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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-QSB



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(Mark One)

|x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------

For the quarterly period ended March 31, 2006

or



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) of the SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------

For the Transition Period from  to

Commission
File No. 000-50508



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DayStar Technologies, Inc.

(Exact name of small business issuer as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 84-1390053                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|13 Corporate Dr. Halfmoon, New York 12065                      |  | (518) 383-4600                      
|(Address of principal executive offices)                       |  | (Issuers telephone number)         

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the
Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such report(s), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No ̈

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

At May 2, 2006, 6,560,723 shares of
the registrants Common Stock, par value $0.01 per share, were outstanding.

Transitional Small Business Disclosure Format:
Yes ̈No  x



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DAYSTAR TECHNOLOGIES, INC.

Quarterly Report on Form 10-QSB

Quarterly Period Ended March 31, 2006

Table of Contents



|                                                                                                      |  |   
|----------------------------------------------------------------------------------------------------- |  | --
|Part I  Financial Information                                                                        |  |   
|                                                                                                      | 
|Item 1. Financial Statements                                                                          |  |   
|                                                                                                      | 
|Consolidated Balance Sheet  March 31, 2006                                                           |  | 3 
|                                                                                                      | 
|Consolidated Statements of Operations - For the Three Months Ended March 31, 2006 and 2005            |  | 4 
|                                                                                                      | 
|Consolidated Statement of Changes in Stockholders Equity - For the Three Months Ended March 31, 2006 |  | 5 
|                                                                                                      | 
|Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005              |  | 6 
|                                                                                                      | 
|Notes to Consolidated Financial Statements                                                            |  | 7 
|                                                                                                      | 
|Item 2. Managements Discussion and Analysis or Plan of Operation                                     |  | 13
|                                                                                                      | 
|Item 3. Controls and Procedures                                                                       |  | 18
|                                                                                                      | 
|PART II  Other Information                                                                           |  |   
|                                                                                                      | 
|Item 2. Unregistered Sales of Equity Securities                                                       |  | 18
|                                                                                                      | 
|Item 6. Exhibits and Reports on Form 8-K                                                              |  | 18
|                                                                                                      | 
|Signatures                                                                                            |  | 19



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PART 1. FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEET

(Unaudited)



|                                                                                                    |  |               |             |  
|--------------------------------------------------------------------------------------------------- |  | ------------- | ----------- | -
|                                                                                                    |  | March 31,2006 |            
|ASSETS                                                                                              |  |               |             |  
|Current Assets:                                                                                     |  |               |             |  
|Cash and cash equivalents                                                                           |  | $             | 4,291,218   |  
|Investments                                                                                         |  |               | 5,131,154   |  
|Other current assets                                                                                |  |               | 348,477     |  
|                                                                                                    |  |               |             |  
|Total current assets                                                                                |  |               | 9,770,849   |  
|                                                                                                    | 
|Property and Equipment, at cost,                                                                    |  |               | 6,712,791   |  
|Less accumulated depreciation and amortization                                                      |  |               | (1,068,431  | )
|                                                                                                    |  |               |             |  
|Net property and equipment                                                                          |  |               | 5,644,360   |  
|Other Assets:                                                                                       |  |               |             |  
|Patents (net of amortization of $22,065)                                                            |  |               | 30,885      |  
|Deposits                                                                                            |  |               | 34,257      |  
|                                                                                                    |  |               |             |  
|Total other assets                                                                                  |  |               | 65,142      |  
|                                                                                                    |  |               |             |  
|Total Assets                                                                                        |  | $             | 15,480,351  |  
|                                                                                                    |  |               |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                |  |               |             |  
|Current Liabilities:                                                                                |  |               |             |  
|Accounts payable                                                                                    |  | $             | 1,082,479   |  
|Wages payable                                                                                       |  |               | 149,012     |  
|Notes payable, current portion                                                                      |  |               | 3,311       |  
|Capital lease obligations, current portion                                                          |  |               | 65,263      |  
|Accrued expenses                                                                                    |  |               | 94,582      |  
|Deferred gain                                                                                       |  |               | 7,000       |  
|                                                                                                    |  |               |             |  
|Total current liabilities                                                                           |  |               | 1,401,647   |  
|Long-Term Liabilities:                                                                              |  |               |             |  
|Notes payable                                                                                       |  |               | 408,795     |  
|Capital lease obligations                                                                           |  |               | 72,459      |  
|Deferred revenue                                                                                    |  |               | 300,000     |  
|Deferred gain                                                                                       |  |               | 7,583       |  
|                                                                                                    |  |               |             |  
|Total long-term liabilities                                                                         |  |               | 788,837     |  
|Commitments and Contingencies (Note 7)                                                              |  |               |            |  
|Stockholders Equity:                                                                               |  |               |             |  
|Preferred stock, $.01 par value; 3,000,000 shares authorized; 0 shares issued and outstanding       |  |               |            |  
|Common stock, $.01 par value; 19,850,000 shares authorized; 6,508,711 shares issued and outstanding |  |               | 65,087      |  
|Common stock Class B, $.01 par value; 150,000 shares authorized, 0 shares issued and outstanding    |  |               |            |  
|Additional paid-in capital                                                                          |  |               | 30,521,813  |  
|Accumulated deficit                                                                                 |  |               | (17,297,033 | )
|                                                                                                    |  |               |             |  
|Total stockholders equity                                                                          |  |               | 13,289,867  |  
|                                                                                                    |  |               |             |  
|Total Liabilities and Stockholders Equity                                                          |  | $             | 15,480,351  |  
|                                                                                                    |  |               |             |  

See accompanying notes to these consolidated financial statements.



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DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                                               |  |                                     |            |   |      |   |            |  
|-------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                               |  | For the Three Months EndedMarch 31, |           
|                                                               |  | 2006                                |            |   | 2005 |  
|Revenue:                                                       |  |                                     |            |   |      |   |            |  
|Research and development contract revenue                      |  | $                                   | 30,000     |   |      | $ |           |  
|Costs and Expenses:                                            |  |                                     |            |   |      |   |            |  
|Research and development                                       |  |                                     | 1,894,468  |   |      |   | 683,574    |  
|Selling, general and administrative                            |  |                                     | 1,257,197  |   |      |   | 581,517    |  
|Depreciation and amortization                                  |  |                                     | 218,072    |   |      |   | 132,319    |  
|                                                               |  |                                     |            |   |      |   |            |  
|Total costs and expenses                                       |  |                                     | 3,369,737  |   |      |   | 1,397,410  |  
|Other Income (Expense):                                        |  |                                     |            |   |      |   |            |  
|Interest expense                                               |  |                                     | (21,936    | ) |      |   | (14,243    | )
|Other income                                                   |  |                                     | 114,182    |   |      |   | 17,239     |  
|                                                               |  |                                     |            |   |      |   |            |  
|Total other income                                             |  |                                     | 92,246     |   |      |   | 2,996      |  
|                                                               |  |                                     |            |   |      |   |            |  
|Loss from Continuing Operations                                |  |                                     | (3,247,491 | ) |      |   | (1,394,414 | )
|Income from discontinued operations of DayStar Solar, LLC      |  |                                     |           |   |      |   | 4,833      |  
|                                                               |  |                                     |            |   |      |   |            |  
|Net Loss                                                       |  | $                                   | (3,247,491 | ) |      | $ | (1,389,581 | )
|                                                               |  |                                     |            |   |      |   |            |  
|Weighted Average Common Shares Outstanding (Basic and Diluted) |  |                                     | 6,501,711  |   |      |   | 3,549,830  |  
|                                                               |  |                                     |            |   |      |   |            |  
|Net Loss Per Share (Basic and Diluted)                         |  | $                                   | (0.50      | ) |      | $ | (0.39      | )
|                                                               |  |                                     |            |   |      |   |            |  

See accompanying notes to these consolidated financial statements.



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DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2006

(Unaudited)



|                                    |  |              |  |                          |        |  |                    |            |   |       |   |             |   |  |   |            |  
|----------------------------------- |  | ------------ |  | ------------------------ | ------ |  | ------------------ | ---------- | - | ----- | - | ----------- | - |  | - | ---------- | -
|                                    |  | Common Stock |  | AdditionalPaid-InCapital |        |  | AccumulatedDeficit |            |   | Total |  
|                                    |  | Shares       |  | Amount                   |        |  |                   
|BALANCES, December 31, 2005         |  | 6,370,756    |  | $                        | 63,708 |  | $                  | 29,659,388 |   |       | $ | (14,049,542 | ) |  | $ | 15,673,554 |  
|Exercise of Consultant warrants     |  | 5,000        |  |                          | 50     |  |                    | 37,450     |   |       |   |            |   |  |   | 37,500     |  
|Exercise of Representative warrants |  | 77,530       |  |                          | 775    |  |                    | 464,405    |   |       |   |            |   |  |   | 465,180    |  
|Exercise of Class B public warrants |  | 100          |  |                          | 1      |  |                    | 999        |   |       |   |            |   |  |   | 1,000      |  
|Exercise of stock options           |  | 10,325       |  |                          | 103    |  |                    | 28,687     |   |       |   |            |   |  |   | 28,790     |  
|Grants of Restricted Stock          |  | 45,000       |  |                          | 450    |  |                    | (450       | ) |       |   |            |   |  |   |           |  
|Warrants issued for services        |  |             |  |                          |       |  |                    | 18,292     |   |       |   |            |   |  |   | 18,292     |  
|Compensatory Stock Options          |  |             |  |                          |       |  |                    | 252,473    |   |       |   |            |   |  |   | 252,473    |  
|Compensatory Restricted Stock       |  |             |  |                          |       |  |                    | 60,569     |   |       |   |            |   |  |   | 60,569     |  
|Net loss                            |  |             |  |                          |       |  |                    |           |   |       |   | (3,247,491  | ) |  |   | (3,247,491 | )
|                                    |  |              |  |                          |        |  |                    |            |   |       |   |             |   |  |   |            |  
|BALANCES, March 31, 2006            |  | 6,508,711    |  | $                        | 65,087 |  | $                  | 30,521,813 |   |       | $ | (17,297,033 | ) |  | $ | 13,289,867 |  
|                                    |  |              |  |                          |        |  |                    |            |   |       |   |             |   |  |   |            |  

See accompanying notes to these consolidated financial statements.



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DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                        |  |                                     |            |   |      |   |            |  
|----------------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                        |  | For the Three Months EndedMarch 31, |           
|                                                                        |  | 2006                                |            |   | 2005 |  
|Cash Flows from Operating Activities:                                   |  |                                     |            |   |      |   |            |  
|Net loss                                                                |  | $                                   | (3,247,491 | ) |      | $ | (1,389,581 | )
|Adjustments to reconcile net loss to cash used in operating activities: |  |                                     |            |   |      |   |            |  
|Depreciation and amortization                                           |  |                                     | 218,072    |   |      |   | 132,319    |  
|Share-based compensation                                                |  |                                     | 313,042    |   |      |   | 55,385     |  
|Warrants issued for services                                            |  |                                     | 18,292     |   |      |   | 6,381      |  
|Gain on sale/leaseback                                                  |  |                                     | (1,750     | ) |      |   | (1,750     | )
|Changes in operating assets and liabilities:                            |  |                                     |            |   |      |   |            |  
|(Increase) decrease in:                                                 |  |                                     |            |   |      |   |            |  
|Receivables                                                             |  |                                     | 520,022    |   |      |   |           |  
|Other assets                                                            |  |                                     | (145,915   | ) |      |   | (65,618    | )
|Increase (decrease) in:                                                 |  |                                     |            |   |      |   |            |  
|Accounts payable                                                        |  |                                     | 230,685    |   |      |   | (201,182   | )
|Accrued expenses                                                        |  |                                     | (56,020    | ) |      |   | 13,078     |  
|                                                                        |  |                                     |            |   |      |   |            |  
|Net cash used in operating activities                                   |  |                                     | (2,151,063 | ) |      |   | (1,450,968 | )
|Cash Flows from Investing Activities:                                   |  |                                     |            |   |      |   |            |  
|Purchase of investments                                                 |  |                                     | (3,122,334 | ) |      |   | (903,766   | )
|Proceeds from sale of investments                                       |  |                                     | 3,072,195  |   |      |   | 3,078,528  |  
|Purchase of equipment                                                   |  |                                     | (1,306,183 | ) |      |   | (563,983   | )
|                                                                        |  |                                     |            |   |      |   |            |  
|Net cash provided by (used in) investing activities                     |  |                                     | (1,356,322 | ) |      |   | 1,610,779  |  
|Cash Flows from Financing Activities:                                   |  |                                     |            |   |      |   |            |  
|Payments on notes payable                                               |  |                                     | (755       | ) |      |   |           |  
|Proceeds from Consultant warrant exercise                               |  |                                     | 37,500     |   |      |   |           |  
|Proceeds from Representative warrant exercise                           |  |                                     | 465,180    |   |      |   |           |  
|Proceeds from Class B public warrant exercise                           |  |                                     | 1,000      |   |      |   |           |  
|Proceeds from exercise of stock options                                 |  |                                     | 28,790     |   |      |   |           |  
|Payments on capital leases                                              |  |                                     | (16,407    | ) |      |   | (3,404     | )
|                                                                        |  |                                     |            |   |      |   |            |  
|Net cash provided by (used in) financing activities                     |  |                                     | 515,308    |   |      |   | (3,404     | )
|                                                                        |  |                                     |            |   |      |   |            |  
|Increase / (Decrease) in cash and cash equivalents                      |  |                                     | (2,992,077 | ) |      |   | 156,407    |  
|Cash and cash equivalents, beginning of period                          |  |                                     | 7,283,295  |   |      |   | 316,041    |  
|                                                                        |  |                                     |            |   |      |   |            |  
|Cash and cash equivalents, end of period                                |  | $                                   | 4,291,218  |   |      | $ | 472,448    |  
|                                                                        |  |                                     |            |   |      |   |            |  
|Supplemental Cash Flow Information:                                     |  |                                     |            |   |      |   |            |  
|Cash paid for interest                                                  |  | $                                   | 13,697     |   |      | $ | 7,127      |  
|                                                                        |  |                                     |            |   |      |   |            |  
|Non-Cash Transactions:                                                  |  |                                     |            |   |      |   |            |  
|Equipment lease financing                                               |  | $                                   |           |   |      | $ | 38,595     |  
|                                                                        |  |                                     |            |   |      |   |            |  
|Equipment note payable                                                  |  | $                                   |           |   |      | $ | 415,618    |  
|                                                                        |  |                                     |            |   |      |   |            |  

See accompanying notes to these consolidated financial statements.



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DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



|1. | Principles of Consolidation, Organization and Nature of Operations:
|-- | -------------------------------------------------------------------

The accompanying consolidated financial statements include the accounts of DayStar Technologies, Inc. and DayStar Solar, LLC (formerly International Energy Trading, LLC), a wholly-owned subsidiary of DayStar
Technologies, Inc. All significant intercompany transactions have been eliminated in consolidation. During the second quarter of 2005, DayStar Technologies, Inc. discontinued operations of DayStar Solar, LLC.

DayStar Technologies, Inc. (the Company) was formed in 1997 for the purpose of researching, developing, manufacturing and marketing
innovative products to the renewable energy / photovoltaic industry. From its inception, the Company has focused primarily on concentrator photovoltaic and thin-film solar cells. The principal source of revenue for the Company has been revenue from
government funded research and development contracts.



|2. | Future Operations:
|-- | ------------------

The Company has experienced
losses from operations and anticipates incurring substantial losses in the future. The Companys current business plans include significant expenditures to continue the development of the current manufacturing production capability and to
expand development efforts for next generation production processes. These activities require the Company to increase headcount, purchase production equipment, build-out additional manufacturing facilities, and design and manufacture prototype
deposition equipment. The Company does not believe that it can achieve profitability until development, implementation and commercialization of next generation processes are achieved.

Without additional financing, the Company would need to delay certain of these activities and defer certain capital expenditures. The Companys
financing plan includes (1) obtaining private equity funding, (2) evaluating the likelihood of converting the Class B public warrants to common stock, (3) completing a secondary public offering and (4) obtaining debt financing.



|3. | Significant Accounting Policies:
|-- | --------------------------------

Revenue
Recognition  The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104). SAB 104 requires that four basic criteria must be met before revenue can be recognized:
(1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the sellers price to the buyer is fixed and determinable; and (4) collectibility is reasonably assured.

Research and development contract revenue is recognized as the Company meets milestones as set forth under the contract. All of the Companys
revenue during the three months ended March 31, 2006 is from contracts with a New York State government agency.

Share-Based
Compensation  Prior to January 1, 2006, the Company accounted for stock option awards granted under the Companys Equity Incentive Plan in accordance with the recognition and measurement provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25) and related Interpretations, as permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, (SFAS 123). Share-based employee compensation expense was not recognized in the Companys consolidated statements of operations prior to January 1, 2006, as all stock option awards granted had an
exercise price equal to or greater than the market value of the common stock on the date of the grant (other than for certain option modifications resulting in exercise prices below the fair market value at the date of modification). As permitted by
SFAS 123, the Company reported pro-forma disclosures presenting results and earnings per share as if the Company had used the fair value recognition provisions of SFAS 123 in the Notes to Consolidated Financial Statements. Share-based compensation
related to non-employees and modifications of options granted were accounted for based on the fair value of the related stock or options in accordance with SFAS 123 and its interpretations.



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Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting
Standards No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)), which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on
estimated fair values. Additionally, the Company follows the Securities and Exchange Commissions Staff Accounting Bulletin No. 107 Share-Based Payment (SAB 107), issued in March 2005, which provides supplemental
SFAS 123(R) application guidance based on the views of the SEC. The Company adopted SFAS 123(R) using the modified prospective transition method. Under this transition method, share-based compensation expense recognized during the three months ended
March 31, 2006 included: (a) compensation expense for all share-based awards granted prior to, but not yet vested, as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS
123, and (b) compensation expense for all share-based awards granted beginning January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In accordance with the modified prospective
transition method, the Companys consolidated financial statements for prior periods have not been restated to reflect the impact of SFAS 123(R).

Loss Per Share  Loss per share is presented in accordance with the provisions of SFAS No. 128, Earnings Per Share. Basic Earnings Per Share (EPS) is calculated by dividing the income or
loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or
converted into common stock. These common stock equivalents have been omitted from earnings per share because they are anti-dilutive. Basic and diluted EPS were the same for the three months ended March 31, 2006 and 2005.

Discontinued Operations  In June 2005, the Company discontinued operations of DayStar Solar, LLC. The results of operations associated with
this business, have been reported as discontinued operations in the accompanying consolidated statements of operations. The accompanying consolidated statements of cash flows include the effects of both continuing and discontinued operations.

Reclassifications  Certain reclassifications have been made to the 2005 financial statements to conform to the 2006
presentation.

Impact of Recently Issued Accounting Pronouncements 

SFAS No. 151, Inventory Costs. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, which revised
ARB 43, relating to inventory costs. This revision is to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). This Statement requires that these items be recognized as a
current period charge regardless of whether they meet the criterion specified in ARB 43. In addition, this Statement requires the allocation of fixed production overhead to the costs of conversion be based on normal capacity of the production
facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. SFAS 151 became effective for the Company on January 1, 2006. The adoption of SFAS 151 did not have a material impact on the
Companys consolidated financial statements.

SFAS No. 153, Exchanges of Nonmonetary Assets. In December 2004,
the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which changes the guidance in APB Opinion 29, Accounting for Nonmonetary Transactions. This Statement amends Opinion 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the
entity are expected to change significantly as a result of the exchange. SFAS 153 is effective during fiscal years beginning after June 15, 2005. SFAS 153 became effective for the Company on January 1, 2006. The adoption of SFAS 153 did
not have a material impact on the Companys consolidated financial statements.

SFAS No. 154, Accounting Changes and
Error Corrections. In May 2005, the FASB, issued SFAS No. 154, Accounting Changes and Error Corrections  a replacement of APB No. 20 and FASB Statement No. 3. SFAS 154 requires that a voluntary change in
accounting principle be applied retrospectively with all prior period financial statements presented on the basis of the new accounting principle. SFAS 154 also requires that a change in method of depreciating or amortizing a long-lived
non-financial asset be accounted for prospectively as a change in estimate, and corrections of errors in previously issued financial statements should be termed a restatement. SFAS 154 is effective for accounting changes and correction of errors
made in fiscal years beginning after December 15, 2005.



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SFAS 154 became effective for the Company on January 1, 2006. The adoption of SFAS 154 did not have a material impact on the Companys consolidated
financial statements.

SFAS No. 155 Accounting for Certain Hybrid Financial Instruments  An Amendment of FASB
No. 133 and 140 In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments  An Amendment of FASB Statement No. 133 and 140 (SFAS 155). SFAS 155
simplifies the accounting for certain hybrid financial instruments that contain an embedded derivative that otherwise would have required bifurcation. SFAS 155 also eliminates the interim guidance in FASB Statement No. 133, which provides
that beneficial interest in securitized financial assets are not subject to the provisions of FASB Statement No. 133. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entitys first
fiscal year that begins after September 15, 2006, which for the Company will be as of January 1, 2006. The Company does not believe that the adoption of SFAS 155 will have a material impact on its consolidated financial statements.

FSP No. 123 (R)-3 Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards

In November 2005, the FASB issued FASB Staff Position No. FAS No. 123(R)-3, Transition Election Related to Accounting
for the Tax Effects of Share-Based Payment Awards (FSP 123R-3). FSP 123R-3, which is effective November 10, 2005 provides for a practical transition method that may be elected to calculate the pool of excess tax benefits
available to absorb tax deficiencies upon the adoption of FAS 123(R). The method comprises a computational component that establishes the beginning balance of the additional paid in capital (APIC) pool related to employee compensation and a
simplified method to determine the subsequent impact on the APIC pool of awards that are fully vested and outstanding upon the adoption of FAS 123(R). An election to use this method may be made the later of one year from the effective date of FSP
123R-3 or the initial adoption date for FAS 123(R). The Company is evaluating whether it will adopt this alternative, but does not believe adopting this alternative would have a material impact on its consolidated financial statements.

FSP No. 123 (R)-4 Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon
the Occurrence of a Contingent Event

In February 2006, the FASB issued FASB Staff Position
No. FAS No. 123(R)-4,Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event (FSP 123R-4). FSP 123R-4
amends FAS 123(R) to incorporate that a cash settlement feature that can be exercised only upon the occurrence of a contingent event that is outside the employees control does not meet certain conditions in SFAS 123(R) until it becomes
probable that the event will occur. The guidance in this FASB Staff Position was applied as part of the Companys adoption of FAS 123(R) effective January 1, 2006 and did not have a material impact on its consolidated financial statements.



|4. | Share-Based Compensation
|-- | ------------------------

Equity Incentive
Plan  In September 2003, the Company adopted an Equity Incentive Plan (the Plan) to enable employees, outside directors and consultants to acquire an equity interest in the Company. Issuances under the Plan may be in the form
of Incentive and Non-Qualified Stock Options, Restricted Stock, Stock Units and Stock Appreciation Rights. The Plan reserves 1,050,000 shares of the Companys Common Stock for issuance for these purposes. There were 52,769 shares available for
grant under the Plan as of March 31, 2006. Under the plan, the term of stock options shall not exceed ten years and incentive stock options shall not be granted with an exercise price of less than 100% of the fair market value of the common
stock, and non-qualified stock options shall not be granted with an exercise price of less than 85% of the fair market value of the common stock, both measured at the time of grant.

As discussed in Note 3, Significant Accounting Policies  Share-Based Compensation, effective January 1, 2006, the Company adopted the
fair value recognition provisions of SFAS 123(R), using the modified prospective transition method. The adoption of SFAS 123(R) resulted in share-based compensation expense for the three months ended March 31, 2006 of $252,473, of which $93,777
was recorded to research and development and $158,696 to selling, general and administrative expenses. These expenses reduced basic and diluted earnings per share by $0.04 for the quarter. The Company did not recognize a tax benefit from the
share-based compensation expense because



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the Company considers it is more likely than not that the related deferred tax assets, which have been reduced by a full valuation allowance, will not be
realized. Accordingly, because the Company is not able to realize these excess tax benefits, such benefits have not been recognized in the consolidated statement of cash flow for the three months ended March 31, 2006.

For the three months ended March 31, 2005, the Company applied the intrinsic value method of accounting for stock options as prescribed by APB 25.
Since all options granted during the three months ended March 31, 2005 had an exercise price equal to the closing market price of the underlying common stock on the grant date, no share-based compensation expense was recognized. If share-based
compensation expense had been recognized based on the estimated fair value of each option granted in accordance with the provisions of SFAS 123, as amended by SFAS 148, the Companys net loss and net loss per share would have been reduced to
the following pro-forma amounts:



|                                                                     |  |   |            |  
|-------------------------------------------------------------------- |  | - | ---------- | -
|Net loss, as reported                                                |  | $ | (1,389,581 | )
|Pro forma share-based compensation expense, net of tax benefit       |  |   | (45,011    | )
|Employee share-based compensation expense under the intrinsic method |  |   |           |  
|                                                                     |  |   |            |  
|Pro forma net loss                                                   |  | $ | (1,434,592 | )
|                                                                     |  |   |            |  
|Net loss per share, basic and diluted, As reported                   |  | $ | (0.39      | )
|Pro forma share-based compensation expense                           |  |   | (0.01      | )
|Employee share-based compensation expense under the intrinsic method |  |   |           |  
|                                                                     |  |   |            |  
|Pro forma                                                            |  | $ | (0.40      | )
|                                                                     |  |   |            |  

Pro-forma compensation expense under SFAS 123, among other computational differences, does not
consider potential pre-vesting forfeitures. Because of these differences, the pro-forma share-based compensation expense presented above for the three months ended March 31, 2005 under SFAS 123 and the share-based compensation expense
recognized during the three months ended March 31, 2006 under SFAS 123(R) are not directly comparable. In accordance with the modified prospective transition method of SFAS 123(R), the prior comparative quarterly results have not been restated.

The Black-Scholes option-pricing model was used to estimate the option fair values. This option-pricing model requires a number of
assumptions, of which the most significant are, expected stock price volatility, the expected pre-vesting forfeiture rate and the expected option term (the amount of time from the grant date until the options are exercised or expire). Expected
volatility was calculated based upon actual historical stock price movements over the period from the Companys initial public offering through March 31, 2006, and further reviewed against industry comparables for consistency. Expected
pre-vesting forfeitures were estimated based on actual historical pre-vesting forfeitures over the period from the Companys initial public offering through March 31, 2006. The expected option term was calculated using the
simplified method permitted by SAB 107.

The weighted average per share fair value of stock options granted during the three
months ended March 31, 2006 and 2005 was $11.12 and $3.14, respectively. The fair value was estimated as of the grant date using the Black-Scholes option pricing model with the following assumptions:



|                          |  |                             |      |   |      |   |      |  
|------------------------- |  | --------------------------- | ---- | - | ---- | - | ---- | -
|                          |  | Three Months EndedMarch 31, |     
|                          |  | 2006                        |      |   | 2005 |  
|Expected volatility       |  |                             | 88   | % |      |   | 89   | %
|Risk-free interest rate   |  |                             | 4.65 | % |      |   | 4.50 | %
|Expected dividends        |  | $                           |     |   |      | $ |     |  
|Expected terms (in years) |  |                             | 6.25 |   |      |   | 10   |  



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The following table summarizes stock options outstanding and activity as of and for the three months
ended March 31, 2006:



|                               |  |         |   |  |                               |       |                                                    |      |                          |   |          
|------------------------------ |  | ------- | - |  | ----------------------------- | ----- | -------------------------------------------------- | ---- | ------------------------ | - | ---------
|                               |  | Shares  |   |  | WeightedAverageExercise Price |       | WeightedAverageRemainingContractualTerm (in years) |      | AggregateIntrinsic Value
|Outstanding at January 1, 2006 |  | 293,375 |   |  | $                             | 8.04  |                                                    |      |                          |   |          
|Granted                        |  | 47,400  |   |  | $                             | 14.52 |                                                    |      |                          |   |          
|Forfeited                      |  | (8,921  | ) |  | $                             | 6.29  |                                                    |      |                          |   |          
|Exercised                      |  | (10,325 | ) |  | $                             | 2.40  |                                                    |      |                          |   |          
|                               |  |         |   |  |                               |       |                                                    |      |                          |   |          
|Outstanding at March 31, 2006  |  | 321,529 |   |  | $                             | 9.22  |                                                    | 9.04 |                          | $ | 1,262,997
|                               |  |         |   |  |                               |       |                                                    |      |                          |   |          
|Exercisable at March 31, 2006  |  | 76,675  |   |  | $                             | 6.28  |                                                    | 8.75 |                          | $ | 526,532  
|                               |  |         |   |  |                               |       |                                                    |      |                          |   |          

The total intrinsic value, or the difference between the exercise price and the market price on
the date of exercise, of all options exercised during the three months ended March 31, 2006, was $116,616. Cash received from stock options exercised during the three months ended March 31, 2006 was $28,790. The Company did not realize any
tax deductions related to the exercise of stock options during the three months ended March 31, 2006. The Company will record such deductions to additional paid in capital when realized.

The following table summarizes the Companys stock options outstanding and currently exercisable at March 31, 2006:



|                         |  |         |  |                                         |  |                              |       |        |        |                              |   |      
|------------------------ |  | ------- |  | --------------------------------------- |  | ---------------------------- | ----- | ------ | ------ | ---------------------------- | - | -----
|                         |  |         |  | Options Outstanding                     |  | Options Exercisable         
|Range of Exercise Prices |  | Number  |  | WeightedAverageRemainingContractualLife |  | WeightedAverageExercisePrice |       | Number |        | WeightedAverageExercisePrice
|3.45 - 4.00              |  | 20,000  |  | 7.9                                     |  | $                            | 3.62  |        | 11,667 |                              | $ | 3.73 
|2.06 - 2.54              |  | 82,129  |  | 8.4                                     |  | $                            | 2.40  |        | 26,300 |                              | $ | 2.39 
|2.59 - 6.83              |  | 38,400  |  | 8.9                                     |  | $                            | 4.98  |        | 14,708 |                              | $ | 3.00 
|10.40 - 15.03            |  | 181,000 |  | 9.5                                     |  | $                            | 13.84 |        | 24,000 |                              | $ | 13.81
|                         |  |         |  |                                         |  |                              |       |        |        |                              |   |      
|                         |  | 321,529 |  | 9.0                                     |  | $                            | 9.22  |        | 76,675 |                              | $ | 6.28 

Total unrecognized share-based compensation expense from unvested stock options as of
March 31, 2006 was $1,729,518, which is expected to be recognized over a weighted average period of approximately 3 years.

In
addition to the stock options discussed above, the Company recognized share-based compensation expense related to Restricted Stock grants, of $60,569 and $55,385 for the three months ended March 31, 2006 and 2005, respectively. The following
table summarizes Non-vested Restricted Stock and the related activity as of and for the three months ended March 31, 2006:



|                              |  |        |  |                                        |      
|----------------------------- |  | ------ |  | -------------------------------------- | -----
|                              |  | Shares |  | Weighted Average Grant-Date Fair-Value
|Non-vested at January 1, 2006 |  | 38,750 |  | $                                      | 10.64
|Granted                       |  | 45,000 |  | $                                      | 13.06
|                              |  |        |  |                                        |      
|Non-vested at March 31, 2006  |  | 83,750 |  | $                                      | 11.94



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|5. | Warrants
|-- | --------

Class A public warrants
 As of March 31, 2006, there were no Class A public warrants outstanding. On August 11, 2005, the Company redeemed all then outstanding Class A public warrants.

Class B public warrants  As of March 31, 2006, 5,115,153 Class B public warrants were outstanding. The Class B public warrants included
in the units became exercisable on March 22, 2004. The exercise price of a Class B public warrant is $10.00. The Class B public warrants expire on February 11, 2009, the fifth anniversary of the completion of the initial public offering.
The Company does not have the right to redeem the Class B public warrants.

Representative warrants  As of March 31,
2006, 8,192 warrants issued to underwriters, in connection with the initial public offering, were outstanding. Each warrant gives the holder the right to purchase one unit for $6.00. A unit consists of one share of common stock, one Class A
redeemable public warrant and two Class B non-redeemable public warrants. As noted above, on August 11, 2005, any Class A public warrants then outstanding were redeemed. During the three months ended March 31, 2006, 38,765
Representative warrants were exercised which included the exercise of the Class A warrants to common stock. Accordingly, 77,530 shares of Common stock and 77,530 Class B non-redeemable public warrants were issued, resulting in proceeds to the
Company of $465,180.

Consultant warrants As of March 31, 2006, 71,450 Consultant warrants were outstanding. Under
contracts with three of the Companys consultants, monthly grants, through January 31, 2006, of 1,650 warrants to purchase one share of the Companys common stock at a price of $3.00 are to be issued based on service rendered.
Accordingly 1,650 warrants have been issued during the three months ended March 31, 2006, under these arrangements. During the three months ended March 31, 2006, 5,000 Consultant warrants were exercised for common stock.

The fair value of the Consultant warrants charged to expense during the three months ended March 31, 2006 was $18,292. There were no Consultant warrants issued
during the three months ended March 31, 2005, and therefore no expense was recorded. The fair value of the Consultant warrants issued during the three months ended March 31, 2006 was calculated using the Black-Scholes pricing model with
the following assumptions: dividend yield of zero percent; expected volatility of 87.91%; risk free interest rate of 4.65% and a term of three years.



|6. | Discontinued Operations
|-- | -----------------------

During the second quarter
of 2005, the Company discontinued operations of its subsidiary, DayStar Solar, LLC. This entity was in the business of reselling and installing solar electricity systems for residential customers in northern California. The discontinuance of this
business operation coincided with the closure of the facility in Grass Valley, California. There were no results of operation from DayStar Solar, LLC for the three months ended March 31, 2006. Results of operations from DayStar Solar, LLC, for
the three months ended March 31, 2005 were as follows:



|                         |  |   |       
|------------------------ |  | - | ------
|Revenue                  |  | $ | 34,597
|Cost of revenue          |  |   | 26,665
|Operating expenses       |  |   | 3,099 
|                         |  |   |       
|Total costs and expenses |  |   | 29,764
|                         |  |   |       
|Net income               |  | $ | 4,833 
|                         |  |   |       

Revenue from the sale and installation of solar electricity systems is recognized when installation is complete
and collectibility is reasonably assured.



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|7. | Commitments and Contingencies
|-- | -----------------------------

Operating
Lease - On March 10, 2006, the Company entered into a fifty-one month lease for approximately 50,000 square feet of factory and office space in Santa Clara, California. The lease expires in August of 2010. The space will be the location of
the Companys equipment development group, responsible for the development of certain next generation manufacturing equipment. Monthly payments under the lease are $18,144 per month during the first twelve months, and increase by $1,008 per
month during each twelve month period thereafter. The terms of the lease allow for early termination by the landlord effective at the thirty-sixth month of the lease term.

In addition to the minimum payments under operating leases disclosed in the Companys Annual Report on Form 10-KSB for the year ended
December 31, 2005, future minimum lease payments under this new lease as of March 31, 2006, are as follows:



|                         |  |        |          
|------------------------ |  | ------ | ---------
|Year Ending December 31, |  | Amount
|2006                     |  | $      | 127,008  
|2007                     |  |        | 224,784  
|2008                     |  |        | 236,880  
|2009                     |  |        | 248,976  
|2010                     |  |        | 172,368  
|                         |  |        |          
|Total                    |  | $      | 1,010,016
|                         |  |        |          



|8. | Subsequent Events
|-- | -----------------

Employment Agreements -
In April 2006, the Company entered into employment agreements with all eight of its executive officers. Annual base salaries under these agreements total $1,374,500. Each agreement is for an initial three-year term. The agreements are automatically
extended for a one year period on the anniversary date and annually thereafter unless either party gives the other 90 days written notice prior to the anniversary date of the intent not to extend the agreement. The agreements contain provisions for
both the Company and the executive officers, which allow either party to terminate prior to the expiration of the agreements.

Under each employment
agreement, the executive officer is entitled to participate in an annual bonus and management incentive program, as currently offered or subsequently modified by the Board. Each executive officers incentive compensation program is within the
sole discretion of the board of directors, and the Company has the right to alter, amend or eliminate all or any part of any incentive program at any time, without compensation. Each executive officer is also entitled to participate in all of the
Companys employee benefit plans.



|Item 2. | Managements Discussion and Analysis or Plan of Operation
|------- | ---------------------------------------------------------

The following discussion and
analysis provides information that we believe is relevant to an assessment and understanding of our results of operation and financial condition. You should read this analysis in conjunction with our audited consolidated financial statements and
related footnotes. This discussion and analysis contains statements of a forward-looking nature relating to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may
cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements, including those
set forth in the Companys Annual Report on Form 10-KSB.

The following discussion and analysis should be read in conjunction with the unaudited
financial statements contained in Part I, Item 1, and the related notes.



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Overview

We began operations in 1997 for the purpose of developing thin-film, copper-indium-gallium-selenide solar cells, known as a CIGS solar cells, and more cost-effective processes for manufacturing such solar cells. From inception, we have
focused our efforts on research and development, manufacturing, development of an initial customer base and raising capital.

On
February 11, 2004, we successfully completed an initial public offering of 2.1 million units. A unit consisted of one share of common stock, one Class A redeemable public warrant and two Class B non-redeemable public warrants. Each
warrant gave the holder the right to purchase one share of common stock. The net proceeds from the offering, after deducting underwriting fees and offering expenses, were $8.3 million. The proceeds were used to fund (1) research and development
expenses to further develop and refine our proprietary thin-film solar cell fabrication processes, (2) purchase capital equipment to create development-scale vacuum deposition hardware, measurement and test equipment, and solar cell packaging
hardware, (3) fund general, sales and corporate expenses, and (4) pay outstanding obligations.

On June 21, 2005, we
publicly announced that we intended to redeem our outstanding Class A public warrants at $.25 per warrant. The warrant holders had the ability to exercise each warrant for one common share at $6.00 per share. There were 2,371,830 Class A
public warrants issued in conjunction with the initial public offering and a subsequent financing. In addition, the exercise of Representative warrants, issued in conjunction with the initial public offering, added 70,324 Class A public
warrants subject to redemption. The exercise period ended August 11, 2005. During the exercise period, 2,425,062 of the Class A public warrants (99.3% of the total outstanding) were exercised for an equal number of shares of common stock
and we received $14.5 million in proceeds from the warrant exercises. Additionally, the exercise of other equity instruments, primarily Representative and Consultant warrants, generated proceeds of approximately $2.4 million. The proceeds from all
such exercises will be used to complete the build-out of the facility in Halfmoon, New York; fund costs related to ramping up production, accelerating development of and transitioning to our next generation of production (Gen III); and for general operating costs and corporate purposes.

During 2006, we expect to continue the development of the Gen II process and production capability, expand development of the Gen IIIprocess and continue efforts for LightFoilproduct development. The development of the Gen II process includes producing and selling limited amounts of solar cells while increasing headcount,
primarily manufacturing personnel and enhancing our manufacturing support capability. The Gen IIIeffort will
include increasing engineering and manufacturing headcount, building-out additional manufacturing facilities, designing and manufacturing prototype deposition equipment, and purchasing and installing automated cell processing equipment. The
development efforts for LightFoilproducts require additional development engineering headcount and
purchasing production equipment.

We will require additional financing to implement the above programs. We have historically funded our
operations principally from the sale of equity securities and, to a lesser extent, through government grants and contracts. We expect to need additional capital infusions to execute our business plan, and will require additional capital to complete
our next generation manufacturing processes. If adequate capital resources are not available to us, we will be forced to curtail or terminate operations.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. A summary of those accounting policies can be found in the notes to the consolidated financial statements set forth
in the Annual Report on Form 10-KSB. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial condition and results of operations and require judgments on the part of management about
matters that are uncertain. We have identified the following accounting policies that are important to the presentation of our financial condition and results of operations.

Revenue RecognitionWe recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition (SAB
104). SAB 104 requires that four basic criteria must be met before revenue can be



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recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the sellers price to
the buyer is fixed and determinable; and (4) collectibility is reasonably assured.

Capital GrantsAmounts earned under
capital grants for the direct reimbursement of property and equipment costs are recorded as a reduction of the cost of the property or equipment subject to the grant. If we fail to meet specified criteria, we must repay the unearned portion of the
grant.

PatentsCosts incurred to prosecute patents are expensed as incurred. Patent costs paid to obtain patents from third
parties are capitalized and amortized over the life of the patent.

Long-lived AssetsOur policy regarding long-lived assets is
to evaluate the recoverability or usefulness of these assets when the facts and circumstances suggest that these assets may be impaired. This analysis relies on a number of factors, including changes in strategic direction, business plans,
regulatory developments, economic and budget projections, technological improvements, and operating results. The test of recoverability or usefulness is a comparison of the asset value to the undiscounted cash flow of its expected cumulative net
operating cash flow over the assets remaining useful life. Any write-downs would be treated as permanent reductions in the carrying amount of the asset and an operating loss would be recognized. To date, we have had recurring operating losses
and the recoverability of our long-lived assets is contingent upon executing our business plan that includes monitoring our manufacturing costs and significantly increasing sales. If we are unable to execute our business plan, we may be required to
write down the value of our long-lived assets in future periods.

Share-Based CompensationPrior to January 1, 2006, we
accounted for stock option awards granted under the Companys Equity Incentive Plan in accordance with the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, (APB 25) and related Interpretations, as permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (SFAS 123). Share-based employee
compensation expense was not recognized in our consolidated statements of operations prior to January 1, 2006, as all stock option awards granted had an exercise price equal to or greater than the market value of the common stock on the date of
the grant (other than for certain option modifications resulting in exercise prices below the fair market value at the date of modification). As permitted by SFAS 123, we reported pro-forma disclosures presenting results and earnings per share as if
we had used the fair value recognition provisions of SFAS 123 in the Notes to Consolidated Financial Statements. Share-based compensation related to non-employees and modifications of options granted were accounted for based on the fair value of the
related stock or options in accordance with SFAS 123 and its interpretations.

Effective January 1, 2006, we adopted the provisions of
Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)), which requires the measurement and recognition of compensation expense for all share-based payment awards to
employees and directors based on estimated fair values. Additionally, we follow the Securities and Exchange Commissions Staff Accounting Bulletin No. 107 Share-Based Payment (SAB 107), issued in March 2005, which
provides supplemental SFAS 123(R) application guidance based on the views of the SEC. We adopted SFAS 123(R) using the modified prospective transition method. Under this transition method, share-based compensation expense recognized during the three
months ended March 31, 2006 included: (a) compensation expense for all share-based awards granted prior to, but not yet vested, as of January 1, 2006, based on the grant date fair value estimated in accordance with the original
provisions of SFAS 123, and (b) compensation expense for all share-based awards granted beginning January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In accordance with the
modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect the impact of SFAS 123(R).

Results of Operations

Comparison of the Three Months Ended March 31, 2006 and 2005

Certain reclassifications have been made to the 2005 financial information to conform to the 2006 presentation.



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Research and development contract revenue.Our research and development contract revenue was
$30,000 for the three months ended March 31, 2006. There was no research and development contract revenue for the three months ended March 31, 2005. All of our revenue during the three months ended March 31, 2006 was research and
development contract revenue earned as a result of achieving various milestones under an agreement with a New York State government agency.

Research and development expenses. Research and development expenses were $1,894,468 for the three months ended March 31, 2006 compared to $683,574 for the three months ended March 31, 2005, an increase of $1,210,894 or
177%. Research and development expenses increased due to an increase in the number of engineering personnel and increased development activities related to creating the capability to manufacture photovoltaic cells. Additionally, the implementation
of SFAS No. 123(R), effective January 1, 2006, added $93,777 in share-based compensation expense for research and development personnel during the three months ended March 31, 2006. We expect to incur significant additional research
and development expenses in 2006 as engineering personnel are added, we begin the development of our next generation manufacturing equipment at our new facility in Santa Clara, California, and we continue to develop and enhance our manufacturing
technologies.

Selling, general and administrative expenses. Selling, general and administrative expenses were $1,257,197 for the
three months ended March 31, 2006 compared to $581,517 for the three months ended March 31, 2005, an increase of $675,680 or 116%. The increase in selling, general and administrative expenses corresponded with our increase in headcount and
overall growth over the comparative periods. As a result, salaries, consulting and other administrative costs increased during the three months ended March 31, 2006 as compared to the three months ended March 31, 2005. Additionally the
implementation of SFAS No. 123(R), effective January 1, 2006, added $158,696 in share-based compensation expense for selling, general and administrative personnel during the three months ended March 31, 2006. During the remainder of
2006, in conjunction with the ramp up of our production capacity and in anticipation of expansion to our next generation manufacturing facility, we expect to incur increased selling, general and administrative expenses.

Depreciation and amortization expense. Depreciation and amortization expenses were $218,072 for the three months ended March 31, 2006
compared to $132,319 for the three months ended March 31, 2005, an increase of $85,753. Depreciation and amortization expense increased primarily as a result of significant capital equipment being placed in service in the Halfmoon facility
during 2005 and the first quarter of 2006, as we continued to develop our manufacturing technologies to produce photovoltaic cells.

Interest expense. Interest expense was $21,936 for the three months ended March 31, 2006 compared to $14,243 for the three months ended March 31, 2005, an increase of $7,693. Interest costs result from capital lease
obligations and notes payable.

Other income.Other income was $114,182 for the three months ended March 31, 2006 compared to
$17,239 for the three months ended March 31, 2005, an increase of $96,943. Other income primarily represents interest on investments.

Net loss.Our net loss was $3,247,491 for the three months ended March 31, 2006 compared to a loss of $1,389,581 for the three months ended March 31, 2005. The increase in net loss was due primarily to investing in
engineering and operating activities and the personnel required to develop our process for manufacturing photovoltaic cells in our initial production facility, as well as a corresponding increase in selling, general and administrative activity
during the three months ended March 31, 2006. Throughout the remainder of 2006, we expect to continue to incur significant expenses related to (1) commencing manufacturing in our Gen II manufacturing facility, (2) escalating
development efforts and implementation of the next generation Gen III manufacturing processes, and (3) expanding operations to include our next generation manufacturing facility. We also anticipate additional share-based compensation expense as
a result of the implementation of SFAS No. 123(R), effective January 1, 2006. Without significant product revenue anticipated, we also expect to experience significant net losses throughout the remainder of 2006.



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##### Table of Contents

Liquidity and Capital Resources

Liquidity. At March 31, 2006, our cash and cash equivalents and investments totaled $9,422,372. Net cash used in operating activities was $2,151,063 for the three months ended March 31, 2006 compared
to $1,450,968 for the three months ended March 31, 2005. The activity for the three months ended March 31, 2006 is primarily the result of operating expenses paid in cash of $1,755,085 for research and development expenses and $1,065,246
for selling, general and administrative expenses. During 2005 and 2006, we have been increasingly investing in our operations in Halfmoon, New York, and hiring personnel and consultants to begin production and sales of our thin-film solar cells.

Expenditures for equipment purchases for the three months ended March 31, 2006 were $1,306,183. We continue to purchase equipment and
adapt the Halfmoon facility to establish our initial production lines in New York. We are beginning to implement plans at our Santa Clara, California facility to develop our next generation manufacturing equipment.

Capital Resources.We have historically financed our operations primarily from proceeds of the sale of equity securities, revenues received under
research and development contracts and grants, non-cash compensation arrangements and equipment lease financing. We presently do not have a credit facility with a lending institution.

We have been awarded certain research and development contracts and grants by the state of New York. These contracts and grants have been provided as an
incentive for DayStar to increase employment in the state and further advance research and technology in the solar energy industry. Following is a summary of the current contracts and grants:



| |  |  | $1,000,000 Research and Development ContractPayment under the contract will be in phases as we meet facility scale-up and production milestones to commercially produce
solar cells. As of March 31, 2006, we had earned $450,000 under this contract.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $250,000 Research and Development ContractPayment under the contract will be in phases as we meet certain milestones in the design, installation, and performance of an
energy waste reduction system. As of March 31, 2006, we had earned $205,000 under this contract.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $600,000 Capital GrantPayment under the agreement was in three phases as we met certain equipment acquisition and employment milestones. As of March 31, 2006, we
had met the milestones required and received all funds under the agreement. Terms of the grant require us to meet and maintain specified employment criteria, as defined, over a five year period. If we fail to meet the specified criteria, we must
repay any unearned portion of the grant.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

While we expect to continue to pursue similar cost-sharing government research
contracts in the future, there can be no assurance that we will obtain such funds.

We have experienced negative cash flows from operations
since our inception and do not anticipate generating sufficient positive cash flows to fund our operations in the foreseeable future. We expect that our available cash balance, including monies from New York state incentives, exercise of
Representative warrants, and possible equipment financing will be sufficient to finance development of the Gen II process through 2006. Additional financing will be necessary to fund development efforts for LightFoilproducts and development and implementation of the Gen IIImanufacturing process. Accordingly, we are currently exploring ways to raise additional financing.

Without additional financing, we would need to delay certain of these activities and defer certain capital expenditures. Our financing plan includes
(1) obtaining private equity funding, (2) evaluating the likelihood of converting the Class B public warrants to common stock, (3) completing a secondary public offering, (4) obtaining debt financing and (5) increasing
government grant and other contract revenue. Such financing may not be available to us on terms that are acceptable to us, if at all, and any new equity financing may be dilutive to our stockholders.



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##### Table of Contents

Commitments.At March 31, 2006, we had outstanding approximately $2,450,000 of purchase
orders for equipment. The equipment is expected to be received during the remainder of 2006. Other material commitments include rental payments under operating leases for office space and equipment, and commitments under employment contracts with
our executive officers. These commitments are discussed further in the Commitments and Contingencies and Subsequent Eventsfootnotes to our consolidated financial statements.

Off-Balance Sheet Arrangements.The only off-balance sheet obligations are for operating leases entered into in the ordinary course of business.

We lease 23,500 square feet of office and manufacturing space in Halfmoon, New York. We lease 18,000 square feet in one location under a
five year lease that commenced July 1, 2004 for $9,750 per month. In a second location in the same corporate park, we lease 5,500 square feet of office space under a forty-five month lease that commenced October 1, 2005 for $5,769 per
month. In March 2006, we signed a lease for approximately 50,000 square feet of factory and office space in Santa Clara, California under a fifty-one month lease that commences June 2006, for $18,144 per month. We also maintain two leases for
certain office equipment with terms of three and five years that expire in August 2007 and November 2008.



|Item 3. | Controls and Procedures.
|------- | ------------------------

The Companys
President and Chief Executive Officer and the Companys Chief Financial Officer have reviewed the disclosure controls and procedures relating to the Company at March 31, 2006 and concluded that such controls and procedures were effective
to provide reasonable assurance that all material information about the financial and operational activities of the Company was made known to them. There were no changes in the Companys internal control over financial reporting, as of the end
of the period covered by this report that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.

PART II. OTHER INFORMATION



|Item 2. | Unregistered Sales of Equity Securities
|------- | ---------------------------------------

On March
31, 2006, the Company issued warrants to three consultants, to purchase 1,650 shares of the Companys common stock, at an exercise price of $3.00 per share. The warrants have a contractual term of five years and were fully vested at the time of
issuance. Neither the warrants, nor the shares underlying the warrants, were registered at the time of issuance and no registration rights were granted. The warrants were issued pursuant to an exemption under Rule 701 of the Securities Act, Rule 506
of Regulation D and Rule 4(2). The warrants were in consideration of past consulting services.



|Item 6. | Exhibits and Reports on Form 8-K
|------- | --------------------------------

(a) The following
exhibits are filed as part of this report:



|            |  |                                                                                                                                                                                                                                                       
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                           
|            | 
|3.1         |  | Registrants Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No.
333-110337), as amended)                                         
|            | 
|3.2         |  | Amendment to Registrants Amended and Restated Certificate of Incorporation effective December 31, 2003 (incorporated by reference to Exhibit 3.2 to our Registration Statement on
Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as amended)
|            | 
|3.3         |  | Registrants Amended and Restated Bylaws (incorporated by reference to Exhibit 3.3 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as
amended)                                                               
|            | 
|4.1         |  | Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as
amended)                                                                       
|            | 
|4.2         |  | Form of Class A Public Warrant (incorporated by reference to Exhibit 4.2 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as amended)                                                                         
|            | 
|4.3         |  | Form of Class B Public Warrant (incorporated by reference to Exhibit 4.3 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as amended)                                                                         
|            | 
|4.4         |  | Form of Unit Certificate (incorporated by reference to Exhibit 4.4 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as amended)                                                                               



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##### Table of Contents

|            |  |                                                                                                                                                                                
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                    
|            | 
|4.5         |  | Form of Warrant Agent Agreement (incorporated by reference to Exhibit 4.5 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as amended) 
|            | 
|4.6         |  | Form of Representatives Warrant (incorporated by reference to Exhibit 4.6 to our Registration Statement on Form SB-2 filed November 7, 2003 (Reg. No. 333-110337), as
amended)
|            | 
|31.1        |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                 
|            | 
|31.2        |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                 
|            | 
|32.1        |  | Certification of the Chief 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 the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                         

(b) Reports on Form 8-K

On March 10, 2006, the Company entered into a fifty-one month lease for approximately 50,000 square feet of factory and office space in Santa Clara, California. The lease expires in August of 2010. The space will
be the location of the Companys Equipment Development Group, responsible for the development of certain next generation manufacturing equipment.

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.



|                           |  |  |  |     |  |                         |  |                                                                              
|-------------------------- |  |  |  | --- |  | ----------------------- |  | -----------------------------------------------------------------------------
|DAYSTAR TECHNOLOGIES, INC. |  |  |  |    
|                           |  |  | 
|Date: May 12, 2006         |  |  |  | By: |  | /s/ JOHN R. TUTTLE     
|                           |  |  |  |     |  |                         |  | John R. Tuttle                                                               
|                           |  |  |  |     |  |                         |  | Chairman, President and Chief Executive Officer (Principle Executive Officer)
|                           |  |  | 
|Date: May 12, 2006         |  |  |  | By: |  | /s/ STEPHEN A. AANDERUD
|                           |  |  |  |     |  |                         |  | Stephen A. Aanderud                                                          
|                           |  |  |  |     |  |                         |  | Chief Financial Officer (Principal Financial and Accounting Officer)         



19