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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 September 30, 2005



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 November 11, 2005, 6,282,006 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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##### Table of Contents

DAYSTAR TECHNOLOGIES, INC.



Quarterly
Report on Form 10-QSB

Quarterly Period Ended September 30, 2005

Table of Contents



|                                                                                                               |  |   
|-------------------------------------------------------------------------------------------------------------- |  | --
|Part I  Financial Information                                                                                 |  |   
|                                                                                                               | 
|Item 1. Financial Statements                                                                                   |  |   
|                                                                                                               | 
|Consolidated Balance Sheet - September 30, 2005                                                                |  | 3 
|                                                                                                               | 
|Consolidated Statements of Operations - For the three months and nine months ended September 30, 2005 and 2004 |  | 4 
|                                                                                                               | 
|Consolidated Statement of Changes in Stockholders Equity for the nine months ended September 30, 2005         |  | 5 
|                                                                                                               | 
|Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004                    |  | 6 
|                                                                                                               | 
|Notes to Consolidated Financial Statements                                                                     |  | 7 
|                                                                                                               | 
|Item 2.
Managements Discussion and Analysis or Plan of Operation                                              |  | 12
|                                                                                                               | 
|Item 3.
Controls and Procedures                                                                                |  | 17
|                                                                                                               | 
|PART II  Other Information                                                                                    |  |   
|                                                                                                               | 
|Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds                                            |  | 17
|                                                                                                               | 
|Item 6.
Exhibits and Reports on Form 8-K                                                                       |  | 17
|                                                                                                               | 
|Signatures                                                                                                     |  | 18



2



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##### Table of Contents

PART 1. FINANCIAL INFORMATION



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



DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY



CONSOLIDATED BALANCE SHEET



(Unaudited)



|                                                                                                    |  |                   |             |  
|--------------------------------------------------------------------------------------------------- |  | ----------------- | ----------- | -
|                                                                                                    |  | September 30,2005 |            
|ASSETS                                                                                              |  |                   |             |  
|CURRENT ASSETS:                                                                                     |  |                   |             |  
|Cash and cash equivalents                                                                           |  | $                 | 9,510,145   |  
|Investments                                                                                         |  |                   | 5,039,005   |  
|Receivables                                                                                         |  |                   | 90,000      |  
|Other current assets                                                                                |  |                   | 108,477     |  
|                                                                                                    |  |                   |             |  
|Total current assets                                                                                |  |                   | 14,747,627  |  
|                                                                                                    | 
|PROPERTY AND EQUIPMENT, at cost                                                                     |  |                   | 4,499,606   |  
|Less accumulated depreciation and amortization                                                      |  |                   | (662,913    | )
|                                                                                                    |  |                   |             |  
|Net property and equipment                                                                          |  |                   | 3,836,693   |  
|                                                                                                    | 
|OTHER ASSETS                                                                                        |  |                   |             |  
|Patents (net of amortization of $20,310)                                                            |  |                   | 32,640      |  
|Security deposits                                                                                   |  |                   | 18,653      |  
|                                                                                                    |  |                   |             |  
|Total other assets                                                                                  |  |                   | 51,293      |  
|                                                                                                    |  |                   |             |  
|TOTAL ASSETS                                                                                        |  | $                 | 18,635,613  |  
|                                                                                                    |  |                   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                |  |                   |             |  
|CURRENT LIABILITIES:                                                                                |  |                   |             |  
|Accounts payable                                                                                    |  | $                 | 285,753     |  
|Wages payable                                                                                       |  |                   | 94,470      |  
|Notes payable, current portion                                                                      |  |                   | 36,672      |  
|Capital lease obligations, current portion                                                          |  |                   | 61,531      |  
|Accrued expenses                                                                                    |  |                   | 45,249      |  
|Deferred gain                                                                                       |  |                   | 7,000       |  
|                                                                                                    |  |                   |             |  
|Total current liabilities                                                                           |  |                   | 530,675     |  
|                                                                                                    | 
|LONG-TERM LIABILITIES:                                                                              |  |                   |             |  
|Notes payable                                                                                       |  |                   | 376,916     |  
|Capital lease obligations                                                                           |  |                   | 105,659     |  
|Deferred gain                                                                                       |  |                   | 11,083      |  
|                                                                                                    |  |                   |             |  
|Total long-term liabilities                                                                         |  |                   | 493,658     |  
|                                                                                                    | 
|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; 6,278,466 shares issued and outstanding |  |                   | 62,785      |  
|Common stock Class B, $.01 par value; 150,000 shares authorized, 0 shares issued and outstanding    |  |                   |            |  
|Additional paid-in capital                                                                          |  |                   | 29,274,387  |  
|Deferred equity compensation                                                                        |  |                   | (55,385     | )
|Accumulated deficit                                                                                 |  |                   | (11,670,507 | )
|                                                                                                    |  |                   |             |  
|Total stockholders equity                                                                          |  |                   | 17,611,280  |  
|                                                                                                    |  |                   |             |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                          |  | $                 | 18,635,613  |  
|                                                                                                    |  |                   |             |  



See accompanying
notes to these consolidated financial statements.



3



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DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENTS OF OPERATIONS



(Unaudited)



|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|---------------------------------------------------------------- |  | ---------------------------------------- | ---------- | - | --------------------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                 |  | For the Three Months Ended September 30, |            |   | For the Nine Months Ended September 30, |  
|                                                                 |  | 2005                                     |            |   | 2004                                    |   |            | 2005 |  |   | 2004       |  
|REVENUE:                                                         |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|Research and development contract revenue                        |  | $                                        | 115,000    |   |                                         | $ |           |      |  | $ | 365,000    |   |  | $ |           |  
|                                                                 |  |                                          |            |  
|COSTS AND EXPENSES:                                              |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|Selling, general and administrative                              |  |                                          | 714,487    |   |                                         |   | 588,040    |      |  |   | 2,198,681  |   |  |   | 1,895,204  |  
|Research and development                                         |  |                                          | 824,467    |   |                                         |   | 484,082    |      |  |   | 2,139,731  |   |  |   | 964,206    |  
|Depreciation and amortization                                    |  |                                          | 178,677    |   |                                         |   | 19,031     |      |  |   | 477,999    |   |  |   | 62,627     |  
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|Total costs and expenses                                         |  |                                          | 1,717,631  |   |                                         |   | 1,091,153  |      |  |   | 4,816,411  |   |  |   | 2,922,037  |  
|                                                                 |  |                                          |            |  
|OTHER INCOME (EXPENSE):                                          |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|Interest expense                                                 |  |                                          | (22,813    | ) |                                         |   | (9,042     | )    |  |   | (69,773    | ) |  |   | (603,280   | )
|Other income                                                     |  |                                          | 102,416    |   |                                         |   | 19,937     |      |  |   | 139,607    |   |  |   | 43,498     |  
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|Total other income (expense)                                     |  |                                          | 79,603     |   |                                         |   | 10,895     |      |  |   | 69,834     |   |  |   | (559,782   | )
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|LOSS FROM CONTINUING OPERATIONS                                  |  |                                          | (1,523,028 | ) |                                         |   | (1,080,258 | )    |  |   | (4,381,577 | ) |  |   | (3,481,819 | )
|Income (loss) from discontinued operations of DayStar Solar, LLC |  |                                          | (2,088     | ) |                                         |   | 1,985      |      |  |   | (2,547     | ) |  |   | (2,482     | )
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|NET LOSS                                                         |  | $                                        | (1,525,116 | ) |                                         | $ | (1,078,273 | )    |  | $ | (4,384,124 | ) |  | $ | (3,484,301 | )
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (BASIC AND DILUTED)   |  |                                          | 6,050,112  |   |                                         |   | 3,549,830  |      |  |   | 4,563,204  |   |  |   | 3,284,238  |  
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|NET LOSS PER SHARE:                                              |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  
|(Basic and diluted)                                              |  | $                                        | (.25       | ) |                                         | $ | (0.30      | )    |  | $ | (.96       | ) |  | $ | (1.06      | )
|                                                                 |  |                                          |            |   |                                         |   |            |      |  |   |            |   |  |   |            |  



See accompanying
notes to these consolidated financial statements.



4



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DAYSTAR TECHNOLOGIES, INC. AND SUBSIDIARY



CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY



FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005



(Unaudited)



|                                             |  |              |  |                      |        |        |                          |   |        |                                  |      |   |                    |   |            |       |  |   |          |   |  |   |             |   |  |   |            |  
|-------------------------------------------- |  | ------------ |  | -------------------- | ------ | ------ | ------------------------ | - | ------ | -------------------------------- | ---- | - | ------------------ | - | ---------- | ----- |  | - | -------- | - |  | - | ----------- | - |  | - | ---------- | -
|                                             |  | Common Stock |  | Class B Common Stock |        |        | AdditionalPaid-InCapital |   |        | DeferredEquity BasedCompensation |      |   | AccumulatedDeficit |   |            | Total | 
|                                             |  | Shares       |  | Amount               |        | Shares |                          |   | Amount |                                  |      |   |                    |  
|BALANCES, December 31, 2004                  |  | 3,491,830    |  | $                    | 34,918 |        | 29,000                   |   |        | $                                | 290  |   |                    | $ | 12,903,377 |       |  | $ | (227,389 | ) |  | $ | (7,286,383  | ) |  | $ | 5,424,813  |  
|Exercise of Class A public warrants          |  | 2,425,062    |  |                      | 24,252 |        |                         |   |        |                                  |     |   |                    |   | 14,526,121 |       |  |   |         |   |  |   |            |   |  |   | 14,550,373 |  
|Exercise of Class B public warrants          |  | 125          |  |                      | 1      |        |                         |   |        |                                  |     |   |                    |   | 1,249      |       |  |   |         |   |  |   |            |   |  |   | 1,250      |  
|Exercise of Consultant warrants              |  | 110,000      |  |                      | 1,100  |        |                         |   |        |                                  |     |   |                    |   | 669,479    |       |  |   |         |   |  |   |            |   |  |   | 670,579    |  
|Exercise of Representative warrants          |  | 170,324      |  |                      | 1,703  |        |                         |   |        |                                  |     |   |                    |   | 808,231    |       |  |   |         |   |  |   |            |   |  |   | 809,934    |  
|Conversion of Class B common stock           |  | 58,000       |  |                      | 580    |        | (29,000                  | ) |        |                                  | (290 | ) |                    |   | (290       | )     |  |   |         |   |  |   |            |   |  |   |           |  
|Redemption of Class A public warrants        |  |             |  |                      |       |        |                         |   |        |                                  |     |   |                    |   | (4,273     | )     |  |   |         |   |  |   |            |   |  |   | (4,273     | )
|Exercise of stock options                    |  | 23,125       |  |                      | 231    |        |                         |   |        |                                  |     |   |                    |   | 64,446     |       |  |   |         |   |  |   |            |   |  |   | 64,677     |  
|Amortization of deferred stock compensation  |  |             |  |                      |       |        |                         |   |        |                                  |     |   |                    |   |           |       |  |   | 165,623  |   |  |   |            |   |  |   | 165,623    |  
|Amortization of warrants issued for services |  |             |  |                      |       |        |                         |   |        |                                  |     |   |                    |   |           |       |  |   | 6,381    |   |  |   |            |   |  |   | 6,381      |  
|Warrants issued for services                 |  |             |  |                      |       |        |                         |   |        |                                  |     |   |                    |   | 306,047    |       |  |   |         |   |  |   |            |   |  |   | 306,047    |  
|Net loss                                     |  |             |  |                      |       |        |                         |   |        |                                  |     |   |                    |   |           |       |  |   |         |   |  |   | (4,384,124  | ) |  |   | (4,384,124 | )
|                                             |  |              |  |                      |        |        |                          |   |        |                                  |      |   |                    |   |            |       |  |   |          |   |  |   |             |   |  |   |            |  
|BALANCES, September 30, 2005                 |  | 6,278,466    |  | $                    | 62,785 |        |                         |   |        |                                  |     |   |                    | $ | 29,274,387 |       |  | $ | (55,385  | ) |  | $ | (11,670,507 | ) |  | $ | 17,611,280 |  
|                                             |  |              |  |                      |        |        |                          |   |        |                                  |      |   |                    |   |            |       |  |   |          |   |  |   |             |   |  |   |            |  



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 Nine Months EndedSeptember 30, |           
|                                                                        |  | 2005                                   |            |   | 2004 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                   |  |                                        |            |   |      |   |            |  
|Net loss                                                                |  | $                                      | (4,384,124 | ) |      | $ | (3,484,301 | )
|Adjustments to reconcile net loss to cash used in operating activities: |  |                                        |            |   |      |   |            |  
|Depreciation and amortization                                           |  |                                        | 477,999    |   |      |   | 62,627     |  
|Stock-based compensation                                                |  |                                        | 165,623    |   |      |   | 949,581    |  
|Warrants issued for services                                            |  |                                        | 312,428    |   |      |   | 233,280    |  
|Calculated interest on conversion of equity units to common Stock       |  |                                        |           |   |      |   | 506,650    |  
|Gain on sale/leaseback                                                  |  |                                        | (5,250     | ) |      |   | (5,250     | )
|Gain on sale of assets                                                  |  |                                        | (2,549     | ) |      |   |           |  
|Charge off of deferred financing costs to interest expense              |  |                                        |           |   |      |   | 67,687     |  
|Changes in operating assets and liabilities:                            |  |                                        |            |   |      |   |            |  
|(Increase) decrease in:                                                 |  |                                        |            |   |      |   |            |  
|Receivables                                                             |  |                                        | (90,000    | ) |      |   | 86         |  
|Other current assets                                                    |  |                                        | (88,595    | ) |      |   | (55,584    | )
|Increase (decrease) in:                                                 |  |                                        |            |   |      |   |            |  
|Accounts payable                                                        |  |                                        | (259,636   | ) |      |   | (216,688   | )
|Accrued expenses                                                        |  |                                        | 48,472     |   |      |   | (232,033   | )
|                                                                        |  |                                        |            |   |      |   |            |  
|Net cash used in operating activities                                   |  |                                        | (3,825,632 | ) |      |   | (2,173,945 | )
|CASH FLOWS FROM INVESTING ACTIVITIES:                                   |  |                                        |            |   |      |   |            |  
|Investments                                                             |  |                                        | (1,108,304 | ) |      |   |           |  
|Purchase of equipment                                                   |  |                                        | (1,927,586 | ) |      |   | (869,210   | )
|Proceeds from sale of assets                                            |  |                                        | 3,120      |   |      |   |           |  
|                                                                        |  |                                        |            |   |      |   |            |  
|Net cash used in investing activities                                   |  |                                        | (3,032,770 | ) |      |   | (869,210   | )
|CASH FLOWS FROM FINANCING ACTIVITIES:                                   |  |                                        |            |   |      |   |            |  
|Proceeds from notes payable                                             |  |                                        |           |   |      |   | 130,000    |  
|Payments on notes payable                                               |  |                                        | (2,030     | ) |      |   | (230,000   | )
|Proceeds from sale of stock                                             |  |                                        |           |   |      |   | 8,978,360  |  
|Net proceeds from Class A public warrant exercise                       |  |                                        | 14,546,100 |   |      |   |           |  
|Proceeds from Consultant warrant exercise                               |  |                                        | 670,579    |   |      |   |           |  
|Proceeds from Representative warrant exercise                           |  |                                        | 809,934    |   |      |   |           |  
|Proceeds from Class B public warrant exercise                           |  |                                        | 1,250      |   |      |   |           |  
|Proceeds from exercise of stock options                                 |  |                                        | 64,677     |   |      |   |           |  
|Payments on capital leases                                              |  |                                        | (38,004    | ) |      |   | (29,618    | )
|Cost of financing                                                       |  |                                        |           |   |      |   | (53,350    | )
|                                                                        |  |                                        |            |   |      |   |            |  
|Net cash provided by financing activities                               |  |                                        | 16,052,506 |   |      |   | 8,795,392  |  
|                                                                        |  |                                        |            |   |      |   |            |  
|INCREASE IN CASH                                                        |  |                                        | 9,194,104  |   |      |   | 5,752,237  |  
|Cash and cash equivalents, beginning of period                          |  |                                        | 316,041    |   |      |   | 64,979     |  
|                                                                        |  |                                        |            |   |      |   |            |  
|Cash and cash equivalents, end of period                                |  | $                                      | 9,510,145  |   |      | $ | 5,817,216  |  
|                                                                        |  |                                        |            |   |      |   |            |  
|SUPPLEMENTAL CASH FLOW INFORMATION:                                     |  |                                        |            |   |      |   |            |  
|Cash paid for interest                                                  |  | $                                      | 47,619     |   |      | $ | 39,157     |  
|                                                                        |  |                                        |            |   |      |   |            |  
|NON-CASH TRANSACTIONS:                                                  |  |                                        |            |   |      |   |            |  
|Equipment lease financing                                               |  | $                                      | 38,595     |   |      | $ |           |  
|                                                                        |  |                                        |            |   |      |   |            |  
|Equipment note payable                                                  |  | $                                      | 415,618    |   |      | $ |           |  
|                                                                        |  |                                        |            |   |      |   |            |  
|Deferred Equity compensation                                            |  | $                                      |           |   |      | $ | 268,657    |  
|                                                                        |  |                                        |            |   |      |   |            |  



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 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.



Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United
States of America (GAAP) have been omitted from these unaudited consolidated financial statements. These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the
Companys Annual Report on Form 10-KSB for the year ended December 31, 2004. The results of operations for the nine months ended September 30, 2005 and 2004 are not necessarily indicative of the operating results for the full year.



In the opinion of management, all adjustments, consisting only of normal
recurring accruals, have been made to present fairly the Companys financial position at September 30, 2005 and the results of its operations and its cash flows for the nine months ended September 30, 2005 and 2004.



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.



International Energy Trading, LLC (IET) was formed in 2001 to manufacture and sell thin-film photovoltaic products developed and patented by DayStar Technologies, Inc. IET was a dormant subsidiary until
2003 at which time the name was formally changed to DayStar Solar, LLC and the company commenced selling and installing solar energy systems. During the second quarter of 2005 the Company decided to discontinue operations of DayStar Solar, LLC.



The Company has historically funded operations principally from the sale of
equity securities and through government grants and contracts. The Company will need additional capital resources to execute its business plan, and to complete its next generation manufacturing processes, which include a continuous pallet
manufacturing process (Gen-III) and a continuous, roll-to-roll manufacturing process (Gen-IV). If adequate capital resources are not available, the Company will be forced to curtail or terminate operations.



As the Company brings its manufacturing facility in Halfmoon to production capacity and
continues to develop its next generation manufacturing processes, significant investment in both equipment and personnel will be required. Therefore, the Company expects continued increases in selling, general and administrative, as well research
and development expenses into 2006. The increase in net losses generated while bringing production on-line will be offset, to a limited degree in 2006, by revenue from the sale of CIGS solar cells.



2. Significant Accounting Policies:



Revenue Recognition  Research and development contract revenue
is recognized as the Company meets milestones, as set forth under each contract. The Company recognizes revenue on product sales as product is sold, collectibility is reasonably assured, and delivery has occurred.



Capital Grants  Amounts earned under capital grants which
represent 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.



Stock-Based Compensation  The Company accounts for stock-based compensation for employees using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock, stock options or other similar instruments, granted to employees is measured as
the excess, if any, of the quoted market price of the Companys common stock at the measurement date (generally, the date of grant) over the amount an employee must pay to acquire the stock.



7



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The Company accounts for stock-based compensation for non-employees under SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123 requires that options, warrants, and similar instruments which are granted to non-employees for goods and services be recorded at fair value on the grant date. Fair value is generally determined under
an option pricing model using the criteria set forth in SFAS No. 123. The Company is subject to the pro forma disclosure requirements for stock-based compensation for employees.



SFAS No. 123 requires the Company to provide pro forma information regarding net income as if compensation costs for
the Companys option plans and other awards had been determined in accordance with the fair value based method prescribed in SFAS No. 123. The Company estimates the fair value of each award at the grant date by using the Black-Scholes
option-pricing model with the following weighted-average assumptions:



|                          |  |                                 |      |   |      |   |      |  
|------------------------- |  | ------------------------------- | ---- | - | ---- | - | ---- | -
|                          |  | Nine Months Ended September 30, |     
|                          |  | 2005                            |      |   | 2004 |  
|Expected volatility       |  |                                 | 92   | % |      |   | 82   | %
|Risk-free interest rate   |  |                                 | 4.10 | % |      |   | 4.83 | %
|Expected dividends        |  | $                               |     |   |      | $ |     |  
|Expected terms (in years) |  |                                 | 10   |   |      |   | 10   |  



|                                                         |  |                                 |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|-------------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                         |  | Three Months EndedSeptember 30, |            |   | Nine Months Ended September 30, |  
|                                                         |  | 2005                            |            |   | 2004                            |   |            | 2005 |  |   | 2004       |  
|Net loss, as reported                                    |  | $                               | (1,525,116 | ) |                                 | $ | (1,078,273 | )    |  | $ | (4,384,124 | ) |  | $ | (3,484,301 | )
|Pro forma stock compensation expense, net of tax benefit |  |                                 | (115,593   | ) |                                 |   | (10,265    | )    |  |   | (334,640   | ) |  |   | (24,391    | )
|Employee stock compensation under the intrinsic method   |  |                                 |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|                                                         |  |                                 |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Pro forma net loss                                       |  | $                               | (1,640,709 | ) |                                 | $ | (1,088,538 | )    |  | $ | (4,718,764 | ) |  | $ | (3,508,692 | )
|                                                         |  |                                 |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Net loss per share, basic and diluted,                   |  |                                 |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|As reported                                              |  | $                               | (0.25      | ) |                                 | $ | (0.30      | )    |  | $ | (0.96      | ) |  | $ | (1.06      | )
|Pro forma stock compensation expense                     |  |                                 | (0.02      | ) |                                 |   | (0.01      | )    |  |   | (0.07      | ) |  |   | (0.01      | )
|Employee stock compensation under the intrinsic method   |  |                                 |           |   |                                 |   |           |      |  |   |           |   |  |   |           |  
|                                                         |  |                                 |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  
|Pro forma                                                |  | $                               | (0.27      | ) |                                 | $ | (0.31      | )    |  | $ | (1.03      | ) |  | $ | (1.07      | )
|                                                         |  |                                 |            |   |                                 |   |            |      |  |   |            |   |  |   |            |  



Loss Per Share
 Loss per share is presented in accordance with the provisions of SFAS No. 128, Earnings Per Share. Basic EPS is calculated by dividing the income or loss available to common stockholders by the weighted 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 and nine months ended September 30, 2005 and 2004.



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##### Table of Contents

At September 30, 2005 common stock equivalents are comprised of:



|                               |  |              |  |                        |  |                        |  |                    |  |          
|------------------------------ |  | ------------ |  | ---------------------- |  | ---------------------- |  | ------------------ |  | ---------
|                               |  | Common Stock |  | Class A public warrant |  | Class B public warrant |  | Consultant warrant |  | Total    
|Public Warrants                |  |             |  |                       |  | 4,984,183              |  |                   |  | 4,984,183
|Representatives Warrants      |  | 74,457       |  | 74,457                 |  | 148,914                |  |                   |  | 297,828  
|Warrants issued to consultants |  |             |  |                       |  |                       |  | 69,850             |  | 69,850   
|Stock options                  |  | 249,775      |  |                       |  |                       |  |                   |  | 249,775  
|                               |  |              |  |                        |  |                        |  |                    |  |          
|Total                          |  |              |  |                        |  |                        |  |                    |  | 5,601,636
|                               |  |              |  |                        |  |                        |  |                    |  |          



Reclassifications
Certain reclassifications have been made to the 2004 financial statements to conform to the 2005 presentation.



Impact of Recently Issued Accounting Pronouncements In May 2005, the Financial Accounting Standards Board, or FASB, issued Statement
of Financial Accounting Standards No. 154, or SFAS 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. The Company does not believe the adoption of SFAS 154 will have a material impact on the Companys financial statements.



In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, which is a revision of SFAS
No. 123, Accounting for Stock-Based Compensation. SFAS No. 123(R) is effective for public companies for annual periods beginning after December 15, 2005, supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees,
and amends SFAS No. 95, Statement of Cash Flows.



SFAS
No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro-forma disclosure is no longer an alternative. The new standard will
be effective for the Company, beginning January 1, 2006. The Company has not yet completed its evaluation but expects the adoption to have an effect on the financial statements similar to the pro-forma effects reported above.



In December 2004, the FASB issued SFAS 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. The Company does not believe the adoption of SFAS 153 will have a material impact on the Companys financial statements.



In November 2004, the FASB issued SFAS 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 overheads 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. The Company does not believe the adoption of SFAS 151 will have a material impact on the Companys financial statements.



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3. Note Payable



In January 2005, the Company finalized an equipment purchase agreement to complete the acquisition of several pieces of equipment from a vendor. The Company paid $120,000
in 2004 as a down payment and took possession of certain equipment. Under the agreement, the Company will have 30 monthly payments of $5,323 followed by another 30 monthly payments of $16,339. The Company recorded a note payable of $415,618 based on
the present value of the payments using an interest rate of 14.75%. If, after January 2007, the Companys common stock trades above $10.00 for 10 consecutive days in a particular month, then the Company will be obligated for an additional
$4,877 in the subsequent months payments as additional consideration of the purchase.



4. Capital Lease Obligation



In March
2005, the Company leased equipment under an agreement classified as a capital lease. Equipment under this lease has a cost of $ 38,595. Future minimum lease payments as of September 30, 2005 under this capital lease are as follows:



|                                            |  |        |  
|------------------------------------------- |  | ------ | -
|Year                                        |  | Amount |  
|2005                                        |  | 2,983  |  
|2006                                        |  | 11,932 |  
|2007                                        |  | 11,932 |  
|2008                                        |  | 11,932 |  
|2009                                        |  | 3,977  |  
|                                            |  |        |  
|Total future minimum lease payments         |  | 42,756 |  
|Less amount representing interest           |  | (7,962 | )
|                                            |  |        |  
|Present value of net minimum lease payments |  | 34,794 |  
|                                            |  |        |  



5. Equity Incentive Plan



The Company has an Equity Incentive Plan to enable employees, outside
directors and consultants to acquire an equity interest in the Company. The Plan reserves shares of the Companys common stock for issuance for these purposes. 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.



In January 2005, the Company granted 12,000 fully vested stock
options under the plan with an exercise price of $2.59 per share. In February 2005, 10,000 stock options were granted under the plan vesting over 48 months with an exercise price of $4.81 per share. In April 2005, 16,400 stock options were granted
under the plan with an exercise price of $6.83 per share, vesting over a 48 month period. In June 2005, the Company granted 9,000 fully vested stock options, 8,800 stock options vesting in one year and 67,700 stock options vesting over 48 months,
with an exercise price of $14.85 per share. In August 2005, 8,900 stock options were granted under the plan with an exercise price of $13.99 per share, vesting over a 48 month period. In October 2005, 27,200 stock options were granted under the plan
with an exercise price of $10.96 per share, vesting over a 48 month period. All grants were at the market price on the date of grant.



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##### Table of Contents

6. Warrants



Class A public warrants  On June 21, 2005 the Company publicly announced that it intended to redeem its outstanding Class A public warrants.
The Class A public warrants became eligible for redemption by the Company at $0.25 per warrant on June 15, 2005, when the last reported sale price of the Companys common stock had equaled or exceeded $8.50 for five consecutive
trading days. There were 2,371,830 Class A public warrants issued in conjunction with the Companys initial public offering and a subsequent financing. In addition, the exercise of Representative warrants, issued in conjunction with the
Companys initial public offering, added 70,324 Class A public warrants subject to redemption. The Class A public warrants were exercisable at a price of $6.00 per share.



The exercise period ended August 11, 2005. During the exercise period, 2,425,062 of the Companys Class A public warrants
(99.3% of the total outstanding) were exercised for an equal number of shares of common stock and the Company received $14,550,373 in proceeds from the warrant exercises. At the end of the exercise period, 17,092 Class A public warrants
remained outstanding. The Company redeemed the outstanding warrants for $0.25 per warrant, or a total cost of $4,273.



Class B public warrants  As of September 30, 2005, 4,984,183 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.



Representativewarrants  At September 30, 2005, 74,457 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.
After August 11, 2005, 50,000 Representative warrants were exercised which included the exercise of the Class A warrants to common stock. Accordingly, 100,000 shares of Common stock and 100,000 Class B non-redeemable public warrants were issued,
resulting in proceeds to the Company of $600,000.



Consultant Warrants
 In April 2005, the Company granted 30,000 fully vested warrants to four consultants to purchase common stock at a price of $3.00 per share. In addition, under contracts with three of these consultants, monthly grants 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 14,850 warrants have been issued during 2005 under these arrangements.



The fair value of the warrants was $52,945 and $306,047, respectively, for the three and nine
months ended September 30, 2005, and was charged to Equity based compensation expense. The fair value of the warrants was calculated using the Black-Scholes pricing model with the following assumptions: dividend yield of zero percent; expected
volatility of 92%; risk free interest rate of 4.50% and a term of five years.



8. Discontinued Operations



During the second quarter of 2005,
the Company decided to discontinue 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 and completed the consolidation of operations in New York. Results of operations from DayStar Solar, LLC, for the three months and nine months ended
September 30, 2005 and 2004 were as follows:



|                         |  |                                 |        |                                 |      |   |        |  |   |        |   |  |   |         |  
|------------------------ |  | ------------------------------- | ------ | ------------------------------- | ---- | - | ------ |  | - | ------ | - |  | - | ------- | -
|                         |  | Three Months EndedSeptember 30, |        | Nine Months Ended September 30, |     
|                         |  | 2005                            |        |                                 | 2004 |   | 2005   |  |   | 2004   |  
|Revenue                  |  | $                               |       |                                 |      | $ | 50,946 |  | $ | 65,189 |   |  | $ | 114,330 |  
|                         |  |                                 |        |                                
|Cost of revenue          |  |                                 | 74     |                                 |      |   | 44,632 |  |   | 58,538 |   |  |   | 103,481 |  
|Operating expenses       |  |                                 | 2,014  |                                 |      |   | 4,329  |  |   | 9,198  |   |  |   | 13,331  |  
|                         |  |                                 |        |                                 |      |   |        |  |   |        |   |  |   |         |  
|Total costs and expenses |  |                                 | 2,088  |                                 |      |   | 48,961 |  |   | 67,736 |   |  |   | 116,812 |  
|                         |  |                                 |        |                                 |      |   |        |  |   |        |   |  |   |         |  
|Net income (loss)        |  | $                               | (2,088 | )                               |      | $ | 1,985  |  | $ | (2,547 | ) |  | $ | (2,482  | )
|                         |  |                                 |        |                                 |      |   |        |  |   |        |   |  |   |         |  



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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|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.



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 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, the Company
publicly announced that it intended to redeem its 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 Companys initial public offering and a subsequent financing. In addition, the exercise of Representative warrants, issued in conjunction with the Companys 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 Companys Class A public warrants (99.3% of the total outstanding) were exercised for
an equal number of shares of common stock and the Company received $14,550,373 in proceeds from the warrant exercises. Additionally, the exercise of other equity instruments, primarily Representative and Consultant warrants, generated proceeds of
approximately $1.5 million to the Company. The proceeds from all such exercises will be used to complete the build-out of the Companys 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.



In addition to the investment required to develop our first and second generation (Gen-I and Gen-II) production lines, we expect our selling,
general and administrative, and research and development expenses to continue to increase into 2006 as we hire new personnel and invest in new equipment. We anticipate the increase in net losses generated while bringing production on-line will be
offset, to a limited degree in 2006, by revenue from the sale of CIGS solar cells.



We have historically funded our operations principally from the sale of equity securities and 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 which will be characterized by a fully continuous manufacturing process (Gen-III) and a continuous, roll-to-roll manufacturing process (Gen-IV). If adequate
capital resources are not available to us, we will be forced to curtail or terminate operations.



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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 footnotes 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



Research and development contract revenue is recognized as the Company meets milestones as set forth under the contract. The Company recognizes revenue on product sales as product is sold, collectibility is reasonably
assured, and delivery has occurred.



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.



Patents



Patent costs incurred to
prosecute patents developed by us are expensed as incurred. Patent costs paid to obtain patents from third parties are capitalized and amortized over the life of the patent. We review the functional life of our patents on a regular basis. If it is
determined that the functional life is less than the legal life, we would accordingly change the amortization period to the functional life.



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.



Non-employees Equity Grants



The Company accounts for stock-based compensation for non-employees under SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 requires
that options, warrants, and similar instruments which are granted to non-employees for goods and services be recorded at fair value on the grant date. Fair value is determined using the Black-Scholes option-pricing model and using the criteria set
forth in SFAS No. 123.



Reclassifications



Certain reclassifications have been made to the 2004
financial statements to conform to the 2005 presentation.



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Results of Operations



Comparison of Three Months Ended September 30, 2005 and 2004



Research and Development Contract Revenue. Our research and development contract revenue was $115,000 for the three months ended September 30, 2005. There was
no research and development contract revenue for the three months ended September 30, 2004. The research and development contract revenue was earned during the three months ended September 30, 2005, upon attaining certain milestones and
completing various phases under a New York State Research and Development contract.



Selling, general and administrative. Selling, general and administrative expenses were $714,487 for the three months ended September 30, 2005, compared to $588,040 for the three months ended September 30, 2004, an increase
of $126,447 or 22%. The increase in selling, general and administrative expenses resulted primarily from increased salaries as headcount increased, and costs related to conducting business as a public company. In addition, in August 2004, we moved
our corporate headquarters and principal development and production facilities from Grass Valley, California to a larger, more expensive facility in Halfmoon, New York.



Research and development expenses. Research and development expenses were $824,467 for the three months ended September 30,
2005, compared to $484,082 for the three months ended September 30, 2004, an increase of $340,385 or 70%. Research and development expenses increased due to an increase in the number of employees, increased development activities related to
creating the capability to manufacture, and materials required to produce photovoltaic cells. We expect research and development expenses to continue to increase throughout the remainder of 2005 as additional engineering personnel are added.



Depreciation and amortization. Depreciation and amortization expenses
were $178,677 for the three months ended September 30, 2005, compared to $19,031 for the three months ended September 30, 2004, an increase of $159,646 or 839%. Depreciation and amortization expense increased primarily as a result of
capital equipment being placed in service in the Halfmoon facility since the latter part of 2004.



Interest expense. Interest expense was $22,813 for the three months ended September 30, 2005, compared to $9,042 for the three months ended September 30, 2004. Interest expense results primarily from
capital lease obligations and notes payable.



Other income. Other income
was $102,416 for the three months ended September 30, 2005, compared to $19,937 for the three months ended September 30, 2004. Other income primarily represents interest income on investments.



Net loss.Our net loss was $1,525,116 for the three months ended September 30,
2005, compared to a loss of $1,078,273 for the three months ended September 30, 2004. The increase in net loss was due primarily to the investment required to develop our process for manufacturing photovoltaic cells in our initial production
facility, in addition to an increase in the Companys selling, general and administrative activity. In view of the level of expenditures required to sustain operations without significant product or research revenue anticipated in 2005, we also
expect to experience a significant net loss for the fourth quarter of 2005.



Comparison of Nine Months Ended September 30, 2005 and 2004



Research and Development Contract Revenue. Our research and development contract revenue was $365,000 for the nine months ended September 30, 2005. There was no research and development contract revenue for the nine months ended
September 30, 2004. The research and development contract revenue was earned during the nine months ended September 30, 2005, upon attaining certain milestones and completing various phases under New York State Research and Development
contracts.



Selling, general and administrative. Selling, general and
administrative expenses were $2,198,681 for the nine months ended September 30, 2005, compared to $1,895,204 for the nine months ended September 30, 2004, an increase of $303,477 or 16%. The increase in selling, general and administrative
expenses resulted primarily from increased salaries as headcount increased, and costs related to conducting business as a public company. In addition, in August 2004, we moved our corporate headquarters and principal development and production
facilities from Grass Valley, California to a larger, more expensive facility in Halfmoon, New York.



Research and development expenses. Research and development expenses were $2,139,731 for the nine months ended September 30, 2005, compared to $964,206 for the nine months ended September 30, 2004, an
increase of $1,175,525 or 122%. Research and development expenses increased due to an increase in the number of employees,



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increased development activities related to creating the capability to manufacture, and materials required to produce photovoltaic cells. We expect research
and development expenses to increase throughout the remainder of 2005 as additional engineering personnel are added.



Depreciation and amortization. Depreciation and amortization expenses were $477,999 for the nine months ended September 30, 2005, compared to $62,627 for the
nine months ended September 30, 2004, an increase of $415,372 or 663%. Depreciation and amortization expense increased primarily as a result of capital equipment being placed in service in the Halfmoon facility since the latter part of 2004.



Interest expense. Interest expense was $69,773 for the nine months
ended September 30, 2005, compared to $603,280 for the nine months ended September 30, 2004. In February 2004 we recognized non-cash interest expense of $506,650 related to the conversion of the equity unit subscriptions from debt to
equity. Other interest expense results primarily from capital lease obligations and notes payable.



Other income. Other income was $139,607 for the nine months ended September 30, 2005, compared to $43,498 for the nine months ended September 30, 2004. Other income primarily represents interest on
investments.



Net loss.Our net loss was $4,384,124 for the nine months
ended September 30, 2005, compared to a loss of $3,484,301 for the nine months ended September 30, 2004. The increase in net loss was due primarily to the investment required to develop our process for manufacturing photovoltaic cells in
our initial production facility, in addition to an increase in selling, general and administrative activity. In view of the level of expenditures required to sustain operations without significant product or research revenue anticipated in 2005, we
also expect to experience a significant net loss for the fourth quarter of 2005.



Liquidity and Capital Resources



Liquidity. At September 30, 2005, our cash and cash equivalents and investments totaled $14,549,150. On June 21, 2005, the Company publicly announced that it intended to redeem its 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 Companys initial public offering and a
subsequent financing. In addition, the exercise of Representative warrants, issued in conjunction with the Companys 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 Companys Class A public warrants (99.3% of the total outstanding) were exercised for an equal number of shares of common stock and the Company received $14,550,373 in
proceeds from the warrant exercises. Additionally, the exercise of other equity instruments, primarily Representative and Consultant warrants generated proceeds of approximately $1.5 million to the Company.



Net cash used in operating activities was $3,825,632 for the nine months
ended September 30, 2005 compared to $2,173,945 for the nine months ended September 30, 2004. The activity for the nine months ended September 30, 2005 is primarily the result of operating expenses paid in cash of $1,806,130 for
selling, general and administrative expenses, and $2,054,231 for research and development expenses. Since the initial public offering in February 2004, we have invested in expanding operations in Halfmoon, New York, and hired personnel and
consultants to begin production and sales of our thin-film solar cells.



Expenditures for equipment purchases for the nine months ended September 30, 2005 were $1,927,586. We continue to purchase equipment and adapt the Halfmoon facility to establish our initial production lines in New York.



During the nine months ended September 30, 2005, we entered into an
equipment note payable for $415,618 and an equipment financing lease of $38,595.



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



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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 the Company to increase employment in the state and further advance research and technology in the solar energy industry. Following is a summary of the Companys current
contracts and grants:



| |  |  | $1,000,000 Research and Development Contract - Payment under the contract will be in phases as the Company meets facility scale-up and production milestones to commercially
produce solar cells. As of September 30, 2005, the Company had earned $250,000 under this contract.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $250,000 Research and Development Contract - Payment under the contract will be in phases as the Company meets certain milestones in the design, installation, and performance
of an energy waste reduction system. As of September 30, 2005, the Company had earned $115,000 under this contract.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | $600,000 Capital Grant -Payment under the agreement will be in three phases as the Company meets certain equipment acquisition and employment milestones. As of
September 30, 2005, the Company had earned $300,000 under this 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 the 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 the proceeds from the exercises of the Companys Class A public warrants, monies from New York state incentives, equipment financing and the
projected small amounts, if any, of cash that may be generated from operations, will be sufficient to finance our activities until the second half of 2006. Accordingly, the Company is currently exploring additional financing. By the end of 2005, we
expect to have demonstrated production with our Gen-II manufacturing processes in the Halfmoon facility and will be developing a next generation Gen-III continuous manufacturing process. Although product sales may generate some revenues during 2006,
we will require significant additional financing to fund further capital expenditures related to expansion of our manufacturing operations, especially as we approach implementation of the Gen-III continuous manufacturing process.



Without additional financing, the Company would need to delay certain of
these activities and defer certain capital expenditures currently planned at the Halfmoon facility. The Company is currently considering various opportunities to obtain private equity funding. In the alternative, the Company is also considering
conducting a secondary public offering of its securities. 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. If such funds are not available, the
Company will be required to reduce or curtail research and development efforts to generate positive cash flow at the manufacturing operations at the Halfmoon facility.



Capital Commitments.At September 30, 2005, we had outstanding approximately $810,000 of purchase orders for
equipment. The equipment is expected to be received through the first quarter of 2006. Other material commitments include rental payments under operating leases for office space and equipment, and commitments under employment contracts with our
President and Chief Executive Officer, Chief Financial Officer, and a Vice President.



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



The Company leases 18,000 square feet of office and manufacturing space in
Halfmoon, New York under a five year lease that commenced July 1, 2004 for $9,750 per month. The Company also leases 5,500 square feet of office space in Halfmoon, New York under a forty five month lease that commenced October 1, 2005 for
$5,769 per month. The Company leased office space in Grass Valley, California under a three year lease that commenced August 1, 2002 for $2,352 per month. The lease expired July 31, 2005 and the Company did not exercise its option to renew
the lease. As of September 30, 2005, the Company had an operating lease for office equipment at a lease rate of $161 per month ending in August 2007.



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##### Table of Contents

|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 September 30, 2005 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 and Use of Proceeds
|------- | -----------------------------------------------------------



Use of Proceeds From Sales of Registered Securities



On February 5, 2004, the SEC declared effective our Registration Statement on Form SB-2 (Reg. No. 333-110337), and we completed our initial
public offering of 2,100,000 units on February 11, 2004. Each unit consisted of one share of common stock, one Class A redeemable public warrant and two Class B non-redeemable public warrants. The managing underwriter of our initial public
offering was Paulson Investment Company, Inc. The initial public offering price was $5.00 per unit. The gross proceeds of the offering were $10,500,000. Our net proceeds from the offering, after deducting the underwriters discount of $840,000
and other fees and expenses, aggregated $8,282,250. On March 5, 2004 the underwriters exercised a portion of their over-allotment option to purchase 18,500 additional units at the initial public offering price, resulting in additional offering
proceeds of $92,500. After deducting estimated offering expenses and underwriting discounts, we received $74,308 of net proceeds.



As of September 30, 2005, we had applied all of the proceeds from the initial public offering as follows:



|                           |  |   |          
|-------------------------- |  | - | ---------
|Research and development   |  | $ | 3,130,060
|Capital equipment          |  |   | 3,757,355
|Sales and marketing        |  |   | 415,955  
|General corporate expenses |  |   | 1,053,188
|                           |  |   |          
|Total                      |  | $ | 8,356,558
|                           |  |   |          



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



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



|            |  |                                                                                                                                                       
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                           
|31.1        |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    
|            | 
|31.2        |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.    
|            | 
|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.



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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: November 14, 2005    |  |  |  | By: |  | /s/ JOHN R. TUTTLE     
|                           |  |  |  |     |  |                         |  | John R. Tuttle                                 
|                           |  |  |  |     |  |                         |  | Chairman, President and Chief Executive Officer
|                           |  |  |  |     |  |                         |  | (Principal Executive Officer)                  
|                           |  |  | 
|Date: November 14, 2005    |  |  |  | By: |  | /s/ STEPHEN A. AANDERUD
|                           |  |  |  |     |  |                         |  | Stephen A. Aanderud                            
|                           |  |  |  |     |  |                         |  | Chief Financial Officer                        
|                           |  |  |  |     |  |                         |  | (Principal Financial and Accounting Officer)   



18