** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF1934

**For the fiscal year ended December 31,2006Or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**For the transition periodfrom _____ to _____**

**Commission file number 000-31973**

**Beacon Power Corporation**

(Exact name of registrantas specified in its charter)

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

 

**(978) 694-9121**

(Registrant’s telephone number, including area code)

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**Securities registered pursuant to Section 12(b) ofthe Act:** None

**Securities registeredpursuant to Section 12(g) of the Act:**

**Common Stock, par value $.01 per sharePreferred Share Purchase Rights**

(Title of class)

Indicate by check mark if the registrant is a well known seasonedissuer, as defined in Rule 405 of the Securities Act. Yes o   No x

Indicate by check mark if the registrant is not required to filereports pursuant to Section 13 or Section 15(d) of the Act. Yes o   No x

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

Indicate by check mark if disclosure of delinquent filers pursuantto Item 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K x

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in rule 12b-2 of the ExchangeAct.

| Large accelerated  filer    o |   | Accelerated filer    o |   | Non-accelerated filer     x |
|---------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------------|

 

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

As of June 30, 2006 the market value of the voting andnon-voting common stock of the registrant held by non-affiliates of theregistrant was $74,573,811. In determining the market value of non-affiliatedvoting stock, shares of the registrant’s common stock beneficially owned byeach executive officer, director and any known person to be the beneficialowner of more than 20% of the registrant’s voting stock have been excluded.This determination of affiliate status is not necessarily a conclusivedetermination for other purposes.

The number of shares of the Registrant’s common stock, par value$.01 per share, outstanding as of March 21, 2007 was 71,342,885.

**DOCUMENTS INCORPORATED BY REFERENCE**

The Exhibit Index (Item No. 15)located on pages 68 through 70 incorporates several documents by referenceas indicated therein. Portions of the definitive Proxy Statement for BeaconPower Corporation’s Annual Meeting of Stockholders to be filed within 120 daysafter the end of the fiscal year ended December 31, 2006 are incorporatedby reference into Part III of this Form 10-K.

 

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**Table of Contents**

|               | ** ** | ** **                                                                                                         | ** ** | **Page** |
|---------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I   |       |                                                                                                               |       |     |
| Item 1.       |       | Business                                                                                                           |       | 1        |
| Item 1A.      |       | Risk Factors                                                                                                       |       | 10       |
| Item 1B.      |       | Unresolved Staff Comments                                                                                          |       | 16       |
| Item 2.       |       | Properties                                                                                                         |       | 16       |
| Item 3.       |       | Legal  Proceedings                                                                                                 |       | 16       |
| Item 4.       |       | Submission of Matters to a Vote of Security Holders                                                                |       | 17       |
| PART II  |       |                                                                                                               |       |     |
| Item 5.       |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       | 18       |
| Item 6.       |       | Selected Consolidated Financial Data                                                                               |       | 21       |
| Item 7.       |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       | 22       |
| Item 7A.      |       | Quantitative and Qualitative Disclosures about Market  Risk                                                        |       | 36       |
| Item 8.       |       | Financial Statements and Supplementary Data                                                                        |       | 37       |
| Item 9.       |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       | 37       |
| Item 9A.      |       | Controls and Procedures                                                                                            |       | 37       |
| Item 9B       |       | Other  Information                                                                                                 |       | 37       |
| PART III |       |                                                                                                               |       |     |
| Item 10.      |       | Directors and Executive Officers of the Registrant                                                                 |       | 38       |
| Item 11.      |       | Executive Compensation                                                                                             |       | 38       |
| Item 12.      |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       | 38       |
| Item 13.      |       | Certain Relationships and Related Transactions                                                                     |       | 38       |
| Item 14.      |       | Principal Accountant Fees and Services                                                                             |       | 38       |
| PART IV  |       |                                                                                                               |       |     |
| Item 15.      |       | Exhibits, Financial Statement Schedules                                                                            |       | 39       |
| Signatures    |       | 68                                                                                                                 |

 

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**Note Regarding Forward Looking Statements:**

This Annual Reporton Form 10-K may include statements that are not historical factsand are considered “forward-looking” statements within the meaning of thePrivate Securities Litigation Reform Act of 1995. These “forward-looking”statements are identified by the use of terms and phrases such as “believe,” “expect,”“plan,” “anticipate,” and similar expressions identifying forward-lookingstatements. Investors should not rely on forward-looking statements becausethey are subject to a variety of risks, uncertainties, and other factors thatcould cause actual results to differ materially from Beacon Power Corporation’sexpectation. These factors include: a short operating history; a history oflosses and anticipated continued losses from operations; a need to raiseadditional capital combined with a questionable ability to do so; thepossibility that our stock may be removed from the Nasdaq Stock Market if weare unable to meet minimum bid price or other compliance criteria; limitedexperience manufacturing any product and no experience supplying frequencyregulation services on a commercial basis; limited commercial contracts forsales to date; the dependence of sales on the achievement of productdevelopment and commercialization milestones, including design modificationsthat may be needed following a recent malfunction that occurred while testing aprototype flywheel; the uncertainty of the political and economic climate, andthe different electrical grid characteristics and requirements of any foreigncountries into which Beacon hopes to sell or operate, including the uncertaintyof enforcing contracts, the different market structures, and the potentialsubstantial fluctuation in currency exchange rates in those countries;significant technological challenges to successfully complete productdevelopment; dependence on third-party suppliers; the potential for intensecompetition from companies with greater financial resources, especially fromcompanies that are already in the frequency regulation market; possiblegovernment regulation that would impede the ability to market products orservices or affect market size; the complexity and other challenges ofarranging project finance and resources for one or more frequency regulationpower plants; possible product liability claims and the negative publicitywhich could result; any failure to protect intellectual property; retaining keyexecutives and the possible need in the future to hire and retain keyexecutives; the recent volatility in the stock price of companies operating inthe same sector. Such statements made by the Company fall within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. All such forward-lookingstatements are necessarily only estimates of future results and the actualresults achieved by the Company may differ materially from these estimates dueto a number of factors as discussed in the section entitled “Item 7. Management’sDiscussion and Analysis of Financial Condition” and “Results of Operations - Certain Factors Which May Affect FutureResults” of this Form 10-K.

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**PART I**

**Item 1.**                        Business

**Overview**

Beacon Power Corporation and its subsidiary(collectively “Beacon,” “the Company,” “we,” “our” or “us”) design, develop,configure and expect to begin offering for sale, advanced products and servicesto support more reliable and cost-effective electricity grid operation. Webelieve that our sustainable energy storage and power conversion solutions canhelp provide reliable electric power for the utility, renewable energy, anddistributed generation markets. Beacon is a development-stage company that wasincorporated in Delaware on May 8, 1997. Because we have not yet generateda significant amount of revenue from our expected principal operations, we areaccounted for as a development stage company under Statement of FinancialAccounting Standards No. 7. We maintain our principal offices and researchand development laboratory at 234 Ballardvale Street, Wilmington,Massachusetts, 01887-1032. Our telephone number is 978-694-9121.

We file annual, quarterly and current reports, proxystatements and other information with the U.S. Securities and ExchangeCommission (the “SEC”). You may read and copy any documents that we file at theSEC’s public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. Youmay call the SEC at 1-800-SEC-0330 for further information onthe public reference room. Our SEC filings are also available to the publicfree of charge at the SEC’s Web site at www.sec.gov.

Our Web site address is www.beaconpower.com. All ofour filings with the SEC, including annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and all amendments to those reports are made available free of charge on ourWeb site as soon as reasonably practical after being filed electronically with,or furnished to, the SEC. The content on our Web site does not constitute partof this annual report. We also make available our Corporate Governance policiesand our Code of Conduct on our Web site. Additionally, paper copies of thesedocuments may be obtained free of charge by writing our Investor RelationsDepartment at our principal executive office.

The focus of our research and development has been toestablish commercially viable flywheel-based energy storage technologies thatcan provide highly reliable energy solutions for the worldwide electricity gridat competitive costs. We expect to generate revenues from the commercializationof our flywheel energy storage systems to supply frequency regulation servicesto the electricity grid in North America. We believe that as the companyexpands its production capabilities we can become a provider of frequencyregulation services to grid operators on a global basis. In addition, webelieve that as the commercialization of our technologies continues we will developother cost-effective applications for our flywheel systems that will provideadditional revenue opportunities.

Our initial market focuswill be on the geographic regions of the domestic grid that have beenderegulated. These regions and their Independent System Operator (ISO)designations are: New England (ISO New England); California (California ISO);Texas (ERCOT); New York (New York ISO); and the Mid-Atlantic (PJMInterconnect). These regional ISOs or grid operators purchase frequencyregulation services from independent providers in open bid markets that theymanage and maintain. We are seeking to become one such provider. We believe ourtechnology will offer grid operators the benefits of greater reliability;faster response time; cleaner operation, including zero direct emissions ofcarbon dioxide (CO2),nitrogen oxide, sulfur dioxide and mercury; and lower maintenance costscompared to conventional power generation facilities that also providefrequency regulation services. We believe that we will have lower operatingcosts and faster response time than the majority of other entities that providefrequency regulation services, which we believe will allow us to havesufficient margins to make the company economically viable.

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**The FrequencyRegulation Market**

Levels of power supply and demand on the power gridchange from second to second and minute to minute. The need to balanceelectricity supply and demand on the grid requires a special service tomaintain stable power frequency called frequency regulation. Deviations fromnominal grid frequency can have a negative impact on the operability of devicesthat obtain power from the grid. In North America, grid frequency is maintainedat 60 cycles per second (Hertz, or Hz). In Europe and other parts of the world,the same requirement exists for balancing power supply and demand on the grid,but at a frequency of 50 Hz. In North America, the effectiveness of maintaininggrid frequency is measured by performance standards provided by the NorthAmerican Energy Reliability Council (NERC). Financial penalties are imposed ongrid operators when performance standards fall below levels deemed acceptable. Similarstandard-setting entities for frequency regulation exist in most other parts ofthe world.

In North America,the frequency regulation market in areas that are deregulated and accessiblevia open-bid market mechanisms was valued at over $650 million in 2006. Basedon global electrical production, we believe that the worldwide frequencyregulation market is several times this amount. Significant growth in the USopen-bid market is expected due to a combination of factors, including:

·       Anticipatedexpansion of open-bid grid operating regions such as the Midwest ISO

·       Increaseddemand for electricity

·       Greateruse of renewable energy sources—including wind and solar

Under the open-bid market, grid operators forecast theneed for frequency regulation as a percentage of expected power demand, andapproved suppliers submit bids for these services. Bids are stacked from lowestto highest prices until the cumulative amount of bids is sufficient to meet thecalculated need. The price submitted by the highest selected bidder determineswhat every bidder is paid.

To fully exploit this regulatory-driven open-bidmarket, we expect to design, build, own and operate a number of frequencyregulation facilities. Our business model, which is a sale-of-services model,is similar to that of independent power producers who also design, build, ownand operate their own power plants. Each Smart Energy MatrixTM frequencyregulation facility will be up to 20 megawatts (MW) in size. A Smart EnergyMatrixTM is a multi-flywheel energy storage system designed to provide reliableand sustainable frequency regulation services for utility grids. A Smart EnergyMatrixTM can be scaled to any size to provide one or more megawatts of frequencyregulation capacity. Smart Energy MatrixTM frequency regulation plants that are20 MW or less in size offer the advantage of being eligible to use fast-trackinterconnection regulations that allow plants of this capacity or smaller to beapproved more quickly in accordance with streamlined regulatory rules. A keybenefit of our business model is that we begin to obtain revenues from the saleof services immediately upon installation of each megawatt. Another key benefitof our business model is that we avoid the costs and lengthy procurement cyclestypically associated with marketing capital equipment to the utility sector.

The key qualification for our participation in thesemarkets is the ability to demonstrate that our technology can provide therequired services within the rules determined by the grid operators. Toattain this qualification and accelerate market entry we have installed twoscale-power 100-kilowatt (kWh) demonstration models of our Smart EnergyMatrixTM for evaluation by grid operators. Each of these scale-power systemsconsists of multiple flywheels. In 2005, we were awarded contracts for thesesystems by the California Energy Commission (CEC) and the New York State EnergyResearch and Development Authority (NYSERDA), in cooperation with the U.S.Department of Energy, to test the viability of our flywheel technologies forfrequency regulation by grid operators. During 2005, we shifted virtually all ofour development spending towards meeting the requirements of these two pilotprograms. The demonstration systems are scale-power prototypes of the SmartEnergy Matrix TM multi-flywheel system. An ancillary benefit of these contractsis that the funds we have received have subsidized a portion of our 

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core research anddevelopment efforts, and any losses attributable to these contracts would havebeen costs incurred as part of our ongoing research and development efforts.

Both the California and New York systems wereinstalled and evaluated in formal field trials. The demonstration units containfully functional control, communication and interconnection elements similar oridentical to the elements of our planned 20 MW frequency regulation facilities.The purpose of these pilot systems is twofold: 1) to demonstrate the ability ofour flywheel technology to provide frequency regulation services consistentwith the technical requirements of the grid operators, including the CaliforniaISO and New York Independent System Operator (New York ISO), and 2) to obtaincertification or other approval from system operators to use our technology toprovide commercial frequency regulation services in their respective states andterritories.

The California system completed its field trial on January 31,2007, earning a positive evaluation from both the CEC and the California ISO. TheCalifornia ISO is a not-for-profit organization that manages the flow ofelectricity for California’s open-market power grid. On December 26, 2006,the California ISO certified our flywheel technology for use as a frequencyregulation resource in California.

The New York demonstration unit incorporatestechnology we gained from the California unit and contains additional voltagesupport and power quality capabilities. These added capabilities are designedto demonstrate the technical efficacy of two entirely new applications for ourcore technology.

On March 22, 2007, the New York State EnergyResearch and Development Authority (NYSERDA) and the U.S. DOE confirmed thesuccessful outcome of field trial testing of our scale-power flywheel frequencyregulation system in New York. At the same time, the New York ISO determinedthat our technology is a viable technology for frequency regulation on its gridand is acceptable for provision of commercial frequency regulation in the Stateof New York. Our New York-based flywheel system field trial reached thissignificant milestone after the U.S. DOE (through Sandia National Laboratories,which co-monitored the demonstration with NYSERDA) concluded that the unit’sperformance had been successfully demonstrated and that additional testing wasnot required. The flywheel system will remain in place in Amsterdam, New York,to respond to any additional control methodology demonstration that may berequested by the New York ISO should we decide to deploy on a commercial scalein the State of New York.

We believe the performance characteristics of theSmart Energy MatrixTM will match the requirements of the frequency regulationmarket quite well, as our Matrix is designed to quickly release or absorbexcess energy when power on the grid exceeds demand or when demand exceedssupply. We will be able to provide a response time that is up to 100 timesfaster than incumbent generators providing this service. The Smart EnergyMatrixTM recycles excess energy when generated power exceeds load and deliversit when load increases.

We project that our cost structure will besignificantly lower than most incumbent frequency regulation service providers.Our Smart Energy 25 flywheel is designed to operate with low energy losses,little or no mechanical maintenance for 20 or more years and withoutsignificant degradation in energy conversion efficiency. In particular, ourtechnology is different from incumbent frequency regulation providers in thatit does not use fossil fuel. Fossil fuel is a large variable cost for mostcompeting frequency regulation providers.

Because our Smart Energy MatrixTM does not burn fossilfuel, our cost structure is insulated from the negative impact of priceincreases for coal, oil and natural gas. Historically, market prices forfrequency regulation are highly correlated with wholesale energy prices,especially spot market prices. Consequently, as the price of energy rises, webelieve that revenues for frequency regulation can generally be expected torise, but without a proportional increase in our cost per megawatt. Since itdoes not burn fuel, the environmental benefits of our technology are quitesignificant. Our technology’s ability to reduce carbon 

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dioxide (CO2) emissions was studied by KEMA, Inc.,an international energy industry consulting firm, commissioned to evaluate thepotential of our technology to reduce greenhouse gas and other emissions.Compared to conventional fossil-fuel based frequency regulation providers, ourtechnology is estimated to produce up to 89% less CO2. The results of this study indicate thatthe dramatically cleaner performance of our flywheel systems can be expected tooffer significant value to regulators, grid operators, and utilities facingincreasing demands to lower CO2 emissions.

The location of our first megawatt-scale frequencyregulation plant will be dependent on a number of factors, including but notlimited to the availability and cost of land and related power plantconstruction, grid interconnection requirements, and comparative market pricingavailable for frequency regulation in the various regional markets.

To successfully compete in the frequency regulationmarket we will need to obtain significant additional funding to expand ourflywheel manufacturing capacity and construct frequency regulation facilities.

On December 28, 2006,a malfunction occurred during the testing of a 25 kWh prototype flywheel in oneof our test cells at our Wilmington, Massachusetts facility. This occurred asour engineers were powering down a prototype Smart Energy 25 flywheel, afterhaving run various tests on the unit over the course of several days, includingoperating it at full speed of 16,000 revolutions per minute (rpm). Themalfunction was initiated when a circuit breaker in the test facility tripped,cutting the power to the magnetic bearing that supported the flywheel while itrotated. There were no injuries or loss of important data or design information.However, as a result of the malfunction, one of our test cells and theprototype unit were damaged. We have completed a comprehensive analysis of themalfunction, performed by our engineers with support from qualified outsidespecialists. The analysis concluded that the design of the flywheel’s rotatingassembly is sound but a redesign of certain stationary components is required.The time needed to modify and procure parts to accommodate the redesign of suchstationary components will extend our previously stated development schedulefor the development of the Smart Energy 25 system. We now expect to completeprototype development by the end of July 2007, rather than by the end ofMarch, and to place our first megawatt of flywheel-based frequency regulationinto service in April 2008, rather than by the end of December 2007.

**Defenseapplications**

We are in the design phasefor a flywheel energy storage system for satellites capable of achievingmaximum theoretical specific energy density. The program is jointly funded bythe Air Force Research Lab (AFRL) and the Defense Advanced Research ProjectsAgency (DARPA). We believe that our high-energy flywheel technology isincreasingly attractive as a platform for power regulation ofmicro-distribution systems typical of space platforms, navy vessels and othermilitary hardware. We are actively pursuing defense and military-relatedprojects that, in addition to generating revenue to help cover operating costs,effectively provide non-dilutive R&D funding for key technology innovationsand advancements that can be transferred to commercial markets.

**OtherFlywheel-based Market Opportunities**

Other applicationsfor which we believe our technologies may be well suited include:

·       Reactivepower support (VAR support)

·       Angularstability control

·       Rampmitigation

·       Voltagesupport for rail systems

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·       Peakpower support (load balancing)

·       Stabilizationof distributed generation systems

·       Uninterruptiblepower supply (UPS)

We are evaluating theseadditional applications to determine whether they represent commerciallyattractive market opportunities; however, our focus in the near term will be todeploy company-owned flywheel facilities for the frequency regulation market.

**Competition**

In the frequency regulation market, we believe ourSmart Energy MatrixTM will offer superior performance and cost benefits overincumbent fossil fuel and hydro-powered generators. These incumbent generatorscan supply frequency regulation if they are willing and able, on short notice,to increase or decrease generation of a specified amount during a specifiedperiod. Participating generators both sell electricity in their role asgenerators, and sell frequency regulation services using some of their reservegenerating capacity. Providing regulation services is qualitatively differentthan generating electricity because the generator’s output varies constantly inresponse to continually changing signals from the grid operator, it is priceddifferently, it carries a different cost structure, therefore it is soldthrough a different market within the ISO.

Not all generators provide frequency regulationservices. Some, such as nuclear power plants, are unable to vary their outputin the manner needed to participate in this market. Others may be capable ofproviding such services, but choose not to do so. Many generators prefer tosell electricity and not provide frequency regulation services, due to thehigher operating and maintenance costs that arise from providing frequencyregulation as compared to the steady generation of electricity. The constant upand down of supplying frequency regulation services is hard on their equipment.Fossil fuel generators suffer more wear and tear from this process than dohydro-powered generators.

Most bidders in the frequency regulation auctions arefossil fuel generators. Fossil fuel generators are subject to increasing fuelprices and high operating and maintenance costs arising from ramping equipmentup and down to supply frequency regulation services. They are also affected byopportunity costs that arise from using generating capacity to providefrequency regulation services rather than to produce the maximum amount ofelectricity for the grid. Although hydro-powered generators have loweroperating and maintenance costs than fossil fuel producers, they aregeographically limited. Compared to the fossil fuel generators, our SmartEnergy MatrixTM will have much lower operating and maintenance costs and minimalfuel costs. Consequently, we believe that we will be a successful bidder toprovide frequency regulation services to regional grid operators that utilizeauction markets.

We also believe that,given the demands of providing frequency regulation, other forms of energystorage such as batteries, lower energy flywheels, fuel cells andelectrochemical capacitors will not be able to effectively compete with theSmart Energy MatrixTM. For example, batteries have a short economic life and aregenerally not environmentally attractive. Metal flywheels cannot store as muchenergy as can our composite flywheels, because they cannot spin as fast withoutincurring a significant weight, size and cost penalty. Other compositeflywheels have only a fraction of the energy required to provide the service.

**Discussion ofOperations**

We have experienced net losses since our inceptionand, as of December 31, 2006, had an accumulated deficit of approximately$150 million. We are focused on the development and commercialization of ourSmart Energy MatrixTM flywheel system for frequency regulation and completion ofour research and development contracts. We do not expect to have positiveEBITDA (Earnings before interest, taxes, depreciation and amortization) orpositive cash flow until at least 2010 and must raise 

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additional equity toexecute our business plan and continue as a going concern. We expect to raiseadditional capital this year and in 2008 through the sale of common stock toexecute our business plan. The expansion of our manufacturing capabilities andbuilding and installing frequency regulation facilities to achieve ourobjectives will require substantial additional outlays of capital.

Our business plan calls for completion of testing anddevelopment of our Smart Energy 25 flywheel design in July of 2007 anddeployment of our first megawatt of flywheel-based frequency regulation in April 2008.We began development of the Smart Energy 25 flywheel in the first quarter of2006. This flywheel is the core component of the Smart Energy MatrixTM with thebalance of the system made up of electronics and software. Our 2006 developmentefforts required us to nearly double our engineering and technical workforceand to increase our rate of expenditure for development materials. Additionalfunding will be needed in 2007 to fully develop the Smart Energy 25, build afull-power prototype and prepare for volume manufacturing capacity. In theevent that full-scale development of the Smart Energy MatrixTM is constrained,the time to achieve profitability or positive cash flow will be extended.

During 2005 we raised approximately $17 million byissuing approximately 13.3 million shares of common stock and issuing warrantsto purchase 3.8 million shares of common stock. We also received $100,000 forextending an existing warrant by two years that was set to expire in May 2005.In February 2007, we raised an additional amount of approximately $10.6million by selling approximately 11.8 million shares of common stock andwarrants to purchase 5.9 million shares at an exercise price of $1.33 pershare.

Our losses and uses ofcash may fluctuate significantly from quarter to quarter as revenues (if any),costs of development, inventories and receivables fluctuate. In addition cashmay fluctuate by period due to the timing of capital expenditures for expandingmanufacturing capabilities or construction of frequency regulation facilities.These fluctuations in cash requirements could put additional pressure on ourcash position. There can be no assurance that we will be able to raise therequired capital on a timely basis or that sufficient funds will be availableto us on terms that we deem acceptable, if they are available at all.

**Approvals andCertifications**

Both the California ISO and the New York ISO have nowcertified or otherwise approved Beacon’s technology for commercial use inproviding frequency regulation within their respective states. As previouslynoted, on December 26, 2006, the California ISO certified Beacon’sflywheels for use as a frequency regulation resource in California. And on March 22,2007, the New York ISO confirmed that Beacon’s flywheel technology is alsoacceptable and viable for use for frequency regulation on the New York ISOgrid, and that New York ISO is currently determining how the service would beintegrated into its tariff structure.

In prior years, we have obtained UnderwritersLaboratory approval for our existing 2-kWh and 6-kWh Smart Energyflywheel products and we have received certification that our smaller SmartEnergy flywheel systems meet Telcordia standards, which are the baseline forperformance and safety standards established by the telecommunicationsindustry. Our Smart Energy products are, to our knowledge, the only flywheelproducts that have passed a Zone 4 earthquake test while operating, making themsuitable for use anywhere in the United States. Our Smart Energy flywheelsystems have also been successfully tested for compliance with the Institute ofElectrical and Electronics Engineers (IEEE) 587 standards, which is therequired standard for all Uninterruptible Power Supply systems.

In prior years we havealso obtained Underwriters Laboratory approval for our Smart Power M5, M5 Plus,M4 and M4 Plus inverter systems. The California Energy Commission and New York’sPublic Service Commission have also approved these products for on-gridapplications.

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**Our Technology**

*Flywheel-basedproducts*

Our patented composite flywheels offer superiorreliability and performance at competitive costs compared to other energystorage devices. Our composite flywheel is a rotating wheel on hybrid magneticbearings and operates in a near-frictionless vacuum-sealed environment. Theflywheel is powered up to its operational speed using a permanent magnet motorand electricity from an external power source (typically the grid). When thecomposite rim spins, it stores energy kinetically. The flywheel is able to spinfor extended periods with great efficiency because friction and drag arevirtually eliminated by the use of hybrid magnetic bearings and a vacuum-sealedenvironment. Because it has very low friction, little power is required tomaintain the flywheel’s operating speed. When electrical power is needed, themomentum of the spinning flywheel drives a generator and its bi-directionalinverter converts the kinetic energy into electrical energy.

Steel flywheels have been used since the industrialrevolution in applications such as piston engines to store energy during thepower stroke for release during the compression stroke. These applications arelimited by the revolutions per minute at which steel flywheels are able tooperate and by the limited density of storage of energy by volume of steel. Ourproducts employ new enabling materials such as high-strength fiber, efficientelectric drives, and low-loss, long-life bearings to create new generations offlywheel products. Our composite flywheels are fabricated from a proprietarymixture of high-strength, lightweight fiber composites, such as graphite andfiberglass combined with resins, which allow the flywheel to rotate at highspeeds and store large amounts of energy relative to similar size and weightflywheels made from metals. For example, a 600-pound steel flywheelrunning at 8,000 revolutions per minute (RPM) will store approximately 900 watt-hoursof energy and can deliver up to 850 watt-hours of energy. In contrast, our 500-pound6-kilowatt hour composite flywheel running at 22,500 RPM stores 7,200watt-hours of energy and delivers 6,000 watt-hours of energy. On a per-poundbasis, composite flywheel technology delivers nearly 10 times the energy ofsteel flywheels.

Our proprietary technologyenables the design of maintenance-free flywheel products in that our productsemploy an internal rather than external vacuum system and its bearing systemshave been designed and developed to need no scheduled replacement ormaintenance. Many flywheel products rely on bearings and external vacuumsystems that require periodic maintenance and replacement. Our Smart Energyflywheel systems have dramatically longer discharge times than any otherflywheel energy storage systems; this is possible because our technologiesresult in higher amounts of stored energy and minimal energy losses duringoperation.

**Research andDevelopment**

Our research anddevelopment efforts are essential to our ability to successfully design anddeliver products, as well as to modify and improve existing products to reflectthe evolution of markets and customer needs. Our engineers work closely withpotential customers to define product features and performance requirements toaddress specific needs for both flywheel-based solutions and renewable energyapplications. Research and development expenses, including engineeringexpenses, were approximately $4,748,000 in 2006, $1,408,000 in 2005 and$3,532,000 in 2004. We expect research and development expenses in 2007 to behigher than those in 2006 due primarily to the costs of completing thedevelopment of the Smart Energy 25 flywheel and design of the facility fordeploying our Smart Energy MatrixTM for frequency regulation services. At December 31,2006, we employed 20 engineers and technicians and six manufacturing employeesfull time and had five independent contractors engaged in research anddevelopment and design work on manufacturing and frequency regulationfacilities. At December 31, 2005, we employed 15 engineers and techniciansand had three independent contractors engaged in research and development.

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**Manufacturing**

Our Wilmington, Massachusetts facility was designedfor the assembly and testing of flywheel systems and we used the facility forthat purpose in 2006 for development of the Smart Energy 25 flywheel. In 2007we expect to complete development and begin low volume production of our SmartEnergy MatrixTM product.

In 2007 we expect to build out manufacturing capacityto meet expected 2008 production requirements through expansion of our currentfacility or additional locations. We expect to begin staffing for the assemblyand testing of our flywheel systems during 2007 and beyond. In addition toassembly work at our Wilmington, Massachusetts facility, we rely on outsidesuppliers to provide components for our systems. For our mechanical flywheelsystems and the related electronics, we are working to establish a minimum oftwo suppliers for each component to reduce any adverse impact of a loss orinterruption by a supplier.

In 2005 and 2006 we alsoassembled and tested a small quantity of Smart Power M-series inverters at ourfacility. We believe we have adequate vendor sources for all the components ofthe Smart Power M-series inverter systems. Although we are continuing tosupport our inverter products, we do not believe that inverters will be asignificant portion of our business going forward and we are uncertain as towhen or at what price we will be able to sell our inventories.

**Sales and Marketing**

In 2006, sales and marketing activities for ourflywheel-based frequency regulation services focused on establishing efficacyfor our technology as a frequency regulation provider as a path to obtainingcertification to operate our technology in the deregulated open bid markets. Asignificant achievement in validating the capability of our technology toprovide frequency regulation was the formal certification that our technologycould be used for frequency regulation in California and New York. TheCalifornia ISO provided this certification in December 2006, and the NewYork ISO provided its acceptance of our technology in March, 2007.

Sales and marketing activities will broaden in 2007 aswe seek more certifications or other forms of approval to operate in open bidmarkets in addition to the California and New York markets. Simultaneously, weare assessing the comparative value of all the open bid markets in order todecide in which markets and in what sequence our merchant facilities should bebuilt and brought on-line.

Consistent with our focuson participating in multiple deregulated open bid markets in the near term, wehave increased our level of involvement in regulatory affairs on both anational and regional level. We joined the North American Electric ReliabilityCouncil (NERC) at the beginning of 2007, and we increased participation inregional ISO events related to becoming a market participant for frequencyregulation throughout 2006. We have continued our membership in the PJMInterconnect and expect to join other relevant ISO committees in 2007.

**Backlog**

At December 31, 2006,we did not have any firm commercial sales commitments for our products and services.We have been awarded several research and development contracts from which weexpect to derive revenues in 2007 of approximately $1,226,000.

**Customer Service**

We expect to providemaintenance and support for our products by utilizing our own customer servicepersonnel as well as support as needed from our engineering organization. Inthe future we may elect to 

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contractall or part of the customer service activities to outside sources if we deem iteffective from both a customer satisfaction and an overall cost perspective.

**IntellectualProperty**

Our success depends upon our ability to develop andmaintain the proprietary aspects of our technologies and to operate withoutinfringing on the proprietary rights of others. To some extent, our successalso depends upon the same abilities on the part of our suppliers.

We rely on a combination of patent, trademark, tradesecret and copyright law and contract restrictions to protect the proprietaryaspects of our technology. We seek to limit disclosure of our intellectualproperty by requiring employees, consultants, and any third parties with accessto our proprietary information to execute confidentiality agreements and byrestricting access to that information. Our patent and trade secret rights areof material importance to our current and future prospects. We are activelypursuing both national and foreign patent protection.

The intellectual propertyrights of our flywheel-based products are primarily embodied in patents that wehold or which are pending, but in addition include flywheel technologies andpatents that we are licensed to use, in perpetuity. We hold U.S. patents on ourflywheel vacuum system, heat pipe cooling system, output paralleling algorithm,metal hub, low-loss motor, co-mingled rims, earthquake-tolerant bearings andbearing cooling device. In February 2007, we received our first foreignpatent, in Australia, on our vacuum system, and an additional U.S. patent, on abearing damper. We also have 15 pending U.S. and foreign patent applications,and several other applications being prepared for filing. We hold a perpetual,exclusive, royalty-free, worldwide license by SatCon Technology Corporation touse its flywheel technologies and patents for stationary terrestrial flywheelapplications. This license includes 11 issued U.S. patents and 11 U.S. andforeign patent applications that expire on various dates between 2012 and2021and covers SatCon’s technologies and patents and all improvements made bySatCon through November 16, 2000, the date of our initial public offering.We are not entitled to any improvements to the flywheel technology that SatCondevelops subsequent to that date. We expect to develop additional intellectualproperties and trade secrets as we continue developing additional Smart Energyand Smart Power systems. We own all technology improvements that we havedeveloped that are based on the technology licensed from SatCon.

**GovernmentRegulation**

We expect to be asubstantial beneficiary of any government deregulation of North American andother electricity markets. In the U.S., in particular, the open-bid market forfrequency regulation services reflects a set of market rules by which wecan access revenue-producing markets without the need to find and sellequipment to traditional end-use customers. This open market environmentimplies the potential for fast growth using our high-energy carbon compositeflywheel technology and a design, build, own and operate business model.

**Employees**

At December 31, 2006, our headcount was 39 full-timeemployees, five part-time employees and five independent contractors, of whichapproximately 26 were engineers, technicians, and manufacturing staff involvedin research and development and one was in sales, marketing and customerservice. The remaining twelve people were involved in administrative tasks.None of our employees is represented by a union and we consider our relationswith employees to be satisfactory.

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**Item 1A.**                RiskFactors Relating to Our Business

***We face significanttechnical challenges in completing the development of the Smart Energy MatrixTM.We may fail to develop our 25kWh generation flywheel system, which is acritical requirement for the development of the Smart Energy MatrixTM and, evenif we are able to develop the 25kWh system, we may fail to develop the SmartEnergy MatrixTM.***

Although we havesuccessfully developed three high-energy flywheel systems (the 2kWh and 6kWhfor telecom and the 6kWh for the grid) that had similar technical challenges,there can be no assurance that we will be able to successfully develop the25kWh system. The successful development of our new Smart Energy 25 flywheelsystem, which will be used in the SmartEnergy MatrixTM*,* involvessignificant technological and cost challenges, including:

·       Timelydevelopment of cost-effective designs for key components of the Smart Energy MatrixTM such as the rim,motor, power electronics, magnetic bearing system and the master controllersoftware

·       Prototypetest malfunctions could result in damage to our other equipment and testfacility, re-engineering costs and production delays

·       Developmentand production delays and/or cost increases may occur if we are unable toestablish multiple source suppliers for key components to meet our engineeringrequirements, cost objectives and development and production schedules and wedo not have contracts with all of these suppliers

·       Developmentof cost-effective designs on schedule that will meet system performancerequirements such as:

**·****      **Arotor-cooling scheme to avoid overheating during operation

**·****      **Cost-effectivebearings to ensure acceptable vibration levels at all speeds; and

**·**       Atouchdown bearing system to stabilize the rotor during abnormal conditions suchas an earthquake

·       Rampingup and maintaining production rates

·       Controllingthe quality and cost of goods we buy from key suppliers; and

·       Potentialdelays in our schedule and/or cost increases that could result if we are unableto extend the lease on our current facility or obtain a suitable, timely leaseon another facility.

There can be noassurance that we will be successful in meeting these challenges. In addition,even if we are able to develop the new Smart Energy 25 flywheel system, we planto integrate multiple Smart Energy 25 flywheels into a common building toproduce the Smart Energy MatrixTM.This effort will pose significant technological and cost challenges including:

·       Meetingthe technical requirements for interconnection to the utility grid; and

·       Developing a communicationand control system adequate to meet the performance standards of grid managers.

***Our stock may be removed fromThe Nasdaq Capital Market System.***

On March 27,2007 we received a letter from the Nasdaq Capital Market dated March 27,2007 indicating that our common stock has not met the $1.00 minimum bid pricerequirement for continued listing for the past 30 days and that our commonstock is, therefore, subject to delisting from the Nasdaq Capital Market,pursuant to Nasdaq Marketplace Rule 4310(c)(4). Therefore in accordancewith Marketplace Rule 4310(c) (8) (D), we will be provided 180calendar days, or until September 24, 2007, to 

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regain compliance. To attain compliance, our commonstock must close at $1.00 per share or more for a minimum of ten consecutivedays before September 24, 2007. In the event that our stock does not meetthis requirement, but meets the requirements for initial inclusion on theNasdaq Capital Market as set forth in Marketplace Rule 4310(c), we may begranted an additional 180 calendar day period to regain compliance. If we havenot met the compliance criteria by September 24, 2007 and we are not eligiblefor an additional compliance period, Nasdaq will provide written notice thatour stock will be delisted. There can be no assurance that we will continue tomeet the Nasdaq Capital Market’s listing requirements and therefore may loseour eligibility for quotation on the Nasdaq Capital Market. Should our stocklose its eligibility to be quoted on the Nasdaq Capital Market, we will seek tohave our stock quoted on the OTCBB. While we know of no reason that our stockwill not be accepted for quotation on OTCBB, we cannot guarantee thatacceptance. If our stock is not accepted for listing on the OTCBB, we will betraded on the pink sheets.

***Our ability to complete development of our Smart Energy MatrixTM willrequire substantial funds. Our stockholders may be adversely affected ifwe issue debt securities or additional equity securities to obtain financing.***

We will require substantialfunds to conduct research and development activities, market our products andservices, and increase our revenues. We anticipate that such funds will beobtained from external sources and intend to seek additional equity or debt tofund future operations. Although approximately $10 million was raised in February 2007,we estimate that we will need to raise an additional $20 million during theremainder of 2007 in order to complete development of the Smart Energy MatrixTMflywheel system, build, operate and receive fees for frequency regulationservices and have sufficient working capital to continue to execute ourbusiness plan.

Our actual capital requirementswill depend on many factors. The additional funding we require may not beavailable on favorable terms, if at all. Such additional funding may only beavailable on terms that may, for example, cause substantial dilution to commonstockholders, and/or have liquidation preferences and/or pre-emptive rights. Ifwe raise additional funds by issuing debt securities or additional equitysecurities, existing stockholders may be adversely affected because newinvestors may have rights superior to current stockholders and currentstockholders may be diluted.

If we do not succeed in raisingadditional funds we will be unable to complete planned development of ourproducts and services. In addition, we could be forced to take unattractivesteps, such as discontinuing product development, limiting the servicesoffered, reducing or foregoing sales and marketing efforts and attractivebusiness opportunities, or discontinuing operations entirely.

Weexpect that it will be several years before we will recognize significantrevenues from the products we intend to offer and the services we intend toprovide. A large portion of our expenses are fixed, including expenses relatedto facilities, equipment and key personnel. In addition, we expect to spendsignificant amounts to fund product development based on our core technologies.We also expect to incur substantial expenses to manufacture our Smart Energy MatrixTM product in thefuture. As a result, operating expenses may increase significantly over thenext several years and, consequently, we will need to generate substantialcommercial revenue to achieve profitability. Even we do achieve profitability,we may not be able to sustain or increase profitability on a consistent basis.

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***We intend to bringour frequency regulation services to market through participation in the energyauction markets, where on a national basis the amount of frequency regulationrequired is typically one percent of all power produced. If changes in thispercentage occur due to regulatory modifications and are not offset by aproportionate increase in pricing for frequency regulation, our business plancould be adversely affected.***

The regulatory landscape is in constant flux, and weare aware that a North American Electric Reliability Council (NERC)subcommittee is in the process of developing a new NERC standard that mayreduce the amount of frequency regulation required by lowering the ratio offrequency regulation to power generated. There is not yet a consensus on thepotential changes to the standard. The new NERC standard may not be adopted ascurrently proposed, and even if adopted, regional grid operators have the unilateraloption under FERC rules to adhere to regional frequency regulationstandards that are not less rigorous, and may in fact be more rigorous, thanthe proposed new standard  Even if a newstandard is passed, the belief by such ISOs and other powerful utilitystakeholders that such changes could create possible negative impacts onoverall grid reliability make it likely that more rigorous standards willcontinue to be the rule in at least some areas, including California andNew England. However, if adopted, the proposed changes potentially could beharmful to us by: a) reducing the amount of frequency regulation required byIndependent System Operators in such a way as to reduce the total size of theUS frequency regulation market, b) lowering the price of frequency regulationas a consequence of any potential lower demand that might result from a changein regulatory standards, and c) increasing our cost of providing the service. Anycombination of these things could adversely impact our ability to access themarkets for frequency regulation or to do so on a profitable or sustainablebasis.

Other market-expandingdevelopments may partially counterbalance the uncertainty posed by the abovepossible changes in the NERC standard. For example, efforts by some states toincrease the amount of renewable energy that is produced for the grid from windand solar power may expand the market for frequency regulation services. Fromconversations with grid operators, we believe that the variable changes inenergy output caused by natural and constant changes in wind speed and cloudcover will require increased frequency regulation to balance this variability.

***Our revenue andsales depend upon the achievement of the product development andcommercialization milestones set forth in our contracts with third parties. Ourfuture revenues will result from similar milestones related to governmentcontracts and from our commercial applications. These revenues will depend onour ability to deliver flywheel systems with certain performance anddependability attributes.***

The majority of ourrevenue is currently derived from contracts with governmental entities in whichpayments to us are based primarily on achieving certain product development andcommercialization milestones as set forth in those contracts. We expect thatour future revenue from government sources will similarly be milestone-driven.On commercial applications for our flywheel systems, our ability to achieverevenues will be dependent on our ability to complete development of oursystems, expand our manufacturing capabilities, and obtain sufficient funds todeploy these systems. It is uncertain whether and to what degree we will beable to meet these goals in the future. To the extent we do not meet suchgoals, we expect our revenue to be negatively impacted.

***Ourbusiness plan includes the design, development, construction, financing andoperation of several frequency regulation power facilities that incorporate ourSmart Energy MatrixTM technology in order to provide frequency regulationservices. We have no prior experience doing this. Should we fail in anymaterial aspect of these tasks, it is unlikely that we will recognizesignificant revenue under our current business model.***

Our business plan callsfor the design, development, construction, financing and operation of one ormore commercial-level frequency regulation power plants that incorporate ourSmart Energy MatrixTM technology. However, we have no experience with suchprojects at a commercial level, although we have designed, developed,constructed and installed two one-tenth scale demonstration units at existingutility 

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sites onthe grid and have operated or are now operating them in demonstration andtesting mode. However, we have never done these things commercially, nor everobtained project financing (although we have experience in equitytransactions). We expect that executing these tasks on a commercial level willbe complex and challenging and we may not be successful. If we are notsuccessful, then we will not achieve the revenues planned in our businessmodel.

***We have a history of losses and anticipate future losses and we will havelimited revenues in the near term. Unless we raise additional capital tooperate our business, we may not be able to continue as a going concern.Even with the cash raised in February 2007, our cash balances aresufficient to fund operations only into approximately the fourth quarter of2007.***

We have incurred significant losses from operations sinceour inception. As shown in our consolidated financial statements, we incurredsignificant losses from operations of approximately $12,682,000, $9,448,000 and$9,049,000 and operating cash decreases of approximately $8,482,000, $8,923,000and $8,260,000, during the years ended December 31, 2006, 2005 and 2004,respectively. We expect to have positive EBITDA and be cash flow positive by2010; however, to be successful we will need to raise additional capital in2007 and 2008. In the event that we are not successful in raising equity or thetiming of bringing in additional cash is delayed, we may not be successful.

We had approximately $5.3 million in cash and cashequivalents on hand at December 31, 2006. Approximately $10 million of additional equity funding was raised in February 2007.Based on our current cash usage rates and additional expenditures expected insupport of our business plan, we estimate that we have adequate cash to fundoperations only into the fourth quarter of 2007.

We are focused on furtherdevelopment of the Smart EnergyMatrixTM to provide frequency regulation services, but this product willnot generate revenues in the near term. We expect future revenues to come froma combination of the sale of services related to the Smart Energy MatrixTM**andpossible sales of Smart Energy 25flywheel units. Other than revenue related to our research anddevelopment contracts in the amount of $2.2 million, we have had no revenues todate from our**Smart Energy MatrixTM. The timing offuture revenues is uncertain.

Miller Wachman, LLP, ourindependent auditors, have included an explanatory paragraph related to a goingconcern uncertainty in their audit report on our consolidated financialstatements for the fiscal year ended December 31, 2006, which identifiesour recurring losses and negative cash flows and raises substantial doubt aboutour ability to continue as a going concern.

Ourfinancial statements have been prepared on the basis of a going concern, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business. We have not made any adjustments to ourfinancial statements as a result of the going concern uncertainty. If we cannotcontinue as a going concern, we may have to liquidate our assets and mayreceive significantly less than the values at which they are carried on ourfinancial statements. Any shortfall in the proceeds from the liquidation of ourassets would directly reduce the amounts that holders of our common stock couldreceive in liquidation.

***Although the marketfor frequency regulation services is large and growing, we have notdemonstrated an ability to sell into that market.***

We intend to provide frequency regulation servicesusing our Smart Energy MatrixTMin the spot or auction markets of regional grid operators, such as PJMInterconnection. In order to bid in these markets, one must be qualified to doso. We expect to receive the necessary approvals, but there is no assurance wewill be successful.

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Even if we successfullyqualify to participate in the auction markets, if the structure of thesemarkets changes due to regulatory modifications, for example, our business plancould be adversely affected. The central financial attraction for us in theauction market is that we are able to bid electronically into each auction. Theseauctions yield the same sales price for all successful bidders. If the auctionmarket changes, we may be required to change our business plan and there can beno assurance that we will be successful in doing so.

***Increases ordecreases in purchase prices or availability of carbon fiber or other materialsand commodities may affect our ability to achieve profitability.***

We use carbon fiber in themanufacture of our flywheel systems. Other applications that require carbonfiber have substantially increased in the last few years. In response to thisincreased demand, suppliers are adding capacity but shortages and/or pricefluctuations may affect our ability to manufacture our flywheel systems in atimely way and at a reasonable cost.

***Fluctuations inenergy prices may have a material impact on the pricing of frequency regulationservices and therefore the profitability of our flywheel systems.***

The market pricing forfrequency regulation services tends to follow the pricing for energy. In theevent of any substantial future erosion in the price of energy, frequencyregulation prices could be adversely affected.

***New sources ofenergy including the commissioning of nuclear power plants and othertechnologies could adversely affect the demand for frequency regulationservices.***

Potential expansion in theuse of nuclear power or other new energy supply technologies could change thesupply and demand for energy and may impact frequency regulation pricing.

***Failure to protect our intellectual property couldimpair our competitive position.***

Although we are unaware of any challenges to ourintellectual property, we cannot provide assurance that we have or will be ableto maintain a significant proprietary position on the basic technologies usedin our flywheel systems. Our ability to compete effectively against alternativetechnologies will be affected by our ability to protect proprietary technology,systems designs and manufacturing processes. We do not know whether any of ourpending or future patent applications under which we have rights will issue,or, in the case of patents issued or to be issued, that the claims allowed areor will be sufficiently broad to protect our technology or processes fromcompetitors. Even if all of our patent applications are issued and aresufficiently broad, they may be challenged or invalidated. We could incursubstantial costs in prosecuting or defending patent infringement suits, andsuch suits would divert funds and resources that could be used in our business.We do not know whether we have been or will be completely successful insafeguarding and maintaining our proprietary rights.

Further, our competitors or others may independentlydevelop or patent technologies or processes that are substantially equivalentor superior to ours. If we are found to be infringing on third-party patents,we do not know whether we will be able to obtain licenses to use such patentson acceptable terms, if at all. Failure to obtain needed licenses could delayor prevent the development, manufacture or sale of our systems.

We rely, in part, oncontractual provisions to protect trade secrets and proprietary knowledge. Theseagreements may be breached, and we may not have adequate remedies for anybreach. Our trade secrets may also be known without breach of such agreementsor may be independently developed by competitors or others. Our inability tomaintain the proprietary nature of our technology and processes could allowcompetitors or others to limit or eliminate any competitive advantages we mayhave.

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***Government regulation may impair our ability to marketour products.***

Government regulation ofour products, whether at the federal, state or local level, including anychange in regulations or tariffs, product buy downs or tax rebates relating topurchase and installation of our products, may increase the cost and price ofour systems, and may have a negative impact on our revenue and profitability. Wecannot provide assurance that our products will not be subject to existing orfuture federal and state regulations governing traditional electric utilitiesand other regulated entities. We expect that our products and theirinstallation will be subject to oversight and regulation at the local level inaccordance with state and local ordinances relating to building codes, safetyand related matters. We do not know the extent to which any existing or newregulations may impact our ability to distribute, install and service ourproducts. Once our products reach the commercialization stage, federal, stateor local government entities may seek to impose regulations.

***The exercise of options and warrants and other issuances of shares willlikely have a dilutive effect on our stock price.***

As of December 31, 2006,there were outstanding options to purchase an aggregate of 6,546,886 shares ofour common stock at prices ranging from $0.255 per share to $9.31 per share, ofwhich options to purchase 5,672,000 shares were exercisable as of such date. Asof December 31, 2006, there were outstanding warrants to purchase5,543,860 shares of our common stock, all of which were exercisable as of December 31,2006. During February 2007, we issued approximately 11.8 millionshares of common stock and warrants to purchase 5.9 million shares at an exerciseprice of $1.33 per share.

Theexercise of options and warrants at prices below the market price of our commonstock could adversely affect the price of our common stock. Additional dilutionmay result from the issuance of shares of our capital stock in connection withcollaborations or manufacturing arrangements or in connection with otherfinancing efforts.

***Our financial performance could be adversely affectedif we are unable to retain or attract key technical personnel.***

Our future success alsodepends to a large degree on the technical skills of our engineering staff andour ability to attract key technical personnel. Competition for skilledtechnical professionals is intense and we may not be successful in attractingand retaining the talent necessary to design, develop and manufacture ourflywheel products.

***Competitors in thefrequency regulation market include established utilities and independentservice providers with far greater resources than we have.***

The frequency regulationservices market is being served by well-known utilities and independent serviceproviders that use conventional generators. We will be competing withestablished generators that have far greater resources than we do.

***We have anti-takeover defenses that could delay or prevent an acquisitionand changes in control that could adversely affect the price of our commonstock.***

Provisions of our certificate ofincorporation, by-laws, Rights Agreement and Delaware law may have the effectof deterring unsolicited takeovers or delaying or preventing changes in controlof management, including transactions in which our stockholders might otherwisereceive a premium for their shares over then current market prices. Inaddition, these provisions may limit the ability of stockholders to approvetransactions that they may deem to be in their best interest.

Our certificate of incorporationpermits our board of directors to issue preferred stock without stockholderapproval upon such terms as the board of directors may determine. The rights ofthe holders 

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ofour common stock will be subject to, and may be adversely affected by, therights of the holders of any preferred stock that may be issued in the future. Theissuance of preferred stock, while providing desirable flexibility inconnection with possible acquisitions and other corporate purposes, could havethe effect of making it more difficult for a third party to acquire, or ofdiscouraging a third party from acquiring, a majority of our outstanding commonstock. Although we have no present intention of issuing any additionalpreferred stock, an issuance of a substantial number of preferred shares couldadversely affect the price of our common stock.

In addition, our certificate of incorporation and our amended andrestated by-laws provide that:

·       Ourdirectors may only be removed for cause by a majority of the outstandingcapital stock entitled to vote in the election of directors

·       Ourstockholders do not have the power to call special meetings of stockholders;and

·       Theprovisions relating to the classified board, removal of directors and callingof special stockholders meetings may only be amended by a 662¤3% vote of the outstanding shares of common stock,voting together as a single class.

These provisions make it moredifficult for our stockholders to change the composition of the board ofdirectors and approve transactions they may deem to be in their best intereststhat are not approved by the board of directors.

Pursuant to a RightsAgreement, we issued rights as a dividend on common stock on October 7,2002, each of which entitles the holder to purchase 1/100th of a share of newly issued preferred stock for$22.50 in the event that any person not approved by the board of directorsacquires more than 15% (35% in the case of one large shareholder, PerseusCapital, L.L.C. and its affiliates, that at that time owned more than 15%) ofBeacon’s outstanding common stock, or in the event of an acquisition by anothercompany, $22.50 worth of the common stock of the other company at half itsmarket value (in each case the rights held by the acquiring person are notexercisable and become void).

**Item 1B.**               Unresolved Staff Comments

None.

**Item 2.**                        Properties

Our principal executiveoffices, laboratory and manufacturing facilities are located at a singlelocation in Wilmington, Massachusetts. This 51,650 square foot facilityoperates under a lease that expires on September 30, 2007. Our facility isdesigned for the assembly and test of flywheel systems and this capabilitycontinues to be available in the event that we complete development and beginproduction. Testing and development of the Smart Energy 25 flywheel is expectedto be completed by July of 2007. Once development is completed, we willbegin to ramp up our production capabilities in anticipation of having ourfirst frequency regulation facility operational April 2008 and between 10and 20 megawatts in operation by the end of 2008. The build-out of ourmanufacturing capability will require expansion of our existing facility oradditional space at other locations. We are currently evaluating thesealternatives, which may include leasing additional space in our currentfacility or relocating some or all functions to another facility. In addition,we are evaluating several possible locations for our first commercial frequencyregulation facility and expect to make a determination of its location andbegin build-out later in 2007.

**Item3.**                        LegalProceedings

We are not involved in anylegal proceedings that are considered material; however, we may from time totime be involved in legal proceedings in the ordinary course of our business.

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

**None**

**Executive Officers**

Thenames, ages, current positions and principal occupations during the last fiveyears of our current Executive Officers Executive Officers are described below.
| Name                  | ** ** | **Age** | ** ** | **Position**                                                                 |
|-----------------------|------------|---------|------------|------------------------------------------------------------------------------|
| F. William Capp       |       | 58      |       | President and Chief Executive Officer, Director                              |
| Matthew L. Lazarewicz |       | 56      |       | Vice President of Engineering and Chief Technical  Officer                   |
| James M. Spiezio      |       | 59      |       | Vice President of Finance, Chief Financial Officer, Treasurer  and Secretary |

 

*F. William Capp.*

Mr. Capp has served as our President, Chief Executive Officerand Board member since December 1, 2001 when he joined the Company.Mr. Capp received his Bachelor of Science in Aeronautical Engineering fromPurdue University, a Master of Business Administration and a Master’s Degree inMechanical Engineering from the University of Michigan.

*Matthew L. Lazarewicz.*

Mr. Lazarewicz has served as our Vice President ofEngineering since February 1999, and was named our Chief Technical Officerin September of 2001. Mr. Lazarewicz is a Registered ProfessionalEngineer in the Commonwealth of Massachusetts and received both Bachelor’s andMaster’s Degrees in Mechanical Engineering from the Massachusetts Institute ofTechnology. Mr. Lazarewicz also completed his Master’s Degree inManagement at the Massachusetts Institute of Technology Sloan School ofManagement.

*James M. Spiezio.*

Mr. Spiezio joined our Company in May 2000. He hasserved as Vice President of Finance, Chief Financial Officer and Treasurersince July 2000, Secretary since March 2001, and was our CorporateController from May 2000 to July 2000. He has over twenty-six yearsof diversified manufacturing and financial management experience. Mr. Spieziois a graduate of the Indiana University School of Business.

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**PART II**

**Item 5.**                        Market for Registrant’s CommonEquity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is quoted on the NASDAQCapital Market under the symbol “BCON”. The following table sets forth the highand low sales price of the common stock for the periods indicated.
|                                        | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------------|------------|----------|------------|---------|------------|
| **Year ended December 31,  2006** |       |     |       |    |       |
| Fourth quarter                         |       | $        | 1.24       |    | $          | 0.99 |   |
| Third Quarter                          |       | $        | 1.54       |    | $          | 1.12 |   |
| Second quarter                         |       | $        | 1.82       |    | $          | 1.02 |   |
| First Quarter                          |       | $        | 2.15       |    | $          | 1.42 |   |
| **Year  ended December 31, 2005** |       |     |       |    |       |
| Fourth quarter                         |       | $        | 3.02       |    | $          | 1.70 |   |
| Third Quarter                          |       | $        | 5.35       |    | $          | 1.01 |   |
| Second quarter                         |       | $        | 1.22       |    | $          | 0.74 |   |
| First Quarter                          |       | $        | 1.43       |    | $          | 0.60 |   |

 

On March 21,2007 the last reported sale price of our common stock on the NASDAQ CapitalMarket was $0.83 per share, and there were 308 holders of record of commonstock. The number of record holders does not include holders of shares in “streetname” through brokers.

On March 27,2007, we received a letter from the Nasdaq Stock Market indicating that for thelast 30 consecutive business days, the bid price of our common stock hasclosed below the minimum $1.00 per share requirement for continued inclusion onthe Nasdaq Stock Market based on Marketplace Rule 4310(c)(4). Inaccordance with Marketplace Rule 4310(c)(8)(D), we have been provided180 calendar days, or until September 24, 2007, to regain compliance.If at any time before September 24, 2007 our common stock has a closingbid price of $1.00 or more for a minimum of 10 consecutive business daysthe Nasdaq Stock Market Staff will notify us that we comply withRule 4310(c)(4).

If we have not metthe requirements of Rule 4310(c)(4) by September 24, 2007 but meetany one of the three criteria as set forth in Marketplace Rule 4310(c), wewill be granted an additional 180 calendar day compliance period toMarch 21, 2008.

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**Performance Graph**

The line graphbelow compares the cumulative total stockholder return for the past five yearsthrough the year ended December 31, 2006 of our common stock against thecumulative total return of the NASDAQ Stock Market Index and the Dow JonesUtility Index for the same period. The graph and table assume that $100 wasinvested on January 1, 2001, in each of our common stock, the NASDAQ StockMarket Index and the Dow Jones Utility Index, and that all dividends werereinvested. No cash dividends have been declared on our common stock.

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*                    Stockholderreturns over the indicated period should not be considered indicative of futurestockholder returns.

The foregoingPerformance Graph is not deemed to be “soliciting material” or to be “filed”with the SEC or subject to Regulation 14A or 14C under the Securities ExchangeAct of 1934 or to the liabilities of Section 18 of the Securities ExchangeAct of 1934, and will not be deemed to be incorporated by reference into anyfiling under the Securities Act of 1933 or the Securities Exchange Act of 1934,except to the extent we specifically incorporate it by reference into such afiling.

We have never declared or paid cash dividends onshares of our common stock. We expect to retain any future earnings, if any, tofinance the expansion of our business, and therefore do not expect to pay cashdividends in the foreseeable future. Payment of future cash dividends, if any,will be at the discretion of our board of directors after taking into accountvarious factors, including our financial condition, operating results, currentand anticipated cash needs and plans for expansion.

*Equity Compensation Plan Information.**  *Thefollowing table gives information about equity awards under our stock optionplan and employee stock purchase plan, as of December 31, 2006.
| Plan category                                          | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       |                                                                                                                                                 | 6,446,886  |                                                                                                             |       |                                                                                        | $          | 1.23 |   |   |   | 12,653,061 |   |   |
| Equity  compensation plans not approved by security holders |       |                                                                                                                                                 | 100,000    |                                                                                                             |       |                                                                                        | $          | 1.23 |   |   |   | — |   |   |
| Total                                                       |       |                                                                                                                                                 | 6,546,886  |                                                                                                             |       |                                                                                        | $          | 1.23 |   |   |   | 12,653,061 |   |   |

 

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For additional informationconcerning our equity compensation plans, see discussion in footnotes 2 and 8to our consolidated financial statements and under the caption “CompensationDiscussion and Analysis” in our proxy statement for the Annual Meeting ofStockholders to be filed with the Securities and Exchange Commission on orprior to April 30, 2007.

**Purchases of Equity Securities by the Issuer and AffiliatedPurchasers**

There was no stockrepurchase activity in 2006.

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**Item 6.**                        Selected Consolidated FinancialData

The following selected financial data should be readtogether with “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and the financial statements, including the related notes,found elsewhere in this Form 10-K.

Thefollowing tables present selected historical financial data for the years endedDecember 31, 2006, 2005, 2004, 2003 and 2002 and for the period from May 8,1997, the date of Beacon’s inception, through December 31, 2006.

| ** **                                                       | ** ** | ** **                                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Period from**            | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------|------------|------------|------------|------------|------------|------------|------------|---------------------------------|------------|
| ** **                                                       | ** ** | ** **                                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Date of Inception** | ** ** |
| ** **                                                       | ** ** | ** **                                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **May 8, 1997**       | ** ** |
| ** **                                                       | ** ** | **Year ended December 31,**                         | ** ** | **through December 31,** | ** ** |
| ** **                                                       | ** ** | **2006**                                                           | ** ** | **2005**                           | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2006**                        | ** ** |
| ** **                                                       | ** ** | **(in thousands, except per share data)** | ** ** | ** **                         | ** ** |
| **Consolidated Statements of Operations Data:**             |       |                                                               |       |                               |       |       |       |       |       |       |       |                            |       |   |   |
| Revenue                                                          |       | $                                                                  | 969        |                               | $          | 1,487      |       | $          | 325        |       | $          | —                          |       | $ | — |   |   | $ | 3,332 |   |   |
| Cost of goods sold                                               |       | 845                                                                |       | 1,575                              |       | 1,458      |       | —     |       | —     |       |                            | 3,878      |   |   |
| Gross profit                                                     |       | 124                                                                |       | (88                                | )          | (1,133     | )          | —     |       | —     |       |                            | (546       | ) |   |
| Operating expenses:                                              |       |                                                               |       |                               |       |       |       |       |       |       |       |                            |       |   |   |
| Selling, general and administrative                              |       | 6,508                                                              |       | 6,334                              |       | 4,197      |       | 4,936      |       | 5,637      |       |                            | 45,098     |   |   |
| Research and development                                         |       | 4,748                                                              |       | 1,408                              |       | 3,532      |       | 3,550      |       | 7,130      |       |                            | 60,032     |   |   |
| Loss on contract commitments                                     |       | 1,385                                                              |       | 1,535                              |       | —     |       | —     |       | —     |       |                            | 3,295      |   |   |
| Depreciation and amortization                                    |       | 96                                                                 |       | 83                                 |       | 187        |       | 285        |       | 1,644      |       |                            | 4,317      |   |   |
| Casualty loss                                                    |       | 69                                                                 |       | —                             |       | —     |       | —     |       | —     |       |                            | 69         |   |   |
| Restructuring charges                                            |       | —                                                             |       | —                             |       | —     |       | —     |       | 2,159      |       |                            | 2,159      |   |   |
| Loss on impairment of assets                                     |       | —                                                             |       | —                             |       | —     |       | 367        |       | 4,297      |       |                            | 4,664      |   |   |
| Total operating expenses                                         |       | 12,806                                                             |       | 9,360                              |       | 7,915      |       | 9,138      |       | 20,867     |       |                            | 119,634    |   |   |
| Loss from operations                                             |       | (12,682                                                            | )          | (9,448                             | )          | (9,049     | )          | (9,138     | )          | (20,867    | )          |                            | (120,180   | ) |   |
| Interest and other income (expense), net                         |       | 519                                                                |       | 136                                |       | 3,719      |       | 520        |       | 28         |       |                            | 6,778      |   |   |
| Net loss                                                         |       | (12,163                                                            | )          | (9,312                             | )          | (5,330     | )          | (8,618     | )          | (20,839    | )          |                            | (113,402   | ) |   |
| Preferred stock dividends                                        |       | —                                                             |       | —                             |       | —     |       | —     |       | —     |       |                            | (36,826    | ) |   |
| Accretion of redeemable convertible preferred stock              |       | —                                                             |       | —                             |       | —     |       | —     |       | —     |       |                            | (113       | ) |   |
| Loss to common shareholders                                      |       | $                                                                  | (12,163    | )                                  | $          | (9,312     | )          | $          | (5,330     | )          | $          | (8,618                          | )          | $ | (20,839 | ) |   | $ | (150,341 | ) |   |
| Loss per share, basic and diluted                                |       | $                                                                  | (0.21      | )                                  | $          | (0.20      | )          | $          | (0.12      | )          | $          | (0.20                           | )          | $ | (0.49 | ) |   |   |   |   |
| Shares used in  computing net loss per shares, basic and diluted |       | 59,080                                                             |       | 47,666                             |       | 43,453     |       | 42,886     |       | 42,797     |       |                            |       |   |   |

 
|                                   | ** ** | **As of December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------|------------|
| ** **                        | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                        | ** ** | **(in  thousands)**                   | ** ** |
| **Balance Sheet Data:** |       | ** **                            |       |
| Cash and cash  equivalents        |       | $                                     | 5,251      |   | $ | 13,890 |   | $ | 5,097 |   | $ | 8,909 |   | $ | 17,867 |   |
| Working capital                   |       | 3,310                                 |       | 13,223 |   | 4,213 |   | 8,838 |   | 16,865 |   |
| Total assets                      |       | 7,258                                 |       | 16,126 |   | 7,086 |   | 12,067 |   | 20,906 |   |
| Total stockholders’  equity  |       | 3,900                                 |       | 13,655 |   | 5,110 |   | 9,692 |   | 18,075 |   |
|                                   |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Item 7.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operation

The following discussionof our financial condition and results of operations should be read inconjunction with our financial statements, the notes to those financialstatements and other financial information appearing elsewhere in this document.In addition to historical information, the following discussion and other partsof this document contain forward-looking statements that reflect plans,estimates, intentions, expectations and beliefs. Actual results could differmaterially from those discussed in the forward-looking statements. See “NoteRegarding Forward-Looking Statements.” Factors that could cause or contribute to such differences include, butare not limited to, those set forth in the “Risk Factors” in Item 1A andcontained elsewhere in this Form 10-K.

**Critical accountingpolicies and estimates**

The preparation of financial statements requiresmanagement to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues, expenses and related disclosures. On an ongoingbasis, management evaluates our estimates and assumptions including but notlimited to those related to revenue recognition, asset impairments, inventoryvaluation, warranty reserves and other assets and liabilities. Management basesits estimates on historical experience and various other assumptions that itbelieves to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

*RevenueRecognition.**  *Althoughwe have shipped products and recorded contract revenues, our operations havenot yet reached a level that would qualify us to emerge from the developmentstage. Therefore we continue to be accounted for as a development stage companyunder Statement of Financial Accounting Standards No. 7 “Accounting andReporting by Development Stage Enterprises.”

We recognize revenues in accordance with accountingprinciples generally accepted in the United States of America. Generally,revenue is recognized on transfer of title, typically when products are shippedand all related costs are estimable. For sales to distributors, we make anadjustment to defer revenue until products are subsequently sold bydistributors to their customers.

*GovernmentContract Revenue Recognized on the Percentage-of-Completion Method.**  *We recognize contract revenues using thepercentage-of-completion method, based primarily on contract costs incurred todate compared with total estimated contract costs. Changes to total estimatedcontract costs or losses, if any, are recognized in the period in which theyare determined. Revenues recognized in excess of amounts billed are classifiedas current assets, and included in “Prepaid expenses and other current assets”in our balance sheets. Amounts billed to clients in excess of revenues recognizedto date are classified as current liabilities under “Advance billings oncontracts.”  Changes in projectperformance and conditions, estimated profitability, and final contractsettlements may result in future revisions to construction contract costs andrevenue.

All of our research and development contracts aresubject to cost review by the respective agencies. Our reported results fromthese contracts could change adversely as a result of these reviews.

*Losson Contract Commitments.**  *Eachquarter, we perform an evaluation of expected costs to complete our in-progresscontracts that we account for using the percentage-of-completion method. In theevent that the total expected costs to complete a contract exceed the expectedtotal contract revenue, we immediately record a loss on the contract to theextent that the expected loss exceeds the expected revenue from the contract.

*InventoryValuation.*   We value our inventory at the lowerof actual cost or the current estimated market value. We regularly reviewinventory quantities on hand and record a provision for excess and obsoleteinventory based primarily on historical usage for the prior twelve month periodand future sales 

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forecasts. Although wemake every effort to ensure the accuracy of our forecasts of future productdemand, any significant unanticipated changes in demand or technologicaldevelopments could have a significant impact on the value of our inventory andthus our reported operating results. For the years ended December 31,2006, 2005 and 2004, reserves were recorded to fully offset the value of ourinventory. These impairment charges were made due to the uncertainty ofrealizing any future value from the inventory due to the lack of substantialrevenues to date from our inverter product line. Materials used in thedevelopment of the Smart Energy 25 flywheel and our other development effortsare considered research and development materials, and are expensed as incurredin accordance with Statement of Financial Accounting  Standards No. 2 “*Accounting  for Research and Development Costs*.”

*PatentCosts.*   We will capitalize external legal costsincurred in the defense of our patents where we believe that the futureeconomic benefit of the patent will be increased. We monitor the legal costsincurred and the anticipated outcome of the legal action and, if changes in theanticipated outcome occur, capitalized costs will be adjusted in the period thechange is determined. Patent costs are amortized over the remaining life of thepatents. We own intellectual property in the form of patents on our flywheelvacuum system, our heat pipe cooling systems, DC output paralleling, metal hub,low-loss motor, co-mingled rims and earthquake-tolerant bearings on ourflywheel products, and anti-islanding software, drawings, source code, andproduction know-how on our inverter products, and expect to obtain otherpatents during 2007 and beyond. These costs were being amortized during 2004,but we recorded impairment charges to write down these assets to zero on thebalance sheet at December 31, 2004. These impairment charges were made dueto the uncertainty of realizing any future value from this property mainly duethe lack of substantial revenues to date. Accordingly, all costs incurredduring 2005 and 2006 related to the development of intellectual property havealso been expensed as incurred.

*WarrantyReserves.*   Our warranties require us to repair orreplace defective products returned to us during the applicable warranty periodat no cost to the customer. We record an estimate for warranty-related costsbased on actual historical return rates, anticipated return rates and repaircosts at the time of sale. A significant increase in product return rates, or asignificant increase in the costs to repair products, could have a materialadverse impact on future operating results for the period or periods in whichsuch returns or additional costs materialize and thereafter.

*IncomeTaxes.*   Deferred tax assets and liabilities aredetermined based on differences between the financial reporting and income taxbases of assets and liabilities, as well as net operating loss and tax creditcarry-forwards, and are measured using the enacted tax rates and laws that willbe in effect when the differences reverse. Deferred tax assets are reduced by avaluation allowance to reflect the uncertainty associated with their ultimaterealization.

Significant management judgment is required indetermining the provision for income taxes, the deferred tax assets andliabilities and any valuation allowance recorded against deferred tax assets. Thevaluation allowance is based on our estimates of taxable income and the periodover which our deferred tax assets will be recoverable. In the event thatactual results differ from these estimates or we adjust these estimates infuture periods we may need to establish an additional valuation allowance orreduce our current valuation allowance which could materially impact our taxprovision.

*Long-Lived Assets.*   Inaccordance with Statement of Financial Accounting Standards No. 144 “Accountingfor the Impairment or Disposal of Long-Lived Assets” long-lived assets we holdand use are reviewed to determine whether any events or changes incircumstances indicate that the carrying value of the asset may not berecoverable. The conditions to be considered include whether or not the assetis in service, has become obsolete, is damaged, or whether external marketcircumstances indicate that the carrying amount may not be recoverable. Whenappropriate we recognize a loss for the difference between the estimated fairvalue of the asset and the carrying amount. The fair value of the asset ismeasured using either available market prices or estimated discounted cashflows. Our analyses indicate that there was an 

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impairment ofcertain long-lived assets as a result of the December prototypemalfunction, and we recognized an asset impairment charge of approximately$18,000 in 2006. This represents the estimated cost to repair certain damageditems. Based on our annual analysis, no asset impairment charges wereconsidered necessary for 2005 or 2004.

**Overview**

Our initial productstrategy was to develop high energy, composite flywheels for back-up poweringof telecommunications applications. With the collapse of the telecommunicationsmarket which began in 2001, we recognized that our Smart Energy flywheel products as alternative backup solutionsto the telecommunications industry were not a means to produce meaningfulrevenues. With that recognition, we initiated a series of cost cutting measuresthroughout 2002 and 2003. The focus of these efforts was to reduce cash usagewhile preserving our intellectual properties and maintaining the integrity ofour public company requirements while evaluating all potential product marketsfor our technologies and considering acquisitions or mergers that could lead toincreased shareholder value. We have:

(i)            Identified promisingapplications for our Smart Energy MatrixTM design in the electric utility powergrid marketplace.

(ii)        Pursued additionaldevelopment and design contracts for a variety of applications by federalagencies. We have been successful in obtaining contracts and are continuing ourefforts to obtain additional research and development funding.

(iii)    Field-tested scale-model SmartEnergy Matrix flywheel systems for frequency regulation in two states, whichhas resulted in certification of our technology for frequency regulation in theState of California. In March 2007, NYSERDA and the US DOE determined thatthe test of our second demonstration system in New York was also a success andthat no further data acquisition or testing was required. This milestone hasset the stage for us to become a fully qualified market participant should wedecide to commercialize our technology in New York.

(iv)      Completed a significantportion of the development effort for our Smart Energy 25 flywheel in 2006.

We must raiseadditional funds to execute our business plan. Although funding ofapproximately $10 million was raised in February 2007, based on our rateof expenditure of cash and the additional expenditures expected to support ourbusiness plan we estimate that we have sufficient cash to fund operations intoapproximately the fourth quarter of 2007. We need to obtain additionalinvestments in 2007 to fund:

·       Ourcontinuation as a going concern

·       Ongoingresearch and development of the Smart Energy 25 flywheel and the Smart EnergyMatrixTM multi-flywheel system

·       Theramp up of our manufacturing and assembly capacity

·       Thedesign and build-out of facilities to provide frequency regulation services tothe electricity grid

·       Workingcapital requirements; and

·       Theidentification and development of new business opportunities.

We are continuing to develop the Smart Energy 25flywheel, which is the core component of the Smart Energy MatrixTM flywheelsystem. In order to complete development of the Smart Energy MatrixTM flywheelsystem, build, operate and receive fees for frequency regulation services of atleast one megawatt from a commercial sized flywheel-based frequency regulationsystem and have sufficient working capital to 

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continue to execute ourbusiness plan through 2007, we will need to raise approximately $20 million offunding. Also, we will need to raise additional amounts beyond the foregoing$20 million to finance the various additional frequency regulation facilitiesthat are contemplated by our business plan.

As part of our new business development, we mayevaluate possible acquisitions of enterprises or technologies that we wouldconsider synergistic from a market, technology or product perspective.

From inception through December 31, 2006, we haveincurred losses of approximately $150.4 million. We expect to continue to incurlosses as we expand our product development and begin to increase ourmanufacturing capacity.

*Revenues.*   Wewere awarded fixed price research and development contracts from governmentagencies and are pursuing similar contracts from other government agencies. Wehave determined that we will recognize revenues using the percentage ofcompletion method for such contracts. We are continuing to evaluate markets forour flywheel systems but we have not recognized revenues from these products. Wehave placed development prototype flywheels with potential customers andshipped pre-production units. These flywheel products were provided topotential customers without charge or on a demonstration basis to allow usaccess to field test information and to demonstrate the application of ourtechnologies.

*Costof Goods Sold.**  *Cost ofgoods sold on fixed price research and development contracts are predominantlybeing recorded on the percentage of completion method and consist primarily ofdirect labor and material, subcontracting and associated overhead costs.

*Selling,General and Administrative Expenses.**  *Our sales and marketing expenses consistprimarily of compensation and benefits for sales and marketing personnel andrelated business development expenses. In 2004 we expanded our sales andmarketing effort into the renewable energy market for the Smart Power M5**inverter product. We continue to rely on engineeringpersonnel to provide technical specifications and product overviews to ourpotential customer base. We expect sales and marketing expenses to continue toincrease as we expand efforts to define new markets for our products. Generaland administrative expenses consist primarily of compensation and benefitsrelated to our corporate staff, professional fees, insurance and travel. In2005 we incurred significant non-recurring professional expenses relating tothe failed attempt to acquire NxtPhase T&D Corporation and our fundraisingefforts. In 2006, our selling, general and administrative expenses increased,primarily due to compensation costs associated with equity based compensation. Weexpect our selling, general and administrative expenses to increase slightly in2007 over 2006 due primarily to the implementation and reporting expensesassociated with compliance with the internal control provisions of theSarbanes-Oxley Act of 2002, fundraising activities, and marketing, sales and businessdevelopment expenses related to the Smart Energy Matrix.

*Researchand Development.**  *Ourcost of research and development consists primarily of the cost of compensationand benefits for research and development, staffing, as well as materials andsupplies used in the engineering design and development process. These costsare expected to increase in 2007 as compared to 2006 as we complete thedevelopment and testing of the Smart Energy 25 flywheel and the design of theSmart Energy MatrixTM and frequency regulation facility.

*Losson Contract Commitments.**  *We will establish reserves for anticipated losses oncontract commitments if, based on cost estimates to complete the commitment, wedetermine that a loss will be incurred. We recorded a $1.4 million chargeduring 2006 and $1.5 million in 2005 for anticipated losses on our research anddevelopment contracts. We did not accrue such losses during 2004. We are mostlikely to recognize probable losses on contract commitments early in a product’sintroduction prior to being able to realize expected decreases in cost per unitthrough engineering design changes, operating efficiencies, and volumepurchasing discounts. On government contracts, we will, on a quarterly basis,evaluate our estimated costs to complete and establish reserves whenappropriate.

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*Restructuringand asset impairment charges.**  *Wedid not recognize any material restructuring charges in 2006, 2005 or 2004.Asset impairment charges of approximately $18,000 were recorded in 2006 relatedto damages resulting from the prototype malfunction in December 2006.

*Depreciationand Amortization.**  *Ourdepreciation and amortization is primarily related to depreciation on capitalexpenditures and the amortization of lease and leasehold costs related to ourfacilities. We have intellectual property in the form of patents on ourflywheel vacuum system, our heat pipe cooling systems, DC output paralleling,metal hub, low-loss motor, co-mingled rims and earthquake-tolerant bearings onour flywheel products, and anti-islanding software, drawings, source code, andproduction know-how on our Smart PowerM5 inverter system, and expect to obtain other patents during 2006 andbeyond. These costs were being amortized during 2004, but we recordedimpairment charges to write down these assets to zero on the balance sheet at December 31,2004. These impairment charges were made due to the uncertainty of realizingany future value from this property mainly due the lack of substantial revenuesto date. Accordingly, all costs incurred during 2005 and 2006 related to thedevelopment of intellectual property have been expensed as incurred.

*Interest and OtherIncome/Expense, net.**  *In2006, non-operating income consists primarily of interest income resulting fromcash on hand, and approximately $18,000 received in settlement of a classaction suit relating to unfair practices engaged in by certain insurancebrokerage firms. In 2005 and 2004, our non-operating income and expenses areprimarily attributable to realized gains on the sale of our available-for-salesecurities and a warrant, a write-back resulting from loan payments on areserved loan to a former officer of the Company, a cash settlement relating toour failed attempt to acquire NxtPhase T&D Corporation, interest incomeresulting from cash on hand, accrued dividends receivable and the 7% conversionpremium from the conversion of our holdings of Series A Preferred Stock ofEvergreen Solar, Inc., partially offset by interest expense associatedwith our capital leases.

**AccountingPronouncements**

*Recently AdoptedAccounting Pronouncements*

*Share-BasedPayments*

During the first quarter of 2006, we adopted theprovisions of, and accounted for, stock-based compensation in accordance withthe Financial Accounting Standards Board’s Statement of Financial AccountingStandards No. 123R (“SFAS 123R”), “*Share-Based Payment.*”In conjunction with the adoption of SFAS 123R, we also adopted SEC StaffAccounting Bulletin 107 (“SAB 107”), which provides additional guidance ondisclosure topics related to share-based payments.

Under the fair value recognition requirements of SFAS123R, stock-based compensation cost is measured at the grant date based on thefair value of the award and is recognized as an expense as it is earned overthe requisite service period, which is the vesting period. To implement thisstandard, we elected the modified-prospective transition method, under whichprior periods are not revised for comparative purposes. The valuationprovisions of SFAS 123R apply to new grants and to grants that were outstandingas of the effective date and are subsequently modified. Estimated compensationexpense for grants that were outstanding as of the effective date will berecognized over the remaining vesting period using the compensation costestimated for the SFAS 123 pro forma disclosures.

The adoption of SFAS 123Rhad a material impact on our consolidated financial position and results ofoperations. See Note 8 of our Consolidated Financial Statements for furtherinformation regarding our stock-based compensation assumptions and expenses,including pro forma disclosures for prior periods as if we had recordedstock-based compensation expense during such periods.

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*Accounting Changesand Error Corrections*

During the first quarterof 2006, we also adopted SFAS No. 154 “*Accounting Changes andError Corrections—A Replacement of APB Opinion No. 20 and FASB StatementNo 3,*”which became effective for accounting changes and correctionsof errors made in fiscal years beginning after December 15, 2005. ThisStatement applies to all voluntary changes in accounting principle. When apronouncement includes specific transition guidance, those provisions should befollowed. This statement requires retrospective application to prior periods’financial statements of changes in accounting principle, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. There have been no accounting changes or errorcorrections required since our adoption of this pronouncement that requiredretroactive restatements.

*Inventory Costs*

In November 2004, theFinancial Accounting Standards Board (FASB) issued SFAS No. 151, “*Inventory Costs—An Amendment of ARB No. 43, Chapter 4*,”which clarifies the accounting for abnormal amounts of idle facility expense,freight, handling costs and wasted material (spoilage). We adopted SFASNo. 151 in 2006. However, due to our lack of substantial revenues from ourinverter product line and the uncertainty of any future value, our inventory isfully-reserved. Materials used in our research and development effort areexpensed as incurred. Therefore, the adoption of SFAS No. 151 did not havea material impact on our results of operations or financial condition.

*Correcting PriorYear Errors*

In September 2006,the SEC issued Staff Accounting Bulletin (SAB) No. 108, “*Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*,” which becameeffective for fiscal years ending after November 15, 2006. SAB No. 108requires that companies utilize a “dual-approach” to assessing the quantitativeeffects of financial statements misstatements. The dual approach includes bothan income statement-focused and balance sheet-focused assessment. To date,implementation of this guidance has not had any significant impact on ourfinancial position or results of operations.

*Accounting forRegistration Payment Arrangements*

In December, 2006, theFASB issued FASB Staff Position No. EITF 00-19-2, “*Accounting for Registration Payment Arrangements.*” ThisStaff Position, which is in effect immediately, specifies that the contingentobligation to make future payments or otherwise transfer consideration under aregistration payment arrangement should be separately recognized and measuredin accordance with FASB Statement No. 5, “*Accountingfor Contingencies*.” Since we currently have an active registrationstatement on file with the SEC, any agreement related to equity-raisingactivity would need to be evaluated according to the terms of this StaffPosition. Although there is no current impact on our results of operations orfinancial obligation, it is possible that these requirements could have animpact on future financial statements.

*Recently IssuedAccounting Pronouncements and Regulations*

*Fair ValueMeasurements*

In July 2006, theFASB issued SFAS No. 157, “*Fair Value Measurements*,”which enhances existing guidance for measuring assets and liabilities at fairvalue. SFAS No. 157 defines fair value, establishes a framework formeasuring fair value and expands disclosure about fair value measurements. SFASNo. 157 applies to other accounting pronouncements that require fair valuemeasurements; it does not require any new fair value measurements. SFAS No. 157is effective for financial statements for fiscal year ends 

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beginningafter November 15, 2007, which will be the first quarter of our 2008fiscal year. We do not expect this statement will have a material impact on ourresults of operations or financial position.

*Accounting for TaxUncertainties*

In July 2006, theFASB issued FASB Interpretation No. 48 (“FIN 48”), “*Accountingfor Uncertainty in Income Taxes—an Interpretation of Statement No. 109*.”This Statement addresses uncertainty in tax positions recognized in a company’sfinancial statements and stipulates a minimum recognition threshold andmeasurement of a tax position taken or expected to be taken in a tax return. FIN48 applies to fiscal years beginning after December 15, 2006, and thuswill apply to our first fiscal quarter of 2007. We are still assessing theimpact that FIN No. 48 will have on our results of operations, financialpositions, or cash flows; but currently, we do not expect the impact to bematerial.

**Results ofoperations.**

**Comparison of Year ended December 31, 2006 and2005**

| ** **                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **(in thousands)**                    | ** ** |
| Revenue                                   |       | $                                          | 969        |   | $ | 1,487 |   |   | $ | (518 | ) |   |   | (35 | %) |   |
| Cost of goods  sold                       |       | 845                                        |       | 1,575 |   |   | (730 | ) |   |   | (46 | %) |   |
| Gross margin                              |       | 124                                        |       | (88 | ) |   | 212 |   |   |   | 241 | % |   |
| Selling, general  and administrative      |       | 6,508                                      |       | 6,334 |   |   | 174 |   |   |   | 3 | % |   |
| Research and  development                 |       | 4,748                                      |       | 1,408 |   |   | 3,340 |   |   |   | 237 | % |   |
| Loss on contract  commitments             |       | 1,385                                      |       | 1,535 |   |   | (150 | ) |   |   | (10 | %) |   |
| Depreciation and  amortization            |       | 96                                         |       | 83 |   |   | 13 |   |   |   | 16 | % |   |
| Casualty Loss                             |       | 69                                         |       | — |   |   | 69 |   |   |   | 0 | % |   |
| Interest and  other income (expense), net |       | 519                                        |       | 136 |   |   | 383 |   |   |   | 282 | % |   |
| Net loss                                  |       | $                                          | (12,163    | ) | $ | (9,312 | ) |   | $ | (2,851 | ) |   |   | (31 | %) |   |

 

*Revenue.*

Thefollowing table provides details of our revenues for the twelve months ended December 31,2006 and 2005.

| ** **                     | ** ** | ** **   | ** ** | ** **                           | ** ** | **Cumulative** | ** ** | ** **   | ** ** |
|--------------------------------|------------|--------------|------------|--------------------------------------|------------|----------------|------------|--------------|------------|
| ** **                     | ** ** | ** **   | ** ** | **Year ended**                  | ** ** | **Contract**   | ** ** | **Total**    | ** ** |
| ** **                     | ** ** | **Percent**  | ** ** | **December 31,**                | ** ** | **Value**      | ** ** | **Contract** | ** ** |
| ** **                     | ** ** | **complete** | ** ** | **2006**                             | ** ** | **2005**       | ** ** | **Earned**   | ** ** | **Value** | ** ** |
| ** **                     | ** ** | ** **   | ** ** | **(dollars in thousands)** | ** ** |
| CEC                            |       |         | 94         | %                                    |       | $              | 226        |         | $          | 929 |   |   | $ | 1,155 |   |   |   | $ | 1,233 |   |   |
| NYSERDA PON 846                |       |         | 88         | %                                    |       | 235            |       | 330          |       |   | 565 |   |   |   | 646 |   |   |
| Bechtel Bettis                 |       |         | 100        | %                                    |       | —         |       | 71           |       |   | 98 |   |   |   | 98 |   |   |
| NYSERDA PON 800                |       |         | 84         | %                                    |       | 32             |       | 21           |       |   | 52 |   |   |   | 63 |   |   |
| Air Force  Research Laboratory |       |         | 35         | %                                    |       | 263            |       | —       |       |   | 263 |   |   |   | 750 |   |   |
| Sandia DOE Earmark             |       |         | 10         | %                                    |       | 75             |       | —       |       |   | 75 |   |   |   | 752 |   |   |
| Total Contract Revenue         |       |         |       |                                 |       | $              | 831        |         | $          | 1,351 |   |   | $ | 2,208 |   |   |   | $ | 3,542 |   |   |
| M5 and  accessories            |       |         |       |                                 |       | 138            |       | 136          |       |   |   |   |   |   |   |   |   |
| Total                          |       |         |       |                                 |       | $              | 969        |         | $          | 1,487 |   |   | $ | 2,208 |   |   |   | $ | 3,542 |   |   |

 

In the year ended December 31, 2006, we recordedrevenue from flywheel-related research and development contracts, using thepercentage of completion method, of approximately $831,000, and 

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recorded revenue ofapproximately $138,000 from the sale of Smart Power M5TM inverter systems andrelated products. In 2005 we recorded revenue from flywheel related governmentcontracts of approximately $1,351,000 and recorded approximately $136,000 fromthe sale of Smart Power M5inverter systems and related products. Contract revenue was lower in 2006compared to 2005 by approximately $520,000, or 38%, primarily the result of thecompletion of the majority of the milestones on our demonstration contractswith CEC and NYSERDA in 2005. This decrease was partially offset by revenue ona contract awarded in September 2006 from the U.S. Department of Energy(DOE), to be administered by Sandia National Laboratories. The purpose of thiscontract is to design a 20-megawatt Smart Energy MatrixTM frequencyregulation facility. This project directly supports our plan to develop acommercial-scale flywheel-based frequency regulation facility in 2008. TheSandia contract, valued at $752,500 over a 12-month period, will providefunding for a portion of our expected development cost.

*Cost of Goods Sold.**  *Cost of goods sold in 2006 includes costs incurred inperformance of government contracts calculated on the percentage of completionmethod in the amount of approximately $831,000 and the cost of materials,labor, overheads and warranty accruals for inverter products sold in the amountof approximately $14,000.

*Selling, General and Administrative Expenses.*
|                                    | ** ** | **Amount**              | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Year ended  December 31, 2005 |       |                    | $          | 6,334 |   |   |
| Reductions:                        |       |                    |       |   |   |
| Subcontractors  and consultants    |       |                    | (748       | ) |   |
| Legal and  professional fees       |       |                    | (700       | ) |   |
| Public company  expenses           |       |                    | (149       | ) |   |
| Audit fees                         |       |                    | (37        | ) |   |
| Increases:                         |       |                    |       |   |   |
| Stock  compensation expense        |       |                    | 1,609      |   |   |
| Salaries and  benefits             |       |                    | 70         |   |   |
| Office equipment  upgrades         |       |                    | 36         |   |   |
| Other                              |       |                    | 93         |   |   |
| Year ended  December 31, 2006 |       |                    | $          | 6,508 |   |   |

 

In total, selling, generaland administrative costs increased 2.7%, or approximately $174,000 from 2005 to2006. Increases were primarily related to the following: non-cash stockcompensation of approximately $1,609,000 due to the implementation of FAS123R;salaries and benefits of additional staff of approximately $70,000; computerupgrades of approximately $36,000; and other expenses which were primarilyrelated to our preparations for the requirements of Section 404 of theSarbanes Oxley Act of 2002. These increases were partially offset bynon-recurring costs that were incurred in 2005 related to a possibleacquisition that ultimately was not completed. Costs associated with thepotential acquisition were legal and professional fees of approximately$700,000; subcontractor and consultant costs of approximately $748,000, publiccompany expenses of approximately $149,000, and audit fees of approximately$37,000. We expect our selling, general and administrative expenses to besomewhat higher in 2007 than 2006 due primarily to anticipated fund-raisingexpenses, implementation and reporting expenses associated with compliance withthe Sarbanes-Oxley Act of 2002, increases in staffing needed to support themove to production, and increased marketing and sales expenses associated withflywheel products.

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*Research andDevelopment Expenses.*

*Research and development expenses:*
|                                                  | ** ** | **Amount**              | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Year ended  December 31, 2005               |       |                    | $          | 1,408 |   |   |
| Increases:                                       |       |                    |       |   |   |
| Expense materials                                |       |                    | 1,172      |   |   |
| Salaries and  benefits                           |       |                    | 851        |   |   |
| Stock  compensation expense                      |       |                    | 724        |   |   |
| Engineering and  manufacturing overheads applied |       |                    | 157        |   |   |
| Consultants and  subcontractors                  |       |                    | 81         |   |   |
| Facility costs                                   |       |                    | 165        |   |   |
| Software  maintenance                            |       |                    | 78         |   |   |
| Travel                                           |       |                    | 58         |   |   |
| Other                                            |       |                    | 54         |   |   |
| Year ended December 31,  2006               |       |                    | $          | 4,748 |   |   |

 

The increase from 2005 to 2006 of approximately $3.3million or 237% is primarily due to increased expenses for developmentmaterials of approximately $1,172,000, increased headcount-related expensesresulting from hiring engineering personnel to support our flywheel developmentof approximately $851,000, FAS123 non-cash stock compensation expense ofapproximately $724,000, lower overheads allocated to contracts of approximately$157,000, increased used of consultants of approximately $81,000, higherfacility charges of approximately $165,000, higher software maintenance chargesof approximately $78,000, increased travel charges of approximately $58,000,and other miscellaneous expenses of approximately $54,000. We expect researchand development costs to increase substantially in 2007 over 2006 levels due toincreased headcount and development material for the 25kWh flywheel anddevelopment activities on the Smart Energy Matrix.

*Losson contract commitments.*   We recorded contractcommitment losses on our research and development contracts in 2005 of$1,535,000 based on expected cost overruns related to material, labor andoverhead, as well as unplanned overruns in the amount of labor required tocomplete the contracts. During 2006, we recorded additional charges totalingapproximately $1,385,000 to the contract loss reserve. This amount consists ofour expected cost share for the Sandia contract of approximately $240,000;increases in estimated material, labor, and travel costs expected to be neededto complete existing contracts of approximately $314,000; increases in thelabor and overhead rates applied to the contracts based on actual costs ofapproximately $786,000, and other costs of $45,000.

*Depreciationand Amortization.**  *Depreciationexpense in 2006 was approximately $13,000, or 16% higher in 2006 than in 2005,due primarily to depreciation on new assets acquired during the latter half of2005, upgrades to our office equipment, and capital expenditures in 2006 todevelop our production capability for the Smart Energy 25.

*Casualtyloss.**  *On December 28,2006, a malfunction occurred during the testing of a Smart Energy 25 flywheelwhich resulted in the loss of the flywheel and other inventory in the area(which had previously been expensed), as well as minor damage to the buildingimprovements and other equipment. A casualty loss of approximately $69,000 wasrecorded for the estimated cost of repairs to the building improvements ofapproximately $34,000, the cost to repair fixed assets of approximately$18,000, replace damaged supplier equipment of $6,000 and perform necessaryclean up of approximately $11,000. Additional costs to complete the buildingclean up and to assess the cause of the failure will be approximately $125,000.We expect that we will recover a portion of the additional costs frominsurance.

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*Interestand Other Income/(Expense), net.**  *Interestand other income increased by approximately $383,000, or 282% from 2005 to2006, primarily due to the increase in interest income due to higher cashbalances. This increase was offset by the write-back of an officer loan reservein 2005 of approximately $102,000, and lower gains on the sale of equipment.

*Net Loss.**  *As a result of the changes discussed above, the netloss for 2006 was approximately $12,163,000 which compares to a net loss in2005 of approximately $9,312,000, an increase in net loss of approximately$2,851,000 or 31%.

**Comparison of Year ended December 31, 2005 and2004**
|                                           | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **(in thousands)**                    | ** ** |
| Revenues                                  |       | $                                          | 1,487      |   | $ | 325 |   |   | $ | 1,162 |   |   |   | 358 | % |   |
| Cost of goods  sold                       |       | 1,575                                      |       | 1,458 |   |   | 117 |   |   |   | 8 | % |   |
| Gross margin                              |       | (88                                        | )          | (1,133 | ) |   | 1,045 |   |   |   | 92 | % |   |
| Selling, general  and administrative      |       | 6,334                                      |       | 4,197 |   |   | 2,137 |   |   |   | 51 | % |   |
| Research and  development                 |       | 1,408                                      |       | 3,532 |   |   | (2,124 | ) |   |   | 60 | % |   |
| Loss on contract  commitments             |       | 1,535                                      |       | — |   |   | 1,535 |   |   |   | n/a |   |   |
| Depreciation and  amortization            |       | 83                                         |       | 187 |   |   | (104 | ) |   |   | 56 | % |   |
| Interest and  other income (expense), net |       | 136                                        |       | 3,719 |   |   | (3,583 | ) |   |   | 96 | % |   |
| Net loss                                  |       | $                                          | 9,312      |   | $ | 5,330 |   |   | $ | 3,982 |   |   |   | 75 | % |   |

 

*Revenue.**  *In 2005 we recorded revenue fromflywheel related government contracts of approximately $1,351,000 and recordedapproximately $136,000 from the sale of SmartPower M5 inverter systems and related products. In 2004 we recordedrevenue from the sale of our SmartPower M5 inverter systems and related products in the amount ofapproximately $204,000. Revenue from flywheel related government contracts wasapproximately $121,000. Also in 2004, we provided $42,000 of engineeringconsulting services to third parties; these services were recorded as areduction to research and development expense.

*Cost of Goods Sold.**  *Cost of goods sold in 2005 includes costs incurred inperformance of government contracts calculated on the percentage of completionmethod in the amount of approximately $1,336,000 and the cost of materials,labor, overheads and warranty accruals for inverter products sold in the amountof approximately $61,000. Also included in cost of good sold is a charge forabnormal idle plant costs in the amount of $178,000. In 2004, we established areserve for our Smart Power M5 inventory of $1,025,000 as a result of lowerthan anticipated sales volumes of the Smart Power M5**anduncertainty as to when or at what price we will be able to sell our inventories.In addition to this charge to Cost of Goods Sold, we recorded an additionalreserve for future warranty expenditures relating to the Smart Power M5**inverter of approximately $28,000.

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*Selling, General and Administrative Expenses.*
|                                                  | ** ** | **Amount**              | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Year ended  December 31, 2004               |       |                    | $          | 4,197 |   |   |
| Reductions:                                      |       |                    |       |   |   |
| Directors &  officers insurance premium |       |                    | (83        | ) |   |
| Travel                                           |       |                    | (20        | ) |   |
| Increases:                                       |       |                    |       |   |   |
| Merit increases,  headcount increase             |       |                    | 61         |   |   |
| Public company  expenses                         |       |                    | 451        |   |   |
| Merger costs                                     |       |                    | 837        |   |   |
| Legal &  audit                          |       |                    | 796        |   |   |
| Sales consultants                                |       |                    | 75         |   |   |
| Other                                            |       |                    | 20         |   |   |
| Year ended  December 31, 2005               |       |                    | $          | 6,334 |   |   |

 

The increase from 2004 to2005 of approximately $2.1 million was primarily the result of additionalprofessional costs incurred in the potential acquisition of NxtPhase ofapproximately $837,000, additional audit and legal costs relating to thebusiness combination proxy as well as drafting merger documents and costs ofdrafting and reviewing fundraising documents of approximately $796,000. Thisacquisition did not occur, and these costs were taken as period costs in 2005. Furthercost increases included additional public company expenses such as Nasdaq fees,Board of Directors fees, and costs of a cancelled special meeting regarding theNxtPhase acquisition of approximately $451,000, headcount increases ofapproximately $61,000, additional business development consulting ofapproximately $75,000 and other general expenses of approximately $21,000,partially offset by lower D&O insurance premiums of approximately $83,000and less travel of approximately $20,000. We expect our selling, general andadministrative expenses to be somewhat lower in 2006 than 2005 due primarily tothe non-recurring acquisition costs that will not be expended in 2006,partially offset by the additional costs expected in the implementation andreporting expenses associated with compliance with the Sarbanes-Oxley Act of2002, fundraising activities, and marketing and sales expenses associated withflywheel products.

*Research and Development Expenses.*

| ** **                                       | ** ** | **Amount**              | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| Year ended  December 31, 2004               |       |                    | $          | 3,532 |   |   |
| Reductions:                                      |       |                    |       |   |   |
| Engineering and  manufacturing overheads applied |       |                    | (1,719     | ) |   |
| Expense materials                                |       |                    | (302       | ) |   |
| Amortization of  IP                              |       |                    | (109       | ) |   |
| Facility costs                                   |       |                    | (120       | ) |   |
| Other  miscellaneous R&D costs               |       |                    | (86        | ) |   |
| Increases:                                       |       |                    |       |   |   |
| Salaries,  benefits/merit and new hires          |       |                    | 212        |   |   |
| Year ended  December 31, 2005               |       |                    | $          | 1,408 |   |   |

 

The decrease from 2004 to 2005 of approximately $2.1million is primarily due to engineering effort being applied to governmentresearch and development contracts in the amount of $1.7 million, a 

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reduction in developmentmaterials of approximately $302,000, lower facility costs due implementing FAS 151accounting for idle plant capacity of approximately $120,000, and othermiscellaneous development expenses were generally lower due to the focus ofengineering on our research and development contracts. These decreases werepartially offset by an increase in salaries due to yearly merit increases andsalaries for strategic new hires of approximately $212,000. We expect cost ofresearch and development in 2006 to be significantly higher than 2005 due toincreased headcount and development material for the 25kWh flywheel anddevelopment activities on the Smart Energy Matrix.

*Losson contract commitments.*   We recorded contractcommitment losses on our research and development contracts in 2005 of $1.5million. These costs relate to a combination of planned cost-share expendituresand unplanned overruns in the amount of labor and overhead required to completethe contracts.

*Depreciationand Amortization.**  *Thedecrease from 2004 to 2005 of approximately $104,000 is primarily attributableto continuing reductions in the depreciable base of our assets caused bybudgetary restrictions on capital expenditures during 2004 and 2005. Depreciationin 2006 will be higher than 2005 due to capital expenditures relating toproduction capability for the Smart Energy Matrix.

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

| ** **                         | ** ** | **Amount**              | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Year ended  December 31, 2004 |       |                    | $          | 3,719 |   |   |
| Reductions:                        |       |                    |       |   |   |
| Gain on Evergreen  investment      |       |                    | (3,623     | ) |   |
| NxtPhase  settlement expense       |       |                    | (150       | ) |   |
| Increases:                         |       |                    |       |   |   |
| Gain on sale of  assets            |       |                    | 50         |   |   |
| Officer loan  payoff               |       |                    | 80         |   |   |
| Increase in  interest earned       |       |                    | 60         |   |   |
| Year ended  December 31, 2005 |       |                    | $          | 136 |   |   |

 

The decrease from 2004 to 2005 of $3.6 million isprimarily attributable to gains from the sale of an investment in EvergreenSolar, Inc. realized in 2004 of approximately $3,623,000, and a smallsettlement agreement with NxtPhase of $150,000. These reductions were partiallyoffset by increases in interest income due to higher cash balances ofapproximately $60,000, a reduction to the reserve established for an officer’sunpaid loan balance which was fully repaid in 2005 in the amount ofapproximately $80,000, and gains realized on the sale of equipment ofapproximately $50,000.

*Net Loss.**  *As a result of the changes discussed above, the netloss for 2005 was approximately $9,312,000 which compares to a net loss in 2004of approximately $5,330,000, an increase in net loss of approximately$3,982,000 or 75%.

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**Liquidity and Capital Resources**

| ** **                                 | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                    | ** ** |
| Cash and cash  equivalents                 |       | $                                          | 5,251      |   | $ | 13,890 |   | $ | 5,097 |   |
| Working capital                            |       | 3,310                                      |       | 13,223 |   | 4,213 |   |
| Cash provided by (used  in)                |       |                                       |       |   |   |   |   |
| Operating activities                       |       | (8,442                                     | )          | (8,923 | ) | (8,260 | ) |
| Investing activities                       |       | (272                                       | )          | 176 |   | 4,745 |   |
| Financing activities                       |       | 75                                         |       | 17,540 |   | (297 | ) |
| Net decrease in  cash and cash equivalents |       | $                                          | (8,639     | ) | $ | 8,793 |   | $ | (3,812 | ) |
| Current ratio                              |       | 2.0                                        |       | 6.4 |   | 3.1 |   |

 

Our cash requirements depend on many factorsincluding, but not limited to, research and development activities, continuedefforts to commercialize our products, facility costs as well as general andadministrative expenses. Since we are still in the development stage and havenot yet begun our principal operations, we do not generate enough cash fromoperations to satisfy our working capital requirements. We expect to makesignificant expenditures to fund our operations, develop technologies andexplore opportunities to find and develop additional markets to sell ourproducts. In previous years, we took significant actions to reduce our cashexpenditures for product development, infrastructure and production readinessby significantly reducing headcount, development spending and capitalexpenditures. However, as we near completion of development of the Smart EnergyMatrixTM and prepare to begin commercial activity aimed at revenue generation in2008, we have begun to increase our headcount, and have spent additional fundson expense materials, capital equipment and market analyses to understand thesize of markets, competitive aspects and advantages that our products couldprovide.  We expect to use more cashresources during 2007 as we continue to work on our government research anddevelopment contracts and develop the capacity to manufacture our Smart Energy25 flywheels in anticipation of having a frequency regulation facility inservice during the second quarter of 2008.

We must raiseadditional equity to execute our business plan. Based on our rate ofexpenditure of cash and the additional expenditures expected to support ourbusiness plan, we have sufficient cash to fund operations into approximatelythe fourth quarter of 2007. We need to obtain additional investments during2007 to fund:

·       Ourcontinuation as a going concern

·       Ongoingresearch and development of the Smart Energy 25 flywheel and the Smart EnergyMatrixTM multi-flywheel system

·       Theramp up of our manufacturing and assembly capacity

·       Thebuild-out of facilities to provide frequency regulation services to theelectricity grid

·       Workingcapital requirements; and

·       Theidentification and development of new business opportunities.

We are continuing todevelop the Smart Energy 25 flywheel, which is the core component of the SmartEnergy MatrixTM flywheel system. In order to complete development of the SmartEnergy MatrixTM flywheel system, build, operate and receive fees for frequencyregulation services of at least one megawatt from our flywheel-based commercialfrequency regulation system and have sufficient working capital to continue toexecute our business plan through 2007, in addition to the $10.6 milliontransaction in February, we will need to raise approximately $20 million offunding during the remainder of 2007. Also, 

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beginningin 2008 we will need to raise additional amounts beyond the foregoing $20million to finance the various additional frequency regulation facilities thatare contemplated by our business plan.

**Operatingactivities**

Net cash used in operating activities wasapproximately ($8,442,000) and ($8,923,000) for the twelve months ended December 31,2006 and 2005, respectively. The primary component to the negative cash flowfrom operations is from net losses. Net loss for 2006 was approximately($12,163,000). This loss was offset by non-cash charges of approximately$96,000 for depreciation, approximately $2,333,000 related to stockcompensation expense, and a net increase in the asset impairment reserve ofapproximately $18,000. Changes in operating assets and liabilities generatedapproximately $1,640,000 of cash, which was offset by expenses paid against apreviously-recorded restructuring reserve of approximately $366,000.

For 2005, we had a netloss of approximately ($9,312,000). This included facility-related cashpayments charged against restructuring reserves of approximately ($349,000),reductions to the asset impairment reserve for disposed fixed assets ofapproximately ($122,000), a reversal of a portion of the reserved note to ourformer CEO of approximately ($102,000), offset by non-cash employee stockcompensation of approximately $645,000 and depreciation and amortization ofapproximately $83,000. Changes in operating assets and liabilities generatedapproximately $234,000 of cash during 2005.

**InvestingActivities**

Net cash generated (used)in investing activities was approximately ($272,000) and $176,000 for 2006 and2005, respectively. In 2006, the primary use of cash was the purchase ofproperty and equipment of approximately $317,000, offset by reductions ofrestricted cash of approximately $45,000. The principal source of cash during2005 was proceeds from the sale of property and equipment of approximately$127,000 and a reduction of restricted cash of approximately $90,000, partiallyoffset by the purchase of capital equipment of approximately ($41,000).

**FinancingActivities**

Net cash generated by financing activities wasapproximately $75,000 and $17,540,000 for 2006 and 2005, respectively. For2006, approximately $54,000 in cash was provided by the exercise of employeestock options, along with approximately $21,000 received for shares issuedunder the employee stock purchase plan. For 2005 the primary source of cash wasproceeds from the issuance of our common stock in two separate PIPEtransactions in the amount of approximately $17,108,000, exercise of stockoptions of approximately $713,000, and the expensing of capitalized deferredfinancing costs for a failed business combination of approximately $328,000 andapproximately $4,000 for shares issued under our employee stock purchase plan,offset by purchases of our common stock to treasury of ($613,000).

As part of our new business development, we mayevaluate possible acquisitions of enterprises or technologies that we considersynergistic from a market, technology or product perspective. We may makeinvestments in companies for strategic business reasons. Because our primarymotivation in making these investments may not be to realize a profit on theinvestment itself, but rather to expand our business prospects, theseinvestments may lack any financial return to the Company and may result in aloss of principal and may impair our liquidity.

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Thefollowing table summarizes our commitments at December 31, 2006:

| ** **                              | ** ** | **Year ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|------------|------------|------------|------------|
| **Description of Commitment** | ** ** | ** **                                 | ** ** | **2006**   | ** ** | **2007**   | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Operating leases                        |       | $                                          | —     |       | $          | 397,059    |       |   | $ | — |   |   | $ | 397,059 |   |
| Purchase  obligations                   |       | 1,116,780                                  |       | —     |       |       | —     |   |   | 1,116,780 |   |
| Total Commitments                       |       | $                                          | 1,116,780  |       | $          | 397,059    |       |   | $ | — |   |   | $ | 1,513,839 |   |
|                                         |            |                                            |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The amounts listed foroperating leases represent payments for the occupancy of our principalexecutive offices, laboratory and manufacturing facilities located inWilmington, Massachusetts. Our commitment on this lease is secured by anirrevocable letter of credit in the amount of $174,346. A cash deposit securesthis letter of credit. We also have non-cancelable purchase obligations thatinclude firm orders with vendors for materials relating to our research anddevelopment contracts.

*Investments*

There were no investmentsduring 2006.

On May 24, 2005 and July 26,2005 Perseus 2000 Expansion, L.L.C., an affiliate of one of our then largestshareholders, invested an aggregate of $2.9 million and received 3,452,381shares of our common stock, and a warrant to purchase 800,000 shares of ourcommon stock at $1.008, and another affiliate, Perseus Capital, L.L.C., paid $0.1million for an extension to an existing warrant extending its term for twoadditional years.

On November 8, 2005,we distributed 9,868,421 newly issued shares of common stock to ten “accreditedinvestors”, as defined in the Securities Act of 1933, as amended. The number ofshares was determined by dividing the gross proceeds of $15 million by a shareprice of $1.52, derived by applying a 20% discount to the five-day volumeweighted average price just prior to the closing date. We also issued warrantsto purchase an additional 3,410,527 shares of common stock at an exercise priceof $2.21. Each warrant is exercisable for a period of five years. Thistransaction resulted in net proceeds of approximately $14 million net ofexpenses and commissions in the amount of approximately $1 million. We haveagreed to use these proceeds for working capital purposes only. For furtherdetails, see the Securities Purchase Agreement which was filed as Exhibit 10.1to our Current Report on Form 8-K filed on November 7, 2005.

On April 22, 2005, weentered into an agreement to acquire NxtPhase T&D Corporation (“NxtPhase”),a privately held Canadian corporation. Under terms of the agreement, we wouldacquire NxtPhase by issuing approximately 19 million new shares of our commonstock to NxtPhase stockholders and employees. On November 22, 2005, weagreed to terminate the proposed business combination with NxtPhase and to payNxtPhase $150,000 as a release from any and all liabilities related to theagreement. We also expensed approximately $850,000 of related deferredprofessional fees in the 3rd quarter of 2005.

Inasmuch as we are notexpecting to become cash flow positive until at least 2010, our ability tocontinue as a going concern will depend on our ability to raise additional capital.We may not be able to raise this capital at all, or if it we are able to do so,it may be on terms that are adverse to shareholders. We believe that project debtfinancing will not be available to us to meet our cash requirements for 2007.

**Inflation**

Our operations have not been materially affected by inflation.

**Item7A.**                Quantitative andQualitative Disclosures about Market Risk

Our cash equivalents andinvestments, all of which have maturities of less than ninety days, couldexpose us to interest rate risk. At December 31, 2006, we hadapproximately $159,000 of cash equivalents that were held in a non-interestbearing checking account. Also at December 31, 2006 we had 

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approximately$5.1 million of cash equivalents that were held in interest-bearing moneymarket accounts at high-quality financial institutions, some of which areinvested in off-shore securities. The fair value of these investmentsapproximates their cost. A 10% change in interest rates would change theinvestment income realized on an annual basis by approximately $27,000, whichwe do not believe is material. The funds invested in money market accounts maynot be covered under FDIC Insurance, and therefore may be at some risk of loss.

**Item 8.**                        Financial Statements andSupplementary Data

Our financial statementsrequired by this item are attached to this Report beginning on page 34,Item 15.

**Item 9.**                        Changes in and Disagreements withAccountants on Accounting and Financial Disclosure

Effective August 27, 2004, our former independent registeredpublic accounting firm, Deloitte & Touche LLP (“Deloitte”), resignedas the independent registered public accounting firm. Deloitte performed thereview and audit of our books and accounts for the fiscal years ending December 31,2003 and 2002 and the interim quarterly reviews through the quarter ended June 30,2004. The resignation was the decision of Deloitte. There were no disagreementsduring the past two fiscal years and the subsequent interim periods ending June 30,2004 and through August 27, 2004 between Deloitte and our management onany matter of accounting principles or practices, financial statementdisclosure or auditing scope or procedure, which disagreement, if not resolvedto the satisfaction of Deloitte, would have caused it to make reference theretoin its reports on the financial statements for such years.

On October 29, 2004, the audit committee of our board ofdirectors approved the engagement of Miller Wachman LLP (“Miller Wachman”) asour new independent registered public accounting firm.

**Item 9A.**                Controls and Procedures

Our management, with theparticipation of our chief executive officer and chief financial officer, hasevaluated the effectiveness of our disclosure controls and procedures (asdefined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Actof 1934, as amended) as of the end of the period covered by this AnnualReport on Form 10-K. Based on that evaluation, the chief executiveofficer and chief financial officer have concluded that our disclosure controlsand procedures are effective in enabling us to record, process, summarize, andreport information required to be included in our periodic SEC filings withinthe required time period. Management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving their objectives and management necessarilyapplies its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures. Based on the evaluation of our disclosure controls andprocedures as of December 31, 2006, our chief executive officer and chieffinancial officer concluded that, as of such date, our disclosure controls andprocedures were effective at the reasonable assurance level.

In addition, ourmanagement, with the participation of the chief executive officer and chieffinancial officer, has evaluated whether any change in our internal controlover financial reporting (as defined in Rule 13a-15(f) under the SecuritiesExchange Act of 1934, as amended) occurred during the period covered bythis Annual Report on Form 10-K. Based on that evaluation, the chiefexecutive officer and chief financial officer have concluded that there hasbeen no change in our internal control over financial reporting during theperiod covered by this Annual Report on Form 10-K that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

**Item9B.**               Other Information

Not applicable.

37

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**PART III**

**Item 10.**                 Directors and Executive Officers ofthe Registrant

(a)   Information regarding our directors isincorporated by reference to the information set forth under the caption “Electionof Directors” in our definitive proxy statement for the Annual Meeting ofStockholders to be filed with the Securities and Exchange Commission on orprior to April 30, 2007 (Proxy Statement).

(b)   Information regarding our executive officersis included under the caption “Executive Officers” on page 13 of thisreport.

(c)   Information regarding Section 16(a) BeneficialOwnership Reporting Compliance is included under the caption “Section 16(a) BeneficialOwnership Reporting Compliance” in the Proxy Statement, and is incorporated byreference herein.

(d)   Information regarding our Audit Committee,including the committee’s financial experts, is included under the caption “Boardof Directors’ Meetings and Committees” in the Proxy Statement, and isincorporated by reference herein.

(e)   We have adopted a codeof conduct that applies to all of our employees, including our chief executiveofficer and our chief financial officer. A copy of our *CorporateCode Of Conduct* can be found on the Internet at our websitewww.beaconpower.com, or by request, free of charge by writing to our InvestorRelations Department at our principal executive office 234 Ballardvale Street,Wilmington, MA 01887. We intend to disclose on our website any amendments tothe Code, or any waiver from a provision of the Code.

**Item 11.**                 ExecutiveCompensation

Information regarding executive compensation is incorporated byreference to the information set forth under the caption “CompensationDiscussion and Analysis” in our Proxy Statement.

**Item 12.**                 Security Ownership of CertainBeneficial Owners and Management

Information regarding security ownership of certain beneficialowners and management is incorporated by reference to the information set forthunder the caption “Security Ownership of Certain Beneficial Owners andManagement” in our Proxy Statement.

**Item 13.**                 Certain Relationships and RelatedTransactions

Information regarding certain relationships and relatedtransactions is incorporated by reference to the information set forth underthe caption “Certain Relationships and Related Transactions” in our Proxy Statement.

**Item 14.**                 Principal Accountant Fees andServices

Informationregarding principal accounting fees and services is incorporated by referenceto the information set forth under the caption “Ratification of Selection ofIndependent Auditors” in our Proxy Statement.

 

38

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**PART IV**

**Item 15.**                 Exhibits, Financial StatementSchedules

(a)   1. Financial Statements

**BEACONPOWER CORPORATION AND SUBSIDIARY(A Development Stage Company)Index to Consolidated Financial Statements**

|                                                                                                                                                                                                         | ** ** | **Page** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| Report of Independent Registered Public Accounting  Firm                                                                                                                                                |       | 40       |
| Consolidated  Balance Sheets at December 31, 2006 and 2005                                                                                                                                         |       | 41       |
| Consolidated Statements of Operations for the years  ended December 31, 2006, 2005 and 2004 and for the period from  May 8, 1997 (date of inception) to December 31, 2006                |       | 42       |
| Consolidated Statements of Stockholders’ Equity for  the years ended December 31, 2006, 2005 and 2004 and for the period from  May 8, 1997 (date of inception) to December 31, 2006 |       | 43       |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2006, 2005 and 2004 and for the period from  May 8, 1997 (date of inception) to December 31, 2006                |       | 47       |
| Notes to Consolidated Financial Statements                                                                                                                                                              |       | 49       |

 

 

39

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**Reportof Independent Registered Public Accounting Firm**

To the Stockholders and Board of Directors ofBeacon Power Corporation:

We have audited the accompanying consolidated balancesheets of Beacon Power Corporation and Subsidiary (the “Company”) (a developmentstage company) as of December 31, 2006 and 2005, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows foreach of the three years in the period ended December 31, 2006 and for theperiod from May 8, 1997 (date of inception) through December 31,2006. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the consolidated financial statements. An auditincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall consolidated financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Beacon Power Corporation and its subsidiary as of December 31,2006 and 2005 and the results of their operations and their cash flows for thethree years in the period ended December 31, 2006 and the period from May 8,1997 (date of inception) through December 31, 2006 in conformity with U.S.generally accepted accounting principles.

The accompanying financialstatements have been prepared assuming that the Company will continue as agoing concern. As discussed in Note 1 to the financial statements, the Company’srecurring losses from operations and negative cash flows raise substantialdoubt about its ability to continue as a going concern. Management’s plansconcerning these matters are also described in Note 2. The financial statementsdo not include any adjustments that might result from the outcome of thisuncertainty.

/s/ Miller Wachman LLP

Boston, MassachusettsMarch 29, 2007

40

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**BEACONPOWER CORPORATION AND SUBSIDIARY(A Development Stage Company)Consolidated Balance Sheets**

| ** **                                                                                                                                                              | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Assets**                                                                                                                                                              | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                         |       |                  |       |                  |       |
| Cash and cash equivalents                                                                                                                                               |       | $                     | 5,251,337  |                  | $          | 13,890,162 |   |
| Accounts receivable, trade, net                                                                                                                                         |       | 506,402               |       | 588,440               |       |
| Unbilled costs on contracts in progress                                                                                                                                 |       | 133,240               |       | 437,759               |       |
| Prepaid expenses and other current assets                                                                                                                               |       | 777,276               |       | 777,385               |       |
| Total current assets                                                                                                                                                    |       | 6,668,255             |       | 15,693,746            |       |
| Property and  equipment, net                                                                                                                                            |       | 415,406               |       | 212,296               |       |
| Restricted cash                                                                                                                                                         |       | 174,346               |       | 219,568               |       |
| Total assets                                                                                                                                                            |       | $                     | 7,258,007  |                  | $          | 16,125,610 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                                          | ** ** | ** **            | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                    |       |                  |       |                  |       |
| Accounts payable                                                                                                                                                        |       | $                     | 453,077    |                  | $          | 137,290 |   |
| Accrued compensation and benefits                                                                                                                                       |       | 456,075               |       | 151,318               |       |
| Other accrued expenses                                                                                                                                                  |       | 834,832               |       | 844,742               |       |
| Advance billings on contracts                                                                                                                                           |       | 445,719               |       | 74,820                |       |
| Accrued contract loss                                                                                                                                                   |       | 821,032               |       | 548,614               |       |
| Restructuring reserve                                                                                                                                                   |       | 347,408               |       | 713,469               |       |
| Total current liabilities                                                                                                                                               |       | 3,358,143             |       | 2,470,253             |       |
| Commitments and  contingencies (Note 5)                                                                                                                                 |       |                  |       |                  |       |
| Stockholders’ equity:                                                                                                                                              |       |                  |       |                  |       |
| Preferred Stock, $.01 par value; 10,000,000 shares  authorized; no shares issued or outstanding                                                                         |       | —                |       | —                |       |
| Common stock, $.01 par value; 110,000,000 shares  authorized; 59,524,687 and 58,700,036 shares issued and outstanding at December 31,  2006 and 2005, respectively |       | 595,247               |       | 587,000               |       |
| Deferred stock compensation                                                                                                                                             |       | —                |       | (1,063,145            | )          |
| Additional paid-in-capital                                                                                                                                              |       | 154,426,395           |       | 153,089,842           |       |
| Deficit accumulated during the development stage                                                                                                                        |       | (150,408,939          | )          | (138,245,501          | )          |
| Treasury stock, 421,692 shares at cost                                                                                                                                  |       | (712,839              | )          | (712,839              | )          |
| Total stockholders’ equity                                                                                                                                         |       | 3,899,864             |       | 13,655,357            |       |
| Total liabilities and  stockholders’ equity                                                                                                                        |       | $                     | 7,258,007  |                  | $          | 16,125,610 |   |

 

See notes to consolidated financial statements.

41

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**BEACONPOWER CORPORATION AND SUBSIDIARY(A Development Stage Company)Consolidated Statements of Operations**

| ** **                                  | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** | **Cumulative from**           | ** **   |
|---------------------------------------------|------------|-------------|-------------|------------|------------|------------|------------|------------------------------------|--------------|
| ** **                                  | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** | **May 8, 1997**          | ** **   |
| ** **                                  | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** | **(date of inception)**  | ** **   |
| ** **                                  | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** | **through December 31,** | ** **   |
| ** **                                  | ** ** | **2006**    | ** **  | **2005**   | ** ** | **2004**   | ** ** | **2006**                           | ** **   |
| Revenue                                     |       | $           | 968,577     |       | $          | 1,487,258  |       | $                                  | 324,694      |   |   | $ | 3,331,713 |   |   |
| Cost of goods  sold                         |       | 845,102     |        | 1,575,240  |       | 1,457,869  |       |                               | 3,878,211    |   |   |
| Gross profit  (loss)                        |       | 123,475     |        | (87,982    | )          | (1,133,175 | )          |                               | (546,498     | ) |   |
| Operating expenses:                         |       |        |        |       |       |       |       |                               |         |   |   |
| Selling, general and administrative         |       | 6,508,375   |        | 6,334,219  |       | 4,196,371  |       |                               | 45,098,568   |   |   |
| Research and development                    |       | 4,747,685   |        | 1,408,233  |       | 3,532,059  |       |                               | 60,031,463   |   |   |
| Loss on contract commitments                |       | 1,384,978   |        | 1,534,298  |       | —     |       |                               | 3,295,250    |   |   |
| Depreciation and amortization               |       | 95,669      |        | 83,031     |       | 187,230    |       |                               | 4,316,666    |   |   |
| Casualty loss                               |       | 69,084      |        | —     |       | —     |       |                               | 69,084       |   |   |
| Restructuring charges                       |       | —      |        | —     |       | —     |       |                               | 2,159,280    |   |   |
| Loss on impairment of assets                |       | —      |        | —     |       | —     |       |                               | 4,663,916    |   |   |
| Total operating expenses                    |       | 12,805,791  |        | 9,359,781  |       | 7,915,660  |       |                               | 119,634,227  |   |   |
| Loss from  operations                       |       | (12,682,316 | )           | (9,447,763 | )          | (9,048,835 | )          |                               | (120,180,725 | ) |   |
| Other income (expense):                     |       |        |        |       |       |       |       |                               |         |   |   |
| Interest income                             |       | 500,468     |        | 162,044    |       | 102,908    |       |                               | 4,545,387    |   |   |
| Interest expense                            |       | —      |        | —     |       | —     |       |                               | (1,093,703   | ) |   |
| Gain on sale of investment                  |       | —      |        | —     |       | 3,562,582  |       |                               | 3,562,582    |   |   |
| Other income (expense)                      |       | 18,410      |        | (26,385    | )          | 53,385     |       |                               | (236,286     | ) |   |
| Total other income (expense), net           |       | 518,878     |        | 135,659    |       | 3,718,875  |       |                               | 6,777,980    |   |   |
| Net loss                                    |       | (12,163,438 | )           | (9,312,104 | )          | (5,329,960 | )          |                               | (113,402,745 | ) |   |
| Preferred stock  dividends                  |       | —      |        | —     |       | —     |       |                               | (36,825,680  | ) |   |
| Accretion of  convertible preferred stock   |       | —      |        | —     |       | —     |       |                               | (113,014     | ) |   |
| Loss to common  shareholders                |       | $           | (12,163,438 | )          | $          | (9,312,104 | )          | $                                  | (5,329,960   | ) |   | $ | (150,341,439 | ) |   |
| Loss per share,  basic and diluted          |       | $           | (0.21       | )          | $          | (0.20      | )          | $                                  | (0.12        | ) |   |   |   |   |
| Weighted-average common  shares outstanding |       | 59,080,224  |        | 47,665,868 |       | 43,452,727 |       |                               |         |   |   |

 

See notes to consolidated financial statements.

42

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**BEACON POWER CORPORATION ANDSUBSIDIARY(A Development Stage Company)Consolidated Statements of Stockholders’ Equity**
|                                                                          | ** ** | **Class A**         | ** ** | **Class C**         | ** ** | ** **            | ** ** | ** **     | ** ** | **Deferred** | ** ** | **Deferred** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|--------------|------------|
| ** **                                                               | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Consulting** | ** ** | **Stock**    | ** ** |
| **Description**                                                          | ** ** | ** **               | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**     | ** ** | **Amount**   | ** ** | **Shares**   | ** ** | **Amount** | ** ** | **Expense** | ** ** | **Compensation** | ** ** |
| BALANCE AT MAY 8,  1997 (DATE OF INCEPTION)                              |       | —                   |       | $                        | —     |                  |       | —         |       |         | $          | —       |       | — |   | $ | — |   |   | $ | — |   |   |   | $ | — |   |   |
| Issuance of  Founder’s Shares                                       |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 6,750,000    |       | 67,500 |   |   | — |   |   |   | — |   |   |
| Issuance of Class  A preferred stock                                     |       | 1,390,000                |       | 5,662,500                |       |                  | —     |           |       | —       |       | —       |       | — |   |   | (275,000 | ) |   |   | — |   |   |
| Recapitalization                                                         |       | 3,373,313                |       | 67,466                   |       |                  | —     |           |       | —       |       | (6,746,626   | )          | (67,466 | ) |   | — |   |   |   | — |   |   |
| Rounding for  fractional shares                                          |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | (2           | )          | — |   |   | — |   |   |   | — |   |   |
| Issuance of Class  C preferred and common stock                          |       | —                   |       | —                   |       |                  | 6          |           |       | 29,866       |       | 13,476       |       | 134 |   |   | — |   |   |   | — |   |   |
| Deferred  Consulting                                                     |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | 773,284 |   |   |   | — |   |   |
| Series A Issuance  for Consulting                                        |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 134,464      |       | 1,345 |   |   | (498,284 | ) |   |   | — |   |   |
| Repayment of  subscription receivable                                    |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Issuance of Series  A preferred stock for services and interest on loans |       | 4,594                    |       | 11,485                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Dividend on  preferred stock                                             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Accretion of  redeemable preferred stock to redemption value             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Deferred Stock  Compensation                                             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | (1,269,445 | ) |   |
| Issuance of stock  options for consulting services                       |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | (47,892 | ) |   |
| Issuance of Stock  Options to settle lawsuit                             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Amortization of  Deferred Stock Compensation                             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | 1,298,924 |   |   |
| Issuance of  warrants                                                    |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Proceeds from  stock offering, net of related expenses                   |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 9,200,000    |       | 92,000 |   |   | — |   |   |   | — |   |   |
| Conversion of  Series A preferred stock                                  |       | (4,767,907               | )          | (5,741,451               | )          |                  | —     |           |       | —       |       | 9,535,814    |       | 95,358 |   |   | — |   |   |   | — |   |   |
| Conversion of  Series C preferred stock                                  |       | —                   |       | —                   |       |                  | (6         | )              |       | (29,866      | )          | 12           |       | — |   |   | — |   |   |   | — |   |   |
| Conversion of  convertible preferred stock                               |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 19,823,704   |       | 198,237 |   |   | — |   |   |   | — |   |   |
| Payment of accrued  dividend                                             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 859,330      |       | 8,593 |   |   | — |   |   |   | — |   |   |
| Cashless Warrant  exercise                                               |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 1,982,876    |       | 19,829 |   |   | — |   |   |   | — |   |   |
| Exercise of Stock  Options                                               |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 1,451,987    |       | 14,520 |   |   | — |   |   |   | — |   |   |
| Shares issued through  ESPP                                              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 102,491      |       | 1,025 |   |   | — |   |   |   | — |   |   |
| Option extension  for CEO                                                |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Option extension  for severed employees                                  |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Purchase of  Treasury Stock                                              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Deferred Stock  Compensation revaluation                                 |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | (87,031 | ) |   |
| Issuance of  restricted stock units for bonus                            |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | (727,195 | ) |   |
|                                                                          |            |                          |            |                          |            |                       |            |                |            |              |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

43

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|                                                       | ** ** | **Class A**         | ** ** | **Class C**         | ** ** | ** **            | ** ** | ** **     | ** ** | **Deferred** | ** ** | **Deferred** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|--------------|------------|
| ** **                                            | ** ** | **Preferred Stock** | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Consulting** | ** ** | **Stock**    | ** ** |
| **Description**                                       | ** ** | ** **               | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**     | ** ** | **Amount**   | ** ** | **Shares**   | ** ** | **Amount** | ** ** | **Expense** | ** ** | **Compensation** | ** ** |
| Net loss                                              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Balance, December  31, 2003                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 43,107,526   |       | 431,075 |   |   | — |   |   |   | (832,639 | ) |   |
| Deferred Stock  Compensation revaluation              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | 78,083 |   |   |
| Issuance of  restricted stock units for bonus         |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | (679,807 | ) |   |
| Amortize deferred  stock compensation and issue RSUs  |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 643,160      |       | 6,431 |   |   | — |   |   |   | 727,196 |   |   |
| Shares issued  through ESPP                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 8,124        |       | 82 |   |   | — |   |   |   | — |   |   |
| Issuance of  non-employee stock options               |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Exercise of Stock  Options                            |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 30,000       |       | 300 |   |   | — |   |   |   | — |   |   |
| Net loss                                              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Balance, December  31, 2004                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 43,788,810   |       | 437,888 |   |   | — |   |   |   | (707,167 | ) |   |
| Deferred stock  compensation revaluation              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | 27,360 |   |   |
| Issuance of  restricted stock units for bonus         |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | (1,063,145 | ) |   |
| Amortize deferred  stock compensation and issue RSUs  |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 593,080      |       | 5,931 |   |   | — |   |   |   | 679,807 |   |   |
| Shares issued  through ESPP                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 7,273        |       | 73 |   |   | — |   |   |   | — |   |   |
| Issuance of  non-employee stock options               |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Cashless exercise  of stock warrants                  |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 24,215       |       | 242 |   |   | — |   |   |   | — |   |   |
| Exercise of stock  options                            |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 965,856      |       | 9,658 |   |   | — |   |   |   | — |   |   |
| Issuance of stock  for cash                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 13,320,802   |       | 133,208 |   |   | — |   |   |   | — |   |   |
| Stock buyback to  pay officer loan                    |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Net loss                                              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Balance, December  31, 2005                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 58,700,036   |       | 587,000 |   |   | — |   |   |   | (1,063,145 | ) |   |
| Issuance of  restricted stock units for bonus         |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 696,160      |       | 6,961 |   |   | — |   |   |   | — |   |   |
| Issuance of  officer restricted stock units           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 10,533       |       | 106 |   |   | — |   |   |   | — |   |   |
| Amortize deferred  stock compensation and issue RSUs  |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | 1,063,145 |   |   |
| Shares issued  through ESPP                           |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 17,958       |       | 180 |   |   | — |   |   |   | — |   |   |
| Stock-based  compensation                             |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Executive  performance-based RSU compensation expense |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Exercise of stock  options                            |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | 100,000      |       | 1,000 |   |   | — |   |   |   | — |   |   |
| Net loss                                              |       | —                   |       | —                   |       |                  | —     |           |       | —       |       | —       |       | — |   |   | — |   |   |   | — |   |   |
| Balance, December  31, 2006                           |       | —                   |       | $                        | —     |                  |       | —         |       |         | $          | —       |       | 59,524,687 |   | $ | 595,247 |   |   | $ | — |   |   |   | $ | — |   |   |
|                                                       |            |                          |            |                          |            |                       |            |                |            |              |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

44

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| ** **                                                                    | ** ** | ** **     | ** ** | ** **       | ** ** | ** **   | ** ** | ** **              | ** ** | ** **       | ** ** | **Total**              | ** ** |
|-------------------------------------------------------------------------------|------------|----------------|------------|------------------|------------|--------------|------------|-------------------------|------------|------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **Additional** | ** ** | **Stock**        | ** ** | ** **   | ** ** | ** **              | ** ** | ** **       | ** ** | **Stockholders’** | ** ** |
| ** **                                                                    | ** ** | **Paid-in**    | ** ** | **Subscription** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **(Deficiency)** | ** ** |
| **Description**                                                               | ** ** | **Capital**    | ** ** | **Receivable**   | ** ** | **Deficit**  | ** ** | **Shares**              | ** ** | **Amount**       | ** ** | **Equity**             | ** ** |
| BALANCE AT MAY 8, 1997 (DATE OF INCEPTION)                               |       | $              | —     |             |       | $            | —     |                    |       | $                | —     |                   | $          | — |   | $ | — |   |   | $ | — |   |   |
| Issuance of Founder’s Shares                                             |       | —         |       |             |       |         |       | (67,500                 | )          | —           |       | —                 |       |   | — |   |   |
| Issuance of Class A preferred stock                                      |       | —         |       |             | (5,000,000 | )            |       | —                  |       | —           |       | —                 |       |   | 387,500 |   |   |
| Recapitalization                                                              |       | —         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Rounding for fractional shares                                                |       | —         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Issuance of Class C preferred and common stock                           |       | —         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 30,000 |   |   |
| Deferred Consulting                                                           |       | —         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 773,284 |   |   |
| Series A Issuance for Consulting                                         |       | 496,939        |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Repayment of subscription receivable                                          |       | —         |       |             | 5,000,000  |         |       | —                  |       | —           |       | —                 |       |   | 5,000,000 |   |   |
| Issuance of Series A preferred stock for  services and interest on loans |       | —         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 11,485 |   |   |
| Dividend on preferred stock                                                   |       | —         |       |             | —     |         |       | (2,245,680              | )          | —           |       | —                 |       |   | (2,245,680 | ) |   |
| Accretion of redeemable preferred stock to redemption  value                  |       | —         |       |             | —     |         |       | (113,014                | )          | —           |       | —                 |       |   | (113,014 | ) |   |
| Deferred Stock Compensation                                                   |       | 1,269,445      |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Issuance of stock options for consulting services                             |       | 47,892         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Issuance of Stock Options to settle lawsuit                                   |       | 303,160        |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 303,160 |   |   |
| Amortization of Deferred Stock Compensation                                   |       | —         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 1,298,924 |   |   |
| Issuance of warrants                                                          |       | 36,520,366     |       |             | —     |         |       | (34,580,000             | )          | —           |       | —                 |       |   | 1,940,366 |   |   |
| Proceeds from stock offering, net of related expenses                         |       | 49,249,537     |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 49,341,537 |   |   |
| Conversion of Series A preferred stock                                   |       | 5,646,093      |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Conversion of Series C preferred stock                                   |       | 29,866         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Conversion of convertible preferred stock                                     |       | 36,496,431     |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 36,694,668 |   |   |
| Payment of accrued dividend                                                   |       | 1,077,714      |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 1,086,307 |   |   |
| Cashless Warrant exercise                                                     |       | (19,829        | )          |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Exercise of Stock Options                                                     |       | 1,395,046      |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 1,409,566 |   |   |
| Shares issued through ESPP                                                    |       | 123,190        |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 124,215 |   |   |
| Option extension for CEO                                                      |       | 315,394        |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 315,394 |   |   |
| Option extension for severed employees                                        |       | 31,197         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | 31,197 |   |   |
| Purchase of Treasury Stock                                                    |       | —         |       |             | —     |         |       | —                  |       | 132,000          |       | (99,660                | )          |   | (99,660 | ) |   |
| Deferred Stock Compensation revaluation                                       |       | 87,031         |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
| Issuance of restricted  stock units for bonus                                 |       | 727,195        |       |             | —     |         |       | —                  |       | —           |       | —                 |       |   | — |   |   |
|                                                                               |            |                |            |                  |            |              |            |                         |            |                  |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

45

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|                                                      | ** ** | ** **     | ** **  | ** **       | ** ** | ** **   | ** **                     | ** **              | ** ** | ** **       | ** **   | **Total**         | ** ** |
|------------------------------------------------------|------------|----------------|-------------|------------------|------------|--------------|--------------------------------|-------------------------|------------|------------------|--------------|-------------------|------------|
| ** **                                           | ** ** | **Additional** | ** **  | **Stock**        | ** ** | ** **   | ** **                     | ** **              | ** ** | ** **       | ** **   | **Stockholders'** | ** ** |
| ** **                                           | ** ** | **Paid-in**    | ** **  | **Subscription** | ** ** | **Retained** | ** **                     | **Treasury Stock** | ** ** | **(Deficiency)** | ** **   |
| **Description**                                      | ** ** | **Capital**    | ** **  | **Receivable**   | ** ** | **Deficit**  | ** **                     | **Shares**              | ** ** | **Amount**       | ** **   | **Equity**        | ** ** |
| Net loss                                             |       | —         |        |             | —     |         |                           | (86,597,243             | )          | —           |         | —            |       |   | (86,597,243 | ) |   |
| Balance, December 31, 2003                           |       | 133,796,667    |        |             | —     |         |                           | (123,603,437            | )          | 132,000          |         | (99,660           | )          |   | 9,692,006 |   |   |
| Deferred Stock Compensation revaluation              |       | (78,083        | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Issuance of restricted stock units for bonus         |       | 679,807        |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Amortize deferred stock compensation and issue RSUs  |       | (33,022        | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 700,605 |   |   |
| Shares issued through ESPP                           |       | 3,854          |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 3,936 |   |   |
| Issuance of non-employee stock options               |       | 16,288         |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 16,288 |   |   |
| Exercise of Stock Options                            |       | 26,400         |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 26,700 |   |   |
| Net loss                                             |       | —         |        |             | —     |         |                           | (5,329,960              | )          | —           |         | —            |       |   | (5,329,960 | ) |   |
| Balance, December 31, 2004                           |       | 134,411,911    |        |             | —     |         |                           | (128,933,397            | )          | 132,000          |         | (99,660           | )          |   | 5,109,575 |   |   |
| Deferred stock compensation revaluation              |       | (27,360        | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Issuance of restricted stock units for bonus         |       | 1,063,145      |        |             | —     |         |                           | —                  |       | 212,940          |         | (455,838          | )          |   | (455,838 | ) |   |
| Amortize deferred stock compensation and issue RSUs  |       | (40,020        | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 645,718 |   |   |
| Shares issued through ESPP                           |       | 3,842          |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 3,915 |   |   |
| Issuance of non-employee stock options               |       | —         |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Cashless exercise of stock warrants                  |       | (242           | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Exercise of stock options                            |       | 703,297        |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 712,955 |   |   |
| Issuance of stock for cash                           |       | 16,975,269     |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 17,108,477 |   |   |
| Stock buyback to pay officer loan                    |       | —         |        |             | —     |         |                           | —                  |       | 76,752           |         | (157,341          | )          |   | (157,341 | ) |   |
| Net loss                                             |       | —         |        |             | —     |         |                           | (9,312,104              | )          | —           |         | —            |       |   | (9,312,104 | ) |   |
| Balance, December 31, 2005                           |       | 153,089,842    |        |             | —     |         |                           | (138,245,501            | )          | 421,692          |         | (712,839          | )          |   | 13,655,357 |   |   |
| Issuance of restricted stock units for bonus         |       | (6,961         | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Issuance of officer restricted stock units           |       | (106           | )           |             | —     |         |                           | —                  |       | —           |         | —            |       |   | — |   |   |
| Amortize deferred stock compensation and issue RSUs  |       | —         |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 1,063,145 |   |   |
| Shares issued through ESPP                           |       | 20,096         |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 20,276 |   |   |
| Stock-based compensation                             |       | 906,488        |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 906,488 |   |   |
| Executive performance-based RSU compensation expense |       | 363,636        |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 363,636 |   |   |
| Exercise of stock options                            |       | 53,400         |        |             | —     |         |                           | —                  |       | —           |         | —            |       |   | 54,400 |   |   |
| Net loss                                             |       | —         |        |             | —     |         |                           | (12,163,438             | )          | —           |         | —            |       |   | (12,163,438 | ) |   |
| Balance, December  31, 2006                          |       | $              | 154,426,395 |             |       | $            |     — |                    |       | $                | (150,408,939 | )                 | 421,692    |   | $ | (712,839 | ) |   | $ | 3,899,864 |   |   |
|                                                 |       |           |        |             |       |         |                           |                    |       |             |         |              |       |   |   |   |   |
|                                                      |            |                |             |                  |            |              |                                |                         |            |                  |              |                   |            |  |  |  |  |  |  |  |  |  |

 

 

46

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**BEACON POWER CORPORATION AND SUBSIDIARY (A Development Stage Company) Consolidated Statement of Cash Flows**

| ** **                                                                   | ** ** | ** **                       | ** **  | ** **            | ** ** | ** ** | ** ** | **Cumulative from**          | ** **  |
|------------------------------------------------------------------------------|------------|----------------------------------|-------------|-----------------------|------------|------------|------------|-----------------------------------|-------------|
| ** **                                                                   | ** ** | ** **                       | ** **  | ** **            | ** ** | ** ** | ** ** | **May 8, 1997**         | ** **  |
| ** **                                                                   | ** ** | ** **                       | ** **  | ** **            | ** ** | ** ** | ** ** | **(date of inception)** | ** **  |
| ** **                                                                   | ** ** | ** **                       | ** **  | ** **            | ** ** | ** ** | ** ** | **through**                       | ** **  |
| ** **                                                                   | ** ** | **Year ended December 31,** | ** **  | **December 31,** | ** ** |
|                                                                              | ** ** | **2006**                         | ** **  | **2005**              | ** ** | **2004**   | ** ** | **2006**                          | ** **  |
| Cash flows from operating  activities:                                       |       |                             |        |                  |       |       |       |                              |        |   |   |
| Net loss                                                                     |       | $                                | (12,163,438 | )                     | $          | (9,312,104 | )          | $                                 | (5,329,960  | ) |   | $ | (113,402,745 | ) |   |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                             |        |                  |       |       |       |                              |        |   |   |
| Depreciation and amortization                                                |       | 95,669                           |        | 83,031                |       | 187,230    |       |                              | 4,316,667   |   |   |
| Loss on sale of fixed assets                                                 |       | —                           |        | —                |       | 25,301     |       |                              | 196,169     |   |   |
| Impairment of assets                                                         |       | 18,567                           |        | (122,186              | )          | (9,703     | )          |                              | 4,550,594   |   |   |
| (Expenses paid) restructuring charge                                         |       | (366,061                         | )           | (349,175              | )          | (343,547   | )          |                              | 347,408     |   |   |
| Reserve for officer’s note                                              |       | —                           |        | (102,044              | )          | (17,931    | )          |                              | —      |   |   |
| Interest expense relating to issuance of warrants                            |       | —                           |        | —                |       | —     |       |                              | 371,000     |   |   |
| Non-cash charge for change in option terms                                   |       | —                           |        | —                |       | —     |       |                              | 346,591     |   |   |
| Non-cash charge for settlement of lawsuit                                    |       | —                           |        | —                |       | —     |       |                              | 303,160     |   |   |
| Amortization of deferred consulting expense, net                             |       | —                           |        | —                |       | —     |       |                              | 1,160,784   |   |   |
| Amortization of deferred stock compensation                                  |       | 1,063,145                        |        | 645,718               |       | 700,605    |       |                              | 3,699,721   |   |   |
| Options and warrants issued for consulting services                          |       | —                           |        | —                |       | 16,288     |       |                              | 1,585,654   |   |   |
| Services and interest expense paid in preferred stock                        |       | —                           |        | —                |       | —     |       |                              | 11,485      |   |   |
| Gain on sale of investments                                                  |       | —                           |        | —                |       | (3,562,582 | )          |                              | (3,562,582  | ) |   |
| Stock-based compensation                                                     |       | 1,270,124                        |        | —                |       | —     |       |                              | 1,270,124   |   |   |
| Changes  in operating assets and liabilities:                                |       |                             |        |                  |       |       |       |                              |        |   |   |
| Accounts receivable                                                          |       | 82,038                           |        | (536,335              | )          | 76,028     |       |                              | (506,402    | ) |   |
| Inventory                                                                    |       | —                           |        | 222,593               |       | 16,091     |       |                              | —      |   |   |
| Unbilled costs on government contracts                                       |       | 304,519                          |        | (437,759              | )          | —     |       |                              | (133,240    | ) |   |
| Prepaid expenses and other current assets                                    |       | 109                              |        | 142,055               |       | (26,239    | )          |                              | (876,936    | ) |   |
| Accounts payable                                                             |       | 315,787                          |        | (251,899              | )          | 241,114    |       |                              | 453,077     |   |   |
| Accrued compensation and benefits                                            |       | 304,757                          |        | 20,709                |       | (25,391    | )          |                              | 456,075     |   |   |
| Advance billings on contracts                                                |       | 370,899                          |        | 74,820                |       | —     |       |                              | 445,719     |   |   |
| Accrued interest                                                             |       | —                           |        | —                |       | —     |       |                              | 275,560     |   |   |
| Dividend receivable                                                          |       | —                           |        | —                |       | 63,758     |       |                              | —      |   |   |
| Accrued loss on contract commitments                                         |       | 272,418                          |        | 548,614               |       | —     |       |                              | 821,032     |   |   |
| Other accrued expenses and current liabilities                               |       | (9,910                           | )           | 451,173               |       | (270,958   | )          |                              | 843,502     |   |   |
| Net cash used in operating activities                                        |       | (8,441,377                       | )           | (8,922,789            | )          | (8,259,896 | )          |                              | (97,027,583 | ) |   |
| Cash flows from investing activities                                         |       |                             |        |                  |       |       |       |                              |        |   |   |
| Purchase of investments                                                      |       | —                           |        | —                |       | (90,352    | )          |                              | (1,190,352  | ) |   |
| Sale of investments                                                          |       | —                           |        | —                |       | 4,752,934  |       |                              | 4,752,934   |   |   |
| Restricted cash                                                              |       | 45,222                           |        | 90,443                |       | 95,221     |       |                              | (174,346    | ) |   |
| Increase in other assets                                                     |       | —                           |        | —                |       | —     |       |                              | (412,072    | ) |   |
| Purchases of property and equipment                                          |       | (317,346                         | )           | (41,851               | )          | (30,845    | )          |                              | (8,811,750  | ) |   |
| Sale of property and equipment                                               |       | —                           |        | 127,357               |       | 17,875     |       |                              | 198,597     |   |   |
| Net cash used in investing activities                                        |       | (272,124                         | )           | 175,949               |       | 4,744,833  |       |                              | (5,636,989  | ) |   |
|                                                                              |            |                                  |             |                       |            |            |            |                                   |             |  |  |  |  |  |  |

 

47

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**BEACON POWER CORPORATION AND SUBSIDIARY (A Development Stage Company) Consolidated Statement of Cash Flows (Continued)**

 

| ** **                                           | ** ** | ** **                       | ** ** | ** **            | ** ** | ** ** | ** ** | **Cumulative from**          | ** **  |
|------------------------------------------------------|------------|----------------------------------|------------|-----------------------|------------|------------|------------|-----------------------------------|-------------|
| ** **                                           | ** ** | ** **                       | ** ** | ** **            | ** ** | ** ** | ** ** | **May 8, 1997**         | ** **  |
| ** **                                           | ** ** | ** **                       | ** ** | ** **            | ** ** | ** ** | ** ** | **(date of inception)** | ** **  |
| ** **                                           | ** ** | ** **                       | ** ** | ** **            | ** ** | ** ** | ** ** | **through**                       | ** **  |
| ** **                                           | ** ** | **Year ended December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005**              | ** ** | **2004**   | ** ** | **2006**                          | ** **  |
| Cash flows from financing  activities:               |       |                             |       |                  |       |       |       |                              |        |   |   |
| Initial public  stock offering, net of expenses      |       | —                           |       | —                |       | —     |       |                              | 49,341,537  |   |   |
| Private stock  offering, net of expenses             |       | —                           |       | 17,108,477            |       | —     |       |                              | 17,108,477  |   |   |
| Payment of  dividends                                |       | —                           |       | —                |       | —     |       |                              | (1,159,373  | ) |   |
| Shares issued  under employee stock purchase plan    |       | 20,276                           |       | 3,915                 |       | 3,936      |       |                              | 152,341     |   |   |
| Exercise of  employee stock options                  |       | 54,400                           |       | 712,955               |       | 26,700     |       |                              | 2,203,622   |   |   |
| Cash paid for  financing costs                       |       | —                           |       | 327,646               |       | (327,646   | )          |                              | —      |   |   |
| Issuance of  preferred stock                         |       | —                           |       | —                |       | —     |       |                              | 32,868,028  |   |   |
| Repayment of  subscription receivable                |       | —                           |       | —                |       | —     |       |                              | 5,000,000   |   |   |
| Proceeds from  capital leases                        |       | —                           |       | —                |       | —     |       |                              | 495,851     |   |   |
| Repayment of  capital leases                         |       | —                           |       | —                |       | —     |       |                              | (1,031,395  | ) |   |
| Repurchase company  stock                            |       | —                           |       | (613,179              | )          | —     |       |                              | (613,179    | ) |   |
| Proceeds from  notes payable issued to investors     |       | —                           |       | —                |       | —     |       |                              | 3,550,000   |   |   |
| Net cash provided  by (used in) financing activities |       | 74,676                           |       | 17,539,814            |       | (297,010   | )          |                              | 107,915,909 |   |   |
| (Decrease)  increase in cash and cash equivalents    |       | (8,638,825                       | )          | 8,792,974             |       | (3,812,073 | )          |                              | 5,251,337   |   |   |
| Cash and cash  equivalents, beginning of period      |       | 13,890,162                       |       | 5,097,188             |       | 8,909,261  |       |                              | —      |   |   |
| Cash and cash  equivalents, end of period $5,251,337 |       | $                                | 5,251,337  |                  | $          | 13,890,162 |       | $                                 | 5,097,188   |   |   | $ | 5,251,337 |   |   |
| Supplemental disclosure  of cash flow information:   |       |                             |       |                  |       |       |       |                              |        |   |   |
| Cash paid for  interest                              |       | $                                | —     |                  | $          | —     |       | $                                 | —      |   |   | $ | 488,126 |   |   |
| Cash paid for  taxes                                 |       | $                                | —     |                  | $          | —     |       | $                                 | 1,500       |   |   | $ | 32,750 |   |   |
| Assets acquired  through capital lease               |       | $                                | —     |                  | $          | —     |       | $                                 | —      |   |   | $ | 535,445 |   |   |

 

See notes to consolidated financial statements.

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**BEACONPOWER CORPORATION AND SUBSIDIARY(A Development Stage Company)Notes to Consolidated Financial Statements**

**Note 1.   Nature of Business and Operations**

*Nature of Business.**  *Beacon Power Corporation(collectively the “Company”, “Beacon”, “we”, “our”, or “us”) (a developmentstage company) was incorporated on May 8, 1997 as a wholly ownedsubsidiary of SatCon Technology Corporation (“SatCon”). Since our inception, wehave been primarily engaged in the development of flywheel devices for storingand transmitting kinetic energy. As discussed in Note 6, during the fourthquarter of 2000, we completed an initial public offering of our common stockand raised approximately $49.3 million net of offering expenses. Because wehave not yet generated a significant amount of revenue from our principaloperations, we are accounted for as a development stage company under Statementof Financial Accounting Standards No. 7.

We have a single operatingsegment, developing alternative power sources. Our organizational structure hasno divisions or subsidiaries dictated by product lines, geography or customertype. In 2006 we derived approximately 86% of our revenue from our research anddevelopment contracts; three of those contracts accounted for 75% of our totalrevenue. Although the loss of any single contract may have a material impact onour financial statements, it would not have a material impact on our businesssince we derive most of our working capital from equity offerings in order todevelop our flywheel systems.

We do not expect to becomeprofitable or cash flow positive until at least 2010 and must raise additionalequity to execute our business plan and continue as a going concern. On February 15,2007, we issued approximately 11.8 million units for $0.90 per unit, each ofwhich consists of one share of our common stock, par value $0.01 per share, anda warrant to purchase 0.5 shares of our common stock at an exercise price of$1.33 per share.  We received netproceeds of approximately $9.8 million after deducting placement agency feesand estimated offering expenses.

On November 8, 2005,we distributed 9,868,421 newly issued shares of our common stock at $1.52 pershare. We also issued five-year warrants to purchase an additional 3,410,527shares of common stock at an exercise price of $2.21 per share. Thistransaction resulted in net proceeds of approximately $14 million net ofexpenses and commissions in the amount of approximately $1 million. Thoseproceeds were used for working capital purposes only. For further details seethe Securities Purchase Agreement which was filed as Exhibit 10.1 to ourCurrent Report on Form 8-K filed on November 7, 2005.

On May 24, 2005 and July 26,2005 Perseus made investments of $1.5 million for a total of $3 million inexchange for 1,666,667 and 1,785,714 shares of common stock, respectively andthe extension for two years of an existing warrant already owned by Perseus.

Based on our current cashusage rates and additional expenditures expected in support of our businessplan, and including the approximately $10 million raised in February of2007, we have enough cash to fund operations into approximately the fourthquarter of 2007. We will seek to obtain additional equity investments during2007 to cover expenses relating to continuing operations, working capital,25kWh flywheel prototype development and new business development.

*Operations.**  *We have experienced net lossessince our inception and, as of December 31, 2006, had an accumulateddeficit of approximately $150.4 million. We are focused on thecommercialization of our Smart Energy MatrixTM flywheel system for frequencyregulation and completion of our government research and development contracts.This ongoing research and development will require substantial additionaloutlays of capital. We took significant actions over the three years ended 2005to reduce our cash expenditures for product development, infrastructure andproduction readiness. However, our efforts in 2006 were expanded as we rampedup efforts to develop our Smart Energy 25 flywheel, for which we haveidentified a sizeable market. Additionally, we began expenditures under ourSandia DOE contract to 

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design and developa 20 megawatt frequency regulation facility. We have also continued, at areduced level, to assemble and market our inverter product for solar energyapplications. Although we are continuing to support the product, we do notbelieve that inverters will be a significant portion of our business goingforward.

**Note 2.   Basis of Presentation and Summary of SignificantAccounting Policies**

**Basis of Presentation**

*Going concern.**  *The accompanying consolidatedfinancial statements have been prepared on a going concern basis, whichcontemplates the realization of assets and the satisfaction of liabilities inthe normal course of business. As shown in our consolidated financialstatements, we had minimal revenues, and incurred significant losses ofapproximately $12,163,000, $9,312,000 and $5,330,000 and cash decreases fromoperations of approximately $8,442,000, $8,923,000, and $8,260,000, during theyears ended December 31, 2006, 2005 and 2004, respectively. We haveapproximately $5,251,000 of cash and cash equivalents on hand at December 31,2006, which, combined with our February 2007 fundraising of approximately$10 million is adequate to fund operations into approximately the fourthquarter of 2007. Since our operating cash requirements far exceed the cashgenerated from operations, we may be unable to continue as a going concern. Theconsolidated financial statements do not include any adjustments relating tothe recoverability and classification of liabilities that might be necessaryshould we be unable to continue as a going concern.

We recognize that ourcontinuation as a going concern is dependent upon our ability to generatesufficient cash flow to allow us to satisfy our obligations on a timely basis. Thegeneration of sufficient cash flow is dependent, in the short term, on ourability to obtain adequate equity investments, and in the long term, on thesuccessful development of our Smart Energy flywheel product and our ability toprovide frequency regulation services to the electricity grid. We believe thatthe successful achievement of these initiatives should provide us withsufficient resources to meet our long-term cash requirements. In addition weare also considering a number of other strategic financing alternatives, andhave incurred substantial costs in these efforts; however, no assurance can bemade with respect to the success of these efforts or the viability of ourcompany.

*Accounting Principles.**  *The accompanying consolidatedfinancial statements have been prepared using accounting principles generallyaccepted in the United States of America.

*Consolidation.**  *The accompanying consolidatedfinancial statements include the accounts of Beacon Power Corporation and oursubsidiary Beacon Power Securities Corporation. Our other subsidiary, BeaconAcquisition Co. was inactive in 2005 and was dissolved in 2006. All significantinter-company accounts and transactions have been eliminated in consolidation.

*Recapitalization.**  *The accompanying financialstatements reflect a recapitalization of the Company in 1997 when oneshareholder exchanged shares of common stock for Class A preferred stock.

*Reclassifications.*   Certainprior year amounts have been reclassified to conform with current yearpresentation.

*Recently AdoptedAccounting Pronouncements and Recent Pronouncements.**  *Recently adopted accounting pronouncements and recentpronouncements are discussed in Part II, Item 7, “Management’s Discussionand Analysis of Financial Condition and Results of Operation” of our AnnualReport on Form 10-K, and are incorporated in these financialstatements by reference.

**Summary of Significant Accounting Policies**

*Use of Estimates.**  *The preparation of consolidatedfinancial statements in accordance with accounting principles generallyaccepted in the United States of America, requires management to make 

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estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates.

*Cash and Cash Equivalents.**  *Cash and cash equivalents includedemand deposits and highly liquid investments with maturity of three months orless when acquired. Cash equivalents are stated at cost, which approximatesmarket value.

*Accounts Receivable andAllowance for Doubtful Accounts.**  *Weevaluate the collectability of our open receivables on an ongoing basis. Specificreserves for bad debt are recorded based on the age of receivables, and when weare notified of a customer’s inability to satisfy its debt obligations, such asin the event of a bankruptcy filing. We provide an allowance for doubtfulaccounts equal to the estimated uncollectible amounts due from our customers. Ourestimate is based on limited historical collection experience and a review ofthe current status of trade accounts receivable. Accounts receivable arepresented in our balance sheets net of an allowance for doubtful accounts of$18,868 and $13,230 at December 31, 2006 and 2005, respectively.

Two of our contractscontain holdback provisions that allow our customers to withhold 10% from eachinvoice payment. As of December 31, 2006, approximately $55,000 of ouraccounts receivable balance represented holdbacks. This holdback is payableonce work has been satisfactorily completed and the final report has been receivedand approved. We believe these holdbacks will be collected upon completion ofthe contract, and therefore have not recorded any reserve against theseamounts.

*Inventories.**  *Inventories are stated at the lowerof cost (first-in, first-out method) or market and consist of raw materials,work in process and finished goods held for resale. For years ended December 31,2006, 2005 and 2004, reserves were recorded to fully offset the value of ourinventory. These impairment charges were made due to the uncertainty ofrealizing any future value from the inventory due to the lack of substantialrevenues to date from our inverter product line. Materials purchased to supportour research and development efforts are expensed as incurred, in accordancewith Statement of Financial Accounting Standards No. 2, “Accounting forResearch and Development Costs.”

*Unbilledcosts on contracts in process.*   Contract coststhat we incur, such as material purchases, direct labor and overheads, inadvance of billings to customers, are recorded as a current asset in ourbalance sheet as “Unbilled costs on contracts in process.”

*PrepaidExpenses and Other Current Assets.**  *Prepaid expenses at December 31,2006 consist of approximately $472,000 of prepaid insurance premiums (primarilyrelated to directors and officers liability insurance), $148,000 related toadvances to vendors for long-lead orders, $110,000 in deferred financing costsrelated to our equity raising activities, and other miscellaneous prepaid itemssuch as patent retainers and software and other maintenance agreements. Prepaidexpenses at December 31, 2005 consist primarily of prepaid insurancepremiums of $654,000,  most of whichrelates to directors and officers liability insurance and other prepaid itemsincluding legal fee retainers, prepaid rent and advances to vendors forlong-lead orders.

*Propertyand Equipment.**  *Propertyand equipment, including leasehold improvements, are stated at cost anddepreciated using the straight-line method over the estimated useful lives ofthe assets.

*Losson Contract Commitments.**  *We establish reserves for anticipated losses oncontract commitments if, based on our cost estimates to complete thecommitment, we determine that the cost to complete the contract will exceed thetotal expected contract revenue. Most of our contracts have been granted on acost-share basis, for which the expected cost-share is recorded as a contractloss. Additionally, each quarter we perform an evaluation of expected costs tocomplete our in-progress contracts and adjust the contract loss reserveaccordingly. We recorded charges of approximately $1,385,000 and $1,534,000 

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during 2006 and 2005,respectively, for anticipated losses on our research and development contracts.Approximately $240,000 of this charge in 2006 relates to the cost share portionof a contract awarded to us during the third quarter of 2006 from the U.S.Department of Energy (DOE) (to be administered by Sandia National Laboratories)to design a 20-megawatt Smart Energy MatrixTM frequency regulation powerplant. The remainder of the 2006 charge relates to a revision of our labor andoverhead rates and other estimated costs to complete our remaining contractsbased upon current forecasts. These remaining contracts relate primarily to thedevelopment of demonstration units of new products and the design of afrequency regulation plant.

*Long-LivedAssets.**  *Inaccordance with Statement of Financial Accounting Standards No. 144 “Accountingfor the Impairment or Disposal of Long-Lived Assets,” long-lived assets to beheld and used are reviewed to determine whether any events or changes incircumstances indicate that the carrying value of the asset may not berecoverable. The conditions considered include whether or not the asset is inservice, has become obsolete, or whether external market circumstances indicatethat the carrying amount may not be recoverable. We recognize a loss for thedifference between the estimated fair value of the asset and the carryingamount. The fair value of the asset is measured using either available marketprices or estimated discounted cash flows.

*Otherassets and deferred financing costs.**  *We will defer our direct costs incurred to raisecapital or to acquire an entity in a business combination. Direct costs includeonly “out-of-pocket” or incremental costs directly related to the effort, suchas a finder’s fee and fees paid to outside consultants for accounting, legal,or engineering investigations or for appraisals. These costs will becapitalized if the efforts are successful, or expensed when unsuccessful. Indirectcosts are expensed as incurred.

*Advancebillings on contracts.**  *Wemay receive performance-based payments and progress payments from customerswhich may exceed costs incurred on certain contracts, including contracts withagencies of the U.S. Government. Such advances are classified as currentliabilities.

*Restructuringand asset impairment charges.*   We periodically evaluate all of our property andequipment as required by Statement of Financial Accounting Standards No. 144“Accounting for the Impairment or Disposal of Long-Lived Assets.” In 2002, weincurred a restructuring and impairment charge of $6.5 million, of which $4.3million represents impaired capital equipment and leasehold improvements, $.3million relates to severance costs and $1.9 million relates to a reserveagainst future lease payments and related facility costs. The reserve againstfuture lease payments is classified as “Restructuring reserve” in the currentliabilities section of the balance sheet.

Therestructuring reserves are as follows:

| ** **              | ** ** | **Year ended December 31,** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|
| ** **              | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Beginning balance       |       | $                                          | 713,469    |   | $ | 1,062,644 |   |
| Charges for the  period |       | —                                     |       | — |   |
| Reductions              |       | (366,061                                   | )          | (349,175 | ) |
| Ending balance          |       | $                                          | 347,408    |   | $ | 713,469 |   |

 

*RevenueRecognition.**  *Althoughwe have shipped products and recorded contract revenues, our operations havenot yet reached a level that would qualify us to emerge from the developmentstage. Therefore we continue to be accounted for as a development stage companyunder Statement of Financial Accounting Standards No. 7 “Accounting andReporting by Development Stage Enterprises.”

We recognize shipped product revenues in accordancewith accounting principles generally accepted in the United States of America. Generally,revenue is recognized on transfer of title, typically when products are shippedand all related costs are estimable. For sales to distributors, we make anadjustment 

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to defer revenue until theproducts are subsequently sold by distributors to their customers. We havedetermined that this treatment will ensure that the recognition of revenuecannot be impacted by any disputes between us and our distributors on productor possible issues resulting from technology risk as new products areintroduced that may have enhanced functionality to product in distributorinventory.

*GovernmentContract Revenue Recognized on the Percentage-of-Completion Method.**  *We recognize contract revenues using thepercentage-of-completion method. Pursuant to American Institute of CertifiedPublic Accountants’ Statement of Position No. 81-1, “Accounting forPerformance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1),the efforts-expended method, which is based on a measure of the work performed,is an acceptable methodology for determining the amount of revenue to recognizein a given period. We use labor hours as the basis for the percentage ofcompletion calculation, which is measured principally by the percentage oflabor hours incurred to date for each contract to the estimated total laborhours for each contract at completion.

Eachquarter we perform an estimate-to-complete analysis, and any changes to ouroriginal estimates are recognized in the period in which they are determined. Changesin project performance and conditions, estimated profitability, and finalcontract settlements may result in future revisions to construction contractcosts and revenue. During 2006 we recorded contract losses of approximately$1,385,000. Our contract loss reserves are as follows:

| ** **              | ** ** | **Year ended December 31,** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|
| ** **              | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Beginning balance       |       | $                                          | 548,614    |   | $ | — |   |
| Charges for the  period |       | 1,384,978                                  |       | 1,534,298 |   |
| Reductions              |       | (1,112,560                                 | )          | (985,684 | ) |
| Ending balance          |       | $                                          | 821,032    |   | $ | 548,614 |   |

 

*Costof Goods Sold.**  *We costour products at the lower of cost or market. Costs in excess of thismeasurement are expensed in the period in which they are incurred. In addition,we continuously evaluate inventory and purchase commitments to insure thatlevels do not exceed the expected deliveries for the next twelve months. As weare in the early stages of production, our actual manufacturing costs incurredcurrently exceed the fair market value of our products. We provide a five-yearlimited product warranty for our Smart Power M-series product line and accruefor estimated future warranty costs in the period in which the revenue is recognized*.*In 2004, we established a reserve for our Smart PowerM-series inventory as a result of lower than anticipated sales volumes. During2005 and 2006 we continue to have very limited sales of our inverter products. Thecosts related to these sales are not fully reflected in the cost of goods soldas a result of the inventory having been reserved in a prior year. Therefore,our cost of goods sold does not fully reflect the costs associated with theserevenues.

*Stock-BasedCompensation.**  *Duringthe first quarter of 2006, we adopted the provisions of, and accounted for,stock-based compensation in accordance with the Financial Accounting StandardsBoard’s Statement of Financial Accounting Standards No. 123R (“SFAS 123R”),“Share-Based Payment.” Under the fair value recognition provisions of SFAS123R, stock-based compensation cost is measured at the grant date based on thefair value of the award and is recognized as an expense as it is earned overthe requisite service period, which is the vesting period. To implement thisstandard, we elected the modified-prospective transition method, under whichprior periods are not revised for comparative purposes. The fair value of theoptions on their grant date was measured using the Black-Scholes option-pricingmodel, which we believe yields a reasonable estimate of the fair value of thegrants made. The valuation provisions of SFAS 123R apply to new grants and togrants that were outstanding as of the effective date and are subsequentlymodified. Estimated compensation expense for grants that were outstanding as ofthe effective date will be recognized over the remaining vesting period usingthe compensation cost estimated for the SFAS 123 pro forma disclosures.

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The adoption of SFAS 123Rhad a material impact on our consolidated financial position and results ofoperations. See Note 8 for further information regarding our stock-basedcompensation assumptions and expenses, including pro forma disclosures forprior periods as if we had recorded stock-based compensation expense duringsuch periods.

We granted RestrictedStock Units to employees for services performed in 2005, 2004 and 2003 thatvest quarterly during the subsequent year. In addition, our officers weregranted restricted stock units as part of a compensation agreement dated May 8,2006. Our Restricted Stock Unit Deferred Compensation Plan is described in moredetail in Note 8.

*Income Taxes.**  *Deferred income tax assets andliabilities are determined based on the differences between the financialreporting and tax bases of assets and liabilities and tax loss and credit carryforwards using the currently enacted tax rates and laws. A valuation allowancehas been provided because realization of deferred tax assets is unlikely in thenear future (see Note 9).

*Advertising.**  *Advertising expense was approximately $10,000,$14,000 and $15,000 in 2006, 2005 and 2004 respectively, and is expensed asincurred.

*Research and Development.**  *Research and development costs areexpensed as incurred, except costs that relate to our government contracts. Thoseexpenses are capitalized as “Unbilled costs on contracts in progress” andcharged to Cost of Goods Sold once the revenue is recognized under thepercentage of completion method, or charged against the Contract Loss Reserveas incurred if the costs are not recoverable under the terms of the contractagreement.

*Casualty loss.**  *On December 28, 2006, a malfunction occurredduring the testing of a Smart Energy 25 flywheel which resulted in the loss ofthe flywheel and other inventory (which had previously been expensed), as wellas minor damage to the building improvements and other equipment. A casualtyloss of approximately $69,000 was recorded for the estimated cost of repairs tothe building improvements of approximately $34,000, the cost to repair fixedassets of approximately $18,000, costs to replace damaged supplier equipment of$6,000 and costs to perform necessary clean up of approximately $11,000. Additionalcosts to complete the building clean up and to assess the cause of the failurewill be approximately $125,000. We expect that we will recover most, if notall, of the additional costs from insurance.

*Fair Value of FinancialInstruments.*   The carrying amount of cash andcash equivalents, accounts receivable, inventory, accounts payable, accruedexpenses, and other current assets and liabilities approximate their fair values.

*Concentration of CreditRisk.*   Financial instruments that potentiallysubject us to significant concentration of credit risk consist primarily ofcash and cash equivalents. We keep our cash investments withhigh-credit-quality financial institutions. At December 31, 2006substantially all of our cash and cash equivalents were held in interestbearing accounts at financial institutions earning interest at varying ratesfrom 3.45% to 5.7%. At December 31, 2006 and 2005, we had cash balances ata financial institution in excess of federally insured limits. However, we donot believe that it is subject to unusual credit risk beyond the normal creditrisk associated with commercial banking relationships.

*Comprehensive Loss.*   Comprehensiveloss is the same as net loss for all periods presented.

*Loss Per Share—Basic andDiluted.*   Basic loss per share has been computedusing the weighted-average number of shares of common stock outstanding duringeach period. Warrants, options and other securities exercisable for commonshares are used in the calculation of fully-diluted EPS only if theirconversion to common shares would decrease income or increase loss per sharefrom continuing operations. Since the years ended December 31, 2006, 2005and 2004 reflect losses, including the potential conversion of warrants andoptions in the diluted EPS calculation would decrease loss per share. Thus,they are considered anti-dilutive and are not included in the calculation ofearnings per share.

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**Note 3.   Property and Equipment**

Propertyand equipment consisted of the following:

| ** **                                      | ** ** | **Estimated** | ** ** | ** **            | ** ** | ** **            | ** ** |
|-------------------------------------------------|------------|---------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **Useful**    | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                      | ** ** | **Lives**     | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Machinery and  equipment                        |       | 5  years      |       | $                     | 814,875    |                  | $          | 570,424 |   |
| Service vehicles                                |       | 5  years      |       | 16,763                |       | 16,762                |       |
| Furniture and  fixtures                         |       | 7  years      |       | 255,940               |       | 255,940               |       |
| Office equipment                                |       | 3  years      |       | 1,486,951             |       | 1,433,947             |       |
| Leasehold  improvements                         |       | Lease  term   |       | 533,352               |       | 533,352               |       |
| Equipment under  capital lease obligations      |       | Lease  term   |       | 918,285               |       | 918,285               |       |
| Total                                           |       |          |       | $                     | 4,026,166  |                  | $          | 3,728,710 |   |
| Less accumulated  depreciation and amortization |       |          |       | (3,610,760            | )          | (3,516,414            | )          |
| Property and  equipment, net                    |       |          |       | $                     | 415,406    |                  | $          | 212,296 |   |

 

**Note 4.   Commitmentsand Contingencies**

We lease office and light manufacturing space under anoperating lease through September 30, 2007. At December 31, 2006, wehad provided the lessor with an irrevocable letter of credit with a balance of$174,346 which is reduced annually during the lease term. This letter of creditis secured by a cash deposit, which is included in restricted cash in theaccompanying consolidated balance sheets.

Future minimum annual lease payments undernon-cancelable operating leases as of December 31, 2006 are $397,059.

Rent expense was $237,695, $231,188 and $223,031,during 2006, 2005 and 2004, respectively net of restructuring reserves appliedof $337,988, $321,103 and $315,474, respectively. As of December 31, 2006,we have firm non-cancelable purchase commitments with our suppliers to satisfycontractual obligations for our research and development programs in the amountof approximately $1,117,000.

*Legal Proceedings.**  *We may be subject to various legal proceedings, manyinvolving routine litigation incidental to our business. The outcome of anylegal proceeding is not within our complete control, is often difficult topredict and may be resolved over very long periods of time. Estimating probablelosses associated with any legal proceedings or other loss contingencies arevery complex and require the analysis of many factors including assumptionsabout potential actions by third parties. Loss contingencies are recorded asliabilities in the consolidated financial statements when it is both, (i) probableor known that a liability has been incurred and (ii) the amount of theloss is reasonably estimable. If the reasonable estimate of the loss is a rangeand no amount within the range is a better estimate, the minimum amount of therange is recorded as a liability. If a loss contingency is not probable or notreasonably estimable, a liability is not recorded in the consolidated financialstatements.

**Note 5.   PreferredStock**

As a result of the initialpublic offering of our common stock and the conversion of all outstandingshares of all classes of the preferred stock, we amended our charter andcancelled all our classes of preferred stock. We then added a new class ofpreferred stock that can be issued in the future by filing a Certificate ofDesignations with the specific terms as set by our Board of Directors. At December 31,2006 and 2005, there are 10 million shares of $.01 par value preferred stockauthorized with none outstanding.

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**Note 6.   Common Stock**

*Private Placement.*   OnNovember 8, 2005 we completed the private placement of 9,868,421 sharesof our common stock at a price of $1.52 per share, for an aggregate offeringprice of approximately $15 million to certain institutional investors. Wealso offered these investors warrants to purchase 3,410,527 shares of ourcommon stock at an exercise price of $2.21 per share. In connection with thistransaction we paid placement agent fees and expenses of approximately $1million. We agreed to register for resale under the Securities Act all theshares issued in this offering as well as the shares issuable upon exercise ofthe warrants. On March 2, 2006, we filed a registration statement on Form S-3with the Securities and Exchange Commission (File No. 333-130207)that was declared effective on March 7, 2006. These proceeds have been andwill continue to be used for working capital purposes.

On May 24, 2005 and July 26,2005 we issued 1,666,667 and 1,785,714 shares of common stock, respectivelypursuant to an investment agreement dated April 22, 2005. In exchange, wereceived $3 million in the aggregate from Perseus 2000 Expansion, L.L.C. Wealso issued a warrant for the purchase of 800,000 shares of our common stock atan exercise price of $1.008 and an extension for two years of an existingwarrant already owned by Perseus. We agreed to register for resale under theSecurities Act all the shares issued in this offering as well as the sharesissuable upon exercise of the warrants. On March 2, 2006, we filed aregistration statement on Form S-3 with the Securities and ExchangeCommission (File No.333-130208) that was declared effective on March 7,2006. These proceeds have been and will be used for working capital purposes.

On September 1, 2006,we filed a $40 million universal shelf registration on Form S-3 withthe Securities and Exchange Commission. This shelf registration was declaredeffective as of December 14, 2006. We issued approximately 11.8 millionshares from this shelf registration during February 2007, as described inNote 13—Subsequent Event. This transaction used approximately $10.6 million ofthe $40 million shelf registration.

*Initial Public Offering.**  *During the fourth quarter of 2000,we sold 9,200,000 shares of our common stock, inclusive of the underwriters’over allotment, at an initial public offering price of $6 per share. Netproceeds as a result of the stock offering totaled approximately $49.3 millionreflecting gross proceeds of $55.2 million net of underwriter commissions ofapproximately $3.9 million and other estimated offering costs of approximately$2.0 million.

*Shareholder RightsAgreement.**  *InSeptember 2002, and amended as of December 27, 2002, our Board ofDirectors approved a Rights Agreement, under which each holder of common stockon October 7, 2002 automatically received a distribution of one Right foreach share of common stock held. Each Right entitles the holder to purchase1/100th of a share of our newly issued preferred stockfor $22.50 in the event that any person not approved by the board of directorsacquires more than 15% (35% in the case of one large shareholder that alreadyowned more than 15%) of our outstanding common stock, or in the event that weare acquired by another company, $22.50 worth of the common stock of the othercompany at half its market value (in each case any rights held by the acquiringperson are not exercisable and become void).

*Reserved Shares.*   AtDecember 31, 2006, 26,041,238 shares of our common stock were reserved forissuance under our stock option plan, employee stock purchase plan andoutstanding warrants.

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**Note 7.   Redeemable Convertible Preferred Stockand Stock Warrants**

Warrantsoutstanding as of December 31, 2006:

| **Description**                    | ** ** | ** ** | ** ** | **Grant  Date** | ** ** | **Expiration  Date** | ** ** | **Strike  Price** | ** ** | **Issued and  Outstanding** | ** ** |
|------------------------------------|------------|------------|------------|-----------------|------------|----------------------|------------|-------------------|------------|----------------------------------|------------|
| Class F  Financing (extended) |       | 5/23/2000  |       | 5/23/2007       |       | $                    | 2.25       |              |       | 1,333,333                        |       |   |
| May 24, 2005  Financing       |       | 5/24/2005  |       | 5/24/2010       |       | $                    | 1.008      |              |       | 800,000                          |       |   |
| November 8,  2005 Financing   |       | 11/8/2005  |       | 11/8/2010       |       | $                    | 2.21       |              |       | 3,410,527                        |       |   |
| Total warrants  outstanding        |       |       |       |            |       |                 |       |              | 5,543,860  |                             |       |

 

Wehave outstanding three series of warrants to purchase our common stock. Theexercise price and the number of shares of our common stock to be issued uponexercise of the warrants will be adjusted under certain circumstances,including:

·       Subdivisions,stock dividends or combinations of our common stock

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

·       Reorganizations,mergers and similar transactions; and

·       Issuanceof additional shares of our common stock or securities convertible into ourcommon stock at a price per share less than the exercise price in effectimmediately prior to the issuance of the additional securities (only withrespect to the November 2005 Financing Warrants).

Holders of the warrantsare not entitled to receive dividends, vote, receive notice of any meetings ofstockholders or otherwise have any right as stockholders with respect to theirwarrant shares.

*Class F PreferredStock Financing Warrant.*   The warrant, originallyissued in connection with our Class F Preferred Stock financing, isexercisable for 1,333,333 shares of Beacon common stock at an exercise price of$2.25 per share. In connection with the Investment Agreement among us, PerseusCapital, L.L.C. and Perseus 2000 Expansion, L.L.C. dated April 22, 2005,we extended by two years the term of the warrant. The holder of this warrant,Perseus Capital, L.L.C., may exercise the warrant at any time prior to itsexpiration on May 23, 2007.

*April 2005 FinancingWarrant.*   In connection with the investment byPerseus 2000 Expansion, L.L.C., we issued a warrant for 800,000 shares of ourcommon stock, at an exercise price of $1.008.

*November 2005Financing Warrants.*   As part of a financingtransaction, we issued warrants to purchase an aggregate of 3,410,527 shares ofBeacon common stock to twelve “accredited investors.”  Each warrant is exercisable for a period offive years but may not be exercised until six months and one day after November 8,2005, the date of the closing of the financing transaction. The per shareexercise price for the warrant shares is $2.21.

**Note 8.   Stock Based Compensation**

**Description of Plans**

*Stock Option Plan.*

Our Third Amended andRestated 1998 Stock Incentive Plan allows for the granting of stock options topurchase up to 23,000,000 shares of our common stock. Options may be granted toour employees, officers, directors, consultants and advisors. Under the termsof the option plan, incentive stock options are to be granted at the fairmarket value of our common stock at the date of grant, and nonqualified stockoptions are to be granted at a price determined by our Board of Directors. Ingeneral, our Board has authorized vesting periods of one to three years andterms of varying length but in no case more than 10 years. Our stockoption program is a long-term retention program that is intended to attract,retain and 

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provideincentives for talented employees, officers and directors, and to alignstockholder and employee interests. We consider our option program critical toour operation and productivity; essentially all of our employees participate. AtDecember 31, 2006 we had 10,788,907 shares reserved for issuance underthis plan.

*Employee Stock Purchase Plan*

Our Employee StockPurchase Plan (the “ESPP”) allows substantially all of our employees topurchase shares of our common stock at a discount through payroll deductions. Participatingemployees may purchase our common stock at a purchase price equal to 85% of thelower of the fair market value of our common stock at the beginning of anoffering period or on the exercise date. Employees may designate up to 15% oftheir base compensation for the purchase of common stock under this plan. TheESPP provides for the purchase of up to 2,000,000 shares of our commonstock. Shares purchased under the Plan in 2006, 2005, and 2004 totaled17,958, 7,273 and 8,124, respectively and the weighted average purchase priceof the shares purchased was $1.13 in 2006, $1.03, in 2005 and $0.48 in 2004. AtDecember 31, 2006, we had 1,864,154 shares reserved for issuance underthis plan.

*Restricted Stock Unit Arrangements*

Our Third Amended andRestated 1998 Stock Incentive Plan permits the grant of restricted stock units(“RSUs”) to (i) align our employees’ interests with those of the Company, (ii) motivateour employees to achieve key product development milestones and thus createstockholder value, (iii) retain key employees by providing equity to suchemployees and (iv) conserve cash by paying bonuses in the form of RSUs ratherthan in cash, but with the number of such RSUs calculated on a discounted basisto compensate for the reduced liquidity as compared to cash. With respect tothe RSUs that are granted in lieu of cash bonuses, the number of RSUs grantedare based on performance, and are automatically converted into shares of commonstock in four equal tranches in the fiscal year following the year ofperformance. Certain other RSUs are granted to our officers as a form of equityincentive, are not tied to performance, and vest over three-year periods inequal quarterly installments. There are also other performance-based RSU’sgranted to our officers that cliff-vest upon the achievement of certainCompany-specific milestones including earnings levels and revenue goals suchthat our company is no longer treated as a development stage company foraccounting purposes. Both such vesting events require the recipient officer tobe employed by us during the period ending with the milestones. The unvestedportion of any RSU grant is subject to forfeiture upon the holder’s resignationor termination for cause. As of December 31, 2006, certain RSUs grantedunder the officer employment agreements were vested but stock was not issuedbecause the vesting date, December 31, fell on a Sunday and because ourinsider trading window was closed.

Activityrelated to the RSU agreements is as follows:

| ** **                                           | ** ** | **Year ended December 31,** | ** ** |     |
|------------------------------------------------------|------------|--------------------------------------------|------------|----------|
| ** **                                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** |   |
| ** **                                           | ** ** | **(number of shares)**           | ** ** |     |
| *Shares  issued related to vested RSUs:*             |       |                                       |       |     |   |   |
| Current year  grant based upon prior year bonus plan |       | 587,374                                    |       | 593,080  |   |   |
| Vesting of  remaining shares from prior year grant   |       | 108,786                                    |       | —   |   |   |
| Based upon  executive officer agreement              |       | 10,533                                     |       | —   |   |   |
| *Vested  RSUs not yet converted to stock*            |       | 3,511                                      |       | —   |   |   |
| *RSU’s granted but not vested:*                 |       |                                       |       |     |   |
| Based upon 2004  bonus plan                          |       | —                                     |       | 108,786  |   |
| Related to  executive officer agreement              |       | 28,097                                     |       | —   |   |
| Related to  performance-based executive plan         |       | 1,265,823                                  |       | —   |   |
|                                                      |            |                                            |            |          |  |  |  |  |  |  |  |

 

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Stock optionactivity since inception is as follows:

| ** **                           | ** ** | ** **         | ** ** | **Weighted-** | ** ** | **Weighted-** | ** ** |
|--------------------------------------|------------|--------------------|------------|---------------|------------|---------------|------------|
| ** **                           | ** ** | ** **         | ** ** | **Average**   | ** ** | **Average**   | ** ** |
| ** **                           | ** ** | **Number of** | ** ** | **Exercise**  | ** ** | **Fair**      | ** ** |
| ** **                           | ** ** | **Shares**         | ** ** | **Price**     | ** ** | **Value**     | ** ** |
| Outstanding at  inception            |       | —             |       |          |       |          |       |   |   |   |   |
| Granted                              |       | 11,248,860         |       |          | $          | 2.03          |       |   |   | $ | 1.03 |   |   |
| Exercised                            |       | (1,427,987         | )          |          | $          | 0.95          |       |   |   |   |   |   |
| Canceled, forfeited or expired       |       | (7,044,944         | )          |          | $          | 2.42          |       |   |   |   |   |   |
| Outstanding,  December 31, 2003 |       | 2,775,929          |       |          | $          | 1.59          |       |   |   |   |   |   |
| Granted                              |       | 3,847,639          |       |          | $          | 0.74          |       |   |   | $ | 0.43 |   |   |
| Exercised                            |       | (30,000            | )          |          | $          | 0.89          |       |   |   |   |   |   |
| Canceled, forfeited or expired       |       | (395,993           | )          |          | $          | 1.72          |       |   |   |   |   |   |
| Outstanding,  December 31, 2004 |       | 6,197,575          |       |          | $          | 1.06          |       |   |   |   |   |   |
| Granted                              |       | 429,168            |       |          | $          | 1.88          |       |   |   | $ | 1.33 |   |   |
| Exercised                            |       | (965,856           | )          |          | $          | 0.74          |       |   |   |   |   |   |
| Canceled, forfeited or expired       |       | (79,084            | )          |          | $          | 1.74          |       |   |   |   |   |   |
| Outstanding,  December 31, 2005 |       | 5,581,803          |       |          | $          | 1.18          |       |   |   |   |   |   |
| Granted                              |       | 1,104,671          |       |          | $          | 1.48          |       |   |   | $ | 0.98 |   |   |
| Exercised                            |       | (100,000           | )          |          | $          | 0.54          |       |   |   |   |   |   |
| Canceled, forfeited or expired       |       | (39,588            | )          |          | $          | 2.08          |       |   |   |   |   |   |
| Outstanding,  December 31, 2006 |       | 6,546,886          |       |          | $          | 1.23          |       |   |   |   |   |   |

 

The following tablesummarizes information about stock options outstanding at December 31,2006:

| ** **       | ** ** | ** **          | ** ** | **Weighted-**   | ** ** | ** **            | ** ** | ** ** | ** ** | **Vested**          | ** ** |
|------------------|------------|---------------------|------------|-----------------|------------|-----------------------|------------|------------|------------|---------------------|------------|
| ** **       | ** ** | ** **          | ** ** | **Average**     | ** ** | **Weighted-**         | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
| ** **       | ** ** | **Number**          | ** ** | **Remaining**   | ** ** | **Average**           | ** ** | **Vested** | ** ** | **Average**         | ** ** |
| **Exercise**     | ** ** | **of Options** | ** ** | **Contractual** | ** ** | **Exercise**          | ** ** | **Number** | ** ** | **Exercise**        | ** ** |
| **Price**        | ** ** | ** **          | ** ** | **Outstanding** | ** ** | **Life (Years)** | ** ** | **Price**  | ** ** | **of Options** | ** ** | **Price** | ** ** |
| $0.25–$0.74 |       |                | 3,239,886  |            |       |                  | 7.60       |       |       |                | $          | 0.70 |   |   | 3,239,886 |   |   | $ | 0.70 |   |   |
| $0.87–$1.26 |       |                | 1,695,884  |            |       |                  | 6.06       |       |       |                | $          | 0.98 |   |   | 1,303,055 |   |   | $ | 0.92 |   |   |
| $1.51–$2.19 |       |                | 1,153,866  |            |       |                  | 8.15       |       |       |                | $          | 1.87 |   |   | 671,809 |   |   | $ | 2.01 |   |   |
| $2.50–$3.10 |       |                | 130,000    |            |       |                  | 3.35       |       |       |                | $          | 2.64 |   |   | 130,000 |   |   | $ | 2.64 |   |   |
| $4.10–$5.27 |       |                | 222,250    |            |       |                  | 4.17       |       |       |                | $          | 4.40 |   |   | 222,250 |   |   | $ | 4.40 |   |   |
| $6.00–$9.31 |       |                | 105,000    |            |       |                  | 3.81       |       |       |                | $          | 6.40 |   |   | 105,000 |   |   | $ | 6.40 |   |   |
| Total            |       |                | 6,546,886  |            |       |                  |       |       |       |                |       |   |   | 5,672,000 |   |   |   |   |   |
|                  |            |                     |            |                 |            |                       |            |            |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Included in the schedulesabove are grants of options to purchase 25,000 shares made to non-employeeconsultants in 2004. There were no grants made to non-employee consultants in2006 or 2005.

**Stock Compensation**

Beginning on January 1, 2006, we adopted SFAS123R. See Note 2 for a description of our adoption of SFAS 123R. We currentlyuse the Black-Scholes option pricing model to determine the fair value of stockoptions and employee stock purchase plan shares. The valuations determinedusing such model are affected by our stock price as well as assumptionsregarding a number of complex and subjective variables, including our stockprice volatility, expected life of the option, risk-free interest rate andexpected dividends, if any.

We estimate the volatilityof our common stock by using historical volatility. We estimate the expectedterm of the share or option grant, and determine a risk-free interest ratebased on U.S. Treasury issues with remaining terms similar to the expected termof the options. We do not anticipate paying any cash dividends in theforeseeable future and therefore use an expected dividend yield of zero in ourvaluation 

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model.We are required to estimate forfeitures at the time of grant and revise thoseestimates in subsequent periods. All stock-based payment awards are amortizedas they are earned over the requisite service periods of the awards, which aregenerally the vesting periods.

Prior to the adoption ofSFAS 123R, we recognized the estimated compensation cost of restricted stockunits (RSUs) over the vesting term, based on the fair value of our common stockusing the closing stock price on the last day of the fiscal year in which thecompensation was earned.

Since the adoption of SFAS123R, the compensation cost of RSUs is based on the fair value of the stock asof the date of grant, net of expected forfeitures. This cost is expensedratably over the performance period (for performance-based RSUs) or vestingperiod (for all other RSUs). The number of performance-based RSUs for whichstock compensation expense is calculated is based upon management’s assessmentof the likelihood of achieving the performance targets.

Theassumptions used to value stock option grants for the year ended December 31,2006, 2005 and 2004, respectively, are as follows:

| ** **                                                                               | ** ** | **Year ended December 31,** | ** **       |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------------|
| ** **                                                                               | ** ** | **2006**                                   | ** **       | **2005** | ** ** | **2004** | ** ** |
| Risk-free  interest rate                                                                 |       |                                       | 4.43%–5.13% |   |   | 3.8%–4.39% |   | 4.32%–4.49% |   |
| Expected life of  option                                                                 |       |                                       | 3  years         |   |   | 1–3  years |   | 1–3  years |   |
| Expected dividend  payment rate, as a percentage of the stock price on the date of grant |       |                                       | 0%               |   |   | 0% |   | 0% |   |
| Assumed  volatility                                                                      |       |                                       | 93%–129%    |   |   | 103%–129% |   | 95%–115% |   |
| Expected forfeitures                                                                     |       |                                       | 10%              |   |   | 0% |   | 0% |   |

 

Stock-basedcompensation expense recognized on our consolidated statement of operations forthe years ended December 31, 2006, 2005 and 2004, respectively, is asfollows:

| ** **                                                                                                | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Selling, general  and administrative                                                                      |       | $                                          | 1,609,178  |   | $ | 371,346 |   | $ | 376,455 |   |
| Research and  development                                                                                 |       | 724,091                                    |       | 274,372 |   | 324,150 |   |
| Total stock  compensation expense                                                                         |       | $                                          | 2,333,269  |   | $ | 645,718 |   | $ | 700,605 |   |
| Components of  stock compensation expense:                                                                |       |                                       |       |   |   |   |   |
| Amortization of deferred compensation from  restricted stock units (RSUs) granted in lieu of 2005 bonuses |       | $                                          | 1,104,261  |   | $ | 645,718 |   | $ | 700,605 |   |
| Compensation expense related to other RSUs                                                                |       | 407,614                                    |       | — |   | — |   |
| Compensation expense related to stock options                                                             |       | 821,394                                    |       | — |   | — |   |
| Total stock compensation  expense                                                                         |       | $                                          | 2,333,269  |   | $ | 645,718 |   | $ | 700,605 |   |

 

For comparison purposes,the following table sets forth the pro forma amounts of net income and netincome per share for the years ended December 31, 2005 and 2004 that wouldhave resulted if we had accounted for our employee stock plans under the fairvalue recognition provisions of SFAS 123R for those years:

| ** **                                   | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Net loss to  common shareholders as reported |       | $                                          | (9,312,104 | ) | $ | (5,329,960 | ) |
| Pro forma  compensation expense              |       | 249,890                                    |       | 1,255,094 |   |
| Net loss—pro  forma                     |       | $                                          | (9,561,994 | ) | $ | (6,585,054 | ) |
| Loss per share—as  reported             |       | $                                          | (0.20      | ) | $ | (0.12 | ) |
| Loss per share—pro forma                |       | $                                          | (0.20      | ) | $ | (0.15 | ) |

 

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As of December 31,2006, there was approximately $2,172,000 of unrecognized compensation cost,adjusted for estimated forfeitures, related to non-vested stock-based paymentsgranted to our employees and directors. Total unrecognized compensation costwill be adjusted for future changes in estimated forfeitures and recognizedover the remaining vesting periods of the stock grants.

**Note 9.   IncomeTaxes**

Thecomponents of the provision (benefit) for income taxes consisted of thefollowing:

| ** **                            | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **Cumulative from**  | ** **  |
|---------------------------------------|------------|--------------------------------------------|------------|-----------------------|------------|------------|------------|---------------------------|-------------|
| ** **                            | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **May 8, 1997** | ** **  |
| ** **                            | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **(Date of**         | ** **  |
| ** **                            | ** ** | ** **                                 | ** ** | ** **            | ** ** | ** ** | ** ** | **Inception) to**    | ** **  |
| ** **                            | ** ** | **Year ended December 31,** | ** ** | **December 31,** | ** ** |
| ** **                            | ** ** | **2006**                                   | ** ** | **2005**              | ** ** | **2004**   | ** ** | **2006**                  | ** **  |
| State—current                    |       | $                                          | 2,137      |                  | $          | 750        |       | $                         | 750         |   |   | $ | 22,749 |   |   |
| Federal—deferred                 |       | (2,759,406                                 | )          | (3,901,616            | )          | (1,974,627 | )          |                      | (41,483,423 | ) |   |
| State—deferred                   |       | (1,074,671                                 | )          | (35,387               | )          | (325,553   | )          |                      | (6,919,094  | ) |   |
| Increase in  valuation allowance      |       | 3,834,077                                  |       | 3,937,003             |       | 2,300,180  |       |                      | 48,402,516  |   |   |
| Provision (benefit) for  income taxes |       | $                                          | 2,137      |                  | $          | 750        |       | $                         | 750         |   |   | $ | 22,748 |   |   |

 

State minimum taxes areincluded with selling, general and administrative expenses.

A reconciliation of thestatutory federal rate to the effective rate for all periods is as follows:

| Statutory federal  rate benefit | ** ** | (34    | )%       |
|---------------------------------|------------|--------|----------|
| State, net of  federal effect   | ** ** | (6     | )        |
| Valuation  allowance provided   | * *   | 40     | * * |
| Effective rate                  | ** ** | — | %        |

 

Thecomponents of our deferred tax assets and liabilities consisted of thefollowing at December 31:

| ** **                                          | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|-----------------------------------------------------|------------|-------------|------------|-------------|------------|
| Long-term assets:                                   |       |        |       |        |       |
| Net operating  loss carry-forwards                  |       | $           | 40,006,078 |        | $          | 36,480,176 |   |
| Research and  development credits                   |       | 3,286,515   |       | 2,799,435   |       |
| Restructuring  reserves                             |       | 1,611,491   |       | 1,822,757   |       |
| Other                                               |       | 219,564     |       | (799,330    | )          |
| Net deferred tax  assets before valuation allowance |       | 45,123,648  |       | 40,303,038  |       |
| Less valuation  allowance                           |       | (45,123,648 | )          | (40,303,038 | )          |
| Net deferred tax assets                             |       | $           | —     |        | $          | — |   |

 

The valuation allowance increased by $3,834,077 in2006, $3,937,003 in 2005 and $2,300,180 in 2004, primarily due to thegeneration of net operating loss carry forwards and credits for whichrealization is not reasonably assured.

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Thefollowing approximates the net operating loss carry forwards and businesscredits we have available in the future for federal and state tax purposes:

| ** **                                                  | ** ** | **As of December 31,** | ** **  |
|-------------------------------------------------------------|------------|---------------------------------------|-------------|
| ** **                                                  | ** ** | **2006**                              | ** **  | **2005** | ** ** |
| Net operating loss carry  forwards available in the future: |       |                                  |        |   |   |
| Federal                                                     |       | $                                     | 104,031,000 |   | $ | 92,731,000 |   |
| State                                                       |       | 77,259,000                            |        | 80,484,000 |   |
| Total net operating loss carry forwards available           |       | $                                     | 181,290,000 |   | $ | 173,215,000 |   |
| Business credits  available in the future:                  |       |                                  |        |   |   |
| Federal                                                     |       | $                                     | 1,917,000   |   | $ | 1,870,000 |   |
| State                                                       |       | 1,370,000                             |        | 929,700 |   |
| Total business  credits available                           |       | $                                     | 3,287,000   |   | $ | 2,799,700 |   |

 

The net operating loss carry forwards begin to expirein 2017 for federal and 2002 for state tax purposes. The federal research anddevelopment credits begin to expire in 2017. We did not pay any income taxesfrom inception to December 31, 2006.

Under the provisions ofthe Internal Revenue Code, certain substantial changes in our ownership mayhave limited, or may limit in the future, the amount of net operating losscarry forwards and tax credits which could be utilized annually to offsetfuture taxable income and income tax liabilities. The amount of any annuallimitation is determined based upon our value prior to an ownership change.

**Note 10.   RetirementSavings Plan**

In 1998, we created a 401(k) RetirementSavings Plan (the “Plan”) for our full-time employees. Each participant in thePlan may elect to contribute a percentage of his or her annual compensation tothe Plan on a pre-tax basis up to the annual limit established by the InternalRevenue Service. We match employee contributions at a rate of 50% up to thefirst 6% of the employee’s wages. We may also elect to make a profit-sharingcontribution at the discretion of the Board of Directors. Employeecontributions are fully vested. Company matching and profit sharingcontributions vest 20% after two years of service consisting of at least 1,000hours per calendar year and 20% annually thereafter. Company matchingcontributions were $75,847, $51,778 and $61,213 during 2006, 2005 and 2004,respectively. We have not made any profit sharing contributions since the plan’sinception.

**Note 11.   RelatedParty Transactions**

During 2001, we advanced approximately $565,000 to anofficer of the Company, Mr. William Stanton, our former CEO and Presidentand currently a member of our board of directors. This advance was interestbearing and secured by Mr. Stanton’s holdings of Beacon common stock andwas provided to him to allow the exercise of stock options and the payment ofrelated taxes. We capitalized approximately $36,000 of interest over the lifeof the debt. Up to August 5, 2005, Mr. Stanton made payments on thisoutstanding debt of approximately $500,000. On August 5, 2005, Mr. Stantonsurrendered vested stock options to purchase 76,752 shares of our common stockwhich were granted to him on October 13, 2004. We gave Mr. Stantoncredit for $100,544 as a result of such surrender, which equaled the excess ofthe value of the shares issuable upon exercise of the options, based on themid-point of the high and the low trading prices per share of our common stockon August 5, 2005, over the exercise price of the options, to repay infull the outstanding principal of and interest on the loan we advanced to Mr. Stantonas described above. The surrendered stock was added to our treasury, at cost.

There were no related party transactions during 2006**.**

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**Note 12.   QuarterlyResults (Unaudited)**

Inmanagement’s opinion, this unaudited information includes all adjustments,consisting only of normal recurring adjustments, necessary for a fairpresentation of the information for the quarters presented. The operating resultsfor any quarter are not necessarily indicative of results for any futurequarters.

| ** **                                  | ** ** | **2006**    | ** ** |
|---------------------------------------------|------------|-------------|------------|
| ** **                                  | ** ** | **First**   | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **                                  | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Revenue                                     |       | $           | 288,595    |   | $ | 209,439 |   | $ | 277,343 |   | $ | 193,200 |   |
| Gross profit  (loss)                        |       | $           | 43,670     |   | $ | 3,021 |   | $ | 39,357 |   | $ | 37,427 |   |
| Loss from  operations                       |       | $           | (2,968,536 | ) | $ | (3,426,225 | ) | $ | (3,294,067 | ) | $ | (2,993,488 | ) |
| Net (loss) income                           |       | $           | (2,821,650 | ) | $ | (3,272,601 | ) | $ | (3,165,005 | ) | $ | (2,904,182 | ) |
| Loss per share—basic  and diluted      |       | $           | (0.05      | ) | $ | (0.06 | ) | $ | (0.06 | ) | $ | (0.04 | ) |
| Weighted-average common  shares outstanding |       | 58,700,036  |       | 58,950,147 |   | 59,218,443 |   | 59,442,592 |   |

 

| ** **                                  | ** ** | **2005**    | ** ** |
|---------------------------------------------|------------|-------------|------------|
| ** **                                  | ** ** | **First**   | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth** | ** ** |
| ** **                                  | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| Revenue                                     |       | $           | 636,134    |   | $ | 318,304 |   | $ | 304,064 |   | $ | 228,756 |   |
| Gross profit  (loss)                        |       | $           | (34,373    | ) | $ | (15,652 | ) | $ | (43,490 | ) | $ | 5,533 |   |
| Loss from  operations                       |       | $           | (2,258,888 | ) | $ | (1,806,293 | ) | $ | (2,271,509 | ) | $ | (3,111,073 | ) |
| Net (loss) income                           |       | $           | (2,245,000 | ) | $ | (1,764,781 | ) | $ | (2,143,442 | ) | $ | (3,158,881 | ) |
| Loss per  share—basic and diluted      |       | $           | (0.05      | ) | $ | (0.04 | ) | $ | (0.04 | ) | $ | (0.07 | ) |
| Weighted-average common  shares outstanding |       | 43,792,791  |       | 44,801,287 |   | 48,524,912 |   | 54,364,893 |   |

 

**Note 13.   SubsequentEvent**

On February 15, 2007, we consummated the sale of11,814,687 units of the Company to investors at a purchase price of $0.90 perunit. Each unit consists of one share of our common stock, par value $0.01 pershare, and a warrant to purchase 0.5 shares of common stock at an exerciseprice of $1.33 per share. The units were issued pursuant to a prospectussupplement filed with the Securities and Exchange Commission in connection witha shelf takedown from our registration statement on Form S-3 (Fileno. 333-137071), which became effective on December 14,2006. We received net offering proceeds of approximately $9.8 millionafter deducting placement agency fees and estimated offering expenses. Since this sale of units was at a price pershare lower than the closing price on the date of our 2005 financing, we arerequired to make an adjustment to the exercise price and the number of warrantsissued to the investors in that financing. The number of warrants convertibleinto our common stock increased by 327,294 to 3,287,821 as a result of theadjustment and the exercise price was reduced by $0.22 to $1.99.

On March 27,2007, we received a letter from the Nasdaq Stock Market indicating that for thelast 30 consecutive business days, the bid price of our common stock hasclosed below the minimum $1.00 per share requirement for continued inclusion onthe Nasdaq Stock Market based on Marketplace Rule 4310(c)(4). Inaccordance with Marketplace Rule 4310(c)(8)(D), we have been provided180 calendar days, or until September 24, 2007, to regain compliance.If at any time before September 24, 2007 our common stock has a closingbid price of $1.00 or more for a minimum of 10 consecutive business daysthe Nasdaq Stock Market Staff will notify us that we comply withRule 4310(c)(4).

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If we have not met the requirements of Rule 4310(c)(4) bySeptember 24, 2007 but meet any one of the three criteria as set forth inMarketplace Rule 4310(c), we will be granted an additional180 calendar day compliance period to March 21, 2008.

**Note 14.**   Schedule IIValuation and Qualifying Accounts

| ** **                   | ** ** | **2006**            | ** ** |
|------------------------------|------------|---------------------|------------|
| ** **                   | ** ** | ** **          | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Balance at** | ** ** | **costs and** | ** ** | **other** | ** ** | ** ** | ** ** | **Balance at** | ** ** |
| **Description**              | ** ** | ** **          | ** ** | **1/1/2006** | ** ** | **expenses** | ** ** | **accounts** | ** ** | **Deductions** | ** ** | **12/31/2006** | ** ** |
| Product warranty             |       | $                   | 30,081     |   |   | $ | 8,250 |   |   | $ | 4,454 |   | $ | (6,258 | ) | $ | 36,527 |   |
| Commitment  reserve          |       | —              |       |   | — |   |   | — |   | — |   | — |   |
| Accounts  receivable reserve |       | 13,230              |       |   | 5,638 |   |   | — |   | — |   | 18,868 |   |
| Inventory reserve            |       | 2,345,037           |       |   | 664,311 |   |   | (44,476 | ) | (1,156,071 | ) | 1,808,801 |   |
| Asset impairment  reserve    |       | 3,721,707           |       |   | 18,338 |   |   | — |   | (40,389 | ) | 3,699,656 |   |
|                              |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                   | ** ** | **2005**            | ** ** |
|------------------------------|------------|---------------------|------------|
| ** **                   | ** ** | ** **          | ** ** | **Charged to** | ** ** | **Charged to** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Balance at** | ** ** | **costs and** | ** ** | **other** | ** ** | ** ** | ** ** | **Balance at** | ** ** |
| **Description**              | ** ** | ** **          | ** ** | **1/1/2005** | ** ** | **expenses** | ** ** | **accounts** | ** ** | **Deductions** | ** ** | **12/31/2005** | ** ** |
| Product warranty             |       | $                   | 24,512     |   |   | $ | 7,763 |   |   | $ | — |   | $ | (2,194 | ) | $ | 30,081 |   |
| Commitment reserve           |       | 48,265              |       |   | — |   |   | — |   | (48,265 | ) | — |   |
| Accounts  receivable reserve |       | 22,850              |       |   | (9,620 | ) |   | — |   | — |   | 13,230 |   |
| Inventory reserve            |       | 2,887,688           |       |   | — |   |   | (508,608 | ) | (34,043 | ) | 2,345,037 |   |
| Asset impairment  reserve    |       | 3,843,893           |       |   | — |   |   | — |   | (122,186 | ) | 3,721,707 |   |
|                              |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Productwarranty—**Deductions*include amounts paid forconsultants, travel and freight costs to repair/replace our inverter systemsunder our five-year warranty.

*Commitment reserve—**In*2004 we placed a reserve on ourentire inverter inventory and additionally recorded a reserve for futurenon-cancelable vendor commitments. During 2005 we settled all commitmentsrelating to this reserve.

*Accounts receivable reserve—**In*2006 we recorded a reserve forcertain accounts which we deemed to be doubtful. In 2005, we received paymentsagainst previously reserved accounts.

*Inventory reserve—**Our***inventory, containing both flywheelcomponents and inverter components, is fully reserved. We disposed of inventorythat no longer had value to us and we utilized components from our inventory inour research and development contracts during 2005 and 2006. Certain materialspurchased during 2006 to be used for our research and development work flowedthrough our inventory system and so are included in the column titled “Chargedto costs and expenses”, and offset as deductions against our inventory reserve.

*Asset impairment reserve—**In* 2002, we recorded an assetimpairment reserve for underutilized plant and equipment. In 2006 and 2005, wesold or disposed of certain assets and reduced the associated reserve. Weincreased this reserve by approximately $18,000 included in casualty loss basedupon damage to certain assets during the prototype malfunction that occurred inDecember 2006.

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2.                 Financial Statement Schedules

Schedules for which provision is made inthe applicable regulations of the Securities and Exchange Commission have beenomitted because the information is disclosed in the Consolidated FinancialStatements or because such schedules are not required or not applicable.

3.                 Exhibits

The exhibits are listed below under Part IV, Item 15(c) ofthis report.

(c)   Exhibits

| Exhibit    | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                          |
|------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Ref**    | ** ** | ** **                                                                                                                                                                                                                                                                                                                          | **Description   of Document** | ** ** |
| 3.1        |       | (1)        |       | Sixth Amended and  Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                           |
| 3.2        |       | (18)       |       | Amended and  Restated Bylaws.                                                                                                                                                                                                                                                                                                       |
| 3.3        |       | (16)       |       | Certificate of  Designation of Series A Junior Participating Preferred Stock, filed with  the Secretary of State of Delaware on October 4, 2002.                                                                                                                                                                          |
| 4.1        |       | (2)        |       | Rights Agreement  dated as of September 25, 2002 between Beacon and Equiserve Trust  Company, NA.                                                                                                                                                                                                                              |
| 4.2        |       | (3)        |       | Amendment  No. 1 to Rights Agreement dated as of December 27, 2002.                                                                                                                                                                                                                                                       |
| 4.3        |       | (4)        |       | Form of  specimen stock certificate.                                                                                                                                                                                                                                                                                           |
| 10.1.1     |       | (1)        |       | Securities  Purchase Agreement dated May 23, 2000 among the Company, Perseus  Capital, L.L.C., DQE Enterprises, Inc., Micro-Generation Technology  Fund, L.L.C., Mechanical Technology Incorporated, GE Capital Equity  Investments, Inc., The Beacon Group Energy Investment Fund II, L.P. and  Penske Corporation. |
| 10.1.2     |       | (15)       |       | Third Amended and  Restated 1998 Stock Incentive Plan of the Company.                                                                                                                                                                                                                                                               |
| 10.1.3     |       | (16)       |       | Form of  Incentive Stock Option Agreement of the Company.                                                                                                                                                                                                                                                                      |
| 10.1.4     |       | (16)       |       | Form of  Non-Qualified Stock Option Agreement of the Company.                                                                                                                                                                                                                                                                  |
| 10.1.5     |       | (1)        |       | Form of  Non-Qualified Stock Option Agreement of the Company issued to certain  consultants on July 24, 2000 and list of holders thereof.                                                                                                                                                                                 |
| 10.1.6     |       | (15)       |       | Employee Stock  Purchase Plan of the Company.                                                                                                                                                                                                                                                                                       |
| 10.1.7     |       | (1)        |       | Amended and  Restated License Agreement dated October 23, 1998 between the Company  and SatCon Technology Corporation.                                                                                                                                                                                                         |
| 10.1.8     |       | (1)        |       | Lease dated  July 14, 2000 between the Company and BCIA New England Holdings LLC.                                                                                                                                                                                                                                              |
| 10.1.9     |       | (5)        |       | Form of  Director and Officer Indemnification Agreement of the Company.                                                                                                                                                                                                                                                        |
| 10.1.10    |       | (16)       |       | Form of  Restricted Stock Unit Agreement of the Company.                                                                                                                                                                                                                                                                       |
| 10.1.11    |       | (6)        |       | Agreement dated  January 31, 2005 between the Company and the New York State Energy  Research and Development Authority.                                                                                                                                                                                                       |
| 10.1.12    |       | (7)        |       | Agreement dated  January 31, 2005 between the Company and California State Energy  Resources Conservation and Development Commission.                                                                                                                                                                                          |
| 10.1.13    |       | (8)        |       | Investment  Agreement dated April 22, 2005 among the Company, Perseus 2000  Expansion, L.L.C. and Perseus Capital, L.L.C.                                                                                                                                                                                                      |

65

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| 10.1.14 |   | (9)  |   | Common Stock Purchase  Warrant dated May 24, 2005 issued by the Company to Perseus 2000  Expansion, L.L.C.                                                                                                                                                                                                                                                                                                              |
|---------|--------|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1.15 |   | (9)  |   | Amended and  Restated Common Stock Purchase Warrant dated May 24, 2005 issued by the  Company to Perseus Capital, L.L.C.                                                                                                                                                                                                                                                                                                |
| 10.1.16 |   | (9)  |   | Registration Rights  Agreement dated May 24, 2005 among the Company, Perseus 2000 Expansion,  L.L.C. and Perseus Capital L.L.C.                                                                                                                                                                                                                                                                                         |
| 10.1.17 |   | (10) |   | Option Agreement dated  July 25, 2005 between the Company and Lisa Zappala.                                                                                                                                                                                                                                                                                                                                             |
| 10.1.18 |   | (11) |   | Agreement dated  October 7, 2005 between the Company and the Air Force Research  Laboratory.                                                                                                                                                                                                                                                                                                                            |
| 10.1.19 |   | (12) |   | Securities  Purchase Agreement dated November 4, 2005 among the Company and Iroquois  Master Fund Ltd., Gryphon Master Fund, LP, GSSF Master Fund, LP, Nite Capital  LP, Enable Growth Partners, LP, Enable Opportunity Partners, LP, Truk  Opportunity Fund, LLC, Truk International Fund, LP, Capital Ventures  International and UBS O’Connor LLC FBO O’Connor PIPES Corporate Strategies  Master Limited. |
| 10.1.20 |   | (12) |   | Form of  Warrant of the Company issued pursuant to the November 2005 financing.                                                                                                                                                                                                                                                                                                                                    |
| 10.1.21 |   | (19) |   | Performance-based  Restricted Stock Unit Agreement dated May 8, 2006 between the Company  and F. William Capp.                                                                                                                                                                                                                                                                                                     |
| 10.1.22 |   | (19) |   | Performance-based  Restricted Stock Unit Agreement dated May 8, 2006 between the Company  and James M. Spiezio.                                                                                                                                                                                                                                                                                                    |
| 10.1.23 |   | (19) |   | Performance-based  Restricted Stock Unit Agreement dated May 8, 2006 between the Company  and Matthew L. Lazarewicz.                                                                                                                                                                                                                                                                                               |
| 10.1.24 |   | (19) |   | Restricted Stock  Unit and Option Agreement dated May 8, 2006 between the Company and  F. William Capp.                                                                                                                                                                                                                                                                                                            |
| 10.1.25 |   | (19) |   | Restricted Stock  Unit and Option Agreement dated May 8, 2006 between the Company and James M.  Spiezio.                                                                                                                                                                                                                                                                                                           |
| 10.1.26 |   | (19) |   | Restricted Stock  Unit and Option Agreement dated May 8, 2006 between the Company and  Matthew L. Lazarewicz.                                                                                                                                                                                                                                                                                                      |
| 10.1.27 |   | (17) |   | Employment  agreement dated March 2, 2007 between the Company and F. William Capp                                                                                                                                                                                                                                                                                                                                       |
| 10.1.28 |   | (17) |   | Employment  agreement dated March 2, 2007 between the Company and James M. Spiezio                                                                                                                                                                                                                                                                                                                                      |
| 10.1.29 |   | (17) |   | Employment  agreement dated March 2, 2007 between the Company and Matthew L.  Lazarewicz                                                                                                                                                                                                                                                                                                                                |
| 10.1.30 |   | (17) |   | Restricted Stock  Unit and Option Agreement dated March 2, 2007 between the Company and F.  William Capp.                                                                                                                                                                                                                                                                                                               |
| 10.1.31 |   | (17) |   | Restricted Stock  Unit and Option Agreement dated March 2, 2007 between the Company and  James M. Spiezio.                                                                                                                                                                                                                                                                                                              |
| 10.1.32 |   | (17) |   | Restricted Stock  Unit and Option Agreement dated March 2, 2007 between the Company and  Matthew L. Lazarewicz.                                                                                                                                                                                                                                                                                                         |
| 14.1    |   | (13) |   | Corporate Code of  Conduct dated October 15, 2001.                                                                                                                                                                                                                                                                                                                                                                      |

66

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| 16.1 |   | (14) |   | Letter dated  October 20, 2004 from Deloitte & Touche LLP to the Company.                                                                     |
|------|--------|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 21.1 |   | +    |   | Subsidiaries of  the Company.                                                                                                                               |
| 23.1 |   | +    |   | Consent of Miller  Wachman LLP.                                                                                                                             |
| 31.1 |   | +    |   | Certification of  Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                              |
| 31.2 |   | +    |   | Certification of  Principal Financial and Accounting Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                               |
| 32.1 |   | +    |   | Certification of  Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.1 |   | +    |   | Certification of  Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as  adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 |

----

(1)          Incorporated byreference from the Form S-1 filed on November 16, 2000 (FileNo. 333-43386).

(2)          Incorporated byreference from the Form 8-K filed on October 4, 2002 (FileNo. 001-16171).

(3)          Incorporated byreference from the Form 10-K filed on March 31, 2003 (FileNo. 001-16171).

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

(5)          Incorporated byreference from the Form 8-K filed on May 10, 2005 (FileNo. 001-16171).

(6)          Incorporated byreference from the Form 8-K filed on February 14, 2005 (FileNo. 001-16171).

(7)          Incorporated byreference from the Form 8-K filed on February 16, 2005 (FileNo. 001-16171).

(8)          Incorporated byreference from the Form 8-K filed on April 25, 2005 (FileNo. 001-16171).

(9)          Incorporated byreference from the Form 8-K filed on April 25, 2005 (FileNo. 001-16171).

(10) Incorporated by reference from the Form 8-K filed onJuly 29, 2005 (File No. 001-16171).

(11) Incorporated by reference from the Form 8-K filed onOctober 13, 2005 (File No. 001-16171).

(12) Incorporated by reference from the Form 8-K filed onNovember 7, 2005 (File No. 001-16171).

(13) Incorporated by reference from the Form 10-K filed onMarch 31, 2005 (File No. 001-16171).

(14) Incorporated by reference from the Form 8-K filed onNovember 2, 2004 (File No. 001-16171).

(15) Incorporated by reference from the Form S-8 filed onMarch 22, 2006 (File No. 333-132638).

(16) Incorporated by reference from the Form 10-K filed onMarch 30, 2006 (File No. 000-31973).

(17) Incorporated by reference from the Form 8-K filed onMarch 7, 2007 (File No. 000-31973).

(18) Incorporated by reference from the Form 8-K filed onOctober 29, 2006 (File No. 000-31973).

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

+                Filed herewith.

67

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

|            | BEACON POWER CORPORATION |
|------------|--------------------------|
| ** ** | By:                      | /s/ F. WILLIAM CAPP |
|       |                     | F. William Capp |
|       |                     | President and Chief Executive Officer |
|       | Date:                    | March 28, 2007 |

 

Pursuant to the requirements of the Securities Exchange Act of1934, this report has been signed below by the following persons on behalf ofthe Registrant and in the capacities and on the dates indicated.

| Signature               | ** ** | ** **                                                      | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------|------------|-----------------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ F. WILLIAM  CAPP    |       | President and  Chief Executive Officer,                         |       |                 |
| F.  William Capp        |       | and Director (Principal Executive  Officer)                     |       | March 28,  2007 |
| /s/ JAMES M.  SPIEZIO   |       | Vice President of  Finance, Chief Financial                     |       |                 |
| James  M. Spiezio       |       | Officer, Treasurer and Secretary  (Principal Financial Officer) |       | March 28,  2007 |
| /s/ STEPHEN P.  ADIK    |       |                                                            |       |                 |
| Stephen  P. Adik        |       | Director                                                        |       | March 28,  2007 |
| /s/ DANIEL E.  KLETTER  |       |                                                            |       |                 |
| Daniel  E. Kletter      |       | Director                                                        |       | March 28,  2007 |
| /s/ VIRGIL G.  ROSE     |       |                                                            |       |                 |
| Virgil  G. Rose         |       | Director                                                        |       | March 28,  2007 |
| /s/ JACK P.  SMITH      |       |                                                            |       |                 |
| Jack  P. Smith          |       | Director                                                        |       | March 28,  2007 |
| /s/ WILLIAM E.  STANTON |       |                                                            |       |                 |
| William  E. Stanton     |       | Director                                                        |       | March 28,  2007 |
| /s/ LISA W.  ZAPPALA    |       |                                                            |       |                 |
| Lisa W. Zappala         |       | Director                                                        |       | March 28,  2007 |

 

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