,226,415 | ) |
| Loss  per share, basic and diluted          |       | $                                          | (0.03      | )                                         | $          | (0.06                           | )          | $           | (0.12       | )                        | $          | (0.18 | ) |   |   |
| Weighted-average  common shares outstanding |       | 122,929,999                                |       | 88,754,642                                |       | 115,857,585                     |       | 88,711,837  |        |                     |       |

 

See notes to unaudited consolidated financial statements.

 

2

----

 

**BEACON POWER CORPORATION ANDSUBSIDIARIES**

**(A Development Stage Company)**

**Consolidated Statements of Cash Flows(Unaudited)**

 
|                                                                         |       |                                      | ** **  | ** **             | ** ** | **Cumulative  from**     | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|-------------|------------------------|------------|--------------------------|------------|
|                                                                         |       |                                      | ** **  | ** **             | ** ** | **May 8,  1997**    | ** ** |
|                                                                         |       |                                      | ** **  | ** **             | ** ** | **(date  of inception)** | ** ** |
|                                                                         |       |                                      | ** **  | ** **             | ** ** | **through**              | ** ** |
|                                                                         | ** ** | **Nine  months ended September 30,** | ** **  | **September 30,** | ** ** |
|                                                                         | ** ** | **2009**                                  | ** **  | **2008**               | ** ** | **2009**                 | ** ** |
| Cash  flows from operating activities:                                       |       |                                      |        |                   |       |                     |       |
| Net  loss                                                                    |       | $                                         | (14,398,708 | )                      | $          | (16,339,905              | )          | $ | (164,287,721 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                                      |        |                   |       |                     |       |
| Depreciation  and amortization                                               |       | 1,345,540                                 |        | 927,455                |       | 7,101,164                |       |
| Loss  (gain) on sale or disposal of fixed assets                             |       | 7,180                                     |        | 132                    |       | 200,258                  |       |
| Impairment  of assets, net                                                   |       | —                                    |        | —                 |       | 4,551,147                |       |
| Interest  expense relating to issuance of warrants                           |       | 33,849                                    |        | —                 |       | 414,888                  |       |
| Non-cash  charge for change in option terms                                  |       | —                                    |        | —                 |       | 346,591                  |       |
| Non-cash  charge for settlement of lawsuit                                   |       | —                                    |        | —                 |       | 821,160                  |       |
| Amortization  of deferred consulting expense, net                            |       | —                                    |        | —                 |       | 1,160,784                |       |
| Amortization  of deferred stock compensation                                 |       | —                                    |        | —                 |       | 3,699,721                |       |
| Options  and warrants issued for consulting services                         |       | —                                    |        | —                 |       | 1,585,654                |       |
| Services  and interest expense paid in preferred stock                       |       | —                                    |        | —                 |       | 11,485                   |       |
| Gain  on sale of investments                                                 |       | —                                    |        | —                 |       | (3,562,582               | )          |
| Stock-based  compensation                                                    |       | 745,462                                   |        | 1,799,652              |       | 4,712,830                |       |
| Deferred  rent                                                               |       | (79,777                                   | )           | 111,786                |       | (511,894                 | )          |
| Cash  received from landlord for build-out credit                            |       | —                                    |        | 1,430,000              |       | 1,430,000                |       |
| Changes  in operating assets and liabilities:                                |       |                                      |        |                   |       |                     |       |
| Accounts  receivable                                                         |       | (34,480                                   | )           | 334,484                |       | (46,320                  | )          |
| Unbilled  costs on government contracts                                      |       | (369,901                                  | )           | 64,002                 |       | (386,705                 | )          |
| Prepaid  expenses and other current assets                                   |       | 498,929                                   |        | (890,933               | )          | (577,494                 | )          |
| Accounts  payable                                                            |       | (2,717,809                                | )           | 1,895,822              |       | 1,107,711                |       |
| Accrued  compensation and benefits                                           |       | 203,468                                   |        | 441,645                |       | 1,613,506                |       |
| Advance  billings on contracts                                               |       | 23,916                                    |        | 4,859                  |       | 34,727                   |       |
| Accrued  interest                                                            |       | —                                    |        | —                 |       | 275,560                  |       |
| Accrued  loss on contract commitments                                        |       | 68,742                                    |        | 75,966                 |       | 201,268                  |       |
| Other  accrued expenses and current liabilities                              |       | (1,664,444                                | )           | 195,669                |       | 1,597,633                |       |
| Net  cash used in operating activities                                       |       | (16,338,033                               | )           | (9,949,366             | )          | (138,506,629             | )          |
| Cash  flows from investing activities:                                       |       |                                      |        |                   |       |                     |       |
| Purchase  of investments                                                     |       | —                                    |        | —                 |       | (1,190,352               | )          |
| Sale  of investments                                                         |       | —                                    |        | —                 |       | 4,752,934                |       |
| Restricted  cash                                                             |       | (2,532                                    | )           | 174,346                |       | (207,552                 | )          |
| Increase  in other assets                                                    |       | —                                    |        | —                 |       | (412,072                 | )          |
| Purchases  and manufacture of property and equipment                         |       | (2,434,945                                | )           | (10,137,905            | )          | (35,296,546              | )          |
| Sale  of property and equipment                                              |       | —                                    |        | —                 |       | 202,674                  |       |
| Net  cash used in investing activities                                       |       | (2,437,477                                | )           | (9,963,559             | )          | (32,150,914              | )          |
| Cash  flows from financing activities:                                       |       |                                      |        |                   |       |                     |       |
| Initial  public stock offering, net of expenses                              |       | —                                    |        | —                 |       | 49,341,537               |       |
| Stock  offerings, net of expenses                                            |       | 10,149,416                                |        | 17,204                 |       | 81,072,084               |       |
| Payment  of dividends                                                        |       | —                                    |        | —                 |       | (1,159,373               | )          |
|                                                                              |            |                                           |             |                        |            |                          |            |  |  |  |

 

3

----

 
|                                                 |       |                                      | ** ** | ** **             | ** ** | **Cumulative  from**     | ** ** |
|------------------------------------------------------|------------|-------------------------------------------|------------|------------------------|------------|--------------------------|------------|
|                                                 |       |                                      | ** ** | ** **             | ** ** | **May 8,  1997**    | ** ** |
|                                                 |       |                                      | ** ** | ** **             | ** ** | **(date  of inception)** | ** ** |
|                                                 |       |                                      | ** ** | ** **             | ** ** | **through**              | ** ** |
|                                                 | ** ** | **Nine  months ended September 30,** | ** ** | **September 30,** | ** ** |
|                                                 | ** ** | **2009**                                  | ** ** | **2008**               | ** ** | **2009**                 | ** ** |
| Shares  issued under employee stock purchase plan    |       | 60,262                                    |       | 41,197                 |       | 336,083                  |       |
| Exercise  of employee stock options                  |       | —                                    |       | 15,182                 |       | 2,304,091                |       |
| Issuance  of debt                                    |       | —                                    |       | —                 |       | 3,571,993                |       |
| Warrants  issued in relation to lease                |       | —                                    |       | —                 |       | 716,614                  |       |
| Cash  paid for financing costs and other assets      |       | (1,456,354                                | )          | —                 |       | (1,459,502               | )          |
| Issuance  of preferred stock                         |       | —                                    |       | —                 |       | 32,868,028               |       |
| Repayment  of subscription receivable                |       | —                                    |       | —                 |       | 5,000,000                |       |
| Proceeds  from capital leases                        |       | —                                    |       | —                 |       | 495,851                  |       |
| Repayment  of capital leases                         |       | —                                    |       | —                 |       | (1,031,395               | )          |
| Repurchase  company stock                            |       | —                                    |       | —                 |       | (613,179                 | )          |
| Proceeds  from notes payable issued to investors     |       | —                                    |       | —                 |       | 3,550,000                |       |
| Net  cash provided by (used in) financing activities |       | 8,753,324                                 |       | 73,583                 |       | 174,992,832              |       |
| (Decrease)  increase in cash and cash equivalents    |       | (10,022,186                               | )          | (19,839,342            | )          | 4,335,289                |       |
| Cash  and cash equivalents, beginning of period      |       | 14,357,475                                |       | 30,417,095             |       | —                   |       |
| Cash  and cash equivalents, end of period            |       | $                                         | 4,335,289  |                   | $          | 10,577,753               |       | $ | 4,335,289 |   |
| Supplemental  disclosure of cash flow information:   |       |                                      |       |                   |       |                     |       |
| Cash  paid for interest                              |       | $                                         | 176,070    |                   | $          | —                   |       | $ | 723,490 |   |
| Cash  paid for taxes                                 |       | $                                         | —     |                   | $          | —                   |       | $ | 32,750 |   |
| Assets  acquired through capital lease               |       | $                                         | —     |                   | $          | —                   |       | $ | 535,445 |   |
| Warrants  issued in relation to loan (non-cash)      |       | $                                         | —     |                   | $          | 227,946                  |       | $ | 227,946 |   |

 

See notes to unaudited consolidated financial statements.

 

4

----

 

**BEACON POWER CORPORATION ANDSUBSIDIARIES**

**(A Development Stage Company)**

**Notes to Unaudited ConsolidatedFinancial Statements**

**September 30, 2009**

 

**Note1.  Nature of Business and Operations**

 

*Natureof Business*

 

Beacon PowerCorporation (the “Company”, “Beacon”, “we”, “our”, or “us”) (a developmentstage company) was incorporated on May 8, 1997.  Since our inception,we have been primarily engaged in the development of flywheel devices forstoring and transmitting kinetic energy.  We have experienced net lossessince our inception and, as of September 30, 2009, had an accumulateddeficit of approximately $201.3 million. We are generating revenues from the provision of frequency regulationservices to the grid. We expect increased revenues in the future from thecontinued deployment and commercialization of our flywheel energy storagesystems. Because we have not yet generated a significant amount of revenuefrom our principal operations, we are accounted for as a development stagecompany under the Financial Accounting Standards Board’s Accounting StandardsCodification (ASC) Topic 915.

 

In February 2009,we entered into a Stock Purchase Agreement with an investor, Seaside 88, LP,(“Seaside”), which was amended on June 19, 2009. Under the terms of therevised agreement, Seaside will buy 1,500,000 shares of our stock twice permonth at discount of 14% from the 10-day volume weighted average market price,up to an aggregate purchase price of $18,000,000.  (See Note 8 for additional information.)During 2000, we completed an initial public offering of our common stock andraised approximately $49.3 million, net of offering expenses.  Since 2000, we have raised approximately$82.8 million, net of expenses, through the sale of common stock and warrants,including the sale of stock to Seaside during February through October 20,2009.

 

On July 2,2009 we announced the conditional commitment by the Department of Energy (DOE)for a loan guarantee of approximately $43 million. The loan, which would befunded by the U.S. Treasury’s Federal Financing Bank, is expected to providedebt financing for 62.5% of the estimated $69 million total project cost of ourplanned 20 megawatt (MW) plant in Stephentown, New York. We expect to completethe 20 MW facility in Stephentown, New York, within 12 to 18 months from thedate we obtain the first disbursement of funds available from the loanguaranteed by the DOE. Our equity contribution to the project is expected to be$26 million.

 

*Operations*

 

Our focus is todesign, manufacture and operate flywheel-based energy storage systems thatprovide frequency regulation and other highly reliable energy solutions for theworldwide electricity grid at competitive costs. We also plan to sellindividual and large-scale systems outright or on a fractional basis. As weexpand our flywheel production and continue to lower system costs, we believewe will be able to market other cost-effective applications for our flywheelsystems that will further expand our revenues.

 

Our principalmarket focus is on the geographic regions of the domestic grid that provideopen bid markets for regulation services. These regions and their IndependentSystem Operator (ISO) or Regional Transmission Operator (RTO) designations are:New England (ISO New England or ISO-NE); California (California ISO or CAISO);New York (New York ISO or NYISO); Mid-Atlantic (PJM Interconnection); andMidwest (Midwest ISO or MISO).  Eventhough the RTO in Texas (Electric Reliability Council of Texas or ERCOT) is anopen bid market, it is not regulated by the Federal Energy RegulatoryCommission (FERC). Consequently, we are not able to encourage beneficial marketrule changes there by leveraging FERC Order No. 890. This Order wasintended to promote greater competition in electricity markets, in part byallowing non-generation resources (i.e., generators other than fossilfuel-based or hydroelectric generators) to bid and sell into frequencyregulation markets and be compensated on equal terms with traditionalgeneration resources. As a result, we are focusing on the FERC-regulated openbid markets first and will begin to work on entry into ERCOT once we areoperating in the other markets.

 

To execute our businessplan and continue as a going concern will require substantial additionalinflows of capital from equity and/or project financing and/or other sources tobuild regulation facilities and support operations at our Tyngsboro and otherfacilities. Until the U.S. Department of Energy (DOE) loan is closed anddisbursements begin, we will not make substantial expenditures for constructionof the Stephentown facility.  Apart fromsuch expenditures, we will have sufficient cash to fund operations into 2010based on continuing funding from Seaside. We expect to complete the 20 MW facility in Stephentown, New York,within 12 to 18 months from the date we obtain the first disbursement of fundsavailable from the loan guaranteed by the DOE. 

 

5

----

 

The loan is expected toprovide debt financing for 62.5%, or $43 million, of the estimated $69 milliontotal project cost. Approximately $50 million of this total cost is directequipment and facility costs. The remainder includes substantial contingency,legal, due diligence, consulting and administrative costs.  We expect similar facilities to involvesomewhat lower project costs than the Stephentown project costs, because someof the Stephentown costs are either unique to the DOE loan guarantee process orare greater than we expect to apply to subsequent similar facilities.  Of the $26 million not financed by the loan,we have already incurred approximately $13 million in eligible projectexpenditures which will be considered part of our equity contribution to theproject.  A significant portion of thisin-kind contribution will come from the redeployment of 2 MW or more of energystorage from Tyngsboro to the Stephentown site as well as from componentscurrently in construction in progress (CIP). We are exploring fundingalternatives for the remaining $13 million, including a direct equityinvestment by one or more third parties in the New York regulation plant and/orthe sale of our stock.

 

We donot expect to become profitable or have positive cash flow from operations untilat least 2012. Through October 20, 2009, we have raised approximately$11.9 million of net proceeds from the sale of stock to Seaside. We haveelected to exercise our option under the Seaside stock purchase agreement toextend the semi-monthly closings through the scheduled January 5, 2010closing date. Our business plan for 2009 includes closing the loan guaranteedby the DOE, beginning site work at our Stephentown, NY facility as well asreleasing procurement of materials and manufacturing of flywheels for thatsite.  Our business plan for 2010includes the construction of the Stephentown 20 MW facility, installation ofmost of its flywheel systems, and the start of work on a second 20 MW facility.In order to execute our business plans for the remainder of 2009 and 2010, inaddition to the loan guaranteed by the DOE, we will require funding as follows:

 

·                  an estimated$15 million to complete due diligence and provide the required equity portionof the project finance needed for the Stephentown plant.  The equity contribution is a closingrequirement of the loan to be guaranteed by the DOE.

 

·                  an estimated$23 million to fund ongoing operations of the parent company for the remainderof 2009 and all of 2010 and ramp up for the construction of frequencyregulation equipment for Stephentown, of which we expect to receiveapproximately $5 million from remaining closings under our existing agreementwith Seaside.

 

·                  an estimated $7 million tofund the beginning of construction of an additional 20 MW facility in thesecond half of 2010.

 

We will require additional funds from a combination of equity and projectfinance for the deployment of additional 20 MW facilities in the future.  In August 2009, we applied for two grantsfor a total of up to $46.7 million under the DOE’s Smart Grid Demonstrationprogram. If approved, each grant would be used to fund up to 50% of the cost ofour second and third 20 MW plants.  Becausethe total budget for DOE frequency regulation grants is $45 to $50 million, andother companies may have applied for the same grants, there can be no assurancethat either or both of our grant applications will be approved, or if approved,that any such grants will be in the amounts we applied for.

 

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

 

**Basis ofPresentation**

 

The accompanyingunaudited consolidated financial statements have been prepared using accountingprinciples generally accepted in the United States of America except thatcertain information and footnote disclosures normally included in consolidatedfinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted in this Form 10-Q.  We suggestthat the consolidated financial statements presented herein be read inconjunction with our consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2008.  In our management’s opinion, all adjustments consisting of normalrecurring accruals considered necessary for a fair presentation have beenincluded in the accompanying unaudited financial statements.  Operatingresults for the nine months ended September 30, 2009 are not necessarilyindicative of the results that may be expected for the full year ending December 31,2009.

 

*GoingConcern*

 

The accompanyingconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business.  As shown in ourconsolidated financial statements, since our inception, we have had minimalrevenues and incurred losses of approximately $201.3 million, including lossesof approximately $14.4 million during the nine months ending September 30,2009. We had approximately $4.3 million of cash and cash equivalents on hand atSeptember 30, 2009, and have raised an additional $1.8 million in cashsubsequent to the end of the quarter through the sale of stock to Seasidethrough October 20, 2009.  In addition, in October 2009, we madea final draw down of approximately $1.0 million under our existing debtfacility with the Massachusetts Development Finance Agency for 

 

6

----

 

qualified capitalequipment purchases for our Tyngsboro, Massachusetts facility.  Since our operating cash requirements farexceed any cash generated from operations, we may be unable to continue as agoing concern.  The consolidated financial statements contained herein donot include any adjustments relating to the recoverability and classificationof liabilities that might be necessary should we be unable to continue as a goingconcern.

 

Werecognize that our continuation as a going concern is dependent upon ourability to generate sufficient cash flow to allow us to satisfy our obligationson a timely basis.  The generation of sufficient cash flow is dependent inthe short term on our ability to obtain additional equity and debt financing,and in the long term, on the successful commercialization of our Smart EnergyMatrixTM. We believe that the achievement of these initiatives should provide uswith sufficient resources to meet our long-term cash requirements.  In addition we are also considering a numberof other strategic financing alternatives; however, no assurance can be madewith respect to the success of these efforts or the viability of our company.

 

*Reclassificationof prior period amounts*

 

Certain prior period amounts have been reclassified to be consistentwith current period reporting.

 

*Consolidation*

 

The accompanyingconsolidated financial statements include the accounts of Beacon PowerCorporation and our subsidiary, Beacon Power Securities Corporation. In September 2008,we established two wholly-owned subsidiaries, Tyngsboro Regulation Services LLCand Tyngsboro Holding LLC.  In July 2009, we established twoadditional wholly-owned subsidiaries, Stephentown Holding LLC and StephentownRegulation Services, LLC. As of September 30, 2009, these entities remaininactive. The frequency regulation service revenue and costs from the ISO-NEpilot program are accounted for as part of Beacon Power Corporation. Allsignificant inter-company accounts and transactions have been eliminated inconsolidation.

 

*Lossper Share — Basic and Diluted*

 

Basic and dilutedlosses per share have been computed using the weighted-average number of sharesof common stock outstanding during each period. Warrants, options and othersecurities exercisable for common shares are used in the calculation of fullydiluted earnings per share (EPS) only if their conversion to common shareswould decrease income or increase loss per share from continuing operations. Since the three- and nine-month periods ended September 30, 2009, and2008, reflect losses, including the potential conversion of warrants andoptions in the diluted EPS calculation would decrease loss per share.Accordingly, they are considered anti-dilutive and are not included in thecalculation of loss per share.

 

**Summaryof Significant Accounting Policies**

 

*Use ofEstimates*

 

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

 

*LeaseObligation and Deferred Rent*

 

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

 

7

----

 

*Property and Equipment*

 

Propertyand equipment in service is stated at cost and depreciated using thestraight-line method over the estimated useful lives of the assets. Propertyand equipment are defined as tangible items with unit costs exceeding ourcapitalization threshold that are used in the operation of the business, arenot intended for resale and which have a useful life of one year or more. Thecost of fixed assets is defined as the purchase price of the item, as well asall of the costs necessary to bring it to the condition and location necessaryfor its intended use.  These costsinclude labor, overhead, capitalized interest and, if applicable, exit costs.Exit costs for which we are obligated are accounted for in accordance with ASCTopic 410, “*Asset Retirement and Environmental Obligations*.”No overhead is generally applied for internally-constructed projects notdirectly related to our core business (e.g., leasehold improvements.) Repairand maintenance costs are expensed as incurred. Materials used in our development efforts are considered research anddevelopment materials, and are expensed as incurred in accordance with ASCTopic 730, “*Research and Development*.”

 

Capitalassets are classified as “Construction in Progress” (CIP) when initiallyacquired, and reclassified to the appropriate asset account when placed inservice, with the exception of land, which is capitalized upon purchase.Depreciation expense is not recorded on assets not yet placed into service.

 

Materialspurchased to build flywheels, power electronics and other components used inour frequency regulation installations are classified as CIP, along with therelated labor and overhead costs. Some components of the Smart Energy MatrixTM, such as the flywheels and power electronics, areconsidered “fungible” in that they can be moved and redeployed at a differentlocation.  Non-fungible costs are costswhich would not be recovered if we redeployed the matrix or portionsthereof.  In some cases, we may elect todeploy a Smart Energy MatrixTM system at a location for the purpose ofdemonstrating our technology or gaining experience operating in that particularmarket.  In these instances, the costs ofthe fungible components are capitalized, and the remaining costs, which mayinclude such costs as site preparation, interconnection costs and estimatedexit costs, are expensed.

 

*Stock-BasedCompensation*

 

We account forstock-based compensation for employees in accordance with ASC Topic 718, *“Compensation-Stock Compensation*”. Under the fair valuerecognition provision of ASC Topic 718, stock-based compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized as an expense as it is earned over the requisite service period,which is the vesting period. Non-employee stock based compensation is accountedfor in accordance with ASC Topic 505, “*Equity-BasedPayments to Non-Employees.”* In accordance with this topic, costrecognized for non-employee share-based payment transactions is determined bythe fair value of whichever is more reliably measurable: *(a)* thegoods or services received; or *(b)* theequity instruments issued.

 

*Restructuringand Asset Impairment Charges*

 

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

 

In certain instances, wemay determine that it is in the best interest of the Company to move andre-deploy all or part of a Smart Energy MatrixTM System installed at a givenlocation.  When such a determination hasbeen made, we will determine which costs are associated with the movable (fungible)components, and which costs are non-fungible. We will record a period expensefor the net book value associated with the non-fungible components.

 

No asset impairmentcharges were considered necessary for the three or nine months ended September 30,2009, or 2008.

 

*RevenueRecognition*

 

Although we have recordedrevenues for flywheel development and frequency regulation service from theISO-NE Pilot program, and sold photovoltaic inverters, our operations have notyet reached a level that would qualify us to emerge from the 

 

8

----

 

development stage.  Therefore we continue to be accounted for asa development stage company under ASC Topic 915, “*DevelopmentStage Entities*.”

 

·                  *Frequency Regulation Revenue*

 

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

 

·                  *Inverter Sales*

 

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

 

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

 

We recognize contractrevenue using the percentage-of-completion method. We use labor hours as thebasis for the percentage of completion calculation, which is measuredprincipally by the percentage of labor hours incurred to date for each contractto the estimated total labor hours for each contract at completion. Changes tototal estimated contract costs or losses, if any, are recognized in the periodin which they are determined. Changes in project performance andconditions, estimated profitability, and final contract settlements may resultin future revisions to contract costs and revenue.  Revenues recognized in excess of amountsbilled are classified as current assets, and included in “Unbilled costs oncontracts in process” on our balance sheets.  Amounts billed to clients inexcess of revenues recognized to date are classified as current liabilitiesunder “Advance billings on contracts.”  Changes in project performance andconditions, estimated profitability, and final contract settlements may resultin future revisions to construction contract costs and revenue.

 

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

 

Each quarter we perform an estimate-to-completeanalysis, and any changes to our original estimates are recognized in theperiod in which they are determined.  Inthe second quarter of 2008, we recorded a contract loss of approximately$87,000, which represents our expected “cost share” portion of the Tehachapicontract. During the first quarter of 2009, we recorded an additional contractloss on the Tehachapi contract of approximately $132,500, which represents thedifference between our overhead applied based on a “full production” rate, andthe contract bid rate.  Our contract lossreserves are as follows:

 
|                    | ** ** | **Nine  months ended September 30,** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|
|                    | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| Beginning  balance      |       | $                                         | 132,526    |   | $ | 67,419 |   |
| Charges  for the period |       | 132,500                                   |       | 86,601 |   |
| Reductions              |       | (63,758                                   | )          | (10,635 | ) |
| Ending  balance         |       | $                                         | 201,268    |   | $ | 143,385 |   |

 

*Costof Goods Sold*

 

Wevalue our products at the lower of cost or market.  Costs in excess of this measurement areexpensed in the period in which they are incurred.

 

9

----

 

Forfrequency regulation revenue, cost of goods sold represents the cost ofenergy.  From November 2008 (whenthe ISO-NE pilot program began) until late April 2009, we were billed forall of the energy stored on our flywheels, rather than for our net energyusage. Further, we were billed at a retail rate. However, since late April 2009,our energy costs have decreased substantially as we have been billed thewholesale rate for our net energy used, plus retail transmission anddistribution charges.  See furtherdiscussion in Management’s Discussion and Analysis of Financial Condition andResults of Operation.

 

Governmentcontracts are calculated on a percentage of completion basis. In the event thatexpected costs exceed total contract revenue, the excess costs are charged tocontract loss.

 

Weprovide a five-year limited product warranty for our Smart Power M-seriesinverter product line and accrue for estimated future warranty costs in theperiod in which the revenue is recognized*.*  In 2004, we established a reserve for ourSmart Power M-series inventory as a result of lower than anticipated salesvolumes.  During 2009 and 2008 wecontinue to have very limited sales from our inventory of inverter products,which we are no longer manufacturing.  Thecosts related to these sales are not fully reflected in the cost of goods soldas a result of the inventory having been reserved in a prior year.  Therefore, our cost of goods sold does notfully reflect the costs associated with these revenues.

 

**RecentlyIssued Accounting Pronouncements and Regulations**

 

In October 2009, theFASB issued Accounting Standards Update(ASU) 2009-14, “*Software (Topic 985)—CertainRevenue Arrangements That Include Software Elements,”*which changes the accountingmodel for revenue arrangements that include both tangible products and softwareelements. Under this guidance, tangible products containing software componentsand non-software components that function together to deliver the tangibleproduct’s essential functionality are excluded from the software revenueguidance in Subtopic 985-605, “*Software-RevenueRecognition.”.* In addition, hardware components of a tangibleproduct containing software components are always excluded from the softwarerevenue guidance. ASU 2009-14 will be effective for our Company prospectivelyfor revenue arrangements entered into or materially modified in fiscal yearsbeginning on or after June 15, 2010. Early adoption is permitted. In thefuture, should we sell the Smart Energy MatrixTM installations or flywheels,this standard may impact our reporting for such transactions.

 

In October 2009, the FASB issued ASU 2009-13, “*Revenue Recognition (Topic 605)—Multiple-DeliverableRevenue Arrangements,”*which addresses the accounting formultiple-deliverable arrangements to enable vendors to account for products orservices (deliverables) separately rather than as a combined unit.Specifically, this guidance amends the criteria in Subtopic 605-25, “*Revenue Recognition-Multiple-Element Arrangements,”*for separating consideration in multiple-deliverable arrangements. Thisguidance establishes a selling price hierarchy for determining the sellingprice of a deliverable, which is based on: *(a)* vendor-specificobjective evidence; *(b)* third-partyevidence; or *(c)* estimates. This guidancealso eliminates the residual method of allocation and requires that arrangementconsideration be allocated at the inception of the arrangement to alldeliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements. ASU 2009-13 will apply to usprospectively for revenue arrangements entered into or materially modified infiscal years beginning on or after June 15, 2010. Early adoption ispermitted. In the future, should we sell the Smart Energy MatrixTM installationsor flywheels, this standard may impact our reporting for such transactions.

 

**RecentlyAdopted Accounting Pronouncements and Regulations**

 

In June 2009, the FASB issued SFAS No. 168, “*The FASB Accounting Standards Codification and the Hierarchy ofGenerally Accepted Accounting Principles, a replacement of SFAS No. 162”(the Codification)*.  TheCodification will be the single source of authoritative nongovernmental U.S.accounting and reporting standards, superseding existing FASB, AICPA, EITF andrelated literature.  The Codificationeliminates the hierarchy of generally accepted accounting standards, (“GAAP”)contained in SFAS No. 162 and establishes one level of authoritativeGAAP.  All other literature is considerednon-authoritative. This Statement is effective for financial statements issuedfor interim annual periods ending after September 15, 2009, which for uswas September 30, 2009.  There wasno change to our consolidated financial statements upon adoption.  All accounting references have beenupdated.  SFAS references have beenreplaced with Accounting Standard Codification (“ASC”) references.

 

In August 2009, the FASB issuedASU 2009-05, “*Fair Value Measurements andDisclosures (Topic 820)—Measuring Liabilities at Fair Value,”*which makesamendments to Subtopic 820-10, “*Fair ValueMeasurements and Disclosures—Overall”*for the fair value measurementof liabilities and provides clarification that in circumstances in which aquoted price in an active market for the identical liability is not available,a reporting entity is required to measure fair value using one or more of thetechniques provided for in this update. Topic 820 assumes that the fair value of a financial instrument is theprice that would be 

 

10

----

 

paid to transfer aliability in an orderly transaction between market participants. However, mostliabilities have restrictions that do not allow them to be transferred and assuch there is not a market for transferring the liabilities. ASU 2009-05 statesthat in the absence of a market for the liability a company can use:

 

1.              The quoted price of the identical liability whentraded as an asset

2.              a quoted price for similar liabilities or similarliabilities when traded as assets; or

3.              another valuation technique that is consistent withthe principles of Topic 820 such as a present value technique.

 

Whenusing any of these techniques, companies are to apply all of the provisions ofTopic 820 including guidelines for assessing whether the market is active andorderly. ASU 2009-05 applies to us as of September 1, 2009.  We do not expect any significant changes toour financial accounting and reporting as a result of the issuance of ASU2009-05.

 

**Note3.  Accounts Receivable**

 

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

 
|                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|------------------------|------------|-----------------------|------------|
|                        | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Accounts  receivable, trade |       | $                      | 46,320     |                  | $          | 11,840 |   |
| Reserve                     |       | —                 |       | —                |       |
| Accounts  receivable, net   |       | $                      | 46,320     |                  | $          | 11,840 |   |

 

Some of ourresearch and development contracts contain holdback provisions that allow ourcustomers to withhold 10% from each invoice payment. Our accounts receivablebalance includes holdbacks of approximately $15,000 and $6,000 as of September 30,2009 and December 31, 2008, respectively.  These holdbacks arepayable once work has been satisfactorily completed and the final reports havebeen delivered and approved.

 

**Note4.  Property and Equipment**

 

Details of ourproperty and equipment follow:

 
|                                                | ** ** | **Estimated** | ** ** | **As  of:**            | ** ** |
|-----------------------------------------------------|------------|---------------|------------|------------------------|------------|
|                                                | ** ** | **Useful**    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|                                                | ** ** | **Lives**     | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Construction  in progress                           |       | Varied        |       | $                      | 10,328,340 |   | $ | 11,629,918 |   |
| Land                                                |       |          |       | 192,487                |       | 192,487 |   |
| Smart  Energy 25 flywheels                          |       | 20 years      |       | 4,118,290              |       | 2,009,419 |   |
| Smart  Energy MatrixTM installations - fungible |       | 20 years      |       | 907,229                |       | — |   |
| Machinery  and equipment                            |       | 5 - 10 years  |       | 2,880,838              |       | 2,600,410 |   |
| Service  vehicles                                   |       | 5 years       |       | 16,763                 |       | 16,763 |   |
| Furniture  and fixtures                             |       | 7 years       |       | 700,832                |       | 634,294 |   |
| Office  equipment and software                      |       | 3 years       |       | 1,034,443              |       | 1,028,037 |   |
| Leasehold  improvements                             |       | Lease term    |       | 7,804,607              |       | 7,572,244 |   |
| Equipment  under capital lease obligations          |       | Lease term    |       | 698,677                |       | 700,517 |   |
| Total                                               |       |          |       | $                      | 28,682,506 |   | $ | 26,384,089 |   |
| Less  accumulated depreciation and amortization     |       |          |       | (4,562,887             | )          | (3,356,180 | ) |
| Property  and equipment, net                        |       |          |       | $                      | 24,119,619 |   | $ | 23,027,909 |   |

 

11

----

 

InNovember 2008, we deployed 1 MW of capacity under the ISO-NE AlternativeEnergy Storage Technology Pilot Program (Pilot Program) with a system installedinside our Tyngsboro facility, and in July 2009, we deployed a second MWof capacity under this program, with a system installed outside our Tyngsborofacility. The Smart Energy 25 flywheels shown above represent the cost of theflywheels and electronic control modules in use for this pilot program.  In addition, the Smart Energy MatrixTMinstallations — fungible shown above represent the cost of ancillary equipment,such as chillers, installed outside our facility.  This equipment is considered fungible becauseit can be relocated to another site.

 

InJuly 2008, we purchased land in Stephentown, NY, for the construction of afrequency regulation system, the cost of which is reflected as “Land” in theschedule shown above.  On February 23,2009, we announced that we had signed a contract with American Electric Power(AEP), and one of its operating subsidiaries, Columbus Southern Power Companyto build a 1 MW Smart Energy MatrixTM regulation facility at an AEP site inGroveport, Ohio.  On August 31,2009, we purchased an option to lease land in Glenville, New York, where weexpect to build a second 20 MW facility. During the lease option period, we have agreed to negotiate in goodfaith a ground lease to be entered into upon our unilateral exercise of thelease option.  Key terms of the groundlease were substantially delineated in the executed option to the lease. Thelease option period ends on February 28, 2010, but may be extended for upto three consecutive six-month periods. In consideration for this option, we are paying the landlord anon-refundable fee of $4,550 per month.

 

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

 
|                                                                                           | ** ** | **As  of:**            | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------|------------|
|                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|                                                                                           | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Materials  to build production flywheels                                                       |       | $                      | 6,075,026  |   | $ | 6,553,828 |   |
| Smart  Energy 25 flywheels                                                                     |       | 1,331,425              |       | 2,199,164 |   |
| Smart  Energy MatrixTM in progress                                                         |       | 2,723,746              |       | 2,296,608 |   |
| Deposits  and other costs related to the acquisition of land for frequency regulation  systems |       | 15,924                 |       | — |   |
| Machinery  and equipment                                                                       |       | 182,219                |       | 302,267 |   |
| Leasehold  improvements                                                                        |       | —                 |       | 278,051 |   |
| Construction  in progress (CIP)                                                                |       | $                      | 10,328,340 |   | $ | 11,629,918 |   |

 

As of September 30, 2009, and December 31,2008, approximately $10,000,000 and $11,000,000,respectively, of the total shown as CIP represents completed flywheels,materials to build flywheels and other costs related to the Smart EnergyMatrixTM installations under construction at our Tyngsboro and Stephentownsites.  The Smart Energy MatrixTM inprogress costs included in CIP at September 30, 2009 include approximately$1,947,000 for fungible components we expect to deploy either at our site inStephentown, New York or in Groveport, Ohio, and approximately $777,000 in sitecosts related to Stephentown.  The SmartEnergy MatrixTM in progress costs included in CIP at December 31, 2008include approximately $1,912,000 for fungible components we expect to deployeither at our site in Stephentown, New York or in Groveport, Ohio, andapproximately $385,000 in site costs related to Stephentown.  The remaining costs in CIP related to variousmachinery, equipment, tooling, software and computer equipment which were notin service as of the periods reported.

 

**Note5.  Deferred Financing Costs and OtherAssets**

 

Deferred financing costs represent legal and due diligence costs incurredto obtain debt.  Such costs are amortizedover the life of the debt.  Other assetsrepresent advance payments to suppliers for custom materials used in themanufacture of our flywheels or frequency regulation facilities, and legalcosts associated with patents for which we expect to have future commercialvalue.  Patent costs are amortized overthe life of the patent to which they relate. Details of our deferred financing costs and other assets are as follows:

 

12

----

 
|                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
|                                                            | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Prepaid  financing costs associated with the DOE loan guarantee |       | $                      | 937,889    |                  | $          | — |   |
| Deferred  finance charges associated with the MassDev loan      |       | 76,591                 |       | 96,033                |       |
| Supplier  prepayments                                           |       | 475,962                |       | —                |       |
| Patents,  net of amortization                                   |       | 52,460                 |       | —                |       |
| Total                                                           |       | $                      | 1,542,902  |                  | $          | 96,033 |   |

 

**Note6.  Commitments and Contingencies**

 

The followingtable summarizes our purchase obligations and the aggregate maturities andpayments due for our contractual obligations for the five years following September 30,2009:

 
|                     | ** ** | **Description  of Commitment** | ** ** |
|--------------------------|------------|--------------------------------|------------|
|                     | ** ** | **Operating  leases**          | ** ** | **Purchase  Obligations** | ** ** | **Total** | ** ** |
| Period  ending:          |       |                           |       |   |   |   |   |
| September 30,  2009 |       | $                              | —     |   | $ | 2,613,686 |   | $ | 2,613,686 |   |
| December 31,  2009  |       | 180,250                        |       | — |   | 180,250 |   |
| December 31,  2010  |       | 727,437                        |       | — |   | 727,437 |   |
| December 31,  2011  |       | 753,188                        |       | — |   | 753,188 |   |
| December 31,  2012  |       | 778,937                        |       | — |   | 778,937 |   |
| December 31,  2013  |       | 804,689                        |       | — |   | 804,689 |   |
| December 31,  2014  |       | 618,000                        |       | — |   | 618,000 |   |
| Total  Commitments       |       | $                              | 3,862,501  |   | $ | 2,613,686 |   | $ | 6,476,187 |   |

 

At September 30,2009, we had firm purchase commitments with our suppliers to acquire componentsfor our commercial flywheel units, to begin the build-out of the Smart EnergyMatrixTM in Stephentown, and to satisfy contractual obligations for our researchand development programs in the amount of approximately $2.6 million. We havean additional $2.8 million conditional material purchase commitment to a secondsource supplier who is working to meet our qualification requirements.

 

In July 2007, wesigned a seven-year lease on our current corporate headquarters, and relocatedall of our operations to this facility in January 2008.  This facility significantly expands ourmanufacturing capacity and provides sufficient space to continue our researchand development activities. Our facility is located at 65 Middlesex Road,Tyngsboro, Massachusetts.  The103,000-square-foot facility has been renovated and built-out to ourspecifications. We believe our facility has a capacity of approximately 600flywheels per year, and with further capital spending for equipment our capacitywill increase to approximately 1,000 flywheels per year.

 

We provided ourlandlord with an irrevocable letter of credit securing our performance underthe lease with a balance at September 30, 2009 of $200,000, which isreduced periodically over the lease term.  This letter of credit issecured by a cash deposit, which is included in restricted cash in theaccompanying consolidated balance sheets. In addition to our rent payments, we are responsible for real estatetaxes and all operating expenses of the Tyngsboro facility.  Rent expense was approximately $442,000 and$438,000 during the nine months ended September 30, 2009 and 2008,respectively.

 

Additional capitalexpenditures will be required in the future to optimize the plant for maximumproduction.  The amount and timing ofthese expenditures are dependent on requirements of equipment needed to meetproduction schedules as well as having sufficient funding.

 

13

----

 

*LegalProceedings*

 

We may from timeto time be subject to legal proceedings, often likely to involve routinelitigation incidental to our business.  The outcome of any legalproceeding is not within our complete control, may often be difficult topredict and may be resolved over a very long period of time.  Estimatingprobable losses associated with any legal proceedings or other loss contingencyis very complex and requires the analysis of many factors, includingassumptions about potential actions by third parties.  A loss contingencyis recorded as a liability in the consolidated financial statements when it isboth (i) probable and known that a liability has been incurred and (ii) theamount of the loss is reasonably estimable.  If the reasonable estimate ofthe loss is a range and no amount within the range is a better estimate, theminimum amount of the range is recorded as a liability.  If a losscontingency is not probable or not reasonably estimable, a liability is notrecorded in the consolidated financial statements.

 

**Note7.  Long-Term Debt**

 

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

 
|                                                  | ** ** | **As  of:**            | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
|                                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|                                                  | ** ** | **2009**               | ** ** | **2008** | ** ** |
| 6.5%  Note Payable to MassDev, due November 2015 |       | $                      | 3,571,993  |   | $ | 3,571,993 |   |
| Less  unamortized discount (warrants)                 |       | (184,060               | )          | (217,909 | ) |
| Total                                                 |       | 3,387,933              |       | 3,354,084 |   |
| Less  current portion of long term debt               |       | (576,283               | )          | (117,023 | ) |
| Net  long-term debt                                   |       | $                      | 2,811,650  |   | $ | 3,237,061 |   |

 

On June 30, 2008, weentered into an agreement with Massachusetts Development Finance Agency(“MassDev”) pursuant to which MassDev agreed to lend to the Company up to $5million. The loan proceeds were used to help fund the expansion of ourproduction facility.

 

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

 

Payments to MassDev beganin November 2008. The payments are interest only during the first 12months and thereafter, the balance of the principal outstanding under the noteshall be amortized in equal monthly installments of principal and interest overthe remaining term of the note.Based on the amount outstanding as of September 30,2009, principal payments required under the loan over the next five years,excluding discount due to warrants, are as follows:

 
|                    | ** ** | **Amount** | ** ** |
|-------------------------|------------|------------|------------|
| Period  ending:         |       |       |       |
| December 31,  2009 |       | $          | 118,749    |   |
| December 31,  2010 |       | 494,718    |       |
| December 31,  2011 |       | 527,851    |       |
| December 31,  2012 |       | 563,202    |       |
| December 31,  2013 |       | 600,920    |       |
| December 31,  2014 |       | 641,165    |       |
| Thereafter              |       | 625,388    |       |
| Total  Payments         |       | $          | 3,571,993  |   |

 

Pursuant to the note, weentered into a security agreement which grants to MassDev an exclusive firstpriority security interest in all equipment and tenant improvements substantiallyfunded with the proceeds of the loan with an approximate carrying value of$5,314,000 and $6,135,000 at September 30, 2009, and December 31,2008, respectively. We also entered into a collateral assignment 

 

14

----

 

of lease agreement asadditional security for the repayment of borrowings.  This agreement grants MassDev all rights,title and interest in and to our lease for the Tyngsboro facility in the eventthat we default on our obligations.

 

As partial considerationfor the loan, on June 30, 2008, we issued MassDev two warrants. Eachwarrant provides for the purchase of 85,979 shares of our common stock at anexercise price of $1.89 per share, subject to any adjustments as set forth inthe warrants. The warrants are exercisable for seven years commencing on June 30,2008.  The Black-Scholes fair value ofthe warrants is shown as a discount against the loan, and is being amortizedover the life of the loan using the effective interest method at an imputedinterest rate of 1.44%.  The amortizationof this discount resulted in approximately $33,800 charged to interest expenseduring the first nine months of 2009. The effective interest rate of the loan after the final draw down,including the cost of the warrants and other deferred loan costs, isapproximately 8.5%.

 

Additional capitalexpenditures will be required in the future to optimize the plant for maximummanufacturing capacity.  The amount andtiming of these expenditures are dependent on requirements for equipment neededto meet production schedules as well as having sufficient funding.

 

**Note8.  Sale of Stock**

 

OnFebruary 19, 2009, we entered into a common stock purchase agreement withSeaside, (the “Original Agreement”) valued at up to $18 million. On June 19,2009, we entered into a first amendment (the “First Amendment”) to the stockpurchase agreement.

 

TheOriginal Agreement required Seaside to buy $1 million of common stock from usonce each month for up to 18 months, beginning on February 20, 2009, and onthe 20th day of each month thereafter (orthe next closest business day.)  Theagreement was structured in three six-month tranches, or segments, eachcovering 6 monthly closings of $1 million each. Our initial commitment was forthe first six-month tranche, but we had the option, exercisable at our solediscretion, to extend the agreement for up to two additional six-month periods,for a total of up to $18 million over the three tranches.  We paid Seaside $100,000 up front for theright to exercise the first optional extension and agreed to pay an additional$50,000 if we exercised the second such extension.  Additionally, at our sole discretion, wecould freeze the monthly transactions for up to six months by paying a fee toSeaside of $100,000.  At each monthlyclosing, the number of shares of common stock to be issued was determined byapplying a 20% discount to the volume weighted average trading price during thefive trading days preceding the closing. If in any month the five-day weighted average trading price of ourcommon stock is below $0.25, then the closing for that month will not occur andwill not be made up.  The issuance ofshares that would constitute more than 19.9% of the total shares outstanding onthe date of the agreement was subject to shareholder approval.  On June 11, 2009, our shareholdersapproved the issuance of the common stock to Seaside.

 

TheFirst Amendment requires Seaside to buy 1,500,000 shares of our common stocktwice each month at closings on the 5th day and 20th day of each month thereafter (or the nextclosest business day) at a purchase price equal to 86% of our stock’s volumeweighted average trading price over the ten trading days immediately precedingeach closing, but in no event below $0.20 per share, up to an aggregatepurchase price of $18,000,000.  The FirstAmendment clarified that the initial period of six closings under the OriginalAgreement ended at the closing scheduled for the first business day following July 5,2009, and that each subsequent period would comprise six semi-monthly closingsinstead of six monthly closings. We have elected to exercise our two options toextend the Agreement for twelve additional semi-monthly closing dates over aperiod scheduled to end with the January 5, 2010 closing date. We paidSeaside $50,000 to exercise the second option. In addition, we may, at our sole discretion, suspend the semi-monthlyclosings by making a $100,000 payment to Seaside.  We can exercise this right no more than onceduring each period.  All other terms andconditions not addressed by the First Amendment are governed by the OriginalAgreement.

 

Sales of stock to Seasideunder the Original Agreement and First Amendment through September 30,2009, are as follows:

 

15

----

 
| **Transaction date**    | ** ** | **Aggregate  value** | ** ** | **Common  Shares Sold** | ** ** | **Sale  Price  per Share** | ** ** | **Volume  Weighted  Average  Price  (VWAP)** | ** ** | **Net  Proceeds** | ** ** |
|-------------------------|------------|----------------------|------------|-------------------------|------------|----------------------------|------------|----------------------------------------------|------------|-------------------|------------|
| February 20, 2009  |       | $                    | 1,000,000  |                    | 2,656,184  |                       | $          | 0.37648                                      |       | $                 | 0.470600   |   | $ | 889,767 |   |
| March 20, 2009     |       | 1,000,000            |       | 2,896,200               |       | $                          | 0.34528    |                                         | $          | 0.431600          |       | 931,072 |   |
| April 20, 2009     |       | 1,000,000            |       | 1,912,777               |       | $                          | 0.52280    |                                         | $          | 0.653500          |       | 914,855 |   |
| May 20, 2009       |       | 1,000,000            |       | 1,647,772               |       | $                          | 0.60688    |                                         | $          | 0.758600          |       | 946,098 |   |
| June 22, 2009      |       | 1,193,895            |       | 1,500,000               |       | $                          | 0.79593    |                                         | $          | 0.925500          |       | 1,094,839 |   |
| July 6, 2009       |       | 1,118,430            |       | 1,500,000               |       | $                          | 0.74562    |                                         | $          | 0.867000          |       | 1,059,504 |   |
| July 20, 2009      |       | 932,670              |       | 1,500,000               |       | $                          | 0.62178    |                                         | $          | 0.723000          |       | 857,110 |   |
| August 5, 2009     |       | 939,255              |       | 1,500,000               |       | $                          | 0.62617    |                                         | $          | 0.728100          |       | 858,245 |   |
| August 20 2009     |       | 895,260              |       | 1,500,000               |       | $                          | 0.59684    |                                         | $          | 0.694000          |       | 815,594 |   |
| September 8, 2009  |       | 989,295              |       | 1,500,000               |       | $                          | 0.65953    |                                         | $          | 0.766900          |       | 906,608 |   |
| September 21, 2009 |       | 940,155              |       | 1,500,000               |       | $                          | 0.62677    |                                         | $          | 0.728800          |       | 864,143 |   |
| Total  Investment       |       | $                    | 11,008,960 |                    | 19,612,933 |                       |       |                                         |       |              | $          | 10,137,835 |   |

 

On October 5 and October 20,2009, Seaside purchased additional stock under this agreement, as discussed inNote 12, “Subsequent Events.” Becausethe stock was sold at a price below $1.85 per share, certain warrants issued inNovember 2005 were adjusted according to the terms of those warrants, asdiscussed in Notes 9 and 12 below.

 

**Note9.  Stock Warrants**

 

We haveoutstanding various series of warrants to purchase our common stock. Holders ofthe warrants are not entitled to receive dividends, vote, receive notice of anymeetings of stockholders or otherwise have any right as stockholders withrespect to their warrant shares. The following schedule shows warrantsoutstanding as of September 30, 2009:

 
| **Description**                                         | ** ** | **Grant  Date** | ** ** | **Expiration  Date** | ** ** | **Strike  Price** | ** ** | **Issued  and  Outstanding  As of  September 30,  2009** | ** ** |
|---------------------------------------------------------|------------|-----------------|------------|----------------------|------------|-------------------|------------|---------------------------------------------------------------|------------|
| May 24,  2005 Financing                            |       | 5/24/2005       |       | 5/25/2010            |       | $                 | 1.008      |                                                          | 800,000    |   |
| November 8,  2005 Financing (Investors)            |       | 11/8/2005       |       | 5/9/2011             |       | $                 | 1.49       |                                                          | 4,391,119  |   |
| February 15,  2007 Shelf Issue                     |       | 2/15/2007       |       | 2/15/2012            |       | $                 | 1.33       |                                                          | 6,261,786  |   |
| GFI  Tyngsboro Lease                                    |       | 7/23/2007       |       | 7/22/2014            |       | $                 | 1.77       |                                                          | 500,000    |   |
| September 10,  2007 Shelf Issue (Investors)        |       | 9/10/2007       |       | 3/11/2013            |       | $                 | 1.99       |                                                          | 6,122,449  |   |
| September 10,  2007 Shelf Issue (Placement Agents) |       | 9/10/2007       |       | 3/11/2013            |       | $                 | 1.99       |                                                          | 153,061    |   |
| October 31,  2007 Shelf Issue                      |       | 10/31/2007      |       | 5/1/2013             |       | $                 | 2.97       |                                                          | 5,431,805  |   |
| June 30,  2007 Massachusetts Development Loan      |       | 6/30/2008       |       | 6/30/2015            |       | $                 | 1.89       |                                                          | 171,958    |   |
| October 15,  2008 Shelf Issue                      |       | 10/15/2008      |       | 4/16/2014            |       | $                 | 1.20       |                                                          | 8,700,000  |   |
| December 24,  2008 Shelf Issue                     |       | 12/24/2008      |       | 6/25/2014            |       | $                 | 0.74       |                                                          | 8,966,000  |   |
| Total  warrants outstanding                             | ** ** | ** **      | ** ** | ** **           | ** ** | ** **        |       | 41,498,178                                                    |       |

 

16

----

 

The followingshows changes to the warrants outstanding from December 31, 2008, through September 30,2009:

 
| ** **                                                                                                   | ** ** | **#  Warrants** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| Warrants  outstanding as of December 31, 2008                                                           |       | 46,932,939      |       |
| 1/21/2009  Surrender of warrants issued 10/31/2007 by Quercus Trust                                          |       | (5,884,455      | )          |
| Cumulative  adjustments to 11/8/05 warrants due to Seaside pricing through  September 21, 2009 closing: |       | 449,694         |       |
| Warrants  outstanding as of September 30, 2009                                                          |       | 41,498,178      |       |

 

Warrants withactivity during the nine months ended September 30, 2009, are describedbelow:

 

*October 2007Shelf Warrants*

 

In October 2007,we sold 11,911,852 units of the Company at a purchase price of $2.10 perunit.  Each unit consisted of one shareof our common stock, par value $0.01 per share, and a warrant to purchase 0.95shares of common stock at an exercise price of $2.97 per share, for a total of11,316,260 warrants, of which 5,431,805 were outstanding as of September 30,2009. On January 29, 2009, Quercus Trust surrendered their 5,884,455warrants. The warrants became exercisable six months and one day after theirissuance, and expire May 1, 2013. The units were issued pursuant to aprospectus supplement filed with the Securities and Exchange Commission inconnection with an effective registration statement.

 

*November 2005Financing Warrants*

 

As part of afinancing transaction in November 2005, we issued warrants to purchase anaggregate of 2,960,527 shares of our common stock to ten “accreditedinvestors.” In addition, 450,000 warrants were issued to the placementagents.  The per-share exercise price forthe warrant shares was $2.21. Each investor warrant is exercisable at any timeuntil May 9, 2011.  The placementagent warrants expired on November 8, 2008.  The terms of the investor warrants includeanti-dilution provisions which require us to adjust the exercise price and thenumber of shares of our common stock to be issued upon exercise of the warrantsunder certain circumstances, which include:

 

·                  Subdivisions, stock dividends or combinations of ourcommon stock

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

·                  Reorganizations, mergers and similar transactions; and

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

 

Based on thewarrants’ anti-dilution provisions, the exercise price of these warrants wasadjusted as shown below.  Warrants issuedto the placement agent were not subject to adjustment.

 
| ** **                                    | ** ** | **# Warrants** | ** ** | **Exercise  Price** | ** ** |
|-----------------------------------------------|------------|----------------|------------|---------------------|------------|
| Original  Warrant                             |       | 2,960,527      |       | $                   | 2.21       |   |
| Adjustment  based on anti-dilution provision: |       |           |       |                |       |
| Financing  February 2007                 |       | 327,294        |       | $                   | 1.99       |   |
| Financing  October 2008                  |       | 248,808        |       | $                   | 1.85       |   |
| Financing  December 2008                 |       | 404,796        |       | $                   | 1.66       |   |
| Seaside  2/20/09 purchase                     |       | 72,542         |       | $                   | 1.63       |   |
| Seaside  3/20/09 purchase                     |       | 75,260         |       | $                   | 1.60       |   |
| Seaside  4/20/09 purchase                     |       | 51,764         |       | $                   | 1.58       |   |
| Seaside  5/20/09 purchase                     |       | 53,092         |       | $                   | 1.56       |   |
| Seaside  6/22/09 purchase                     |       | 27,063         |       | $                   | 1.55       |   |
| Seaside  7/06/09 purchase                     |       | 27,411         |       | $                   | 1.54       |   |

 

17

----

 
| ** **                | ** ** | **# Warrants** | ** ** | **Exercise  Price** | ** ** |
|---------------------------|------------|----------------|------------|---------------------|------------|
| Seaside  7/20/09 purchase |       | 27,766         |       | $                   | 1.53       |   |
| Seaside  8/5/09 purchase  |       | 28,132         |       | $                   | 1.52       |   |
| Seaside  8/20/09 purchase |       | 28,504         |       | $                   | 1.51       |   |
| Seaside  9/8/09 purchase  |       | 28,886         |       | $                   | 1.50       |   |
| Seaside  9/21/09 purchase |       | 29,274         |       | $                   | 1.49       |   |
| Adjusted  Warrant:        |       | 4,391,119      |       | $                   | 1.49       |   |

 

**Note10.  Stock-Based Compensation**

 

**Descriptionof Plans**

 

*StockOption Plan*

 

Our Third Amendedand Restated 1998 Stock Incentive Plan allows for the granting of stock optionsto purchase up to 23,000,000 shares of our common stock.  Options may begranted to our employees, officers, directors, consultants and advisors. Underthe terms of the option plan, incentive stock options (“ISOs”) are to begranted at the fair market value of our common stock at the date of grant, andnonqualified stock options (“NSOs”) are to be granted at a price determined bythe Board of Directors.  In general, the Board has authorized vestingperiods of one to three years and terms of varying length but in no case longerthan 10 years.  Our stock option program is a long-term retention programthat is intended to attract, retain and provide incentives for talentedemployees, officers and directors, and to align stockholder and employeeinterests.  We consider our option program critical to our operation andproductivity; essentially all of our employees participate.  At September 30,2009, we had 18,392,588 shares reserved for issuance under this plan, of which13,304,971 relate to outstanding options and RSUs.

 

*EmployeeStock Purchase Plan*

 

Our Employee StockPurchase Plan (the “ESPP”) allows substantially all of our employees topurchase shares of our common stock at a discount through payrolldeductions.  Participating employees may purchase our common stock at apurchase price equal to 85% of the lower of the fair market value of the commonstock at the beginning of an offering period or on the exercise date. Employees may designate up to 10% of their base compensation for the purchaseof common stock under this plan.  The ESPP provides for the purchase of upto 2,000,000 shares of our common stock.  At September 30, 2009, wehad 1,635,397 shares reserved for issuance under this plan.

 

*RestrictedStock Unit Arrangements*

 

Our Third Amendedand Restated 1998 Stock Incentive Plan permits the grant of restricted stockunits (“RSUs”) to our employees, officers, directors and other serviceproviders.  We use RSUs to (i) alignour employees’ interests with those of the Company, (ii) motivate ouremployees to achieve key product development milestones and thus createstockholder value, (iii) retain key employees by providing equity to suchemployees and (iv) conserve cash, by paying bonuses in the form of RSUs,rather than in cash, but with the number of such RSUs calculated on adiscounted basis to compensate for the reduced liquidity as compared tocash.  With respect to the RSUs that are granted in lieu of cash bonuses,the number of RSUs granted are based on performance, and are automaticallyconverted into shares of common stock in four equal tranches in the fiscal yearfollowing the year of performance. Certain other RSUs are granted to ourofficers as a form of equity incentive, are not tied to performance, and vestover a three-year period in equal quarterly installments.  There are alsoother performance-based restricted stock units (PSUs) granted to our officersthat cliff-vest upon the achievement of certain earnings-based milestones andupon the Company achieving a level of revenue such that it is no longer treatedas a development stage company for accounting purposes, both such vestingevents subject to the recipient officer being employed by us during the periodending with the milestones. The unvested portion of any RSU or PSU grant issubject to forfeiture upon the holder’s resignation or termination forcause.  As of September 30, 2009,certain RSUs granted under the officer employment agreements were vested butstock was not issued because the trading window was closed to insiders as ofthe respective vesting dates.

 

Restricted stockunit activity as of December 31, 2008 and for the nine months ended September 30,2009 is as follows:

 

18

----

 
|                                                  | ** ** | **Nine  months ended  September 30,** | ** ** | **Year  ended  December 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------|------------|
|                                                  | ** ** | **2009**                                   | ** ** | **2008**                           | ** ** |
|                                                  | * *   | **(number of shares)**                     | ** ** |
| Shares  issued related to vested RSUs:                |       |                                       |       |                               |       |
| Based  on prior year grants                           |       | 35,644                                     |       | 38,084                             |       |
| Based  upon current year executive officer agreements |       | 11,280                                     |       | 14,094                             |       |
|                                                  |       |                                       |       |                               |       |
| Vested  RSUs not yet converted to stock*              |       | 16,348                                     |       | 14,228                             |       |
|                                                  |       |                                       |       |                               |       |
| RSU’s  granted but not vested:                   |       |                                       |       |                               |       |
| Related  to 2007 executive officer agreement          |       | 6,038                                      |       | 24,068                             |       |
| Related  to 2008 executive officer agreement          |       | 23,508                                     |       | 37,602                             |       |
| Related  to 2009 executive officer agreement          |       | 50,753                                     |       | —                             |       |
| Related  to performance-based executive plan**        |       | 1,265,823                                  |       | 1,265,823                          |       |

 

----

*                 RSUs vesting December 31, 2008 were issued on March 10,2009.

 

**          Vesting of the performance-based RSUs (PSUs) issubject to the achievement of performance requirements. Based on our businessplan as of December 2008, which slows the deployment of frequencyregulation installations due primarily to the tightening of credit markets, ourexecutive management does not believe that it is probable that the award willbe earned.  Accordingly, the cumulativecompensation expense recorded as of December 31, 2008, was reversed duringthat period, and no compensation expense was recorded for these PSUs for thenine months ended September 30, 2009.

 

**StockOption Plan Schedules**

 

Stock optionactivity for the first nine months of 2009 was as follows:

 
|                                  | ** ** | ** **     | ** ** | **Weighted-** | ** ** | **Weighted-**  | ** ** |
|---------------------------------------|------------|----------------|------------|---------------|------------|----------------|------------|
|                                  | ** ** | ** **     | ** ** | **Average**   | ** ** | **Average**    | ** ** |
|                                  | ** ** | **Number  of** | ** ** | **Exercise**  | ** ** | **Fair**       | ** ** |
|                                  | ** ** | **Shares**     | ** ** | **Price**     | ** ** | **Value  (1)** | ** ** |
| Outstanding,  December 31, 2008  |       | 11,338,470     |       | $             | 1.18       |           |       |   |
| Granted                               |       | 629,364        |       | $             | 0.50       |           | $          | 0.25 |   |
| Exercised                             |       | —         |       | $             | —     |           |       |   |
| Canceled,  forfeited or expired       |       | (25,333        | )          | $             | (0.89      | )              |       |   |
| Outstanding,  September 30, 2009 |       | 11,942,501     |       | $             | 1.14       |           |       |   |
|                                       |            |                |            |               |            |                |            |  |  |

 

19

----

 

The following tablesummarizes information about stock options outstanding at September 30,2009:

 
| ** **     | ** ** | ** **      | ** ** | **Weighted-**     | ** ** | ** **    |       |            | ** ** | **Vested**    | ** ** |
|----------------|------------|-----------------|------------|-------------------|------------|---------------|------------|-----------------|------------|---------------|------------|
| ** **     | ** ** | ** **      | ** ** | **Average**       | ** ** | **Weighted-** | ** ** | ** **      | ** ** | **Weighted-** | ** ** |
| ** **     | ** ** | **Number**      | ** ** | **Remaining**     | ** ** | **Average**   | ** ** | **Number**      | ** ** | **Average**   | ** ** |
| **Exercise**   | ** ** | **of  Options** | ** ** | **Contractual**   | ** ** | **Exercise**  | ** ** | **of  Options** | ** ** | **Exercise**  | ** ** |
| **Price**      | ** ** | **Outstanding** | ** ** | **Life  (Years)** | ** ** | **Price**     | ** ** | **Vested**      | ** ** | **Price**     | ** ** |
| $0.26  - $0.74 |       | 4,162,597       |       | 5.86              |       | $             | 0.66       |            | 3,605,046  |          | $          | 0.68 |   |
| $0.80  - $1.46 |       | 5,787,184       |       | 6.60              |       | $             | 1.06       |            | 4,397,078  |          | $          | 1.01 |   |
| $1.51  - $2.19 |       | 1,535,470       |       | 5.99              |       | $             | 1.82       |            | 1,484,295  |          | $          | 1.82 |   |
| $2.50  - $3.10 |       | 130,000         |       | 0.60              |       | $             | 2.64       |            | 130,000    |          | $          | 2.64 |   |
| $4.10  - $5.27 |       | 222,250         |       | 1.41              |       | $             | 4.40       |            | 222,250    |          | $          | 4.40 |   |
| $6.00  - $9.31 |       | 105,000         |       | 1.06              |       | $             | 6.40       |            | 105,000    |          | $          | 6.40 |   |
| Total          |       | 11,942,501      |       |              |       |          |       | 9,943,669       |       |          |       |

 

**StockCompensation**

 

We account for our stockcompensation in accordance with ASC Topic 718. We use the Black-Scholes optionpricing model to determine the fair value of stock options and employee stockpurchase plan shares. The valuations determined using this model are affectedby our stock price as well as assumptions we make regarding a number of complexand subjective variables, including our stock price volatility, expected lifeof the option, risk-free interest rate and expected dividends, if any.

 

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

 

Restricted stock units(RSUs) are valued at the stock price at date of grant, and expensed ratablyover the performance period or vesting period, as appropriate.  The numberof PSUs for which stock compensation expense is calculated is based uponmanagement’s assessment of the likelihood of achieving the performance targets.

 

During the firstquarter of 2009, 20,000 options were granted to a consultant.  Half of these options vested on May 5,2009, and the remainder were scheduled to vest on November 5, 2009,subject to the consultant’s continued service to the Company.  In accordance with ASC Topic 505-50, “*Equity-Based Payments to Non-Employees*,” the measurementdates for these options has been determined to be the vesting dates.  The consultant’s services were terminated asof the end of June 2009. The non-vested options were forfeited as of thetermination date.  Under the terms of theoption agreement, the consultant had three months from the termination date toexercise his vested options.  They werenot exercised within that time, consequently the options were forfeited. Theoptions vesting in May 2009 were valued with a life of .75 years (9months), using an effective interest rate that corresponds to U.S. Treasuryinstruments with a similar maturity.

 
|                                                                                      | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                                                                      | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Risk-free  interest rate                                                                  |       | NA                                         |       | 2.01% - 2.90%                             |       | 0.34% - 1.36% |   | 2.01% - 3.33% |   |
| Expected  life of option                                                                  |       | NA                                         |       | 3.5 years                                 |       | .75 - 3.5 years |   | 3.5 years |   |
| Expected  dividend payment rate, as a percentage of the stock price on the date of  grant |       | NA                                         |       | 0%                                        |       | 0% |   | 0% |   |
| Assumed  volatility                                                                       |       | NA                                         |       | 88% - 91%                                 |       | 77% - 90% |   | 87% - 98% |   |
| Expected  forfeitures                                                                     |       | NA                                         |       | 10%                                       |       | 8.3% |   | 10% |   |

 

20

----

 

Stock-based compensationexpense recognized on our consolidated statement of operations for the threeand nine months ended September 30, 2009, and 2008, are as follows:

 
|                                           | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                           | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Operations  and maintenance                    |       | $                                          | 25,424     |                                      | $          | — |   | $ | 89,536 |   | $ | — |   |
| Research  and development                      |       | 73,675                                     |       | 232,350                                   |       | 283,062 |   | 863,913 |   |
| Selling,  general and administrative           |       | 81,640                                     |       | 247,739                                   |       | 372,864 |   | 935,739 |   |
| Total  stock compensation expense              |       | $                                          | 180,739    |                                      | $          | 480,089 |   | $ | 745,462 |   | $ | 1,799,652 |   |
|                                           |       |                                       |       |                                      |       |   |   |   |   |
| Components  of stock compensation expense:     |       |                                       |       |                                      |       |   |   |   |   |
| Compensation  expense related to RSUs          |       | $                                          | 9,200      |                                      | $          | 150,225 |   | $ | 37,925 |   | $ | 466,970 |   |
| Compensation  expense related to stock options |       | 171,539                                    |       | 329,864                                   |       | 707,537 |   | 1,332,682 |   |
| Total  stock compensation expense              |       | $                                          | 180,739    |                                      | $          | 480,089 |   | $ | 745,462 |   | $ | 1,799,652 |   |

 

As of September 30,2009, there was approximately $399,000 of unrecognized compensation cost,adjusted for estimated forfeitures, related to unvested stock-based paymentsgranted to our employees and directors. Total unrecognized compensation costwill be adjusted for future changes in estimated forfeitures and recognizedover the remaining vesting periods of the stock option grants.

 

**Note 11.****PotentialDelisting of the Company’s Stock**

 

On September 16,2009, we received a letter from the Nasdaq Stock Market indicating that for thelast 30 consecutive business days, the bid price of our common stock hadclosed below the minimum $1.00 per share requirement for continued inclusion onthe Nasdaq Stock Market based on Marketplace Rule 5550(a)(2). Inaccordance with Marketplace Rule 5810(c)(3)(A), we have been provided180 calendar days, or until March 15, 2010, to regain compliance. Ifat any time before March 15, 2010 our common stock has a closing bid priceof $1.00 or more for a minimum of 10 consecutive business days, the NasdaqStock Market Staff will notify us that we comply with Rule 5550(a)(2) In the event we do not regain compliance with the Rule prior to theexpiration of the grace period, we may be eligible for an additional graceperiod if we meet the initial listing standards, with the exception of the bidprice, for the Nasdaq Capital Market.  Ifwe meet the initial listing criteria, we may be granted an additional 180 daycompliance period.

 

**Note12.  Subsequent Events**

 

Subsequent events have been evaluated through November 3, 2009, whichis the date the financial statements were issued.

 

On October 13, 2009,we drew down approximately $1 million from MassDev under the June 30,2008, loan agreement.  The loan proceedswere used to purchase some of the machinery and equipment needed to expand ourproduction capability.  This represented the final draw-down under theMassDev agreement.

 

On each of October 5and October 20, 2009, we sold Seaside 1,500,000 shares of Common Stock(3,000,000 shares total) for a purchase price of $0.61705 and $0.62797 pershare, respectively (calculated based upon a 14% discount to the volumeweighted average market price of $0.7175 and $0.7302 per share, respectively,over a period of 10 days prior to the sale to Seaside). From February 2009through October 20, 2009, Seaside has purchased a total of 22,612,933shares at a total price of approximately $12.9 million.

 

Because the stock was sold at a price below $1.85 per share, certainwarrants issued in November 2005 were adjusted according to the terms ofthose warrants.  The October 5 and October 20, 2009,stock sales to Seaside resulted in anincrease in the number of shares exercisable for the November 2005warrants of 59,741, and an adjusted exercise price as of October 20,2009 of $1.47.

 

21

----

 

**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

**NoteRegarding Forward Looking Statements**

 

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

 

**CriticalAccounting Policies and Estimates**

 

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

 

*Loss onResearch and Development Contract Commitments*

 

We establish reservesfor anticipated losses on contract commitments if, based on our cost estimatesto complete the commitment, we determine that the cost to complete the contractwill exceed the total expected contract revenue.  Most of our contracts have been granted on acost-share basis, for which the expected cost-share is recorded as a contractloss. The U.S. Naval Sea Systems Command (NAVSEA) contract, however, has beengranted on a cost-plus-fixed-fee basis. Each quarter, we perform an evaluation of expected costs to complete ourin-progress contracts and adjust the contract loss reserve accordingly.

 

Our engineeringand manufacturing overhead rates are based upon direct labor hours, and thusare sensitive to changes in capacity or headcount. Cost estimates for ourcontracts are also subject to change based upon the number of hours required tocomplete the project as well as the cost of direct materials, contract-relatedtravel and outside services such as consultants.

 

Our contractshistorically have been completed over multiple fiscal periods, and a reservefor contract losses is recorded at the point when we estimate that such a lossmay occur.  Although the allocation ofoverhead to a fixed-price contract does not impact the Company’s total costs orloss from operations, it may result in such costs being recognized in anearlier period than when the costs are actually incurred. Moreover, since ourcurrent production levels are significantly lower than those used in our“full-capacity” overhead rate, our forecasted costs are based upon subjectiveestimates and management judgment, and actual results may differsignificantly.  However, the two fixedprice contracts that we are currently working on are relatively small, and theimpact of our estimates and assumptions relative to these contracts are notexpected to have a material impact on our financial condition or operatingperformance.

 

*Fixed Assets*

 

Propertyand equipment in service is stated at cost and depreciated using thestraight-line method over the estimated useful lives of the assets. Propertyand equipment are defined as tangible items with unit costs exceeding ourcapitalization threshold that are used in the operation of the business, arenot intended for resale and which have a useful life of one year or more. Thecost of fixed assets is defined as the purchase price of the item, as well asall of the costs necessary to bring it to the condition and location necessaryfor its intended use.  These costsinclude material, labor, overhead, capitalized interest and, if applicable,exit costs. Exit costs for which we are obligated are accounted for inaccordance with ASC 410, “*Asset Retirement andEnvironmental*

 

22

----

 

*Obligations*.” Nooverhead is generally applied for internally-constructed projects not directlyrelated to our core business (e.g., leasehold improvements). Repair andmaintenance costs are expensed as incurred. Materials used in our development efforts are considered research anddevelopment materials, and are expensed as incurred in accordance with ASC 730,“*Research and Development*.”

 

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

 

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

 

*Impairmentof Long-Lived Assets*

 

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

 

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

 

As of September 30,2009, in order to determine whether or not the current inventory of flywheels andrelated equipment on hand is impaired, we reviewed the current status of ourStephentown project, and noted the following:

 

 

·                  The first 20 MW installation, planned for Stephentown,NY, is expected to cost approximately $69 million, which includes substantialcontingency, legal, consulting and administrative costs. Some of these costsare either unique to the DOE loan guarantee process, or are greater than weexpect to apply to subsequent similar facilities. All of these costs areeligible project expenses under the loan program rules.

 

·                  The second 20 MW installation is expected to costapproximately 35% less than the first 20 MW plant.  Cost reductions for the second plant areexpected to occur due to savings from

 

·                  Reduced legal, consulting andadministrative costs

·                  Volume supplier agreements, and

·                  Production and construction optimization.

 

 

·                  The location for the first 20 MW installation will bein the NYISO region.  This is currentlythe most attractive market for regulation services. Historically, it hasoffered attractive frequency regulation clearing prices and is expected toprovide us with a control signal that is well-suited to our type of energystorage-based regulation resource.

 

·                  We performed cash flow testing based upon a variety ofscenarios, using historical 24-month average day-ahead and real-time clearingprices for regulation in NYISO.  Ouranalysis included the potential impact of various “worst case” scenarios basedupon potential negative factors, individually and in combination, such as areduction in the frequency regulation clearing price of up to 20%; increases inenergy costs of up to 20%; higher construction costs of up to 30%; or certain 

 

23

----

 

changes in controlsignals.  The clearing prices duringrecent months have been dropping. We believe this primarily due to the overalleconomic climate, and we expect the clearing prices to increase as the economystrengthens.  However, if the currenttrend towards lower prices is sustained for an extended period, it would makemeeting our debt service requirements difficult for that period of time.

 

·                  Our forecast and models indicate that we can expectpositive cash flows from a 20 MW frequency regulation installation inStephentown, New York, and that consequently, as of September 30, 2009; noimpairment reserve is required for our current supply of flywheels and relatedfungible Smart Energy MatrixTM components.

 

**Overview**

 

We design,manufacture and operate flywheel-based energy storage systems that providefrequency regulation and other highly reliable energy solutions for theworldwide electricity grid at competitive costs. We also plan to sellindividual and large-scale systems outright or on a fractional basis. As weexpand our flywheel production and continue to lower system costs, we believewe will be able to market other cost-effective applications for our flywheelsystems that will further expand our revenues.

 

Our principalmarket focus is on the geographic regions of the domestic grid that provideopen-bid markets for regulation services. These regions and their IndependentSystem Operator (ISO) or Regional Transmission Operator (RTO) designations are:New England (ISO New England or ISO-NE); California (California ISO or CAISO);New York (New York ISO or NYISO); Mid-Atlantic (PJM Interconnection); andMidwest (Midwest ISO or MISO). Even though the RTO in Texas (ElectricReliability Council of Texas or ERCOT) is an open bid market, it is notregulated by the Federal Energy Regulatory Commission (FERC). Consequently, weare not able to encourage beneficial market rule changes there that aremandated by FERC Order No. 890. This Order was intended to promote greatercompetition in electricity markets, in part by allowing non-generationresources such as ours to bid and sell into frequency regulation markets and becompensated on equal terms with traditional generation resources. As a result,we are focusing on the FERC-regulated open-bid markets first and will begin towork on entry into ERCOT once we are operating in the other markets.

 

Theseregional ISOs/RTOs or grid operators purchase frequency regulation servicesfrom independent providers in open-bid markets that they manage and maintain.We are seeking to become one such provider. We believe our technology willoffer grid operators the benefits of greater reliability; faster response time;cleaner operation, including zero direct emissions of carbon dioxide (CO2), nitrogen oxide, sulfur dioxide and mercury; and lowermaintenance costs compared to conventional power generation facilities thatalso provide frequency regulation services. We believe that we will have lower operating costs and faster responsetime than the majority of other entities that provide frequency regulationservices, which we believe will allow us to have sufficient margins to make theCompany economically viable.

 

Underthe open-bid market like that operated by NYISO, grid operators forecast theneed for frequency regulation as a percentage of expected power demand, andapproved suppliers submit bids for these services. Bids are stacked from lowestto highest prices until the cumulative amount of bids is sufficient to meet thecalculated need. The price submitted by the highest selected bidder determinesthe price paid to every bidder that has been scheduled to provide service,although each ISO may calculate payments based on formulas that yield differentrevenue results, even with equivalent frequency regulation clearing prices.

 

OurSmart Energy MatrixTM recycles excess energy when generated power exceeds loadand delivers it when load exceeds generated power.  We believe that our low operating costs willallow us to participate with a very favorable profit margin in the open-bid markets.Also, our systems respond up to 100 times faster than fossil fuel generatorsproviding frequency regulation. Certain ISOs have implemented or areconsidering tariff changes that would provide additional or enhanced paymentmechanisms to compensate resources, such as ours, for faster regulationresponse.

 

To participate in thisregulatory-driven open-bid market, we expect to build, own and operate a numberof frequency regulation installations known as Smart Energy MatrixTM systemsdesigned to provide reliable and sustainable frequency regulation services forutility grids. Our primary business model is a sale-of-services model, similarto that of independent power producers who also build, own and operate theirown power plants. Under this model, we will be bidding our services intomultiple open-bid markets for regulation on a daily basis. Additionally, wemay:

 

24

----

 

·                  Participatein pilot programs to demonstrate our technology, such as the ISO-NE AlternativeTechnologies Pilot Program, under rules that may provide alternativebidding and payment plans than those provided by the permanent market rules

 

·                  Sell SmartEnergy MatrixTM systems on an equipment-sale basis in both the U.S. and overseasmarkets

 

·                  Shareownership of some plants together with investors as a means of acceleratingcash flow during the early years of our commercial deployment

 

·                  Enter intobilateral contracts with utilities that currently provide or purchase regulationservices to satisfy their obligations to pay for or provide regulation servicesin their respective grid regions.

 

On November 18,2008, we connected our first 1 MW Smart Energy MatrixTM to the electric grid inTyngsboro, Massachusetts. The 1 MW system was installed under the ISO NewEngland Alternative Technologies Pilot Program, which allows us to generaterevenue for regulation services while we, and ISO-NE, explore ways to optimizethe beneficial impact of the technology and while ISO-NE develops permanentmarket rules that will govern the application of the technology. A secondMW of capacity was connected to the grid in July 2009 and is also earningrevenue. We plan to interconnect a third MW of capacity before the end of 2009.We expect to redeploy the second and third megawatts to the Stephentown site asin-kind equity under the terms of the DOE loan guarantee program.

 

The pilot program and itsrevenue component will continue until permanent rules are in place. Thepilot program was approved by FERC as part of ISO-NE’s compliance with FERCOrder No. 890, which is intended to promote greater competition inelectricity markets, strengthen the reliability of the grid, and allowso-called non-generation resources (which include our flywheel technology), toparticipate in frequency regulation markets on a non-discriminatory basis.

 

As part of the process ofmodifying its market rules, ISO-NE has been adjusting the control signal itsends to our Smart Energy MatrixTM to help maximize our regulation effectiveness.  ISO-NE has a three-part payment model forregulation service:

 

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

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

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

 

Revenues that we arecurrently receiving from this pilot program are lower than those that we expectto receive under permanent market rules, principally because under ISO-NE’spilot program market rules, we are not eligible for opportunity cost payments,which represent approximately one-third of the revenue received by conventionalregulating generators. We are encouraging ISO-NE to develop permanent market rules thatwill provide an additional payment component for alternative technologies thatwould be approximately equal to opportunity cost. The trend at other ISOs hasbeen to incorporate features in their tariffs that intrinsically compensate allresources, including energy storage providers, for opportunity cost.

 

Electricity costs foroperating the 1 MW pilot Smart Energy MatrixTM in Tyngsboro through the end of April 2009were higher than what we expect our electricity costs to be in the future.  Because the 1 MW pilot project is connectedto a distribution-level power line, from November 2008 through late April 2009,we paid the retail price for our gross withdrawals from the grid, instead ofpaying the wholesale price for the net electricity (withdrawals minusinjections), plus retail transmission and distribution charges. However, inlate April 2009, ISO-NE and our local distribution company implemented achange which reduced our commodity cost of electricity by netting theelectricity withdrawn and injected into the grid, and billing for that netusage at the wholesale rate.  Inaddition, a new regulation dispatch signal implemented by ISO-NE in May 2009has reduced the amount of net electricity we need to purchase.  We are still paying retail transmission anddistribution charges. These favorable adjustments now enable us to earnpositive gross margin for the remainder of the pilot program. The cost ofelectricity will be even further reduced for our 20 MW facilities, as we planto be connected to transmission-level (rather than to distribution-level) powerlines.  We will be charged the lowerwholesale commodity price for our net energy usage and will not be subject totransmission and distribution fees, which currently represent approximately 70%of our cost of energy.

 

InOctober 2009, we were approved to earn alternative energy credits underthe Massachusetts Alternative Energy Portfolio Standard (APS) program. Ourflywheel systems were designated as the first resources to qualify under thisprogram by the Massachusetts Department of Energy Resources.  Our systems are eligible for this programbecause they discharge electricity to 

 

25

----

 

providefrequency regulation with zero fuel consumption or emissions.  We have begun earning these state-authorizedAPS credits, or certificates, starting in the second quarter of 2009.  The number of certificates we will earn isbased on a formula that takes into account the amount of stored energy weinject into the grid in Massachusetts. We plan to sell the credits to utilities or other retail electricitysuppliers that need to meet mandated Massachusetts APS requirements, thuscreating an additional revenue source. We are currently evaluating how much the APS certificates may be worthand how to sell them in the most effective manner.  We do not believe the revenue from thesecertificates will be material to the financial statements, and therefore, noentry has been recorded to reflect their receipt as of September 30, 2009.

 

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

 

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

 

·                  Comparativemarket pricing available for frequency regulation in different markets

 

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

 

·                  Availabilityof transmission lines

 

·                  Availabilityand cost of land

 

·                  Ability tosecure all necessary environmental and other permits and approvals

 

·                  Ability toobtain grid interconnection approvals.

 

OnJuly 17, 2008, we received a land-use permit we had requested from thetown of Stephentown, New York.  During thethird quarter of 2008, we purchased approximately seven acres of land at a sitein the town where we plan to build our first 20 MW installation. The site isserved by two transmission companies: National Grid and New York State Electricand Gas (NYSEG). National Grid owns a 115 KVA transmission line that abuts thesite, and NYSEG owns a substation that also abuts the site.

 

Ourinterconnection request for the 20 MW plant includes National Grid as thetransmission provider.  Before we can enter into an interconnectionagreement with NYISO, we were required to perform a System Impact Study, whichis now complete. We must now complete a Facilities Study. The purpose of thesestudies is to confirm that our facility can be safely and reliablyinterconnected with the grid, and to identify any utility upgrades or otherequipment that may be needed before construction can begin.  Construction and development of this site isalso subject to certain state and local permitting processes. After executingan interconnection agreement, necessary upgrades to grid equipment to permitsuch interconnection will begin, in a timeline roughly parallel to ourconstruction of the facility.

 

In October 2009, the New York State PublicService Commission (PSC) granted us a Certificate of Public Convenience andNecessity (CPCN) and approved our petition for lightened regulation for theplanned 20 MW flywheel frequency regulation plant in Stephentown, New York.These approvals include the project’s overall financing. At its October 15thmeeting, the PSC determined that Beacon’s proposed flywheel plant inStephentown is in the public’s interest. In September 2009, the PSCaffirmed that Beacon’s Stephentown plant has met all relevant PSC environmentalrequirements. With these PSC decisions now in place, the Company is authorizedto apply for applicable permits, submit any final plans and drawings to PSC forreview, and prepare to construct and operate the plant.

 

On June 10, 2009, weannounced that we and the New York State Energy Research and DevelopmentAuthority (NYSERDA) are in the process of negotiating a statement of workrelating to a grant to pay for a portion of the interconnection and otheraspects of the Stephentown facility. The value of the grant, if finalized, isexpected to be approximately $2 million.

 

Wemay elect to install 1 MW installations in ISOs to provide early insight tooperating within each market. The economics of these 1 MW systems may not berepresentative of expected revenues and costs for a 20 MW plant, and thereforethe non-fungible costs may be expensed on our income statement rather thanbeing booked as a fixed asset on our balance sheet.  For 

 

26

----

 

example,in the New York market, we are considering whether to deploy a 1 MW resource atthe Stephentown site, but initially interconnected to NYSEG (later to beinterconnected to National Grid, when such interconnection is approved).  Similarly, in Ohio we expect to deploy 1 MWat the AEP facility as described below. The non-fungible costs associated withdeploying small installations (such as at the AEP facility) which are notintended to remain in service for terms exceeding two years will be expensed.

 

On February 23,2009, we announced that we had signed a contract with American Electric Power(AEP), one of the largest generators of electricity in the U.S., and one of itsoperating subsidiaries, Columbus Southern Power Company. The contract willentail building a 1 MW Smart Energy MatrixTM regulation facility at an AEP site inGroveport, Ohio. The system, which will be connected to the grid within theoperating region of the PJM Interconnection (PJM), will provide flywheel-basedfrequency regulation services. Installation of this Smart Energy MatrixTM isexpected to begin in 2010. The 1 MW systemwill provide valuable insight into the operation of our technology on PJM’sgrid and make us better prepared to deploy and profitably operate full scale 20MW plants in PJM’s coverage area.

 

On July 2, 2009, weannounced that we received a conditional commitment from the DOE for a loanguarantee of approximately $43 million. The loan, which would be funded by the U.S. Treasury’s Federal FinancingBank, is expected to provide debt financing for approximately 62.5%, of theestimated $69 million total project cost of our planned 20-megawatt (MW)flywheel-based energy storage installation to be located in Stephentown, NewYork. Of the $26 million not financed by the loan, we have already incurredapproximately $13 million in eligible project expenditures, which will beconsidered part of our equity contribution to the project.  A significant portion of this in-kindcontribution will come from the redeployment of 2 MW or more of energy storagefrom Tyngsboro to the Stephentown site. We are exploring funding alternativesfor the remaining $13 million, including a direct equity investment in theproject by one or more third parties and/or the sale of our stock.  In addition, we are in the process ofnegotiating a statement of work relating to a grant from NYSERDA to pay for aportion of the interconnection and other aspects of the Stephentownfacility.  The value of the grant, iffinalized, is expected to be approximately $2 million.

 

We plan to have an aggregate of up to 3 MW of flywheel energy storagecapacity produced and installed in Tyngsboro before year-end. In addition toour Stephentown, New York, site, our Glenville, New York, site and anidentified site within AEP, we are also identifying and developingadditional sites in our target markets.

 

In volume production, our goal is to complete 20 MW facilities at a costof approximately $25 to $30 million each, though the first 20 MW plant willcost approximately $69 million, of which approximately $50 million is directequipment and facility costs. The remainder of the cost estimate includessubstantial contingency, legal, consulting and administrative costs. Some ofthese costs are either unique to the DOE loan guarantee process or are greaterthan we expect to apply to subsequent similar facilities. In 2010 and beyond, we will continue to havecapital needs that will require additional funding through equity and projectfinancing to fund the ongoing deployment of frequency regulationinstallations.  Our deployment plans are affected by anumber of factors and activities, including but not limited to the following:

 

·                  The timing of the anticipated closing ofthe DOE loan and other fund-raising

 

·                  Component development and quality:

 

·                  Completing the engineering and testing ofcertain components to improve highly durable operation at commercial operatingspeeds.

 

·                  Developing multiple sources for our keycomponents. We are working to expand our supplier base to qualify theircomponents to our designs and specifications.

 

·                  Continuing to work closely with oursuppliers to refine their manufacturing processes and ensure quality results.

 

·                  The need to change market rules insome ISOs to be compatible with our technology and to permit revenue to beachieved at the same level as traditional providers.  See “Regulatory and Market Affairs” fordetails on market rule changes within each of our target markets

 

·                  Our ability to secure all necessaryenvironmental and site related permits and approvals.

 

·      Ourability to obtain grid interconnection approvals on an expedited basis with theISOs or RTOs or through agreements with utilities that can reduce theinterconnect approval process.

 

27

----

 

**Regulatory and Market Affairs**

 

Withineach ISO there is a market tariff and set of market rules that determinewho is allowed to bid into regulation markets, how much regulation providersare paid for their services, and what costs providers must pay to participatein markets. Each ISO has its own market rules that will govern the pace atwhich markets are opened and the degree to which our technology is allowed toparticipate. Historically, the market rules for regulation were written toconform to traditional generators’ abilities to provide regulation. This isunderstandable, because until the advent of our technology, the capabilitiesand limitations of traditional generators defined how regulation could betechnically implemented. In the markets in which we intend to compete, most ofthe ISO market rules contained legacy terms, performance characteristicsand other requirements that did not match our new technology. FERC Order 890has accelerated the pace of market rule changes for those ISOs which are subjectto FERC. In 2008 and the first three quarters of 2009, we made progress withseveral of the ISOs by working with them directly to implement changes tomarket rules to allow energy storage technologies to participate on anon-discriminatory basis in the regulation market. The ISOs have demonstrated aheightened commitment to work collaboratively with us to integrate ourtechnology to their grids.  In additionto market rule changes, several ISOs are evaluating or proposing changesto their regulation dispatch signal in order to ensure our Smart Energy Systemsare deployed most efficiently and effectively for the benefit of the powergrid. These changes would take better advantage of our flywheel’s fast-responsecapability, while recognizing that our resource has limited energy storagecapacity. The proposed market rule changes, coupled with effectiveregulation dispatch signals, will allow our resource to maximize its regulationrevenue while minimizing our consumption and cost of electricity. The currentstatus of each open-bid ISO market is as follows:

 

·                  New YorkISO: We believe that NYISO presents the most favorable grid operating regionfor the first full-scale commercial deployment of our systems. As a result ofFERC Order 890, new management at NYISO and extensive work by us, NYISO hasdeveloped and FERC has approved new tariff and market rules for LimitedEnergy Storage Resources (LESRs) to provide frequency regulation to the NewYork power grid. These new rules recognize the unique operating characteristicsof our technology and remedy key aspects of the current regulation tariff forgenerators that would otherwise limit our technology.  NYISO’s regulation dispatch method for LESRswill take advantage of the LESRs’ fast response rates and maximize theirdeployment. The energy level in our flywheels will be actively managed by NYISOto maintain regulation capability to the extent possible bycharging/discharging as necessary.  Thenew LESR tariff will also allow us to net our electricity costs at wholesalerates.  We believe the new tariff anddispatch mechanisms will provide a highly effective and efficient method forintegrating our flywheels into the NYISO regulation market.  In addition to these market rule changes,in December 2008 the Northeast Power Coordinating Council’s (NPCC) changedits reliability rules to allow LESRs to provide frequency regulation byremoving the requirement that resources be able to generate one hour ofcontinuous energy.The LESRtariff and market changes were approved by FERC on May 15, 2009, with aneffective implementation date of May 12, 2009.  The NYISO regulation service market is nowfully open to flywheel energy storage.

 

·                  ISO NewEngland: On November 18, 2008, ISO-NE launched an Alternative TechnologiesRegulation Pilot program to comply with Order 890.  The purpose of the Alternative TechnologiesRegulation Pilot program is to evaluate the performance of new technologieslike ours that are unable to participate in ISO-NE’s current regulation market,determine how these technologies can best be used to meet New England’sregulation requirements, allow program participants to operate in a realisticmarket environment where they can evaluate their market viability, and provideoperating experience that ISO-NE can use to formulate permanent market rules.ISO-NE has announced it expects to begin working with stakeholders to developpermanent market rules by mid-February 2010.  After they are developed, the process forimplementing new rules is expected to take approximately 6 months.  Until new permanent market rules forenergy storage are implemented we will continue to earn revenue through thepilot program.  We began participating inthe pilot program with a 1 MW resource located inside our plant in Tyngsboro inNovember 2008, and added another 1 MW outside our Tyngsboro facility in July 2009.  We expect to add a third MW in the fourthquarter of this year. Until April 2009, the pilot resource was sent aregulation signal that was similar to one for a traditional generator andtherefore did not recognize that our technology provides regulation in adifferent manner (most importantly, faster) than a traditional generator.  After discussions with ISO-NE, in May 2009,we convinced it to implement a regulation dispatch signal for our pilot projectthat better recognizes our energy storage’s unique capabilities and is similarto the dispatch method developed by NYISO. This new dispatch signal hasimproved the economics of our pilot resources. We are continuing to work with ISO-NE to implement a NYISO-style ofdispatch signal in the permanent rules at the conclusion of the pilotprogram. In addition, as also discussed above, we are working to haveopportunity cost payments included in the permanent market rules so thatthe payments made to our resource are comparable to those made to other partiesthat provide a comparable service.

 

28

----

 

·                  CaliforniaISO: CAISO is in the process of opening its frequency regulation market toenergy storage technologies and we are actively participating in thisendeavor.  In June 2008, CAISO tookthe first step to open its market by proposing to modify its tariff to allowbids for regulation by non-generation resources that are capable of providingthe service and that meet applicable ancillary service standards and technicalrequirements. In February 2009, FERC ordered CAISO to make additionalmodifications to its tariff to ensure that non-generation resources are treatedcomparably to other resources in the CAISO regulation market.  We are actively engaged in this FERCproceeding and in the stakeholder process at the CAISO.  Through this stakeholder process, we continueto work with CAISO and its stakeholders to promote the lessons learned and bestpractices from other ISOs for integrating energy storage into the regulationmarket.  CAISO has announced it expectsto file proposed tariff changes developed through this stakeholder process in March 2010.  In addition, the current definition containedin the Western Electricity Coordinating Council (WECC) Reliability Standardsfor Regulating Reserves only refers to generation resources.  CAISO plans to propose new non-prescriptivelanguage to the WECC standards allowing all resources to provide regulatingservices.  The timing of this proposedchange is expected to be coincident to the proposed tariff changes.

 

·                  Midwest ISO:On February 25, 2008, FERC approved the creation of an Ancillary ServicesMarket (ASM) in the Midwest ISO to begin operating on January 6,2009.  As part of its approval of theASM, FERC required MISO to make further changes to its ASM to remove barriersto new technologies to provide regulation service.  On April 25, 2008, MISO fully compliedwith FERC’s directives by filing a request for an entirely new regulationresource category specifically designed for stored energy resources (“SER”),including our flywheel technology.  FERCapproved this tariff on December 18, 2008. This was the first such tariff in the United States designedspecifically to accommodate energy storage-based regulation resources.  In May 2009, MISO, with the support ofits market stakeholders, submitted to FERC additional tariff modifications toenhance the dispatch algorithm for SERs to better utilize their regulationcapabilities and maximize our revenues in the MISO market.  MISO is proposing to implement the tariffmodifications for SERs, on January 1, 2010, at which point we would beable to participate in this market.

 

·                  PJMInterconnection: PJM amended its tariff language to comply with Order 890 andstated that its current rules allow non-generation resources like ours tofully participate in its regulation market. PJM’s market rules allow us toenter the market. In the summer of 2009 PJM adopted a regulation dispatchsignal for energy storage resources that takes full advantage of our system’sfast-response capability and maximizes benefits to PJM’s grid, and pays us forthe full benefits of our resource.  Weare also working with PJM and market stakeholders to clarify or amend certainaspects of PJM’s tariff in order to ensure we can net our energy consumption atwholesale rates and therefore minimize our costs to provide service in PJM.

 

·                  ERCOT: SinceERCOT is not regulated by the Federal Energy Regulatory Commission, in the pastwe have focused our efforts on the other ISOs. As the performance of our technology is fully demonstrated at asystem-wide level in other ISOs, and as wind generation in Texas increases andtherefore the demand for fast frequency regulation resources rises, we willbegin to focus our attention on this market.

 

**DefenseApplications**

 

Webelieve that our high-energy flywheel technology is increasingly attractive asan energy storage device for space platforms, navy vessels, militaryinstallations and other military hardware and/or systems. We are pursuingdefense and military-related projects that, in addition to generating revenueto help cover operating costs, effectively provide non-dilutive R&D fundingfor key technology innovations and advancements that may be transferred tocommercial markets.

 

OnFebruary 3, 2009, we announced that we entered into a contract with NAVSEAto evaluate the use of flywheel energy storage for multiple shipboardapplications that we expect will lead to a conceptual design of a flywheelsystem for future naval surface combatants and possible retrofit into existingNavy ships.  NAVSEA’s objective is toadvance and improve its shipboard Integrated Power Systems (IPS) at both themajor component and system level. Integrated Power Systems are an essential part of the Navy’sall-electric ship program.  Based on theanticipated power requirements to support advanced launch systems, weapons andsensor systems, and other shipboard functions, electrical energy storage is nowrecognized as a fundamental element of an all-electric IPS.

 

Underterms of this multiyear contract, we will perform an analysis of futureshipboard energy storage needs; identify several flywheel applications thatcould offer the greatest benefit to future naval combatants; assist the Navy’spower plant upgrade development team by characterizing the flywheelapplications under consideration and assisting in system-level studies; and

 

29

----

 

validateresults of those studies.  Based on theresults, we will develop a conceptual flywheel design and simulation model forone or more applications.  The value of theinitial research and development work is estimated at $900,000, $500,000 ofwhich has already been appropriated. Subsequent phases involve work estimated at up to an additional $2.1million.

 

**Discussionof Operations**

 

We haveexperienced net losses since our inception and, as of September 30, 2009,had an accumulated deficit of approximately $201.3 million.  We arefocused on the development and commercialization of our Smart Energy MatrixTMflywheel system for frequency regulation and completion of our research anddevelopment contracts.  We do not expect to have positive EBITDA (earningsbefore interest, taxes, depreciation and amortization) or positive cash flowfrom operations until at least 2012. To execute our business plan, we mustraise additional funds through a combination of equity and/or debt.

 

In2009/2010 and beyond, we will need additional funding to expand ourmanufacturing capabilities and to build and install frequency regulationfacilities in accordance with our business plan. We expect to raise therequired funds in 2009 and 2010 through the DOE loan program guarantee and thesale of stock in the Company, supplemented where possible by government grants.  As previously mentioned, NYSERDA committed a$2 million grant to us with respect to the Stephentown facility, and we haveapplied for two grants from the DOE with respect to two possible facilitiesfollowing the Stephentown facility.  Becausethe total budget for DOE frequency regulation grants is $45 to $50 million, andother companies may have applied for the same grants, there can be no assurancethat either or both of our grant applications will be approved, or if approved,that any such grants will be in the amounts applied for.  In the future, as the number of ourregulation facilities increases and we develop sustainable cash flows fromoperations, we expect to fund additional installations from a combination ofproject financing, equity and available cash flow from existing regulationfacilities.

 

The closing of the DOEloan is subject to the execution of a Loan Guarantee Agreement, under which anumber of additional conditions will need to be met and ancillary agreementsnegotiated and signed.  For example, one of the conditions is thepayment of the credit subsidy cost, representing the “cost of a loanguarantee,” as set forth in section 502(5)(C) of the Federal Credit ReformAct of 1990.  This will be a material amount.  We havetaken steps to obtain funding from the government for the credit subsidy cost,and believe that funding has been authorized by the American Recovery andReinvestment Act of 2009.  We have received a letter from the DOEconfirming that the project may qualify for such funding if physical constructioncommences no later than September 30, 2011 and if laborers and mechanicsemployed in performing the project are paid prevailing wages in accordance withthe Davis-Bacon Act.  However, if such government funds cannot beobtained, we will be required to pay the credit subsidy cost ourselves and toraise additional funding to cover that amount.  There is no guaranteethat the government will pay the credit subsidy cost, or if necessary, that wecan raise additional funding on reasonable terms, or at all, to cover thatamount.

 

The closing of this loan,and the closing of all such loans to all borrowers under the loan guaranteeprogram, is also subject to the Secretary of the Department ofEnergy’s right of termination of the conditional commitment for any reasonat any time before the execution of the Loan Guarantee Agreement, pursuant toregulations of the loan guarantee program.

 

If the loanguaranteed by the DOE does not close on a timely basis, or if government fundsare not available to pay the credit subsidy costs, it will affect the timingfor completing the Stephentown project. We expect to complete the 20 MW facility in Stephentown, New York,within 12 to 18 months from the date we obtain the first disbursement of fundsfrom the loan guaranteed by the DOE.   Inthe event that government funds are not available to cover the credit subsidycost, we would need to find alternative funding for the project, andconstruction would likely be delayed. Apart from expenditures to construct the Stephentown facility, we willhave sufficient cash to fund operations into 2010 based on continuing fundingfrom Seaside.

 

*Revenues*

 

Ourrevenue during the nine months ended September 30, 2009 and 2008 came fromthree sources:

 

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

·                  Frequencyregulation service revenue from the ISO-NE pilot program

·                  Sales ofinverters and accessories.

 

Our business plananticipates earning revenue primarily from the provision of frequencyregulation service and potentially from the sale of our Smart Energy flywheelsystems.  We may also earn revenue fromthe sale of ASP certificates or similar “clean energy” credits.  However, such credits are not expected to bematerial. In the past, we have also earned revenue from research anddevelopment contracts with government agencies, and we continue to pursuesimilar contracts. In addition, we have a small inventory of inverters andaccessories that we sell, although that revenue is insignificant.

 

30

----

 

*Cost ofGoods Sold*

 

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

 

*Researchand Development*

 

In 2008 and prioryears, amounts reported as “Research and development” included not only thecost of our engineering staff, but also the cost of unabsorbed manufacturingoverhead, since most of our activities related to development of the SmartEnergy 25 flywheel and Smart Energy MatrixTM. In 2008, we substantially completed development of the Smart EnergyMatrixTM and began limited production of commercial units and building our firstfrequency regulation installations.  Asof January 1, 2009, we have split the cost of operations and maintenancefrom the cost of our research and development functions.  Since our current production levels are stillwell below our facility’s full capacity, operations and maintenance costs forthe nine months ended September 30, 2009, include a significant amount ofunabsorbed manufacturing overhead.  Inaddition, costs associated with running the 1 MW resource for the ISO-NE pilotprogram, and certain non-fungible costs associated with certain Smart EnergyMatrixTM installations, are also included in “Operations and maintenance.”  “Research and development” represents thecost of compensation and benefits for research and development staff, as wellas materials and supplies used in the engineering design and developmentprocess.  On a combined basis consistentwith reporting in prior years, total operations and maintenance and researchand development costs for the first nine months of 2009 were approximately $2,101,000,or 22%, lower than during the comparable period in 2008.  We expect research and development expensesin 2009 to be lower than in 2008 due to lower legal costs, along with reducedmaterial expenses and subcontractor costs.

 

*Selling,General and Administrative Expenses*

 

Oursales and marketing expenses consist primarily of compensation and benefits forregulatory affairs, sales and marketing personnel and related businessdevelopment expenses. General and administrative expenses consist primarily ofcompensation and benefits related to our corporate staff, professional fees,insurance and travel.  During the ninemonths ended September 30, 2009, selling, general and administrativeexpenses were approximately $752,000, or 12.3%, lower than during theequivalent period in 2008, in large part due to a reduction in stock-basedcompensation expense and a reduction in legal and professional fees.   Historically, the Board of Directors hasgranted equity compensation to officers and employees during the first quarterof each year as part of its long-term incentive compensation program.  In 2009, such grants to the officers weredelayed, and no options have been granted to other company personnel. Thesereductions were partially offset by an increase in public company expenses,primarily related to the periodic stock sales to Seaside, as well as increasesin salaries and benefits resulting from new hires in 2008 and increased healthinsurance costs. Overall, we expect our selling, general and administrativeexpenses for fiscal 2009 to be lower than in 2008, primarily due to lower legalcosts and other planned cost reductions.

 

*Loss onContract Commitments*

 

Weestablish reserves for anticipated losses on contract commitments if, based oncost estimates to complete the commitment, we determine that a loss will beincurred.  In addition, we evaluate ourestimated costs to complete our government contracts on a quarterly basis andadjust the reserves when appropriate.

 

InApril 2008, we were awarded a subcontract to provide a flywheel energystorage system in support of a wind integration research and developmentproject in Tehachapi, California, sponsored by the California EnergyCommission.  We will receiveapproximately $250,000 to offset expenses and will contribute an additional$87,000 of engineering resources for the project, bringing the R&D total toapproximately $337,000.  Accordingly, werecorded a charge of approximately $87,000 to the contract loss reserve during2008 to reflect the expected “cost share” portion of the Tehachapicontract.  During the quarter ended March 31,2009, we increased the loss reserve for the Tehachapi contract by$132,500.  This increase is based uponthe difference between the overhead rate that was bid on this fixed pricecontract and our forecasted overhead rate. No additions were considerednecessary to the loss reserve through the quarter ended September 30,2009.

 

OnFebruary 3, 2009, we announced that we entered into a contract with NAVSEAto evaluate the use of flywheel energy storage for multiple shipboard applicationsthat we expect will lead to a conceptual design of a flywheel system for futurenaval surface combatants and possible retrofit into existing navy ships.  The value of the initial research anddevelopment work is

 

31

----

 

estimatedat $900,000, $500,000 of which has already been appropriated.  Subsequent phases involve work estimated atup to an additional $2.1 million.  Thiscontract was awarded on a “cost plus fixed fee” basis.  Based on our evaluation of the expected costsfor the portion of the contract which has been appropriated, no reserve forcontract loss was considered necessary as of September 30, 2009.

 

*Depreciationand Amortization*

 

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

 

*Interestand Other Income/Expense, net*

 

Our non-operatingincome and expenses are primarily attributable to interest income resultingfrom cash on hand and funds received in settlement of a class action suitrelating to unfair practices engaged in by certain insurance brokerage firms.

 

**Resultsof Operations**

 

***Comparison of Three and Nine Months ended September 30,2009 and 2008***

** **
| ** **                                | ** ** | **Three  months ended September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2009**                                   | ** ** | **2008** | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                                | ** ** | **(in thousands)**                         | ** ** |
| Revenue                                   |       | $                                          | 273        |   | $ | 4 |   | $ | 269 |   | 6725 | % |
| Cost  of goods sold                       |       | 247                                        |       | 6 |   | (241 | ) | -4017 | % |
| Gross  margin                             |       | 26                                         |       | (2 | ) | 28 |   | -1400 | % |
| Operations  and maintenance               |       | 621                                        |       | — |   | (621 | ) | NA |   |
| Research  and development                 |       | 1,626                                      |       | 3,535 |   | 1,909 |   | 54 | % |
| Selling,  general and administrative      |       | 1,463                                      |       | 1,805 |   | 342 |   | 19 | % |
| Loss  on contract commitments             |       | —                                     |       | — |   | — |   | 0 | % |
| Depreciation  and amortization            |       | 479                                        |       | 334 |   | (145 | ) | -43 | % |
| Interest  and other income (expense), net |       | 71                                         |       | 55 |   | 16 |   | 29 | % |
| Net  loss                                 |       | $                                          | (4,092     | ) | $ | (5,621 | ) | $ | 1,529 |   | -27 | % |

** **
| ** **                                | ** ** | **Nine  months ended September 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **$ Change** | ** ** | **%  Change** | ** ** |
| ** **                                | ** ** | **(in thousands)**                        | ** ** |
| Revenue                                   |       | $                                         | 666        |   | $ | 53 |   | $ | 613 |   | 1157 | % |
| Cost  of goods sold                       |       | 705                                       |       | 10 |   | (695 | ) | -6950 | % |
| Gross  margin                             |       | (39                                       | )          | 43 |   | (82 | ) | -191 | % |
| Operations  and maintenance               |       | 2,167                                     |       | — |   | (2,167 | ) | NA |   |
| Research  and development                 |       | 5,303                                     |       | 9,571 |   | 4,268 |   | 45 | % |
| Selling,  general and administrative      |       | 5,356                                     |       | 6,109 |   | 753 |   | 12 | % |
| Loss  on contract commitments             |       | 132                                       |       | 87 |   | (45 | ) | -52 | % |
| Depreciation  and amortization            |       | 1,346                                     |       | 927 |   | (419 | ) | -45 | % |
| Interest  and other income (expense), net |       | (56                                       | )          | 311 |   | (367 | ) | -118 | % |
| Net  loss                                 |       | $                                         | (14,399    | ) | $ | (16,340 | ) | $ | 1,941 |   | -12 | % |

 

32

----

 

*Revenue*

 

The followingtable provides details of our revenues for the three and nine months ended September 30,2009 and 2008:

 
| ** **                             | ** ** | **Percent**  | ** ** | **Three  months ended  September 30,** | ** ** | **Nine  months ended  September 30,** | ** ** | **Cumulative  Contract  Value  Earned as  of  September 30,** | ** ** | **Total  Contract** | ** ** | **Remaining  Value** | ** ** |
|----------------------------------------|------------|--------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------|------------|----------------------|------------|
| ** **                             | ** ** | **complete** | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009**                                                      | ** ** | **2008**            | ** ** | **2009**             | ** ** | **Value** | ** ** | **(Backlog)** | ** ** |
| ** **                             | ** ** | ** **   | ** ** | **(dollars in thousands)**                  | ** ** |
| **Frequency regulation:**              |       |         |       | $                                           | 63         |                                       | $          | —                                                        |       | $                   | 180        |                 | $          | — |   |   |   |   |   |   |   |
| **Contracts:**                         |       |         |       |                                        |       |                                       |       |                                                          |       |                |       |                 |       |   |   |   |   |
| NYSERDA  PON 800                       |       | 86.8         | %          | $                                           | —     |                                       | $          | —                                                        |       | $                   | —     |                 | $          | 1 |   | $ | 55 |   | $ | 63 |   | $ | 8 |   |
| NAVSEA                                 |       | 72.1         | %          | 182                                         |       | —                                     |       | 360                                                           |       | —              |       | 360                  |       | 500 |   | 140 |   |
| Tehachapi                              |       | 53.6         | %          | 29                                          |       | 5                                          |       | 125                                                           |       | 9                   |       | 134                  |       | 250 |   | 116 |   |
| Total  Contract Revenue                |       |         |       | $                                           | 211        |                                       | $          | 5                                                             |       | $                   | 485        |                 | $          | 10 |   | $ | 549 |   | $ | 813 |   | $ | 264 |   |
| **Other (inverters and accessories):** |       |         |       | (1                                          | )          | (1                                         | )          | 1                                                             |       | 43                  |       |                 |       |   |   |   |   |
| Total                                  |       |         |       | $                                           | 273        |                                       | $          | 4                                                             |       | $                   | 666        |                 | $          | 53 |   |   |   |   |   |   |   |

 

In the nine months ended September 30,2009, we earned approximately $180,000 from frequency regulation servicesthrough our participation in the ISO-NE Pilot Program that began in November 2008.Revenues we are currently receiving fromthis pilot program are less than those that we expect to receive underpermanent market rules. Under pilot program market rules, we are not eligiblefor opportunity cost payments, which represent approximately one-third of therevenue received by conventional regulating generators. Even so, we arecurrently running the Tyngsboro system at positive gross margins, due to recentreductions in certain operating costs. We are encouraging ISO-NE to developpermanent market rules that will provide an additional payment componentfor alternative technologies that would be approximately equal to opportunitycost. The trend at other ISOs has been to incorporate features in their tariffsthat intrinsically compensate all resources, including energy storageproviders, for opportunity cost.

 

We completed most of our research and development contracts in 2007,but were awarded two new contracts (Tehachapi and NAVSEA) subsequent to the endof the first quarter of 2008. Consequently, contract revenue during the first nine months of 2008 wasonly approximately $10,000, but we earned approximately $485,000 in contractrevenue during the first nine months of 2009. In addition, we recorded revenue of approximately $1,000 from the saleof Smart Power M5TM inverter systems and related products during the first ninemonths of 2009, compared to approximately $43,000 in the first nine months of2008. In 2009, we expect both frequency regulation and contract revenue toincrease, due to the expected deployment of additional capacity of frequencyregulation as well as additional work performed under the Navy contract awardedearly in 2009.  

 

33

----

 

*Cost ofGoods Sold*

 

Costof goods sold for the three and nine months ended September 30, 2009, and2008 is as follows:

 
| ** **             | ** ** | **Three  months ended September 30, 2009** | ** ** | **Three  months ended September 30, 2008** | ** ** |
|------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **             | ** ** | **Revenue**                                     | ** ** | **Cost  of  Sales**                             | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Sales** | ** ** | **Margin** | ** ** |
| ** **             | ** ** | **(in thousands)**                              | ** ** |
| Frequency  regulation  |       | $                                               | 63         |                                            | $          | 49 |   | $ | 14 |   | $ | — |   | $ | — |   | $ | — |   |
| Contract               |       | 211                                             |       | 198                                             |       | 13 |   | 5 |   | 6 |   | (1 | ) |
| Inverters  and related |       | (1                                              | )          | —                                          |       | (1 | ) | (1 | ) | — |   | (1 | ) |
| Total                  |       | $                                               | 273        |                                            | $          | 247 |   | $ | 26 |   | $ | 4 |   | $ | 6 |   | $ | (2 | ) |
| ** **             | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| ** **             | ** ** | **Nine  months ended September 30, 2009**  | ** ** | **Nine  months ended September 30, 2008**  | ** ** |
| ** **             | ** ** | **Revenue**                                     | ** ** | **Cost  of  Sales**                             | ** ** | **Margin** | ** ** | **Revenue** | ** ** | **Cost  of  Sales** | ** ** | **Margin** | ** ** |
| ** **             | ** ** | **(in thousands)**                              | ** ** |
| Frequency  regulation  |       | $                                               | 180        |                                            | $          | 247 |   | $ | (67 | ) | $ | — |   | $ | — |   | $ | — |   |
| Contract               |       | 485                                             |       | 458                                             |       | 27 |   | 10 |   | 10 |   | — |   |
| Inverters  and related |       | 1                                               |       | —                                          |       | 1 |   | 43 |   | — |   | 43 |   |
| Total                  |       | $                                               | 666        |                                            | $          | 705 |   | $ | (39 | ) | $ | 53 |   | $ | 10 |   | $ | 43 |   |

 

Costof goods sold increased from approximately $10,000 in the first nine months of2008 to approximately $705,000 during the equivalent period of 2009.  During the first nine months of 2009, cost ofgoods sold includes approximately $247,000 for the cost of energy associatedwith the generation of frequency regulation revenue under the ISO-NE pilotprogram.  Cost of energy exceeded revenuefrom frequency regulation because of the manner in which we were connected tothe grid for the pilot program, which resulted in our being paid for energy weprovided to the grid at wholesale rates, while we were billed for the energy weused at retail rates.  As of the end of April 2009,ISO-NE and our service provider changed the metering to a “net meter” throughISO-NE, which resulted in a significant drop in our cost of energy during thesecond quarter of this year.  Our averagegross margin on frequency regulation services during the third quarter of 2009was 22.2%.  Cost of energy during thethird quarter totaled approximately $49,000, of which approximately $35,000, or71%, represents retail transmission and distribution (T&D) charges billedby the local service provider.  Becauseour Stephentown facility will be connected to the grid at the transmissionlevel, we will not incur T&D charges, and so we expect our gross margin tobe considerably higher than in Tyngsboro.

 

34

----

 

Inaddition, cost of goods sold for the first three quarters of 2009 includesapproximately $458,000 for research and development contracts calculated on thepercentage of completion method. Year over year, the increase in cost of salesassociated with contracts was proportional to our increase in contract revenue.In 2009, we expect to be providing more frequency regulation service capacityover a longer period of time than occurred in 2008.

 

*Operations and Maintenance and Research and DevelopmentExpense*

 

As discussed above, as of January 1, 2009, we classify expensesrelated to manufacturing, materials handling, purchasing, Smart Energy MatrixTMoperations, and expensed non-fungible costs associated with certaininstallations as “Operations and maintenance” on our income statement. Prior to2009, such expenses were included as “Research and development” costs, as shownbelow:

 
| ** **                  | ** ** | **Three  months ended September 30,** | ** ** | **Nine  months ended September 30,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **Net  Change** | ** ** | **2009** | ** ** | **2008** | ** ** | **Net  Change** | ** ** |
| ** **                  | ** ** | **(in thousands)**                         | ** ** |
| Operations  and maintenance |       | $                                          | 621        |                                      | $          | — |   | $ | 621 |   | $ | 2,167 |   | $ | — |   | $ | 2,167 |   |
| Research  and development   |       | 1,626                                      |       | 3,535                                     |       | (1,909 | ) | 5,303 |   | 9,571 |   | (4,268 | ) |
| Total                       |       | $                                          | 2,247      |                                      | $          | 3,535 |   | $ | (1,288 | ) | $ | 7,470 |   | $ | 9,571 |   | $ | (2,101 | ) |

 

For the three andnine months ended September 30, 2009, combined operations and maintenanceand research and development expenses decreased by approximately $1,288,000, or36.4%, and $2,101,000 or 22%  incomparison to the equivalent periods in 2008. See the table below forexplanations of the factors which were responsible for the most significantchanges. We expect costs shown for operations and maintenance to decrease asour production volume increases and more overhead is absorbed and capitalizedas part of the cost of our flywheels and Smart Energy Matrix TM installations.We expect research and development costs during 2009 to be lower than in 2008due to lower legal costs, along with lower material and subcontractor costs.

 

The net change isattributed to increases or decreases as shown below:

 

35

----

 
| ** **                      | ** ** | **Three  months ended 9/30/08 compared to  three months ended 9/30/09** | ** ** | **Nine  months ended 9/30/08 compared to  nine months ended 9/30/09** | ** ** | ** **        |
|---------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------|
| ** **                      | ** ** | **Operations  and  maintenance  functions**                             | ** ** | **Research  and  development  functions**                             | ** ** | **Total  change** | ** ** | **Operations  and  maintenance  functions** | ** ** | **Research  and  development  functions** | ** ** | **Total  Change** | ** ** | ** ** |
| **(in  thousands)**             |
| Expense materials               |       | $                                                                       | (446       | )                                                                     | $          | 158               |   | $ | (288 | ) | $ | (420 | ) | $ | 291 |   | $ | (129 | ) | The cost of materials  for Operations and Maintenance (O&M) was considerably higher during the  third quarter of 2008 than in 2009 because we expensed non-conforming  materials received from a supplier, in addition to a development fee paid to  that supplier on a “best efforts” basis. Research and Development (R&D)  materials costs were higher in 2009 than in 2008, primarily due to the cost  of replacing motors as part of the motor-stator redesign needed to reduce the  operating temperature of the flywheels. |
| Salaries and benefits           |       | 224                                                                     |       | (67                                                                   | )          | 157               |   | 305 |   | 372 |   | 677 |   | The increase in cost is  primarily due to increase in headcount during 2008 in engineering,  manufacturing and materials management associated with the move from  development to production activities. The reduction in R&D salaries is  attributable to a reduction in overtime costs. There have been no new hires  in 2009 to date. |
| Subcontractors and  consultants |       | (10                                                                     | )          | (76                                                                   | )          | (86               | ) | 383 |   | (226 | ) | 157 |   | The increase in  O&M, year to date, is primarily due to contractor costs associated with  completing non-fungible costs of the 2 MW matrix in Tyngsboro, partially  offset by lesser use of consultants for R&D. |
|                                 |            |                                                                         |            |                                                                       |            |                   |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

36

----

 
| ** **                | ** ** | **Three  months ended 9/30/08 compared to  three months ended 9/30/09** | ** ** | **Nine  months ended 9/30/08 compared to  nine months ended 9/30/09** | ** ** | ** **        |
|---------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------|
| ** **                | ** ** | **Operations  and  maintenance  functions**                             | ** ** | **Research  and  development  functions**                             | ** ** | **Total  change** | ** ** | **Operations  and  maintenance  functions** | ** ** | **Research  and  development  functions** | ** ** | **Total  Change** | ** ** | ** ** |
| Legal                     |       | 49                                                                      |       | (952                                                                  | )          | (903              | ) | 135 |   | (1,489 | ) | (1,354 | ) | R&D Legal expenses  in 2008 included costs associated with the Arete lawsuit, which was settled  in November 2008. O&M legal and tax advice represents primarily costs  associated with the set up of our frequency regulation operations in New  York. |
| Allocations and  overhead |       | 253                                                                     |       | (198                                                                  | )          | 55                |   | (122 | ) | (457 | ) | (579 | ) | The increase in  overhead allocation year to date is a result of the increase in the level of  production and contract activity, resulting in an increase in overhead  capitalized. Overhead allocations in O&M dropped during the third quarter  of 2009, due to lower production activity, pending the closing of the DOE  loan. |
| Stock Compensation        |       | (21                                                                     | )          | (112                                                                  | )          | (133              | ) | (85 | ) | (406 | ) | (491 | ) | Generally, stock  options and RSUs have been granted to management and employees during the  first quarter of the fiscal year, based on prior year performance, and to new  hires. In 2009, such equity grants were made to officers during the second  quarter of 2009, and no grants have been made to other employees. In  addition, there were no new hires during the first nine months of 2009. |
| Occupancy                 |       | 9                                                                       |       | (47                                                                   | )          | (38               | ) | (143 | ) | (133 | ) | (276 | ) | Occupancy costs in the  first nine months of 2008 included the cost of moving to our new facility in  Tyngsboro, along with impact of cost cutting efforts in 2009. |

 

37

----

 
| ** **                       | ** ** | **Three  months ended 9/30/08 compared to  three months ended 9/30/09** | ** ** | **Nine  months ended 9/30/08 compared to  nine months ended 9/30/09** | ** ** | ** **        |
|----------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------|
| ** **                       | ** ** | **Operations  and  maintenance  functions**                             | ** ** | **Research  and  development  functions**                             | ** ** | **Total  change** | ** ** | **Operations  and  maintenance  functions** | ** ** | **Research  and  development  functions** | ** ** | **Total  Change** | ** ** | ** ** |
| Outside documentation /  testing |       | (1                                                                      | )          | (14                                                                   | )          | (15               | ) | (13 | ) | (16 | ) | (29 | ) | Costs lower due to  reduced use of outside testing services in 2009, |
| Travel                           |       | (10                                                                     | )          | 2                                                                     |       | (8                | ) | (22 | ) | (13 | ) | (35 | ) | Travel reduced as a  cost-cutting initiative. |
| Other                            |       | (18                                                                     | )          | (11                                                                   | )          | (29               | ) | (18 | ) | (24 | ) | (42 | ) | Cost cutting efforts  have been made to conserve cash, given the economic climate during the first  nine months of 2009. |
| Net increase (decrease)          |       | $                                                                       | 29         |                                                                  | $          | (1,317            | ) | $ | (1,288 | ) | $ | — |   | $ | (2,101 | ) | $ | (2,101 | ) |   |
|                                  |            |                                                                         |            |                                                                       |            |                   |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Selling,General and Administrative Expense*

 

Selling, generaland administrative expenses totaled approximately $5,356,000 and $6,109,000 forthe nine months ended September 30, 2009 and 2008, respectively, whichrepresents a decrease of approximately $753,000, or 12%, period over period.For the quarter ended September 30, 2009 and 2008, selling, general andadministrative expenses totaled approximately $1,463,000 and 1,805,000,respectively, a decrease of approximately $342,000, or 19%.  Significant changes in spending are explainedin the table shown below. Overall, we expect our selling, general andadministrative expenses for fiscal 2009 to be lower than in 2008 primarily dueto lower legal costs and other planned cost reductions.

 

38

----

 
| ** **                            | ** **   | **Three  months  ended  September 30,** | ** **   | **Nine  months  ended  September 30,** | ** ** | **Comment**                                                                                                                                                                                                                                                                                                                                                                                              |
|---------------------------------------|--------------|----------------------------------------------|--------------|---------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *** ***                          | *** *** | **(in thousands)**                           | *** *** | *** ***                                |
| Period  Ended September 30, 2008 |         | $                                            | 1,805        |                                        | $          | 6,109                                                                                                                                                                                                                                                                                                                                                                                                    |   |   |
| Stock  Compensation                   |         | (166                                         | )            | (563                                        | )          | Historically, stock  options and RSUs have been granted to management and employees during the  first quarter of the fiscal year, based on prior year performance, and to new  hires. In 2009, such equity grants were made to officers during the second  quarter of 2009, and no grants have been made to other employees. In addition,  there were no new hires during the first nine months of 2009. |
| Legal,  audit and professional fees   |         | (117                                         | )            | (316                                        | )          | Reduction in use of  outside legal services.                                                                                                                                                                                                                                                                                                                                                             |
| Public  company / investor relations  |         | (52                                          | )            | 174                                         |       | Expenses year to date  are higher because more Board/Committee meetings were held earlier in the  year than in the prior year, in addition we incurred costs associated with  the Seaside stock agreement.                                                                                                                                                                                               |
| Salaries  and benefits                |         | 21                                           |         | 133                                         |       | Three G&A employees  were hired during early 2008, primarily to support regulatory efforts. The  increase represents a full nine months of salaries for these individuals,  combined with increased health insurance costs.                                                                                                                                                                          |
| Expense  materials                    |         | (22                                          | )            | (60                                         | )          | Reduction due to cost  cutting efforts.                                                                                                                                                                                                                                                                                                                                                                  |
| Subcontractors  and consultants       |         | 62                                           |         | (18                                         | )          | Planned reduction in  use of consultants, partially offset with a slight increase during the third  quarter related to regulatory efforts, investigation of potential sites, and  applications for grants under the Federal Stimulus Act.                                                                                                                                                                |
| Allocations  and overhead             |         | (39                                          | )            | (77                                         | )          | Represents G&A  overhead allocated to the Navy contract.                                                                                                                                                                                                                                                                                                                                             |
| Office  Supply                        |         | (2                                           | )            | (18                                         | )          | Reduction due to cost  cutting efforts                                                                                                                                                                                                                                                                                                                                                                   |
| Dues  and subscriptions               |         | 13                                           |         | 31                                          |       | Increased memberships                                                                                                                                                                                                                                                                                                                                                                                    |
| Software  maintenance                 |         | 11                                           |         | 24                                          |       | Increase due to  maintenance costs for new software used by regulatory compliance group.                                                                                                                                                                                                                                                                                                                 |
| Hiring  Expense                       |         | (17                                          | )            | (20                                         | )          | There have been no new  hires in 2009; therefore hiring costs have decreased.                                                                                                                                                                                                                                                                                                                            |
| Travel                                |         | (21                                          | )            | (14                                         | )          | Reduction due to cost-cutting  efforts                                                                                                                                                                                                                                                                                                                                                                   |
| Other                                 |         | (13                                          | )            | (29                                         | )          | Planned cost reductions  to conserve cash, given the economic climate during the first nine months of  2009.                                                                                                                                                                                                                                                                                             |
| Period  Ended September 30, 2009 |         | $                                            | 1,463        |                                        | $          | 5,356                                                                                                                                                                                                                                                                                                                                                                                                    |   |   |

 

39

----

 

*Loss onContract Commitments*

 

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

 

Eachquarter we perform an estimate-to-complete analysis, and any changes to ouroriginal estimates are recognized in the period in which they aredetermined.  In the second quarter of2008, we recorded a contract loss of approximately $86,600, which representsour expected “cost share” portion of the Tehachapi contract. During the firstquarter of 2009, we recorded an additional contract loss on the Tehachapicontract of approximately $132,500, which represents the difference between ouroverhead rate based on “full production”, and the contract bid rate.  No loss reserve adjustments were considerednecessary during the quarter ended September 30, 2009.

 

*Depreciationand Amortization*

 

Depreciation andamortization expense increased from approximately $927,000 during the ninemonths ended September 30, 2008, to approximately $1,346,000 for the sameperiod in 2009, an increase of approximately $419,000, or 45%.  Similarly, depreciation and amortizationexpense for the quarter ended September 30, 2009, was 43% higher than forthe same quarter in the prior year. The increase in depreciation andamortization results primarily from capital expenditures relating to leaseholdimprovements at our new manufacturing and office facility in Tyngsboro, as wellas the purchase of machinery and equipment required to begin commercialproduction, and depreciation on the 2 MW of frequency regulation capacity inservice as of the end of the third quarter of 2009.  As of September 30, 2009, we hadapproximately $10.3 million in “Construction in progress,” of whichapproximately $7.4 million is for flywheels or materials to build flywheels andapproximately $2.7 million are costs related to the construction of SmartEnergy MatrixTM systems.  We expectdepreciation expense to continue to increase during 2009 as we build and placeour frequency regulation facilities into commercial operation.

 

*Interestand Other Income (Expense), net*

 

Average cashbalances during the first nine months of 2009 were lower than during the sameperiod in 2008, as were interest rates, resulting in a reduction of interestincome for the first nine months of 2009 of approximately $298,000 as comparedto interest income for the first nine months of 2008.  Interest expense for the first nine months of2009 was approximately $65,000, which was comprised of approximately $176,000cash paid for interest on the MassDev loan and approximately $33,800 warrantamortization, offset by $144,800 capitalized interest applied to our Tyngsbororegulation assets. We began to pay interest on the MassDev loan in October 2008,so there was no interest expense for the nine months ended September 30,2008. Interest expense was a credit for the three months ended September 30,2009, due to a correction in the calculation of capitalized interest.  The correction was not considered material toprior periods. These factors contribute to a reduction of net interest andother income during the nine months ended September 30, 2009 ofapproximately $367,000, or 118%, over the equivalent period last year.

 

*NetLoss*

 

As a result of thechanges discussed above, the net loss for the nine months ended September 30,2009 was approximately $14,399,000 which compares to a net loss during the sameperiod in 2008 of approximately $16,340,000, a decrease in net loss ofapproximately $1,941,000 or 12%.  Netloss for the quarter ended September 30, 2009, was approximately$4,092,000, compared to a net loss for the quarter ended September 30,2008 of $5,621,000, a reduction in the net loss of approximately $1,529,000, or27%, quarter over quarter.

 

40

----

 

**Liquidityand Capital Resources**

** **
| ** **                                 | ** ** | **Nine  months ended September 30,** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                 | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                        | ** ** |
| Cash  and cash equivalents                 |       | $                                         | 4,335      |   | $ | 10,578 |   |
| Working  capital                           |       | (104                                      | )          | 6,463 |   |
| Cash  provided by (used in)                |       |                                      |       |   |   |
| Operating  activities                      |       | (16,338                                   | )          | (9,949 | ) |
| Investing  activities                      |       | (2,437                                    | )          | (9,964 | ) |
| Financing  activities                      |       | 8,753                                     |       | 74 |   |
| Net  decrease in cash and cash equivalents |       | $                                         | (10,022    | ) | $ | (19,839 | ) |
| Current  ratio                             |       | 1.0                                       |       | 2.0 |   |

 

Working capital as of September 30, 2009, has adeficit of approximately $104,000.  Thisdeficit is primarily due to the use of cash for investment in flywheels,materials to build flywheels and other costs related to the construction of theStephentown site and for legal, consulting and other costs associated with thedue diligence for the loan guaranteed by the DOE. All of these costs are eligibleproject expenses under the loan program rules. Accordingly, we expect working capital to be a surplus once we are ableto begin drawing down on this loan.

 

Ourcash requirements depend on many factors including, but not limited to, thecost to build our flywheels and frequency regulation facilities, research anddevelopment activities, facility costs and general and administrativeexpenses.  Since we are still in thedevelopment stage and have not yet generated significant revenue from ourprincipal operations, we do not generate enough cash from operations to satisfyour working capital requirements.

 

OnFebruary 19, 2009, we entered into a common stock purchase agreement withSeaside 88, LP, valued at up to $18 million. This agreement was amended on June 19,2009.  The original agreement requiredSeaside to buy $1 million of our common stock once each month for up to 18months, beginning on February 20, 2009, and on the 20th day of each month thereafter (or the nextclosest business day) at a discount rate of 20% of the volume weighted averagetrading price over the five day trading period immediately before thepurchase.  The amended agreementmaintains the $18 million aggregate maximum purchase price, but accelerates thepurchase to 1.5 million shares twice per month at a 14% discount to the 10-dayvolume weighted average trading price. The agreement is structured in three tranches, or segments, of sixclosings each.  The first tranche endedwith the July 6, 2009 stock purchase. The second tranche ended with the October 5, 2009 closing date, andwe have exercised our option to extend the agreement for a third tranche,meaning there will be 18 closings total over the term of the agreement (subjectto the overall dollar limit). Because we exercised the option to extend theagreement, we expect to have sufficient cash to maintain operations into2010.  The following stock sales havebeen completed as of October 20, 2009:

 
| **Transaction date**   | ** ** | **Aggregate  value** | ** ** | **Common  Shares  Sold** | ** ** | **Sale  Price per  Share** | ** ** |
|------------------------|------------|----------------------|------------|--------------------------|------------|----------------------------|------------|
| February 20, 2009 |       | $                    | 1,000,000  |                     | 2,656,184  |                       | $          | 0.37648 |   |
| March 20, 2009    |       | 1,000,000            |       | 2,896,200                |       | $                          | 0.34528    |   |
| April 20, 2009    |       | 1,000,000            |       | 1,912,777                |       | $                          | 0.52280    |   |
| May 20, 2009      |       | 1,000,000            |       | 1,647,772                |       | $                          | 0.60688    |   |
| June 22, 2009     |       | 1,193,895            |       | 1,500,000                |       | $                          | 0.79593    |   |
| July 6, 2009      |       | 1,118,430            |       | 1,500,000                |       | $                          | 0.74562    |   |
| July 20, 2009     |       | 932,670              |       | 1,500,000                |       | $                          | 0.62178    |   |
| August 5, 2009    |       | 939,255              |       | 1,500,000                |       | $                          | 0.62617    |   |
| August 20, 2009   |       | 895,260              |       | 1,500,000                |       | $                          | 0.59684    |   |
| September 8, 2009 |       | 989,295              |       | 1,500,000                |       | $                          | 0.65953    |   |
|                        |            |                      |            |                          |            |                            |            |  |  |

 

41

----

 
| **Transaction date**    | ** ** | **Aggregate  value** | ** ** | **Common  Shares  Sold** | ** ** | **Sale  Price per  Share** | ** ** |
|-------------------------|------------|----------------------|------------|--------------------------|------------|----------------------------|------------|
| September 21, 2009 |       | 940,155              |       | 1,500,000                |       | $                          | 0.62677    |   |
| October 5, 2009    |       | 925,575              |       | 1,500,000                |       | $                          | 0.61705    |   |
| October 20, 2009   |       | 941,955              |       | 1,500,000                |       | $                          | 0.62797    |   |
| Total  Investment       |       | $                    | 12,876,490 |                     | 22,612,933 |                       |       |   |
|                         |            |                      |            |                          |            |                            |            |  |  |

 

Our ability to obtainsufficient funding will pace our ability to produce and deploy flywheelsystems. In 2010 and beyond, we will continue to have capital needs that willrequire additional equity and debt to fund the ongoing deployment of frequencyregulation facilities. Our business plan for 2009 includes legaland other costs required to finalize the loan guaranteed by the DOE, begin sitework at our Stephentown, New York, facility, as well as begin procurement ofmaterials and manufacturing of flywheels for that site.  Our business plan for 2010 includes theconstruction of the 20 MW Stephentown facility, installation of most of theflywheel systems, and the start of work on a second 20 MW facility. In order toexecute our business plans for 2009 and 2010, in addition to the loanguaranteed by the DOE, we believe we will require funding as follows:

 

·                  an estimated$15 million to complete due diligence and provide the required equitycontribution required to close the loan to be guaranteed by the DOE

 

·                  an estimated$23 million to fund ongoing operations for the remainder of 2009 and all of2010, of which we expect to receive approximately $5 million from remainingclosings under our existing agreement with Seaside

 

·                  an estimated $7 million tofund the beginning of construction of an additional 20 MW facility in thesecond half of 2010.

 

However, thetiming of the disbursement of the DOE loan is directly affected by the timingof the execution of an interconnection agreement with NYISO; hence the ramp upof cash burn will be affected by the same timing.  We willrequire additional funds from a combination of equity and project financing forthe deployment of additional 20 MW facilities in the future.  In August 2009, we applied for grants fora total of up to $46.7 million under the DOE’s Smart Grid Demonstration program.  If approved, each grant would be used to fundup to 50% of the cost of our second and third 20 MW plants.  Because the total budget for DOE frequency regulationgrants is $45 to $50 million, and other companies may have applied for the samegrants, there can be no assurance that either or both of our grant applicationswill be approved or, if approved, that any such grants will be in the amountswe applied for.

 

**Operating Activities**

 

Net cash used inoperating activities was approximately $16,338,000 and $9,949,000 for the ninemonths ended September 30, 2009 and 2008, respectively.  The primarycomponent of the negative cash flow from operations is from our net losses. For the nine months ended September 30, 2009, we had a net loss ofapproximately $14,399,000.  Adjustments to reconcile net loss to cash flowin 2009 include non-cash stock compensation of approximately $745,000,depreciation and amortization of approximately $1,346,000, interest expense onwarrants of approximately $34,000, loss on disposition of fixed assets ofapproximately $7,000, partially offset by a net increase in deferred rent ofapproximately ($79,000) and changes in operating assets and liabilities ofapproximately ($3,992,000).

 

During the sameperiod in 2008, we had a net loss of approximately $16,340,000. Adjustments to reconcile net loss to cash flow for the period include non-cashstock compensation of approximately $1,800,000, depreciation and amortizationof approximately $927,000, a net reduction in deferred rent of approximately$112,000 and cash received from our landlord as a credit for certain buildingimprovements of $1,430,000.  Changes inoperating assets and liabilities provided approximately $2,122,000 of cash.

 

**InvestingActivities**

 

Net cash used ininvesting activities was approximately $2,437,000 and $9,964,000 for the ninemonths ending September 30, 2009 and 2008, respectively.  The principal use of cash in 2009 was thepurchase of property and equipment in the amount of approximately $2,435,000,primarily for the purchase and construction of property and equipment and toincrease the restricted cash required by the ISO-NE for their credit reserve ofapproximately $2,000.  For the ninemonths ended September 30, 2008, the

 

42

----

 

principal use of cash wasthe purchase of property and equipment in the amount of approximately$10,138,000, much of which related to the renovation of the Tyngsboro facility.These charges were partially offset by a reduction in restricted cash ofapproximately $174,000, related to the expiration of the Wilmington lease.

 

**FinancingActivities**

 

Net cash providedby financing activities was approximately $8,753,000 and $74,000 for the firstnine months of 2009, and 2008, respectively. In 2009, funds were provided by the sale of stock to Seaside ofapproximately $10,149,000 and issuance of stock under the employee stockpurchase plan of approximately $60,000, offset partially by cash paid forfinancing costs related to the due diligence for the DOE loan guarantee programand advances to suppliers of approximately $1,456,000.  For the first nine months of 2008, cash providedby financing activities of approximately $18,000 related to a reduction ofcosts previously accrued related to the sale of stock in 2007, issuance ofstock under the employee stock purchase plan of approximately $41,000, and theexercise of employee stock options of approximately $15,000.  We may evaluate possible acquisitions ofenterprises or technologies that we consider synergistic from a market,technology or product perspective. We may make investments in companies forstrategic business reasons or seek other strategic financing relationships thatbenefit our business.

 

At September 30,2009, we had firm purchase commitments with our suppliers to acquire componentsfor our commercial flywheel units, begin the build-out of the Smart EnergyMatrixTM in Stephentown, and satisfy contractual obligations for our researchand development programs in the amount of approximately $2.6 million. We havean additional $2.8 million conditional material purchase commitment to a secondsource supplier that is working to meet our qualification requirements.

 

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

 

Ourcash equivalents, which have maturities of less than three months, may exposeour assets to interest rate risk.  At September 30, 2009, we hadapproximately $109,000 of cash equivalents that were held in non-interestbearing accounts.  Also at September 30, 2009 we had approximately$2,644,000 of cash equivalents that were held in interest-bearing checking accounts,and approximately $1,582,000 invested in interest-bearing money market accountsat high-quality financial institutions, some of which are investedoffshore.  The fair value of theseinvestments approximates their cost. The funds invested in money marketaccounts may not be covered under FDIC Insurance, and therefore may be at somerisk of loss, which we deem to be low. The money market funds are invested primarily in government funds, suchas Treasury Bills. Approximately $890,000 of our cash on hand at September 30,2009 was invested in mutual funds at a brokerage firm that has purchasedsupplementary insurance through Lloyd’s of London.  This insurance coverage provides protectionabove the Securities Investor Protection Corporation (SIPC) coverage in theevent that the broker becomes insolvent. SIPC protects against the loss ofsecurities up to a total of $500,000 (of which $100,000 may be in cash) perclient.  The supplemental insuranceprovided by the broker would cover investments at that brokerage firm up to amaximum of $1 billion, including up to $1.9 million per client for the cashportion of any remaining shortfall. SIPC and the supplemental insurance do notcover market losses; however, management believes the risk of substantialmarket losses is low because our funds are invested primarily in governmentfunds.

 

**Item 4.  Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures*

 

As of the end of the period covered by this report, wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures.  Based on theevaluation, both the Chief Executive Officer and the Chief Financial Officerconcluded that our disclosure controls and procedures, as defined in Rules 13a– 15(e) and 15d – 15(e) promulgated under the Securities Exchange Actof 1934, were effective as of September 30, 2009.

 

*InternalControl over Financial Reporting*

 

There was no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgatedunder the Securities Act of 1934) that materially affected, or is reasonablylikely to materially affect, such internal control over financial reportingduring the quarter ended September 30, 2009.

 

43

----

 

**Part II — OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

None.

 

**Item 1A.  Risk Factors**

 

In addition to otherinformation set forth in this report, you should carefully consider the factorsdescribed in Part I, Item 1A of our Annual Report on Form 10-K forthe year ended December 31, 2008, filed with the SEC on March 16,2009, in Part II, Item 1A of our Quarterly Report on Form 10-Q forthe quarter ended March 31, 2009, filed with the SEC on May 11,2009,  and in Part II Item 1A of ourQuarterly Report on Form 10-Q for the quarter ended June 30, 2009,filed with the SEC on August 6, 2009, which are incorporated herein byreference.  Those factors couldmaterially affect our business, financial condition or future results. Therisks described in such reports are not the only risks we face. Additionalrisks and uncertainties not currently known to us or that we currently deem tobe immaterial may also have a materially adverse effect on our business,financial condition and/or operating results.

 

**Item2.  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 SecurityHolders**

 

None.

 

**Item 5.  Other Information**

 

None.

 

**Item6.  Exhibits**

 
| **Exhibit** | ** ** | ** ** | ** ** | ** **                                                                                                           |
|-------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Ref**    | ** ** | **Description  of Document**                                                                                         |
|        |       |       |       |                                                                                                                 |
| 3.1         |       | (1)        |       | Sixth Amended and  Restated Certificate of Incorporation.                                                            |
|        |       |       |       |                                                                                                                 |
| 3.2         |       | (1)        |       | Certificate of  Amendment of the Sixth Amended and Restated Certificate of Incorporation,  dated June 25, 2007. |
|        |       |       |       |                                                                                                                 |
| 3.3         |       | (1)        |       | Certificate of  Amendment of the Sixth Amended and Restated Certificate of Incorporation,  dated June 26, 2007. |
|        |       |       |       |                                                                                                                 |
| 3.4         |       | (2)        |       | Certificate of  Amendment of the Sixth Amended and Restated Certificate of Incorporation,  dated June 11, 2009. |
|        |       |       |       |                                                                                                                 |
| 3.5         |       | (3)        |       | Amended and Restated  Bylaws, as amended.                                                                            |

 

44

----

 
| **Exhibit** | ** ** | ** ** | ** ** | ** **                                                                                                                                                        |
|-------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Ref**    | ** ** | **Description  of Document**                                                                                                                                      |
| 3.6         |       | (4)        |       | Certificate of  Designation of Series A Junior Participating Preferred Stock, filed with  The Secretary of State of Delaware on October 4, 2002.        |
|        |       |       |       |                                                                                                                                                              |
|        |       |       |       |                                                                                                                                                              |
| 31.1        |       | +          |       | Certification of  Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                    |
|        |       |       |       |                                                                                                                                                              |
| 31.2        |       | +          |       | Certification of  Principal Financial and Accounting Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                     |
|        |       |       |       |                                                                                                                                                              |
| 32.1        |       | +          |       | Certification of  Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|        |       |       |       |                                                                                                                                                              |
| 32.2        |       | +          |       | Certification of  Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

----

(1)               Incorporated by reference from the Form 10-Kfiled on March 17, 2008 (File No. 000-31973).

 

(2)               Incorporated by reference from the Form 10-Qfiled on August 6, 2009 (File No. 000-31973).

 

(3)               Incorporated by reference from the Form 8-K filedon October 1, 1007 (File No. 000-31973).

 

(4)               Incorporated by reference from the Form 10-Kfiled on March 30, 2006 (File No. 000-31973).

 

+                     Filed herewith.

 

45

----

 

**SIGNATURES**

 

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

 
|   | BEACON POWER  CORPORATION                            |
|--------|------------------------------------------------------|
|   |                                                 |
| Date:  | November 3, 2009                                | By: | /s/ F. William Capp |
|   |                                                 | F. William Capp |
|   |                                                 | President and Chief  Executive Officer |
|   |                                                 | Principal Executive  Officer |
|   |                                                 |   |
|   | November 3, 2009                                | By: | /s/ James M. Spiezio |
|   |                                                 | James M. Spiezio |
|   | Vice President of  Finance, Chief Financial Officer, |
|   | Treasurer and Secretary                              |
|   | Principal Financial  Officer                         |

 

46

----