Use these links to rapidly review the documentTable of Contents Item 8. Consolidated Financial Statements and Supplementary Data



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-K

(Mark One)ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2008Oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                to


Commission file number 000-31973

Beacon Power Corporation(Exact name of registrant as specified in its charter)

Delaware(State or other jurisdiction of
incorporation or organization)

04-3372365(I.R.S. Employer
Identification No.)65 Middlesex Road
Tyngsboro, MA(address of principal executive offices)

01879(Zip code)(978) 694-9121(Registrant's telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

Name of each exchange on which registered:Common Stock, par value $.01 per share

The NASDAQ Stock Market LLC
(NASDAQ Capital Market)Preferred Share Purchase Rights

The NASDAQ Stock Market LLC
(NASDAQ Capital Market)


Securities
registered pursuant to Section 12(g) of the Act:None

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to 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 information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a "smaller reporting
company" per rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o


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

As of June 30, 2008 the market value of the voting and non-voting common stock of the registrant held by non-affiliates of the
registrant was $181,375,661. In determining the market value of non-affiliated voting stock, shares of the registrant's common stock beneficially owned by each executive officer, director
and any known person to be the beneficial owner of more than 20% of the registrant's voting stock have been excluded. This determination of affiliate status is not necessarily a conclusive
determination for other purposes.

The
number of shares of the Registrant's common stock, par value $.01 per share, outstanding as of March 10, 2009 was 109,571,910.

DOCUMENTS INCORPORATED BY REFERENCE

The Exhibit Index (Item No. 15) located on pages 110 through 113 incorporates several documents by
reference as indicated therein. Portions of the definitive Proxy Statement for Beacon Power Corporation's Annual Meeting of Stockholders, to be filed no later than April 30, 2009 for the year
ended December 31, 2008, are incorporated by reference into Part III of this Form 10-K.



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Table of Contents



PagePART I


1Item 1.

Business


1Item 1A.

Risk Factors


20Item 1B.

Unresolved Staff Comments


28Item 2.

Properties


28Item 3.

Legal Proceedings


29Item 4.

Submission of Matters to a Vote of Security Holders


29PART II


29Item 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities


29Item 6.

Selected Consolidated Financial Data


30Item 7.

Management's Discussion and Analysis of Financial Condition and Results of
Operation


31Item 7A.

Quantitative and Qualitative Disclosures about Market Risk


54Item 8.

Consolidated Financial Statements and Supplementary Data


55Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure


101Item 9A.

Controls and Procedures


101Item 9B.

Other Information


101PART III


101Item 10.

Directors, Executive Officers and Corporate Governance


101Item 11.

Executive Compensation


101Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters


102Item 13.

Certain Relationships and Related Transactions and Director
Independence


102Item 14.

Principal Accounting Fees and Services


102PART IV


103Item 15.

Exhibits, Financial Statement Schedules


103SIGNATURES


107


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Note Regarding Forward Looking Statements:

This Annual Report on Form 10-K may include statements that are not historical facts and are considered
"forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect Beacon Power Corporation's current views about future
events and financial performances. These "forward-looking" statements are identified by the use of terms and phrases such as "believe," "expect," "plan," "anticipate," and similar expressions
identifying forward-looking statements. Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that could cause actual
results to differ materially from Beacon Power Corporation's expectation. These factors include: a short operating history; a history of losses and anticipated continued losses from operations; a need
to raise additional capital combined with a questionable ability to do so, especially in view of the current situation in the financial markets and the evolving global economic crisis; the complexity
and other challenges of arranging project financing and resources for one or more frequency regulation power plants, including uncertainty about whether we will be successful in obtaining DOE loan
guarantee support for our New York facility; conditions in target markets, including the fact that some ISOs have been slow to comply with the FERC's requirement to update market rules to include new
technology such as ours; our ability to obtain site interconnection approval, landlord approvals, or other zoning and construction approvals in a timely manner; limited experience manufacturing
commercial products or supplying frequency regulation services on a commercial basis; limited commercial contracts for sales to date; the dependence of revenues on the achievement of product
optimization, manufacturing and commercialization milestones; the uncertainty of the political and economic climate, and the different electrical grid characteristics and requirements of any foreign
countries into which we hope to sell or operate, including the uncertainty of enforcing contracts, the different market structures, and the potential substantial fluctuation in currency exchange rates
in those countries; dependence on third-party suppliers; intense competition from companies with greater financial resources, especially from companies that are already in the frequency regulation
market; possible government regulation that would impede the ability to market products or services or affect market size; possible product liability claims and the negative publicity which could
result; any failure to protect intellectual property, or any possible infringement of third party patents; retaining key executives and the possible need in the future to hire and retain key
executives; the historical volatility of our stock price, as well as the volatility of the stock price of other companies in the energy sector, especially in view of the current situation in the
equity and debt financial markets. Such statements made by us fall within the safe harbors provided by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All such forward-looking statements are necessarily only estimates of future results and the actual results we achieve may differ materially from these
estimates due to a number of factors as discussed in the sections entitled "Item 1A. Risk Factors" and "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" of this Form 10-K. Beacon Power Corporation expressly does not undertake any duty to update forward-looking statements.

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PART I

Item 1.    Business

Overview

Beacon Power Corporation and its subsidiaries (collectively "Beacon," "the Company," "we," "our" or "us") designs, develops and is
taking steps to commercialize advanced products and services to support more stable, reliable and efficient electricity grid operation. For more than five years, our primary business strategy has been
to commercialize our patented flywheel energy storage technology to perform frequency regulation services on the grid. Our Smart Energy Matrix, which is now being produced and which is
now operational with the Independent System Operator for New England (ISO-NE) as part of its Alternative Technologies Regulation Pilot Program, is a non-polluting,
megawatt-level, utility-grade flywheel-based energy storage system that provides sustainable frequency regulation services. We believe that our sustainable energy storage and power conversion
solutions can help provide reliable electric power for the utility, renewable energy, and distributed generation markets. We were incorporated in
Delaware on May 8, 1997. Because we have not yet generated substantial commercial revenue from our expected principal operations which will be to provide frequency regulation services, we are
accounted for as a development stage company under Statement of Financial Accounting Standards No. 7. We maintain our principal offices, research and development laboratory and manufacturing
facility at 65 Middlesex Road, Tyngsboro, MA 01879. Our telephone number is 978-694-9121.

The
focus of our research and development has been to establish commercially-viable flywheel-based energy storage technologies that can provide highly reliable energy solutions for the
worldwide electricity grid at competitive costs. Initially, we expect to generate revenues from the commercialization of our flywheel energy storage systems to supply frequency regulation services to
the electricity grid in North America. We believe that as we expand our production capabilities we can become a provider of frequency regulation services to grid operators on a global basis. In
addition we believe that as the commercialization of our technologies continues, we will develop other cost-effective applications for our flywheel systems that will provide additional
revenue opportunities.

Our
market focus is on the geographic regions of the domestic grid that provide open bid markets for regulation services. These regions and their Independent System Operator (ISO) or
Regional Transmission Operator (RTO) designations are: New England (ISO New England or ISO-NE); California (California ISO or CAISO); New York (New York ISO or NYISO);
Mid-Atlantic (PJM Interconnection); Midwest ISO (MISO) and Texas (ERCOT). Because ERCOT is not regulated by FERC, we are not able to encourage beneficial market rule changes there by
leveraging Federal Energy Regulatory Commission (FERC) Order 890, which was intended to promote greater competition in electricity markets, in part by allowing non-generative resources
such as ours the ability to bid and sell into frequency regulation markets. As a result, we are focusing on the other open bid markets first and will begin to work on entry into ERCOT once we are
operating in the other markets.

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

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The Frequency Regulation Market

Levels of power supply and demand on the power grid change from second to second and minute to minute. The need to balance electricity
supply and demand on the grid requires a special service to maintain stable power frequency. This service is called frequency regulation. Deviations from nominal grid frequency can have a negative
impact on the operability of devices that obtain power from the grid. In North America, grid frequency is maintained at 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 maintaining grid frequency is measured by performance
standards provided by the North American Energy Reliability Council (NERC). Financial penalties can be imposed on grid operators when performance standards fall below levels deemed acceptable. Similar
standard-setting entities for frequency regulation exist in most other parts of the world.

In
North America, the frequency regulation market in areas that are accessible via open-bid auction mechanisms was valued at approximately $745 million in 2008 (and is
estimated at the same level for 2009), exclusive of Midwest ISO whose open bid regulation market began in January 2009 and exclusive of ERCOT whose market is mostly structured via bilateral contracts
rather than via open-bid auction. Adding MISO to the 2009 estimate of North American open-bid markets yields an estimated open-bid total of about
$923 million, and adding ERCOT would increase the aggregate estimate of both open-bid and bilaterial markets to more than $1 billion for 2009.

Continued
growth in the US open-bid and international markets is expected due to a combination of factors, including:



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

To
participate in this regulatory-driven open-bid market, we expect to build, own and operate a number of frequency regulation installations known as Smart Energy
Matrix systems designed to provide reliable and sustainable frequency regulation services for utility grids. Our primary business model is a sale-of-services
model, similar to that of independent power producers who also build, own and operate their own power plants. Under this model, we will be bidding our services into multiple open-bid
markets for regulation on a daily basis. Additionally, we may:



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Our
Smart Energy 25 flywheels consist of the flywheels and the associated power electronics. A Smart Energy Matrix is an array of ten Smart Energy 25 flywheels that can
provide 1 MW of energy storage. A frequency regulation installation includes one or more Smart Energy Matrices, along with ancillary equipment and site work. The components of a frequency
regulation installation are divided into three categories:



A
typical full-scale installation would have a capacity of 20 MW. With our sale of services model, installations that are 20 MW in size offer the advantage of being eligible
to use fast-track interconnection regulations that allow this capacity (or smaller) to be potentially approved more quickly in accordance with streamlined regulatory rules than would apply
with a capacity larger than 20 MW.

To
test the viability of our flywheel technologies for frequency regulation, we installed scale-power demonstration systems under contract by the California Energy Commission (CEC) and
the New York State Energy Research and Development Authority (NYSERDA), in cooperation with the U.S. Department of Energy (DOE). The demonstration systems were scale-power prototypes of the Smart
Energy Matrix system. The California and New York field trials were completed during 2007, earning positive evaluations from CEC, CAISO, NYSERDA and NYISO. As a result of the success of
the pilot programs, we designed and are now building multi-megawatt Smart Energy Matrix systems.

On
November 18, 2008, we connected our first 1 MW Smart Energy Matrix to the electric grid in Tyngsboro, Massachusetts. The 1 MW system was installed under the ISO
New England Alternative Technologies Pilot Program, which allows us to generate revenue for regulation services while ISO-NE and Beacon explore ways to optimize the beneficial impact of
the technology and while ISO-NE develops permanent market rules that will govern the application of the technology. The pilot program and its revenue component will continue until such
rules are in place. This process is expected to take approximately 18 months from the November 2008 start. The pilot program was approved by FERC as part of ISO New England's compliance with
FERC Order No. 890, which is intended to promote greater competition in electricity markets, strengthen the reliability of the grid, and allow so-called "non-generation"
resources (which include our flywheel technology), to participate in frequency regulation markets on a non-discriminatory basis.

As
part of the process of modifying its market rules, ISO New England is working with us to optimize performance by adjusting the control signal sent from the ISO to our Smart Energy
Matrix. This "fine-tuning" by the ISO is intended to help maximize regulation effectiveness for the grid while providing fair and equitable regulation service payments to us
and other energy storage-based providers of frequency regulation service. In contrast to, say, NYISO's single part payment model for regulation, ISO New England has a three-part payment
model:



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Revenues
we are currently receiving from this pilot program are less than those that we expect to receive under permanent market rules for two reasons. First, under pilot program market
rules, we are not eligible for opportunity cost payments, which represent approximately one-third of the revenue received by conventional regulating generators. We are encouraging
ISO-NE to develop permanent market rules that will provide an additional payment component for alternative technologies that would be approximately equal to opportunity cost. The trend at
other ISOs has been to incorporate features in their tariffs that intrinsically compensate all resources, including energy storage providers, for opportunity cost. Second, the current signal we are
receiving from ISO-NE does not take full advantage of our speed of response and therefore our mileage payments are not as high as we expect them to be in the future. As discussed above, we
are working with ISO-NE to convince them to adopt a regulation signal that will better utilize our technology's fast response capability in order to maximize benefits to the grid and
payments for our regulation.

Electricity
costs for operating the 1 MW pilot Smart Energy Matrix in Tyngsboro have been higher than what we expect our electricity costs to be in the future. Because the 1
MW pilot project is connected to a distribution level power line, currently we are paying the retail price for all the electricity that we withdraw from the grid instead of paying the wholesale price
of electricity for the net electricity we withdraw from the grid (withdrawals minus injections). For resources such as our 1 MW pilot resource connected at distribution level, the price of electricity
is determined by the retail tariff of the local distribution company versus the ISO wholesale tariff. The retail price of electricity includes charges for both the delivery of the electricity and the
electricity commodity itself, and it is about twice the price of wholesale. Furthermore, the retail tariff does not have a provision for netting the electricity withdrawn and injected back to the
grid.

We
have been working with ISO-NE and our local distribution company to change how we are being charged for electricity for the pilot project. The parties have agreed to allow
the 1 MW pilot resource to net its electricity commodity costs at the wholesale rate, a change that we expect will be implemented during the latter portion of the first quarter of 2009. We are working
to reduce the electricity delivery charges as well. In the future, our 20 MW facilities will be connected to transmission level power lines and therefore our cost for electricity will be the wholesale
commodity price for electricity for our net withdrawals, and we will not incur delivery charges.

Due
to the lower returns in the ISO-NE pilot program, we are electing to modify our deployment schedule. Until such time as the New England market has undergone modifications
that increase returns for megawatts deployed there, we plan to limit the number of megawatts deployed in New England to the 1 MW currently operating in our facility. We expect to deploy additional
systems so that by the end of 2009 we have a minimum of seven megawatts operating in a total of three markets, with New York having five megawatts and Ohio and New England each having 1 MW.

Our
Smart Energy Matrix recycles excess energy when generated power exceeds load and delivers it when load increases, and responds up to 100 times faster than fossil fuel
generators providing this service. Certain ISOs have or are considering payment mechanisms to compensate resources for this faster regulation response. If such performance-based tariffs are approved,
the
potential exists to receive comparatively more revenue for providing regulation services with our fast-response technology versus that received by most conventional regulating generators.

We
believe that our operating cost structure will be significantly lower than most incumbent frequency regulation service providers. Our Smart Energy 25 flywheel is being designed to
operate with low energy losses, minimal mechanical maintenance for 20 or more years and without significant degradation in energy conversion efficiency. In particular, our technology is different from
most frequency regulation providers in that it does not use fossil fuel, which is the largest variable cost for

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most
competing frequency regulation providers. Because our Smart Energy Matrix does not burn fossil fuel, our business plan is partly insulated from the direct impact of the volatile
pricing of coal, oil and natural gas. The change in price of these fuels will be indirectly felt through their impact on the cost of electricity, the market prices for frequency regulation and the
cost of certain components we use to manufacture our flywheels. Historically, wholesale electricity prices have a strong correlation with market prices for frequency regulation. Consequently, as the
price of electricity rises, the price paid for frequency regulation also generally tends to rise. Conversely, however, as fossil fuel prices drop, the price paid for frequency regulation services may
be negatively impacted, which may by partially offset by a reduction in the cost of certain flywheel components.

Since
our Smart Energy Matrix does not burn fuel, the environmental benefits of our technology are significant. Our technology's ability to reduce carbon dioxide
(CO2) emissions was studied by KEMA, Inc., an international energy industry consulting firm commissioned to evaluate the potential of our technology to reduce greenhouse gas and
other emissions. The KEMA study found that, compared to conventional fossil-fuel based frequency regulation providers, our technology may produce up to 89% less CO2. The study
further indicates that the dramatically cleaner performance of our flywheel systems (as contrasted to frequency regulation services supplied by fossil fuel resources) can be expected to offer
significant value to regulators, grid operators, and utilities facing increasing demands to lower CO2 emissions. If, as expected, the Federal government implements a carbon-reduction
program in the form of a cap-and-trade program or carbon tax, we believe that the resulting cost to carbon-intensive regulation providers will increase faster than our
carbon-related costs, which are associated with the purchase of a small amount of electrical make-up energy to compensate for energy conversion losses in our systems. Further, in some
states, additional environmentally-related revenues may be available in the form of renewable energy credits or other credits. For example, Massachusetts recently passed legislation that may provide
alternative compliance payments for qualifying flywheel storage units when they inject energy into the ISO-NE grid.

The
location of our regulation installations and the sequence in which they will be constructed depend on a number of factors, including but not limited to:



On
July 17, 2008, we received a land-use permit we had requested from the town of Stephentown, New York. During the third quarter of 2008, we purchased approximately
seven acres of land at a site in the town where we plan to build our first 20 MW installation. The site is served by two transmission companies: National Grid and NYSEG. National Grid owns a 115 KVA
transmission line that abuts the site, and NYSEG owns a substation that also abuts the site.

Our
interconnection request for the 20 MW plant includes National Grid as the transmission provider. Before we can enter into an interconnection agreement with NYISO, a System Impact
Study, which is currently underway, must be completed. The purpose of the study is to ensure that our installation can safely interface with the grid, and to identify any utility upgrades or other
equipment that may be needed before construction can begin.

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We
may elect to install 1 MW installations in ISOs to provide early insight to operating within each market. The economics of these 1 MW systems may not be representative of expected
revenues and costs for a 20 MW plant and therefore the non-fungible costs may be expensed. For example, in the New York market, we are planning to deploy a 1 MW resource on the
Stephentown site, but interconnected to NYSEG. On October 10, 2008, we entered into a 1 MW interconnection agreement with NYSEG that would connect directly to its substation. Pending
application for and receipt of a building permit from the town of Stephentown for a 1 MW installation, we have the right to build and operate a 1 MW resource connected to the NYSEG substation.
We believe that the value of gaining early insight into the best way to operate and bid our planned 20 MW resource into the NYISO market more than compensates for the costs associated with deploying a
1 MW resource. In addition, the 1 MW resource can later be electrically connected to National Grid's 115 KVA transmission line should we choose to do so. Similarly, in Ohio we expect to deploy 1 MW at
the AEP facility as described below. The non-fungible costs associated with deploying small installations which are not intended to remain in service for terms exceeding two years will be
expensed.

On
February 23, 2009, we announced that we had signed a contract with American Electric Power (AEP), one of the largest generators of electricity in the U.S., and one of its
operating subsidiaries, Columbus Southern Power Company. The contract will entail building a 1 MW Smart Energy Matrix regulation facility at an AEP site in Groveport, Ohio. The system,
which will be connected to the grid within the operating region of the PJM Interconnection (PJM), will provide flywheel-based frequency regulation services. Installation of this Smart Energy
Matrix is scheduled to begin in mid-year 2009. The 1 MW system will provide valuable insight into the operation of our technology on PJM's grid and make us better prepared to
deploy and profitably operate full scale 20 MW plants in PJM's area of coverage. We also expect that the facility will provide us with additional market credibility.

By
the end of 2009, we expect to have deployed a minimum of 7 MW of frequency regulation among three locations: Stephentown, Groveport and Tyngsboro. Additionally, we are currently
identifying and developing sites in other target markets.

We
have applied to the US Department of Energy (DOE) for a loan guarantee that would enable to us to fund a large majority of the planned 20 MW installation in Stephentown. The
satisfactory completion of NYISO's System Impact Study and clear resolution of market rule issues that affect our ability to enter and operate in the NYISO market (described elsewhere), could affect
the timing or success of our DOE loan guarantee application. Lengthy delays or negative outcomes in any of the factors identified above could potentially require us to select a location other than
Stephentown for our first 20 MW installation. Additional megawatts could potentially be deployed in Stephentown by the end of 2009, depending on our ability to obtain sufficient funding, which in turn
may largely depend on the outcome and timing of our DOE loan guarantee application.

In
volume production, our goal is to complete 20 MW facilities at a cost of approximately $25 to $30 million each, though the first 20 MW plant will cost approximately
$60 million. In 2010 and 2011, we will continue to have capital needs that will require additional funding through equity and debt to fund the ongoing deployment of frequency regulation
installations. In addition to obtaining sufficient funding, our deployment plans are affected by other factors and activities, including but not limited to the following:



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Regulatory and Market Affairs

Within each ISO there is a market tariff and set of market rules that determine who is allowed to bid into regulation markets, how much
regulation providers are paid for their services, and what costs providers must pay to participate in markets. Each ISO has its own market rules that will govern the pace at which markets are opened
and the degree to which our technology is allowed to participate. Historically, the market rules for regulation were written to conform to traditional generators' abilities to provide regulation. This
is understandable, because until the advent of our technology, the capabilities and limitations of traditional generators defined how regulation could be technically implemented. In the markets in
which we intend to compete, most of the ISO market rules still contain legacy terms, performance characteristics and other requirements that do not match our new technology. The impact of this
mismatch varies from market to market, and our ability to foster beneficial changes to ISO market rules will determine our timing for entering these markets and building regulation facilities, as well
as the revenues and costs associated with each market.

Of
considerable importance and benefit to us, on February 16, 2007, FERC issued a landmark ruling, Order 890,Preventing Undue Discrimination and
Preference in Transmission Service. This FERC ruling seeks to promote greater competition in electricity markets and strengthen the reliability of the grid. Included in Order
890 was a mandate by FERC that all ISOs must change their market tariffs to allow non-generation resources (such as ours) capable of providing frequency regulation the ability to bid and
sell into these markets. The ruling also stated that market rule changes must be implemented in a completely non-discriminatory manner.

To
insure that we have the right resources to properly address the timely opportunity afforded by FERC Order 890, we have secured expert regulatory and legal counsel and have put a
vigorous regulatory affairs program in place.

We
have encountered wide variations from one ISO to another in the suitability of its framework and market rules for commercial deployment of our systems. We have found that we must
engage in significant interaction with each ISO before the regulation market in that ISO region is ready for energy storage. FERC Order 890 has accelerated the pace of market rule changes and in 2008
we made progress with several of the ISOs by working with them directly to implement changes to market rules to allow energy storage technologies to participate on a non-discriminatory
basis in the regulation market. The ISOs have demonstrated a heightened commitment to work collaboratively with us to integrate our technology to their grids. In addition to market rule changes,
several ISOs are evaluating or proposing changes to their regulation dispatch signal in order to ensure our Smart Energy Systems are deployed most efficiently and effectively for the benefit of the
power grid. These changes would take better advantage of our flywheel's fast response capability, while recognizing our resource has limited energy storage capacity. The proposed market rule changes,
coupled with effective regulation

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dispatch
signals, will allow our resource to maximize its regulation revenue while minimizing our consumption and cost of electricity. The current status of each ISO market is as
follows:



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Defense applications

We have completed the design phase for a flywheel energy storage system for satellites capable of achieving maximum theoretical
specific energy density. The program was jointly funded by the Air Force Research Lab (AFRL) and the Defense Advanced Research Projects Agency (DARPA). We believe that our high-energy
flywheel technology is increasingly attractive as an energy storage device for space platforms, navy vessels and other military hardware and/or systems. We are pursuing defense

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and
military-related projects that, in addition to generating revenue to help cover operating costs, effectively provide non-dilutive R&D funding for key technology innovations and
advancements that may be transferred to commercial markets.

On
February 3, 2009, we announced that we entered into a contract with the U.S. Naval Sea Systems Command (NAVSEA) to evaluate the use of flywheel energy storage for multiple
shipboard applications that we expect will lead to a final conceptual design of a flywheel system for future naval surface combatants and possible retrofit into existing navy ships. NAVSEA's objective
is to advance and improve its shipboard Integrated Power Systems (IPS) at both the major component and system level. The final flywheel design is expected to be based on many aspects of our Smart
Energy 25 flywheel. Integrated Power Systems are an essential part of the Navy's all-electric ship program. Based on the anticipated power requirements to support advanced launch systems,
weapons and sensor systems, and other shipboard functions, electrical energy storage is now recognized as a fundamental element of an all-electric IPS.

Under
terms of this multiyear contract, we will perform an analysis of future shipboard energy storage needs; identify several flywheel applications that could offer the greatest benefit
to future naval combatants; assist the Navy's power plant upgrade development team by characterizing the flywheel applications under consideration and assisting in system-level studies; and validate
results of those studies. Based on the results, we will develop a conceptual flywheel design and simulation model for one or more applications. The value of the initial research and development work
is estimated at $900,000, $500,000 of which has already been appropriated. Subsequent phases involve work estimated at up to an additional $2.1 million.

Other Flywheel-based Market Opportunities

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



We
are evaluating these additional applications to determine whether they represent commercially attractive market opportunities; however, our focus in the near term will be to deploy
company-owned flywheel installations for the frequency regulation market.

Competition

Our competition consists primarily of fossil fuel generators. However, in some locations, hydro generators are an effective source of
competition and some battery companies have recently started offering competitive products. We believe that our Smart Energy Matrix flywheel regulation systems offer significantly
superior performance and cost benefits compared to fossil fueled regulating generators. Although we believe hydro variable costs to be low, we regard the competitive threat from hydro generators to be
limited in part because their capital costs are extremely high, and opportunities to build new hydro generation facilities are limited by environmental concerns as well as location-based geography.
And, although specialized battery companies do constitute competition, they are new to the market and we do not yet have reliable information regarding their cost, performance and other attributes of
their products or services.

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Fossil Fueled Regulating Generators

We believe our Smart Energy Matrix flywheel regulation technology offers significantly superior performance and cost
benefits compared to conventional fossil fueled regulating generators. Flywheel-based regulation is predicted to be much more effective than most fossil fueled generators in providing regulation. A
recent study suggested that 1 MW of fast-response regulation can be expected to deliver abouttwicethe system regulation value of the
average conventional regulation resource in California. The study also found that fast-response regulation may be as much as 17 times more effective than some types of conventional
ramp-limited regulation resources in California, and if California's regulation fleet included about one-third fast-response resources, California's
system-wide regulation capacity requirement could be reduced by as much as 40%.

Not
all fossil fueled generators can provide frequency regulation services. Some, such as nuclear power plants, are unable to or are prohibited by regulators from varying their output in
the manner needed to participate in the frequency regulation market. Others may be capable of providing such services, but choose not to do so due to higher operating and maintenance costs that their
type of generating equipment incurs when performing regulation, since constant up and down throttling required to deliver fossil fuel-based frequency regulation reduces the economic life
of conventional generating equipment.

A
large percentage of regulation in the U.S. is performed by coal-fired units. Any type of carbon tax that could be put into place in the future can be expected to increase
the cost of regulation from such carbon intensive coal-fired units. In contrast, our flywheel energy storage systems do not burn fuel and therefore emit zero direct CO2. Even
accounting for the carbon footprint of make-up energy that we must buy to account for conversion inefficiency, storage-based regulation produces far less direct CO2 than fossil
fuel regulating generators. We believe
that flywheel-based frequency regulation can be expected to cut direct plus indirect CO2 emissions by about 50 percent versus base load gas-fired regulation generators.
Compared to base load coal-fired regulation generators, the reduction in CO2 emissions using flywheel-based regulation systems would be up to 85%. CO2 savings for
battery-based regulation resources would be about the same.

Another
benefit of energy storage-based regulation versus fossil fueled regulation is that ours is a single-purpose solution that deploys just the amount of regulation needed. In
contrast, conventional regulating generators must also produce base load energy in order to provide regulation, and a customer (or customers) must be found to buy the base load energy. This can be
problematic in smaller balancing areas with limited load growth. Sparsely populated areas may not need more base load generation, and transmission limitations can further complicate the problem by
limiting the ability to export new base load energy to distant buyers. Another challenge for conventional regulation technologies is the long lead time required for siting and constructing
fossil-based regulating generators. Because it requires no fuel supply and has zero direct emissions of any type, an energy storage-based regulation resource can be sited, permitted and built in about
18 months, versus two to five years for a fossil-based regulating generator. The ability to site, permit and build a regulation plant quickly can be a decided advantage.

Pumped Hydro Regulating Generators

Although some hydro-powered generators are excellent regulating generators, they are geographically limited. Due to long lead times
required to site and build hydro facilities, as well as the trend toward tougher environmental review of proposed new hydro plants, we do not expect to see significantly greater competition from hydro
facilities in the near future. Recently imposed operating restrictions designed to reduce fish kills may actually constrain some hydro units' supply of regulation.

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Battery-based Regulating Generators

In recent years significant progress has been made in certain battery technologies with respect to their cycling capability and power
degradation characteristics. Two lithium ion battery manufacturers in particular are pursuing the frequency regulation market, and either or
both could become meaningful competitors. A123, a private company based in Massachusetts, is a developer of nanophosphate lithium ion batteries. In 2008 A123 built and deployed a 2 MW energy storage
system that was purchased by the AES Corporation, a global utility. The 2 MW system is in California, co-located near an AES-owned generator. No information on the performance
of the 2 MW system is publicly available, but the purpose of the 2 MW system is believed to include the performance of frequency regulation in combination with the AES generator. The system may become
part of a future CAISO pilot program for energy storage-based regulation resources that could begin in 2009. We believe that A123 has an agreement with the AES Corporation that includes certain
technology development objectives related to the performance of frequency regulation, and could involve purchases by AES of nanophosphate lithium ion battery systems for frequency regulation systems.
Although we do not know for sure, we speculate that the focus of the AES Corporation may be to provide additional capability for its existing generators as opposed to acting as a broad sales channel
that would involve the resale of such systems to third parties who would then compete in open regulation markets.

In
the fourth quarter of 2008 the AES Corporation deployed a second lithium ion battery system from Altair Nanotechnologies. The 1 MW Lithium-Titanate system is connected to a 34 kV
circuit in PJM's service territory and has been termed a "demonstration project" by PJM for frequency regulation. Altair Nanotechnologies is a leading provider of advanced materials and products for
power and energy systems. The company has a joint development agreement with AES Energy Storage LLC, a subsidiary of the AES Corporation, to develop grid-scale energy storage
applications. Altair Nanotechnologies is a publicly traded Canadian company with significant financial and other resources.

Cost
and performance data for the A123 and Altair Nanotechnologies systems are not yet available, but we are monitoring both developments to the extent possible. In establishing supplier
relationships with two lithium ion battery manufacturers, the AES Corporation has signaled its intent to bring battery-based regulation to market, even if (as we speculate) the market AES has in mind
is restricted to its own generation fleet. The AES Corporation is a Fortune 1000 company operating in 29 countries and has significant financial and other resources.

Discussion of Operations

We have experienced net losses since our inception and, as of December 31, 2008, had an accumulated deficit of approximately
$186.9 million. We are focused on the development and commercialization of our Smart Energy Matrix flywheel system for frequency regulation and completion of our research and
development contracts. We do not expect to have positive EBITDA (earnings before interest, taxes, depreciation and amortization) or positive cash flow from operations until at least 2011 and must
raise additional equity and debt to execute our business plan and continue as a going concern. To achieve our objectives on EBITDA and cash flow we will need to obtain sufficient funding through a
combination of equity and debt to commercially install the number of frequency regulation plants included in our business plan. In the event that we are not able to deploy plants as planned due to
capital constraints, positive EBITDA and cash flow would be delayed.

In
2009 and beyond we will need additional funding to expand our manufacturing capabilities and to build and install frequency regulation facilities in accordance with our business plan.
We expect to raise the required funds in 2009 through the DOE loan program guarantee and the sale of stock in the Company. In the future, as the number of our regulation facilities increases and we
develop sustainable cash flows from operations, we expect to fund additional plants from a combination of non-recourse project finance, debt, project equity and available cash flow from
existing regulation facilities.

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In
October 2007, we were notified by the U.S. Department of Energy (DOE) that we were selected to submit a full application for a DOE program that would provide loan guarantees for a
large majority of the project debt needed to finance the construction of our first 20-megawatt flywheel frequency regulation installation. We have completed the application process. On
March 11, 2009, we announced that the U.S. Department of Energy (DOE) completed its formal environmental review of our proposed 20 MW installation in Stephentown, New York, and issued a
"Finding of No Significant Impact" (FONSI). In its determination, the DOE said that the plant "will not have a significant effect on the human environment." This completes the environmental analysis
of the project site that began in July 2008, when the Stephentown Planning Board approved the environmental aspects of the project, by issuing its own Negative Clearance and Determination of
Non-Significance for the project. Under terms of the National Environmental Policy Act (NEPA), all federal agencies must consider the potential environmental impacts of their proposed
actions. The NEPA evaluation comprises reviews of 18 potential environmental impacts, including public health and safety, air quality, wetlands, threatened or endangered species, natural resources,
and geology and soil. The DOE is in the process of completing its due diligence regarding our loan application; this FONSI determination means that our application need not be delayed by the type of
time-consuming Environmental Impact Statement that is sometimes mandated for projects being reviewed. We are the first loan guarantee finalist to complete the NEPA assessment. We
anticipate moving the process of obtaining this loan guarantee forward.

There
is no assurance that we will be successful in obtaining a loan guarantee under the DOE program, or if awarded, that the loan will be offered with terms and conditions that are
acceptable to us or that the timing of any such guarantee-backed loans will be in a timeframe that allows us to execute our business plan. If we are not successful in obtaining such DOE support on a
timely basis for the 20 MW installation at Stephentown, it will affect the timing for completing the project.

Since
our inception in 1997 we have funded our development through the sale of common stock. In November 2000, we completed our initial public offering, raising approximately
$49.3 million net of offering expenses. In 2005, we raised approximately $17.1 million via private placements of common stock. During 2007, we raised approximately $42.6 million,
net of offering expenses, as a result of three financings. In the fourth quarter of 2008, we raised approximately $11.3 million through the sale of common stock and warrants pursuant to a shelf
registration statement. We believe that the capital
raised in 2008 will provide sufficient funding for us to continue to implement our business plan through the second quarter of 2009. We expect to raise a minimum of $30 million in 2009 to
execute our business plan.

Our
profit and losses as well as uses of cash may fluctuate significantly from quarter to quarter due to fluctuations in revenues (if any), costs of development, costs of materials to
build flywheels and other components of our Smart Energy Matrix and the market price for regulation services. In addition, cash may fluctuate by period due to the timing of capital
expenditures for expanding manufacturing capabilities or construction of frequency regulation facilities and the related timing of project financing or equity raises. These fluctuations in cash
requirements could put additional pressure on our cash position. There can be no assurance that we will be able to raise the required capital on a timely basis or that sufficient funds will be
available to us on terms that we deem acceptable, if they are available at all. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of
OperationLiquidity and Capital Resources" for more information concerning our access to and uses for capital.

Our Technology

We believe our patented composite flywheels offer superior reliability and performance compared to other energy storage devices. Our
composite flywheel is a rotating composite rim levitated on hybrid magnetic bearings and operates in a near-frictionless vacuum-sealed environment. The flywheel is powered to its
operational speed using a permanent magnet motor and electricity from an external

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power
source (for frequency regulation application, the grid). When the composite rim spins faster, it stores energy kinetically. The flywheel is able to spin for extended periods with great
efficiency because friction and drag are reduced by the use of magnetic bearings and a vacuum-sealed environment. Because it incurs low friction, little power is required to maintain the flywheel's
operating speed. When an ISO sends a signal that requests electrical power to be provided, the momentum of the spinning flywheel then drives a generator and a bi-directional inverter
converts the kinetic energy into electrical energy for release to the grid or other energy sink. When the ISO sends a signal that requests the system to absorb power, the Smart Energy
Matrix uses power from the grid to drive the motor/generator which in turn spins up the flywheel.

Our
composite flywheels employ high-strength carbon fiber, efficient electric drives, and low-loss, long-life bearings. Our flywheels are fabricated
from a proprietary mixture of high-strength, lightweight fiber composites, including graphite and fiberglass combined with resins, which allow the flywheel to rotate at high speeds and
store large amounts of energy relative to flywheels made from metals.

Our
flywheels and their bearing systems have been designed and developed to require limited maintenance. In contrast, some competing flywheel products rely on bearings and vacuum systems
that require significantly greater periodic maintenance and/or component replacement. Our Smart Energy flywheel systems have dramatically longer discharge times than any other flywheel energy storage
systems known to us.

Research and Development

Our research and development efforts are essential to our ability to successfully design and deliver our systems, as well as to modify
and improve existing products to reflect the evolution of markets and customer needs while reducing our costs. Our engineers work closely with the ISOs to define system feature and performance
requirements to address specific ISO needs. Research and development expenses, including engineering expenses, were approximately $15,398,000 in 2008, $8,387,000 in 2007 and $4,748,000 in 2006. We
expect research and development expenses in 2009 to be lower than in 2008 due primarily to the following factors:



Our
headcount on December 31, 2008 was 61, which included 29 engineers and technicians and 17 manufacturing and materials handling employees. In addition, we utilized the
services of a number of independent contractors primarily engaged in research and development and design work on manufacturing and frequency regulation facilities, as well as market rules and
evaluation of competitive features of each ISO.

ISO-NE Alternative Technology Regulation Pilot Program

To support our efforts to open ISO markets and help foster market rules that optimize pricing and costs, in November 2008, we began
participating in an Alternative Technology Regulation Pilot Program in ISO-NE (the "Pilot Program"). Under this program we are now operating a 1 MW flywheel system at our Tyngsboro
facility. The Pilot Program was put in place by ISO-NE to provide information that ISO-NE will use to evaluate technical and market design changes needed in its regulation
market structure to allow non-generation technologies to participate in the ISO-NE market in compliance with FERC Order 890.

Although
we are earning revenue for operating our 1 MW resource, the control signal currently being provided by ISO-NE for this Pilot Program, called a Trinary signal, does
not currently optimize

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our
revenues and costs, nor optimize the benefits for ISO-NE. We are encouraging ISO-NE to adopt what we believe would be a better signal that improves our economics while
producing greater cost-benefits to the grid.

Under
the Pilot Program, our 1 MW resource does not receive any of the third element of total regulation payments, termed "Opportunity Cost," that is customarily paid to conventional
generators. The Opportunity Cost price component makes up about one-third of the total value of regulation payments received by conventional generators that provide regulation in
ISO-NE. ISO-NE is aware that we consider this feature of their payment methodology discriminatory with respect to our technology. Also, by using characteristics more typically
attuned to a fossil fuel power supplier (principally, by not requiring frequent changes in signal), the Trinary signal which ISO-NE now provides also does not result in compensation to us
for the high "mileage" that our system is capable of handling (as described earlier). NYISO and MISO have already satisfactorily addressed these issues in their current or expected market rules for
non-generation regulation resources, and we believe that ISO-NE intends to adopt changes to address these issues. However, we cannot be sure when ISO-NE will do so,
or if it does, that it will do so in a way that resolves the issues in a way that is sufficiently equitable and beneficial to us.

Given
the impact of the Trinary signal on our revenues and costs, as well as the uncertainty that ISO-NE will act in a timely and effective manner to address the opportunity
cost issue, we have decided to redeploy four of the five MWs of resource that we originally intended to build and operate under the ISO-NE Pilot Program. The four MWs in question will
instead be redeployed to New York. We believe the NYISO control signal and NYISO market rules that we expect to be in place by mid-2009 will allow us to earn attractive revenues with these
assets with associated costs that are reasonable. Costs related to the non-movable and/or non-recoverable components of the four MW installation that had been under
construction at our Tyngsboro facility have been charged to R&D expense during 2008. (See Management Discussion and Analysis.)

Renewable Generation Integration Project

During the second quarter of 2008, we began providing contract services for a wind-related R&D project
co-funded by the California Energy Commission, identified as CEC-PIER Contract 500-07-020, Agents for Renewables Project. Project partners include
Southern California Edison and the California ISO. The objective of the project is to find better ways to coordinate and maximize energy production and delivery from wind generation resources located
in the Tehachapi area of California. The technical approach will include the application of "intelligent agent" controls and our flywheel energy storage in an effort to find ways to deliver as much
wind-generated electricity as possible without exceeding the dynamic ratings limits of the locally-constrained transmission system. "Intelligent agent" control technology has been
identified as a key element of the DOE SmartGrid initiative and is often defined as an advanced control technology that executes autonomously, operates in real-time, communicates with
other agents or users, exploits domain knowledge, and exhibits goal-oriented behavior.

We
are supporting the project's prime contractor, Alternative Energy Systems Consulting, Inc., with the design, development and demonstration of an agent-based system
that:



The
project will re-use portions of the existing flywheel scale-power demonstration system owned by the CEC and tested for regulation on PG&E's grid in 2006 and 2007. One 100
kW Smart Energy 25

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flywheel
will replace the seven smaller flywheels. Our share of the scope of work is valued at $312,676, of which we will receive $250,000 from the CEC and we will provide matching funding of $62,676.

Another
goal of the project is to identify ways to commercialize any new application that may be developed. This project is exploratory and there can be no assurance that a
commercially-feasible application will be developed. However, this project is consistent with our interest in potential applications that have a high cyclic requirement, move a large amount of energy
through the flywheel matrix, potentially address a large global market and facilitate renewable energy.

Wide-Area Energy Storage and Management System to Balance Intermittent Resources in the Bonneville Power Administration and California ISO Control Areas

In 2008 we completed R&D work under Phase I of a planned multi-phase R&D project with the Pacific Northwest National
Laboratory, Bonneville Power Administration (BPA), the California ISO and the California Energy Commission. Under Phase I, we provided $30,000 of in-kind project support to the
consortium of project partners. The goals of the project include developing principles, algorithms, market integration rules, and a functional design and specification for an energy storage and
control system with the ability to help the Bonneville Power Administration and the California ISO better cope with wind generation intermittency and unexpected fast ramps from the deployment of new
wind resources in their balancing areas. The system resulting from this project, if ultimately deployed, would be expected to accomplish these goals by recycling excess energy, controlling
dispatchable load and distributed generation and managing inter-area exchanges of excess energy between the BPA and California ISO Control Areas. A final goal for the project is to
complete a cost-benefit analysis and develop a business model that can justify large-scale investment in the practical deployment of such a system.

Phase I
was successfully completed in 2008. Because the flywheel storage is capable of compensating for the inaccuracies caused by the response delay, dead zone, and deviation
characteristics of the hydro power plant, simulation showed that the aggregated hydro power plant and flywheel storage plant could provide a faster and more accurate regulation service than that of
the hydro plant alone. Simulation results demonstrated the feasibility and efficiency of the proposed Wide Area Energy Management and Energy Storage system, and it was concluded that a total system
consisting of hydro resources and flywheels could be highly effective in mitigating the effects of intermittent wind resources in BPA's and CAISO's service territories.

We
believe Phase II of this project will be approved this year under contract terms discussed with Pacific Northwest National Laboratories, the prime contractor. Under
Phase II, we would expect to provide approximately $80,000 of in-kind project support and to receive approximately $130,000 in payments against a total budget of $210,000 for our
portion of Phase II of the project. Phase II goals would likely include providing numerical factors needed for the possible future design of the system architecture and completion of a
technical design specification for the system. Deployment of such a system could involve many megawatts of flywheel energy storage capacity. However, there is no assurance that Phase II of the
project will be approved or, if approved and successfully completed, that subsequent phases of this project will also be approved and successfully completed in such a way as to lead to commercial
deployment of our flywheel systems specifically to help balance intermittent wind resources.

Manufacturing

We completed the move from our Wilmington, Massachusetts facility to a new corporate headquarters in Tyngsboro, Massachusetts in
January 2008, significantly expanding our manufacturing capacity and providing sufficient space to continue our research and development activities. We signed a seven-year lease in July
2007 for the new facility, located at 65 Middlesex Road, Tyngsboro, MA. The

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103,000
square-foot Tyngsboro facility was fully renovated and built-out to our specifications and has a manufacturing capacity of more than 600 flywheels per year. The
manufacturing capacity of the facility can be further expanded to over 1,000 flywheels per year when necessary.

We
expect to continue to expand staffing for the assembly and testing of our flywheel systems during 2009 and beyond. In addition to assembly work at our Tyngsboro facility, we rely on
outside suppliers to provide components for our systems. For our mechanical flywheel systems and the related electronics, we are working to establish a minimum of two suppliers for each component to
reduce any adverse impact of a loss or interruption by a supplier.

Sales and Marketing

Sales and marketing activities expanded in 2008 and will continue to expand in 2009 as we make preparations to enter
open-bid markets that we consider
attractive. The pricing we expect to receive and costs we expect to incur in providing regulation services are specific to each ISO. Prices and costs are driven by market supply and demand as well as
market rules that define how regulation services must be delivered in a given ISO. In 2008 we pursued a broad program of regulatory reform in a number of ISOs with the goal of improving the pricing we
can expect to receive and costs we can expect to incur. We focused more attention on accelerating the pace of market rule changes in NYISO since we plan to build our first 20 MW plant in Stephentown,
New York. Given our regulatory progress in the New York market, we believe our pricing and costs in New York will support attractive margins. (See "Regulatory and Market Affairs" for further details
on regulatory reform activities.)

Information Sharing and Performance Evaluation Agreement with National Grid

In December 2008, we entered into an information sharing and performance evaluation agreement with National Grid plc, which is
an international electricity and gas company and one of the largest investor-owned energy companies in the world. Under the two-year agreement we will share technical, performance and
economic data on our flywheel energy storage systems. We will also assess the potential operational value of our flywheel energy storage to National Grid's electricity transmission networks in both
the United States and the United Kingdom. Other objectives of the agreement include the evaluation by National Grid of our flywheel systems for wind-related ramp
mitigationanother potential large-scale grid stability application that could be provided by our technology, as well as for our fast-response frequency regulation.

Ramp
mitigation refers to the ability of regulation and reserve generation units to quickly compensate for a rapid system-wide change in aggregate power output caused by
sudden changes in power production. As an intermittent resource, wind power generation often experiences rapid fluctuations in power output. As the amount of wind generation on the grid increases,
many grid operators foresee the need to increase total regional ramping capacity to maintain proper energy balance.

Under
the terms of the agreement, we will work with National Grid to forecast future increases in the demand for regulation and ramping capacity resulting from greater deployment of wind
power. National Grid will also work with us to define an optimal control algorithm for our fast-response energy storage technology that would maximize benefits on the grid.

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Given the powerful trend towards deployment of wind generation, in 2008 we performed market research to better understand the role our technology can play in supporting large-scale
integration of new wind generation. We joined the American Wind Energy Association (AWEA) and the Utility Wind Integration Group (UWIG) to increase our understanding of technical, market and financial
issues, and we committed to exhibit our technology at the May 2009 AWEA Conference in Chicago. We believe that our flywheel-based regulation technology can help supply new fast-response
regulation and ramping capacity that will be needed as more wind and solar generation assets are deployed. The California ISO, for example, estimates that to accommodate the 20% of its electricity
that is being supplied by intermittent renewable resources, regulation requirements will increase by 170 MW to 250 MW for "up regulation" and 100 MW to 500 MW for "down regulation," depending on the
season and hour of the day.

During
2008 we expanded resources dedicated to identifying and developing potential 20 MW sites in multiple ISOs to provide the option to install systems in those ISOs as market pricing,
capital formation and other factors present the right opportunities. We will also look for opportunities to sell our equipment in the U.S. and overseas and to enter into bi-lateral
contracts for the provision of regulation services in the United States.

We
plan to further refine our assessment of the European market for regulation, and we will look for opportunities to demonstrate our frequency regulation technology on a live grid in
Europe. We will also be evaluating the market potential for our systems on islands around the world, because islands generally require a higher percentage of regulation resources and their cost of
regulation is typically higher than mainland grids due to the cost of imported fuel.

Backlog

At December 31, 2008, we did not have any firm commercial sales commitments for our products and services. As of the end
of 2008, we had two ongoing research and development contracts from which we expect to derive final revenue in 2009 of approximately $250,000. In addition, in February 2009 we were awarded a
multi-year contract with the U.S. Naval Sea Systems Command with a potential value of up to $3 million, of which $500,000 has currently been funded.

Intellectual Property

Our success depends upon our ability to develop and maintain the proprietary aspects of our technologies and to operate without
infringing on the proprietary rights of others. To some extent, our success also depends upon the same abilities on the part of our suppliers.

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

The
intellectual property rights of our flywheel-based products are primarily embodied in patents that we hold or are pending, but in addition include flywheel technologies and patents
that we are licensed to use. We hold one or more U.S. patents on our flywheel vacuum system, heat pipe cooling system, output paralleling algorithm, metal hub, low-loss motor,
co-mingled rims, earthquake-tolerant bearings, bearing cooling device, and bearing damper. We also hold one or more foreign patents on our vacuum system, co-mingled rims, and
metal hub. Our patents expire on various dates between 2020 and 2026. We also have 30 pending U.S. and foreign patent applications, and several other applications being prepared for filing. We hold a
perpetual, exclusive, royalty-free, worldwide license from SatCon Technology Corporation to use its flywheel technologies and patents for stationary terrestrial flywheel

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applications.
Our plans for exploring the development of systems for use in space or naval applications do not use the patents licensed from SatCon. See description above,
"Defense Applications".This license includes 15 issued U.S. patents and 12 foreign patents and applications that expire on various
dates between 2012 and 2021, and covers SatCon's technologies and patents and all improvements made by SatCon through November 16, 2000, the date of our initial public offering. We are not
entitled to any improvements to the flywheel technology that SatCon develops subsequent to that date. We expect to develop additional intellectual properties and trade secrets as we continue
developing additional Smart Energy and Smart Power systems. We own all technology improvements that we have developed that are based on the technology licensed from SatCon.

Government Regulation

We expect to be a substantial beneficiary of any government deregulation of North American and other electricity markets. In the U.S.,
in particular, the open-bid market for frequency regulation services reflects a set of market rules that define how suppliers of regulation are able to access these revenue-producing
markets without the need to sell equipment to traditional end-use customers. These open market environments have the potential to provide us a rapid growth in revenue using our
high-energy carbon composite flywheel technology and our merchant plant business model. See also "Regulatory and Market Affairs" for further discussion of how government regulation affects
our business.

Employees

At December 31, 2008, our headcount was 61 full-time employees, three part-time employees and a number
of independent contractors. Our staff included 29 technical employees made up of engineers and technicians involved in research and development activities and 17 manufacturing and materials handling
workers involved in production and research and development activities. We also had five employees in sales, marketing, business development, compliance and customer service. The remaining ten people
were involved in administrative tasks. None of our employees is represented by a union and we consider our relations with employees to be satisfactory.

Other Information

We file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission
(the "SEC"). You may read and copy any documents that we file at the SEC's public reference room at 100 F Street, N.E., Washington, D.C. 20549. You may call the SEC at
1-800-SEC-0330 for
further information on the public reference room. Our SEC filings are also available to the public free of charge at the SEC's Web site at www.sec.gov.

Our
Web site address is www.beaconpower.com. All of our 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 our Web 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 part of this annual report. We also make available our Corporate Governance policies and our Code of Conduct on our Web
site. Additionally, paper copies of these documents may be obtained free of charge by writing our Investor Relations Department at our principal executive office.

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Item 1A.    Risk Factors

We face significant technical challenges in completing the development of the Smart Energy Matrix. We may fail to develop our 25kWh generation flywheel system
to a commercial production design, which is a critical requirement for the development of the Smart Energy Matrix and, even if we are able to develop the 25kWh system, we may fail to
develop the Smart Energy Matrix into a commercial production design.

Although we have successfully developed three high-energy flywheel systems (the 2kWh and 6kWh for telecom and the 6kWh for
the grid) that had similar technical challenges, and we currently have a 1 MW Smart Energy Matrix installation with 25kWh flywheels operating under ISO-NE's pilot
program, there can be no assurance that we will be able to successfully complete development of the 25kWh system and manufacture it on a large scale commercial basis. The successful development of our
Smart Energy 25 flywheel system, which will be used in the Smart Energy Matrix, involves significant technological and cost challenges, including:



There
can be no assurance that we will be successful in meeting these challenges. In addition, even if we are able to complete development of and manufacture commercial quantities of the
new Smart Energy 25 flywheel system, we will have the challenge of integrating multiple Smart Energy 25 flywheels into a common facility, constituting a 20 MW Smart
Energy Matrix. This effort will pose significant technological and cost challenges such as:



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Although the market for frequency regulation services is large and growing, we have not demonstrated an ability to sell into that market at a commercial level. Further,
although the Federal Energy Regulatory Commission has mandated that ISOs allow non-generator resources (such as ours) to provide regulation services, each of several ISOs must modify their
separate market rules for us to be able to sell our frequency regulation services in each such market for us to be able to sell such services on an optimal basis.

We intend to provide frequency regulation services using our Smart Energy Matrix in the open-bid markets of
regional grid operators, such as NYISO. There are significant market rule changes that need to be put in place in some of these markets, and there is no assurance that favorable rule changes will be
implemented or if implemented, that it will be done in a time frame that will allow us to achieve our business plan, or that the revised tariff structure for a particular ISO will result in a market
for that ISO in which we can participate on a profitable basis.

We
are actively engaged both with FERC and several ISOs on the development of new market rules that would allow our participation. However, the timing of when market rules for each
ISO/RTO will be amended to allow our participation is uncertain. There can be no assurance that the amendments to the various tariff structures will occur in a timeframe that will allow us to achieve
our business plan or that the revised tariff structure for a particular ISO will result in a market for that ISO in which we can participate on a profitable basis.

Reductions in energy prices may have a material adverse impact on the pricing of frequency regulation services and therefore our profitability.

The market pricing for frequency regulation services tends to follow the pricing for energy. Hence, when the price of energy drops,
frequency regulation prices may be adversely affected, which could materially affect our profitability.

We
expect the size of the frequency regulation market to grow, in part due to the increased need for regulation resulting from the higher use of intermittent energy sources, such as wind
and solar. A sustained drop in the price of energy may adversely affect the growth of these industries, and consequently, the rate of growth for the frequency regulation market. A lower demand for
frequency regulation could result in lower pricing, which would have a material adverse effect on our business.

The commercialization of our Smart Energy Matrix will require substantial funds. Our stockholders may be adversely affected if we issue debt securities or
additional equity securities to obtain financing.

We will require substantial funds to complete research and development activities, manufacture and deploy our systems, market our
services and increase our revenues. We anticipate that such funds will be obtained from external sources and intend to seek additional equity or debt to fund future operations. We will need to raise
additional funds through the issuance of equity securities in order to build and operate frequency regulation installations and have sufficient working capital to continue to execute our business
plan. The extent of the funds needed is dependent, in part, on the volume of flywheels that we produce and deploy.

A
large portion of our expenses are fixed, including those related to facilities, equipment and key personnel. To execute our business plan, we will incur substantial costs to
manufacture and deploy our Smart Energy Matrix systems. If we do not succeed in raising additional funds, we will be unable to execute our business plan. If this occurs, it will have a
material adverse impact on our business, including our ability to continue as a going concern.

A
fundamental component of our business plan is the use of project financing to fund, at least in part, our Smart Energy Matrix installations. The fact that we are only in
the early stages of deploying commercial systems makes it hard to obtain project finance. Additionally, the adverse conditions of the overall credit markets further complicate our ability to arrange
financing, at least in the near term. We

21

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have
little or no experience in obtaining financing for capital projects. We have applied and are in the due diligence phase of possible project financing of a large majority of the cost of our first
regulation installation. This financing would be part of the Department of Energy (DOE) loan guarantee program. There is no assurance that we will be successful in obtaining this loan or that the
timing will be in the period required for us to achieve our near-term business plan. In the event that we are not successful in obtaining the loan on a timely basis, it could have a
material adverse effect on our financial position.

The
funding we require may not be available on favorable terms, in particular in view of the current situation in the financial markets, if at all. Such funding may only be available on
terms that cause substantial dilution to common stockholders, and/or have liquidation preferences and/or pre-emptive rights. If we raise funds by issuing debt securities or equity
securities, existing stockholders may be adversely affected because new investors may have rights that are superior to current stockholders or through the dilutive effect of new equity securities on
current stockholders.

Our stock price, as well as the stock price of other companies in the energy sector, is likely to be volatile, and purchasers of our common stock could incur substantial
losses.

The market price of our common stock has historically been volatile, and may fluctuate significantly in response to multiple factors,
some of which are beyond our control. The stock market, in general, has recently experienced extreme volatility that has often been unrelated or disproportionate to the operating performance of
particular companies. These broad market fluctuations could result in significant movement in the price of our common stock, which may cause investors in our common stock to be adversely affected and
potentially incur substantial losses. The market price for our stock may be influenced by many factors, including:



Historically, the amount of frequency regulation required in the United States typically has been one percent of all power produced. If a reduction in this percentage
occurs, our business plan could be adversely affected.

Various regulatory organizations, such as FERC and the North American Electric Reliability Council (NERC), as well as the ISOs, oversee
the markets and can implement rules and regulations that may alter the percentage of frequency regulation required. Each ISO decides what amount of regulation it needs procure in order to meet NERCs
requirements. This can vary based on each ISOs evaluation of its region. We cannot predict how these organizations may act in the future, and if any given ISO decides to reduce its amount of
regulation procurement, it could have a material adverse effect on our business.

22

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Our business plan includes the design, development, construction and operation of frequency regulation installations in a variety of locations. Should we fail to execute any
of these tasks, it will have a material adverse effect on the Company.

We have designed, built and are currently operating a 1 MW installation in Tyngsboro under the ISO-NE pilot program, and
have previously built and successfully deployed both 2 kWh and 6 kWh flywheel systems in limited volumes. However, we are now transitioning from low rate initial production to
commercial-scale production of our Smart Energy Matrix Systems, and to be profitable, we will need to expand our manufacturing capabilities; expand our staff and management team; achieve
cost-reduction and engineering goals; obtain site interconnection approvals, landlord approval, or other zoning and construction approvals in a timely manner; obtain equity and project
finance; organize, develop,
finance, build and operate in a number of geographically-dispersed locations; and participate within the market rules of the open-bid markets. However, we have limited experience with such
a transition, or with deploying and operating large, multiple geographically-dispersed frequency regulation installations. If we are unable to execute these tasks, it will have a material adverse
effect on our profitability and could adversely affect our ability to continue as a going concern.

We have a history of losses, anticipate future losses and will have limited revenues in the near term. Unless we raise substantial additional capital to operate our
business, we may not be able to continue as a going concern. Even with the funds raised in 2008, our December 2008 cash balances are sufficient to fund operations only through approximately the second
quarter of 2009. And, although we entered into an equity financing arrangement with Seaside 88, LP in February 2009, that based on the current commitments will involve up to six monthly
investments in the Company of $1,000,000 each, only the first of these investments has occurred as of the date hereof.

We have incurred significant losses from operations since our inception. As shown in our consolidated financial statements, we incurred
significant losses from operations of approximately $23,839,000, $13,620,000 and $12,682,000 and operating cash decreases of approximately $13,859,000, $11,282,000 and $8,441,000 during the years
ended December 31, 2008, 2007 and 2006, respectively. Our business model is based on owning a number of 20 MW frequency regulation installations. Once we are in full-scale
production, our goal is to complete these installations at a cost of approximately $25 to $30 million each. However, the initial installations are expected to cost substantially more. To fund
these, we will need to raise substantial capital in 2009, 2010 and 2011. In the event that we are unable to raise capital or the timing is delayed, it will have a material adverse effect on our
ability to execute our business plan and could impact our ability to continue as a going concern.

Only
the first $1,000,000 of the funds covered by our February 2009 equity financing arrangement with Seaside 88, LP has actually been invested in the Company, with up to
$5,000,000 (in up to five $1,000,000 monthly closings) contemplated by the remaining current commitment not yet having been invested in the Company. Each such closing is subject to certain
customary conditions, as well as to the requirements that the formula price per share (based on a five day VWAP) yields at least $0.25 per share (pre-discount to Seaside) and that the
Company must disclose publicly any material inside information that has not been disclosed as of that time. Also, although the Company has the right to extend the agreement for up to two additional
six month tranches (each for up to $6,000,000) involving similar monthly closings, the Company has not yet exercised those two tranches.

We
had approximately $14,400,000 in cash and cash equivalents on hand at December 31, 2008. Based on our current cash usage rates and additional expenditures expected in support
of our business plan, we estimate that the December balance is adequate to fund operations only through the second quarter of 2009. In order to continue as a going concern and follow our business
plan, we will need to raise a significant amount of capital in 2009 in addition to the funds covered by the Seaside commitments.

23

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Miller
Wachman LLP, our independent auditors, have included an explanatory paragraph expressing uncertainty in their audit report on our consolidated financial statements for the
fiscal year ended December 31, 2008, which identifies our recurring losses and negative cash flows and raises substantial doubt about our ability to continue as a going concern.

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

We are dependent on third-party suppliers for materials and components used to manufacture our flywheels and build our Smart Energy Matrix installations.
Increases in purchase prices or decreases in availability of materials and commodities may affect our ability to achieve profitability. In particular, our systems require carbon fiber, steel and
aluminum, the cost of which may be impacted by the price and availability of oil and other factors.

We purchase components and commodities from third-party suppliers. Delays in availability or receipt of these items, or cost increases,
could negatively impact our ability to manufacture our flywheels, deploy our Smart Energy Matrix installations or become profitable. Certain commodities, such as carbon fiber, aluminum
and steel are basic elements of our flywheel systems. Some of these commodities have, in the past, been subject to shortages and price changes. Future shortages or price changes could impact our
ability to manufacture our flywheel systems in a timely manner and at a reasonable cost. Additionally, certain components which we purchase are technically difficult to manufacture, and suppliers may
have difficulty manufacturing products that meet our specifications and requirements. Although we have taken steps to establish at least two suppliers for our critical components, failure of a key
supplier to produce acceptable components on a timely basis could have a significantly adverse effect on our ability to execute our business plan. Further, there are no guarantees that, should we
receive additional funding that would allow us to accelerate our deployment schedule, our suppliers would be able to meet our accelerated production requirements, which would limit our ability to
accelerate our deployment. Certain components we use in our manufacturing process have lengthy lead times from order date to delivery at our facility.

Our competitive position could be impaired if we either fail to protect our intellectual property or infringe third-party patent rights.

We cannot provide assurance that we have or will be able to maintain a significant proprietary position on the basic technologies used
in our flywheel systems. Our ability to compete effectively against alternative technologies will be affected by our ability to protect proprietary technology, systems designs and manufacturing
processes. We do not know whether any of our pending 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 are
or will be sufficiently broad to protect our technology or processes from competitors. Even if all of our patent applications are issued and are sufficiently broad, they may be challenged or
invalidated. We have incurred substantial costs in prosecuting or defending patent infringement suits, and such suits have diverted funds and resources that could have been used in our business.
Although the Arete claim has been settled, we do not know if we will be completely successful in safeguarding and maintaining our proprietary rights in the future.

24

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Further, our competitors or others may independently develop or patent technologies or processes that are substantially equivalent or 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 patents on acceptable terms, if at all. Even if we were able to obtain a license, the rights may be
nonexclusive, which could result in our competitors gaining access to the same intellectual property, and/or we may be required to pay license fees, royalties and/or other amounts. Failure to obtain
needed licenses could delay or prevent the development, manufacture or sale of our systems, and lead to materially adverse effects on the Company, including ceasing some aspects of our business.

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

Government regulation may impair our ability to market our products.

Government regulation of our services, whether at the federal, state or local level, including any change in regulations, tariffs or
zoning, may increase the cost of our services or decrease our revenue, and may have a negative impact on our profitability. We cannot provide assurance that our services will not be subject to
existing or future federal, state and local regulations governing traditional electric utilities and other regulated entities. We expect that our Smart Energy Matrix installations will be
subject to oversight and regulation at the local level in accordance with state and local ordinances relating to building codes, environmental, safety and related matters. We do not know the full
extent to which current or future regulations may affect our ability to build and operate our systems.

In
addition, if regulatory modifications change the structure of the markets, such modifications could adversely affect our business plan. If the market rules change in the future or
current modifications being developed as a result of FERC Rule 890 are not implemented, we may be required to change our business plan and there can be no assurance that we will be successful
in doing so.

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

As of December 31, 2008, there were outstanding options to purchase an aggregate of 11,338,470 shares of our common stock
at prices ranging from $0.26 per share to $9.31 per share, of which options to purchase 8,395,766 shares were exercisable as of such date. As of December 31, 2008, there were outstanding
warrants to purchase 46,932,939 shares of our common stock, of which 29,096,143 were exercisable as of December 31, 2008.

The
exercise of options and warrants at prices below the market price of our common stock could adversely affect the price of our common stock. Additional dilution may result from the
issuance of shares of our common stock in connection with collaborations or manufacturing arrangements or in connection with financing efforts.

Our financial performance could be adversely affected if we are unable to retain key executive officers.

Our future success and our ability to effectively implement our business plan depends to a large degree on the management provided by
the executive officers and thus on our ability to retain members of our executive team, which are: Mr. Capp, CEO and President; Mr. Spiezio, Vice President of Finance, Chief Financial
Officer, Treasurer and Secretary; and Mr. Lazarewicz, Vice President and Chief Technical Officer. There can be no assurance that we will be successful in retaining our executive officers. On
February 12, 2008, we entered into employment agreements with our executive officers

25

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which
continue until March 31, 2009, unless renewed or terminated. Additional agreements providing for long-term incentive compensation consisting of vesting-based Restricted Stock
Units (RSUs) and stock options were also dated February 12, 2008. Our Compensation Committee is currently working towards the completion of new executive agreements for these individuals to
take effect April 1, 2009, although there is no certainty that such agreements will be completed by that date or at all. Under the terms of the expiring executive contracts, the executives will
have the right to terminate employment at any time and receive the compensation and benefits defined in the employment agreements for non-renewal.

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

Our future success also depends to a large degree on the technical skills of our engineering staff and our ability to attract key
technical personnel. Competition for hiring skilled technical professionals can be intense. We may not be successful in attracting and retaining the talent necessary to design, develop and manufacture
our systems and deploy and operate our frequency regulation installations.

We currently purchase certain components for our flywheels from companies outside of the United States. Further, although our initial target market is within the United
States, we expect to expand our business to other countries in the future. Engaging in business outside of the United States exposes us to a variety of risks related to the specific countries in which
we may operate.

Engaging in business outside of the United States may expose us to a variety of risks, which include:



Due
to the risks shown above, there is no guarantee that we would succeed in expanding and operating our business in countries outside of the United States. Failure to adequately address
these risks could potentially have a material adverse effect on our Company.

26

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If our Smart Energy Matrix systems were to malfunction and/or cause damage, we could be subject to possible product liability claims for both damages and fines
that exceed our liability insurance coverage. Additionally, our stock price could drop as a result of negative publicity from such claims.

We have incorporated technical features in our flywheel systems that are designed to ensure that a failure will not result in any
significant damage, including secondary damage to the electrical grid. However, our Smart Energy Matrix is a complex system, and errors may occur during the manufacturing or installation
process. Should a failure take place, we may incur substantial costs to repair or replace the defective equipment. In addition, failures may result in product liability claims against us. Liability
claims may also be filed against us which have no merit, but which may require us to expend significant resources defending ourselves. Such claims, valid or not, could result in negative publicity.
This could have a materially adverse effect on our business and shareholder value.

Economic conditions could negatively impact our business.

Our operations are affected by local, national and worldwide economic conditions. A reduction in economic activity and uncertainty in
energy prices and the capital and commodities markets could result in a decline in energy consumption, which could adversely affect our revenue and future growth. Instability in the financial markets,
exacerbated by insufficient financial sector liquidity or other economic factors, could also affect our stock price, the cost of capital and/or our ability to raise capital.

Competitors in the frequency regulation market include established utilities, independent service providers and alternative energy storage technology companies with far
greater resources than we have.

The frequency regulation services market is being served by well-known utilities and independent service providers that use
conventional generators. In addition, there are emerging energy storage technologies that have also begun providing this service. Most of these competitors have far greater financial and technical
resources than we do.

We have anti-takeover defenses that could delay or prevent an acquisition and changes in control that could adversely affect the price of our common stock.

Provisions of our certificate of incorporation, by-laws, Rights Agreement and Delaware law may have the effect of deterring
unsolicited takeovers or delaying or preventing changes in control of management, including transactions in which our stockholders might otherwise receive a premium for their shares over then current
market prices. In addition, these provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interest.

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

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



27

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These
provisions make it more difficult for our stockholders to change the composition of the board of directors, as well as approve transactions they may deem to be in their best
interests but that are not approved by the board of directors.

Pursuant
to a Rights Agreement, dated as of September 25, 2002, between the Company and Computershare Trust Company, N.A. (fka Equiserve Trust Company, N.A.), as Rights Agent, as
subsequently amended, 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 directors acquires more than 15% of our outstanding common stock, or in the event of an acquisition by another company,
$22.50 worth of the common stock of the other company at half its market value (in each case the rights held by the acquiring person are not exercisable and become void). The Rights Agreement, as
amended, may have the effect of discouraging a third party from making an offer to acquire us without the support of our Board of Directors, even if such an offer would be at a premium to the market
price of our common stock at the time.

Our stock may be removed from The Nasdaq Stock Market.

On March 10, 2009, our stock closed at $0.42 per share and has closed below $1.00 per share on a daily basis since
November 4, 2008. Due to the current conditions in the capital markets, Nasdaq has temporarily suspended their minimum bid price requirement for continued listing on the Nasdaq Stock Market.
However, once the minimum bid price requirements are reinstated, if our stock price does not meet the minimum price required, we may be subject to delisting from the Nasdaq Stock Market, pursuant to
Nasdaq Marketplace Rule 4310(c)(4). Once notified that we are not in compliance, we will be provided 180 calendar days to regain compliance or face delisting. To attain compliance, our common
stock must close at $1.00 per share or more for a minimum of ten consecutive days before the specified date. In the event that our stock does not meet this requirement, but meets the requirements for
initial inclusion on the Nasdaq Stock Market as set forth in Marketplace Rule 4310(c), we may be granted an additional 180 calendar day period to regain compliance. There can be no assurance
that we will continue to meet the Nasdaq Stock Market's listing requirements and therefore may lose our eligibility for quotation on the Nasdaq Stock Market. Should our stock lose its eligibility to
be quoted on the Nasdaq Stock Market, we will seek to have our stock quoted on the OTCBB. While we know of no reason that our stock will not be accepted for quotation on OTCBB, we cannot guarantee
that acceptance.

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

In January 2008, we relocated our principal executive offices, research and development, and manufacturing facilities from Wilmington,
Massachusetts to a new corporate headquarters located at 65 Middlesex Road, Tyngsboro, Massachusetts. This 103,000 square foot facility, which has been renovated to meet our needs, is
operated under a lease that expires in September 2014, with options to renew for two additional seven-year periods. The facility has a potential capacity for the production of more
than 1,000 flywheels per year, although based on the manufacturing build-out thus far, that capacity is currently 600 flywheels per year. We have purchased land in
Stephentown, New York, in

28

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anticipation
of building our first 20 megawatt frequency regulation facility on that site. In addition, we are evaluating several other possible locations for future Smart Energy
Matrix installations.

Item 3.    Legal Proceedings

On October 9, 2007, Arete Power, Inc. filed a complaint against the Company, claiming damages from alleged willful
infringement of U.S. Patent No. 6,710,489, entitled "Axially Free Flywheel System." On November 21, 2008, Beacon and Arete reached a settlement that ends the litigation and includes an
assignment of the '489 Patent to Beacon with a limited license back to Arete. The settlement also includes a covenant not to sue, whereby Arete Power has agreed not to bring any new complaint against
Beacon alleging infringement of Arete's other flywheel patents. There are no legal proceedings pending.

Item 4.    Submission of Matters to a Vote of Security Holders

None

PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is quoted on the NASDAQ Capital Market under the symbol "BCON". The following table sets forth the high and low sales
price of the common stock for the periods indicated.

High

LowTwelve months ended December 31, 2008Fourth Quarter

$
1.37

$
0.51Third Quarter

$
1.95

$
1.11Second Quarter

$
2.15

$
0.98First Quarter

$
1.61

$
0.84Twelve months ended December 31, 2007Fourth Quarter

$
2.32

$
1.42Third Quarter

$
2.29

$
1.35Second Quarter

$
1.26

$
0.77First Quarter

$
1.21

$
0.76


On
March 10, 2009 the last reported sale price of our common stock on the NASDAQ Capital Market was $0.42 per share, and there were 290 holders of record of common stock. The
number of record holders does not include holders of shares in "street name" through brokers.

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

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

There was no stock repurchase activity in 2008.

29

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Item 6.    Selected Consolidated Financial Data

The following selected financial data should be read together with "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the financial statements, including the related notes, found elsewhere in this Form 10-K. The tables that follow present selected historical financial
data for the years ended December 31, 2008, 2007, 2006, 2005 and 2004 and for the period from May 8, 1997, the date of Beacon's inception, through December 31, 2008.

Period from
May 8, 1997
(date of inception)
through December 31,
2008Twelve months ended December 31,2008

2007

2006

2005

2004(in thousands, except per share data)Consolidated Statements of Operations Data:Revenue

$
68

$
1,389

$
969

$
1,487

$
325

$
4,789Cost of goods sold


53


1,248


845


1,575


1,458


5,179Gross profit


15


141


124


(88
)

(1,133
)

(390
)Operating expenses:Selling, general and administrative


7,074


5,876


6,508


6,334


4,197


58,049Research and development


15,398


8,387


4,748


1,408


3,532


83,816Loss on contract commitments


86


(578
)

1,385


1,535





2,803Depreciation and amortization


1,295


145


96


83


187


5,757Casualty loss (recovery)





(69
)

69








Restructuring charges

















2,159Loss on impairment of assets

















4,664Total operating expenses


23,853


13,761


12,806


9,360


7,916


157,248Loss from operations


(23,838
)

(13,620
)

(12,682
)

(9,448
)

(9,049
)

(157,638
)Interest and other income (expense), net


270


702


519


136


3,719


7,750Net loss


(23,568
)

(12,918
)

(12,163
)

(9,312
)

(5,330
)

(149,888
)Preferred stock dividends

















(36,826
)Accretion of redeemable convertible preferred stock

















(113
)Loss to common shareholders

$
(23,568
)
$
(12,918
)
$
(12,163
)
$
(9,312
)
$
(5,330
)
$
(186,827
)Loss per share, basic and diluted

$
(0.26
)
$
(0.18
)
$
(0.21
)
$
(0.20
)
$
(0.12
)Shares used in computing net loss per share, basic and diluted


90,866


73,604


59,080


47,666


43,453


30

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As of December 31,2008

2007

2006

2005

2004(in thousands)Balance Sheet Data:Cash and cash equivalents

$
14,357

$
30,417

$
5,251

$
13,890

$
5,097Working capital


6,501


28,820


3,310


13,223


4,213Total assets


38,596


39,778


7,258


16,126


7,086Long term debt


4,122











Total stockholders' equity


25,612


36,198


3,900


13,655


5,110


Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operation

The following discussion of our financial condition and results of operations should be read in conjunction with our financial
statements, the notes to those financial statements and other financial information appearing elsewhere in this document. In addition to historical information, the following discussion and other
parts of this document contain forward-looking statements that reflect plans, estimates, intentions, expectations and beliefs. Actual results could differ materially from those discussed in the
forward-looking statements. See "Note Regarding Forward-Looking Statements." Factors that could cause or contribute to such differences include, but are not limited to, those set forth in the "Risk
Factors" in Item 1A and contained elsewhere in this Form 10-K.

Overview

We completed the move to the Tyngsboro facility in January 2008, and we have completed the first phase build-out of
our manufacturing facility. We now have a facility capable of producing up to 600 flywheels per year. We have a second phase manufacturing build-out planned which will increase the
annual manufacturing capacity to more than 1,000 flywheels.

On
November 18, 2008, we began to provide 1MW of frequency regulation service through the ISO-NE Pilot Program. Our 1MW system has been performing with more than 90%
average availability since January 1, 2009, and is earning revenue from frequency regulation services. The revenue we have earned so far is lower than originally anticipated due to the type of
signal being transmitted to us by the ISO, which does not optimize our fast response capability and so results in lower "mileage" payments than expected. We are working with ISO-NE to send
a regulation signal that would utilize our technology's fast response capability, which would not only maximize benefits to the grid, but would also increase our mileage revenue.

The
control signaling employed by the New York and California ISOs to operate our flywheels in our 2006/2007 technology demonstration programs operated the systems at multiple levels
over their entire performance range. This control method required the flywheels to respond proportionally to variable imbalances between electricity supply and demand. In contrast, ISO New England has
been operating Beacon's system using a non-proportional, trinary signal. The trinary control method requires the system to be in one of three stateseither fully charging,
neutral, or fully discharging. We have found that the trinary method of operation does not fully utilize the performance capabilities of the flywheel system, and it causes the flywheels to operate at
a higher temperature than the proportional control method. To compensate for ISO New England's current control method, the 1 MW system has occasionally been operated at a slightly lower overall
output, pending a refinement of the motor-generator design. During the first quarter of 2009, initial testing on the redesigned motor-rotor was favorable, and is now being implemented.

Additionally,
under the current market rules, we are not eligible for "opportunity cost" payments. Such payments comprise approximately one-third of the revenue received by
conventional regulating generators. Opportunity cost payments are provided to conventional regulating generators to

31

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compensate
them for lost revenue as a consequence of providing regulation rather than conventional power generation. We are working with ISO-NE to develop permanent market rules that would
provide an additional payment component that will be approximately equal to opportunity cost. The trend at other ISOs has been to incorporate features in their tariffs that intrinsically compensate
energy storage providers for opportunity cost.

Additionally,
our operational costs for the Pilot Program are higher than expected for future implementations. Our connection to the grid was made through National Grid distribution
lines, rather than directly to the ISO through transmission lines, due to cost and time factors. Consequently, we have had to pay retail rates for the energy we take off the grid and store on our
flywheel system, but we are paid at wholesale rates when that same energy is returned to the grid. National Grid and ISO-NE have agreed to change the metering to "net metering" which
should significantly reduce our costs going forward. We have also incurred higher labor costs related to monitoring the system, especially during the initial weeks. Those costs are also expected to
decrease as we and the ISO gain experience with the system and make minor changes that allow it to respond better to the ISO's control signal. However, although our cost of energy and other operating
costs are expected to decrease, we still do not expect to be able to operate profitably in the ISO-NE region until the revenue factors discussed earlier are addressed.

Our
2008 business plan was to deploy up to 5 MW in ISO-NE under its Alternative Technologies Pilot program. Due to uncertainty and volatility in the equity markets, we
modified our business plan during the fourth quarter of 2008 to ensure sufficient cash reserves into the first quarter of 2009. This combined with delays in utility interconnection work as a result of
severe winter weather and the analysis and refinement of the motor-generator, resulted in a reduction in the number of megawatts we deployed in ISO-NE by the end of 2008 to one MW.

Due
to the economics of the northeastern market, several megawatts of capacity originally planned for the ISO New England Pilot Program will instead be deployed to our site in
Stephentown, New York, and to a second site in the PJM Interconnection. This will allow us to gain bidding and operations experience in two additional regulation markets and broader visibility
as a regulation service provider. The New York system will be interconnected to NYSEG, a major state utility with which we have already entered into an interconnection agreement. The New York ISO is
expected to open the market for energy storage-based regulation services by mid-2009.

On
February 23, 2009, we announced that we had signed a contract with American Electric Power (AEP) and one of its operating subsidiaries, Columbus Southern Power Company, to
build a 1 MW Smart Energy Matrix installation at an AEP site in Groveport, Ohio. The system, which
will be connected to the grid within the operating region of the PJM Interconnection (PJM), will provide commercial revenue from the provision of frequency regulation services. AEP will provide the
site and certain integration services in support of the project, and have an opportunity to gain in-depth knowledge about the performance of our system and its impact on frequency
regulation and grid stability. The agreement calls for us to deliver, install, test and operate, at our expense, a 1 MW Smart Energy Matrix. AEP will provide and /or install materials and
services needed to interconnect our system to PJM, including the foundation, electrical transformer, associated wiring and connection to power lines. AEP has already completed the necessary system
impact study and executed an interconnection agreement. Installation of the Smart Energy Matrix is scheduled to begin in mid-year 2009.

We
need to obtain additional cash during 2009 to 2011 to fund:



32

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By
the end of 2009, we expect to have a total of 7 MW of capacity in service, between the Tyngsboro, Stephentown and Ohio sites. Although we have sufficient cash to fund operations
through the second quarter, we estimate that we will need to raise approximately $30 million during 2009 to fund our business plan and have sufficient working capital to continue to order
long-lead items needed for our 2010 production plan. We could deploy frequency regulations systems faster than contemplated by our current plan should additional funding become available,
e.g., through the DOE loan guarantee program or otherwise.

As
part of our new business development, we may evaluate possible acquisitions of enterprises or technologies that we would consider synergistic from a market, technology or product
perspective.

From
inception through December 31, 2008, we have incurred losses of approximately $186.9 million. We expect to continue to incur losses as we expand our product
development and begin to increase our manufacturing capacity.

Revenue

Our
revenue during 2008 came from three sources:



Our
business plan anticipates earning revenue primarily from the provision of frequency regulation service and potentially from the sale of our Smart Energy Flywheel systems. However, in
the past, we have earned revenue from research and development contracts with government agencies, and we continue to pursue similar contracts. In 2007 we derived approximately 95% of our revenue from
our research and development contracts; two of those contracts accounted for 84% of our total revenue. In 2008, since most of our development contracts were completed in 2007, our revenue was
substantially less than in 2007, and less than 18% of our revenue was derived from our research and development contracts. In addition, we have a small inventory of inverters and accessories that we
sell, although that revenue is insignificant.

Cost of Goods Sold

Cost of goods sold on fixed price research and development contracts are predominantly being recorded on the
percentage-of-completion method and consist primarily of direct labor and material, subcontracting and associated overhead costs. Cost of goods sold for frequency regulation
services consists of the cost of energy. Cost of goods sold does not reflect the true cost of any inverter sales, because our inverter inventory was fully written-off during a prior year.

Selling, General and Administrative Expenses

Our sales and marketing expenses consist primarily of compensation and benefits for sales and marketing personnel and related business
development expenses. Sales and marketing expenses have increased as we have expanded our regulatory activity aimed towards the modification of market rules

33

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to
facilitate our participation in the regulation services market. General and administrative expenses consist primarily of compensation and benefits related to our corporate staff, professional fees,
insurance and travel. In 2008, our selling, general and administrative expenses increased by approximately 20% over the same period in 2007, primarily due to increased legal and professional fees
associated with regulatory activity and continued work on the DOE loan program; higher compensation costs due in part to the hiring of a Director of Regulatory and Market Affairs and a Director of
Human Resources and higher equity-based compensation costs; and increased use of subcontractors and consultants. Our selling, general and administrative expenses for 2007 were approximately 10% lower
than during the same period during 2006, due primarily to a reduction in public company expenses, reduced use of subcontractors and consultants, lower stock compensation expense as a result of fewer
new hire option grants and a lower Black Scholes fair value for options issued during the early portions of the fiscal year and allocation of a portion of our general and administrative expenses to
our Government contracts. These reductions in cost were partially offset by slight increases in salaries and benefits resulting from new hires. Overall, we expect our selling, general and
administrative expenses fo fiscal 2009 to be lower than in 2008 primarily due to lower legal costs and other planned cost reductions.

Research and Development

Our cost of research and development includes the cost of unabsorbed manufacturing overhead since our flywheel production department is
not yet running at full capacity, the cost of compensation and benefits for research and development staff, as well as materials and supplies used in the engineering design and development process. In
2005, we began development efforts on our Smart Energy 25 flywheel system. In 2008, we substantially completed development of the Smart Energy Matrix and began limited production of
commercial units and building our first frequency regulation installations. Research and development costs have increased considerably from 2005 through 2008. Our research and development costs during
2008 were approximately 84% higher than during the same period in 2007, due to legal and professional fees associated with the Arete litigation, higher material costs, higher salary and benefit costs
related to headcount increases to support engineering development and testing as well as manufacturing, higher facility costs and moving expenses and increased use of consultants and contractors. In
2008, we worked to develop at least two suppliers capable of producing each component of the Smart Energy Matrix and, consequently, we incurred substantial tooling and material costs,
some of
which was paid on a "best efforts" basis to suppliers who have not yet been able to meet our specifications. These costs were expensed. We also expensed approximately $1,385,000 for material, outside
contractors, labor, overhead and interest related to the construction of the non-fungible portions of the system outside our Tyngsboro location for the ISO-NE pilot program.

We
expect research and development expenses in 2009 to be lower than in 2008 due to lower legal costs, along with lower expense material and subcontractor costs.

Loss on Contract Commitments

In 2007, we completed all but one of our existing contracts at a lower cost than had been previously expected, and recorded a credit
against previously recognized contract losses of approximately $578,000. In April 2008, we were awarded a subcontract to provide a flywheel energy storage system in support of a wind integration
research and development project in Tehachapi, California, sponsored by the California Energy Commission. We will receive approximately $250,000 to offset R&D expenses and will contribute an
additional $87,000 of engineering resources for the project, bringing the R&D total to approximately $337,000. Accordingly, we recorded a charge of approximately $87,000 to the contract loss reserve
during 2008 to reflect the expected "cost share" portion of the Tehachapi contract.

34

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Depreciation and Amortization

Our depreciation and amortization is primarily related to depreciation on capital expenditures and the amortization of lease and
leasehold costs related to our facilities. Depreciation expense will increase substantially in future periods as we build and deploy our frequency regulation installations.

Interest and Other Income/Expense, net

In 2008, 2007 and 2006, non-operating income consisted primarily of interest income resulting from cash on hand.
Approximately $300, $10,000 and $18,000 were received in 2008, 2007 and 2006, respectively, in settlement of a class action suit relating to unfair practices engaged in by certain insurance brokerage
firms. A loss of approximately $100 and a gain of approximately $3,000 related to the sales of fixed assets were recognized in 2008 and 2007, respectively. Interest expense in 2008 related to the
MassDev loan.

Critical accounting policies and estimates

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

Revenue Recognition

Although we have shipped products and recorded contract and frequency regulation service revenues, our operations have not yet reached
a level that would qualify us to emerge from the development stage. Therefore we continue to be accounted for as a development stage company under Statement of Financial Accounting Standards
No. 7, "Accounting and Reporting by Development Stage Enterprises."



35

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Loss on Contract Commitments

Our contracts have been primarily for the development of demonstration units of new products or the design of a frequency regulation
facility. As such, the work has supported our core research and development efforts. We establish reserves for anticipated losses on contract commitments if, based on our cost estimates to complete
the commitment, we determine that the cost to complete the contract will exceed the total expected contract revenue. Most of our contracts have been granted on a cost-share basis, for
which the expected cost-share is recorded as a contract loss. Additionally, each quarter we perform an evaluation of expected costs to complete our in-progress contracts and
adjust the contract loss reserve accordingly.

Inverter Inventory Valuation

We value our inventory at the lower of actual cost or the current estimated market value. We regularly review inventory quantities on
hand and record a provision for excess and obsolete inventory.

We
have a limited amount of inventory related to our inverter product line, for which reserves were recorded in prior years. These impairment charges were made due to the uncertainty of
realizing any future value from the inventory due to the lack of substantial revenues to date from our inverter product line. Accordingly, for the years ended December 31, 2008, 2007 and 2006,
the value of our inverter product line inventory was fully-offset by these reserves.

Patent Costs

We capitalize external legal costs incurred in the defense of our patents where we believe it is likely that the patent has a future
economic value to us. We monitor the legal costs incurred and the anticipated outcome of the legal action and, if changes in the anticipated outcome occur, capitalized costs will be adjusted in the
period the change is determined. Patent costs are amortized over the remaining life of the patents. We own intellectual property in the form of patents on our flywheel vacuum system, our heat pipe
cooling systems, direct current output paralleling, metal hub, low-loss motor, co-mingled rims and earthquake-tolerant bearings on our flywheel products, and
anti-islanding software, drawings, source code, and production know-how on our inverter products, and expect to obtain other patents during 2009 and beyond. In December 2004,
we recorded impairment charges to write down our capitalized patent costs to zero, due to the lack of substantial revenues to date and the uncertainty of realizing any future value from these patents.
Accordingly, all costs incurred since 2004 related to the development of intellectual property were expensed as incurred. However, as we have now begun to commercialize our technology, going forward
legal costs associated with obtaining patents

36

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which
we expect to have future commercial value will be capitalized and amortized over the life of the patent. We review our intangible assets periodically for impairment, and record impairment
reserves as appropriate.

Warranty Reserves

The solar inverters we have sold carry warranties that require us to repair or replace defective products returned to us during the
applicable warranty period at no cost to the customer. We record an estimate for warranty-related costs based on actual historical return rates, anticipated return rates and repair costs at the time
of sale.

Should
we sell our Smart Energy Matrix systems in the future, it is likely that the terms of sale will include a warranty. In that event, we will estimate the repair costs
under the terms of the warranty, and record an initial provision for warranty costs that we will adjust periodically based on actual results and anticipated future costs at that time.

Income Taxes

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

Significant
management judgment is required in determining the provision for income taxes, the deferred tax assets and liabilities and any valuation allowance recorded against deferred
tax assets. The valuation allowance is based on our estimates of taxable income and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from
these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance or reduce our current valuation allowance which could materially impact our
tax provision. We classify interest and penalties relating to uncertain tax positions in income tax expense.

Property and Equipment

Property and equipment in service is stated at cost and depreciated using the straight-line method over the estimated
useful lives of the assets. Property and equipment are defined as tangible items with unit costs exceeding our capitalization threshold that are used in the operation of the business, are not intended
for resale and which have a useful life of one year or more. The cost of fixed assets is defined as the purchase price of the item, as well as all of the costs necessary to bring it to the condition
and location necessary for its intended use. These costs include labor, overhead, capitalized interest and, if applicable, exit costs. Exit costs for which we are obligated are accounted for in
accordance with SFAS No. 143, "Accounting for Asset Retirement Obligations." No overhead is generally applied for internally-constructed projects
not directly related to our core business (e.g., leasehold improvements.) Repair and maintenance costs are expensed as incurred. Materials used in our development efforts are considered
research and development materials, and are expensed as incurred in accordance with Statement of Financial Accounting Standards No. 2 "Accounting for Research and
Development Costs."

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

Materials
purchased to build flywheels, power electronics and other components used in our frequency regulation installations are classified as CIP, along with the related labor and
overhead costs. Some components of the Smart Energy Matrix, such as the flywheels and power electronics, are

37

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considered
"fungible" in that they can be moved and redeployed at a different location. Other costs are sunk costs which would not be recovered if we redeployed the matrix or portions thereof. In some
cases, we may elect to deploy a Smart Energy Matrix system at a location for the purpose of demonstrating our technology or gaining experience operating in that particular market. In
these instances, the costs of the fungible components are capitalized, and the remaining costs, which may include such costs as site preparation, interconnection costs, capitalized interest and
estimated exit costs, are expensed.

Impairment of Long-Lived Assets

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

In
certain instances, we may determine that it is in the best interest of the Company to re-deploy all or part of a Smart Energy Matrix system installed at a
given location. When such a determination has been made, we will determine which costs are associated with the movable (fungible) components, and which costs are non-fungible. We will
record a period expense for the net book value not associated with the fungible components.

Based
on our annual analysis, no asset impairment charges were considered necessary for 2007 or 2008. Certain long-lived assets were damaged in December 2006 and we
recognized an asset impairment charge of approximately $18,600 in 2006.

Other assets and deferred financing costs

We will defer our direct costs incurred to raise capital or to acquire an entity in a business combination. Direct costs include only
"out-of-pocket" or incremental costs directly related to the effort, such as a finder's fee and fees paid to outside consultants for accounting, legal or engineering
investigations or for appraisals. These costs will be capitalized if the efforts are successful, or expensed when unsuccessful. Indirect costs are expensed as incurred.

Advance billings on contracts

We may receive performance-based payments and progress payments from customers which may exceed costs incurred on certain contracts,
including contracts with agencies of the U.S. Government. Such advances are classified as current liabilities.

Accounting Pronouncements

Recently Adopted Accounting Pronouncements

We adopted Statement of Financial Accounting Standard (SFAS) No. 157, "Fair Value
Measurements," which we adopted effective January 1, 2008, and the following related accounting guidance:



38

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SFAS
No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the
measurement date. SFAS No. 157 establishes criteria to be considered when measuring fair value and expands disclosures about fair value measurements. The determination of fair value sometimes
requires subjective and complex judgment. We did not elect the fair value option for any of our financial assets or liabilities. Therefore, SFAS No. 157 did not have an impact on our financial
statements.

Recently Issued Accounting Pronouncements and Regulations

In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting
Principles." SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements
of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. We do not expect any significant changes to our financial accounting
and reporting as a result of the issuance of SFAS No. 162.

In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activitiesan amendment of SASB Statement
No. 133." SFAS No. 161 requires enhanced disclosures about an entity's derivative and hedging activities. Entities will be required to provide enhanced
disclosures about how and why an entity uses derivative instruments, how these instruments are accounted for, and how they affect the entity's financial position, financial performance and cash flows.
This new standards is effective for our Company as of January 1, 2009. We do not expect any
significant impact on financial accounting or reporting as a result of adoption of this new accounting standard.

In
December 2007, the FASB issued SFAS No. 141R, "Business Combinations". The objective of SFAS No. 141R is to improve the
relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. SFAS
No. 141R retains the purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in purchase accounting.
It also changes the recognition of assets acquired and liabilities assumed arising from contingencies, requires the capitalization of in-process research and development at fair value, and
requires the expensing of acquisition-related costs as incurred. SFAS contains disclosure requirements which are intended to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. SFAS No. 1414R is effective for our Company as of January 1, 2009. We currently do not expect any significant impact on our results of
operations, financial position or cash flows as a result of the adoption of this new accounting standard. However, the adoption of SFAS No. 141R will impact the accounting for any business
combinations occurring subsequent to December 31, 2008.

In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB
No. 51." The objective of SFAS No. 160 is to improve the relevance, comparability and transparency of the financial information that a reporting entity provides
in its consolidated financial statements by establishing accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS
No. 160 is effective for our company as of January 1, 2009. We do not expect any significant impact on financial accounting or reporting as a result of adoption of this new accounting
standard.

39

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In December 2007, the FASB issued EITF 07-01, "Accounting for Collaborative Agreements." EITF 07-01
provides guidance regarding financial statement presentation and disclosure of collaborative arrangements, which includes arrangements entered into regarding development and commercialization of
products. It requires certain transactions between collaborators to be recorded in the income statement on either a gross or net basis when certain characteristics exist in the collaborative
relationship. EITF is effective for our Company as of January 1, 2009. The adoption of EITF 07-01 will not have an effect on our financial condition or our net loss. However,
the adoption of EITF 07-01 may have an effect our accounting for any collaborative arrangements we may enter into in the future.

Results of operations

Comparison of Year ended December 31, 2008 and 2007

Twelve months ended December 31,2008

2007

$ Change

% Change(in thousands)Revenue

$
68

$
1,389

$
(1,321
)

95
%Cost of goods sold


53


1,248


1,195


96
%Gross margin


15


141


(126
)

89
%Selling, general and administrative


7,074


5,876


(1,198
)

20
%Research and development


15,398


8,387


(7,011
)

84
%Loss on contract commitments


86


(578
)

(664
)

115
%Depreciation and amortization


1,295


145


(1,150
)

793
%Casualty loss (recovery)





(69
)

(69
)

100
%Interest and other income (expense), net


270


702


(432
)

62
%Net loss

$
(23,568
)
$
(12,918
)
$
(10,650
)

82
%


Revenue

The following table provides details of our revenues for the twelve months ended December 31, 2008 and 2007.

Twelve months
ended
December 31,

Cumulative
Contract
Value
Earned as
of 2008Percent
complete

Total
Contract
Value

Remaining
Value
(Backlog)2008

2007(dollars in thousands)CEC


100
%
$


$
78

$
1,233

$
1,233

$
NYSERDA PON 846


100
%




81


646


646


NYSERDA PON 800


83
%

3


(1
)

54


63


9Air Force Research Laboratory


100
%




488


750


750


Sandia DOE Earmark


100
%




677


752


752


Tehachapi


4
%

9





9


250


241Total Contract Revenue




$
12

$
1,323

$
3,444

$
3,694

$
250Frequency regulation revenue





10


M5 and accessories





46


66Total




$
68

$
1,389

$
3,444

$
3,694


40

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In
2008, we focused on completing development of the Smart Energy Matrix, manufacturing our initial commercial flywheels, and building our first frequency regulation
facility in Tyngsboro aimed at entering the ISO-NE pilot program in November 2008. We earned approximately $10,000 in revenue from the pilot program during 2008. This amount is not
representative of the amounts we expect to earn going forward, due to a number of factors. Most of our research and development contacts were completed in 2007. Consequently, contract revenue dropped
from approximately $1,323,000 in 2007 to $12,000 in 2008. In addition, we recorded revenue of approximately $46,000 from the sale of Smart Power M5 inverter systems and related products,
compared to approximately $66,000 in 2007. In 2009, we expect both frequency regulation and contract revenue to increase, due to the deployment of additional capacity of frequency regulation and the
Navy contract awarded early in 2009.

Cost of Goods Sold

Cost of goods sold decreased from approximately $1,248,000 in 2007 to approximately $53,000 in 2008. Cost of goods sold represents
approximately $12,000 for research and development contracts calculated on the percentage of completion method. Year over year, the reduction in cost of sales associated with contracts was
proportional to our reduction in contract revenue. Cost of goods sold also includes approximately $41,000 for the cost of energy associated with the generation of frequency regulation revenue under
the ISO-NE Pilot program. Cost of energy exceeded revenue from frequency regulation because of the manner in which we were connected to the grid for the pilot program, which resulted in
our being paid for energy we provided to the grid at wholesale rates, but we were billed for the energy we used at retail rates. We have reached an agreement with ISO-NE and our service
provider to change the metering to a "net meter" through ISO-NE during 2009, which we expect will reduce our energy costs in 2009. However, total energy costs for 2009 will be higher than
in 2008 since the energy costs for 2008 represent the cost related to 1 MW of capacity for a only six-week period. In 2009, we expect to be providing more frequency regulation service
capacity over a longer period of time than occurred in 2008.

Selling, general and administrative expenses

Twelve months
ended
December 31,

Comment(in thousands)Period Ended December 31, 2007

$
5,876Increases (decreases):Legal and professional


966

Increase due primarily to regulatory efforts and costs associated with the DOE loan and MassDev loan programs.Salaries and benefits


792

Increase due to increased headcount, specifically in the regulatory and human resource areas, and increased cost of benefits such as health insurance.Subcontractors and consultants


285

Increased use of consultants for regulatory efforts associated with market rule changes and site selection for frequency regulation facilities.


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Twelve months
ended
December 31,

Comment(in thousands)Allocation of overhead to contracts


158

Only one contract has allowed us to charge General and Administrative overhead, and that contract was completed in 2007. Since overhead allocated to contracts appears as a credit to the Selling, General and Administrative
expense (SG&A), the loss of this credit results in an increase in SG&A expense.Stock compensation expense


(1,055
)
Decrease due to reversal of stock compensation related to officer performance-based RSU grant for which management no longer believes it is probable that the performance requirements will be met.Other


52

Other includes general business expenses that were generally higher due to increased activity.Period Ended December 31, 2008

$
7,074


Selling,
general and administrative expenses totaled approximately $7,074,000 and $5,876,000 for the years ended December 31, 2008, and 2007, respectively, which represents an
increase of approximately $1,198,000, or 20%, year over year. Significant changes in spending are explained in the table shown above. Overall, we expect our selling, general and administrative
expenses for fiscal 2009 to be lower than in 2008 primarily due to lower legal costs and other planned cost reductions.

Research and development expenses:

Twelve months
ended
December 31,

Comment(in thousands)Period Ended December 31, 2007

$
8,387Increases (decreases):Expense materials


2,352

Includes tooling and other non-recurring expenses associated with qualifying suppliers for production, including write-offs for "best effort" attempts and the cost of some non-conforming product we received from
suppliers. Also includes cost of certain materials used to build portions of the Smart Energy Matrix outside our facility in Tyngsboro, Massachusetts which are not "movable" (fungible) to another site.Legal


2,078

Increase due primarily to costs associated with the Arete lawsuit.


42

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Twelve months
ended
December 31,

Comment(in thousands)Salaries and benefits


1,339

Primarily due to increase in headcount in engineering, manufacturing, and materials management associated with move from development to production activities.Consultants and subcontractors


599

Increase due primarily to amounts paid to contractor to build portions of the Smart Energy Matrix outside our facility in Tyngsboro, Massachusetts that are not "movable" (fungible) to another site.Allocation of overhead to contracts


727

All but one contract was complete at end of 2007; shift of effort from contract work to completing development, manufacturing, testing and installing first frequency regulation facility in Tyngsboro resulted in
decrease in overhead charged to contracts in 2008 from 2007.Facility costs


97

Higher cost of new, larger facility.Stock compensation expense


75

Increase in compensation cost for options granted to new hires and as part of the 2007 incentive plan payout, partially offset by the reversal of previously-recorded stock compensation expense associated with a grant
of performance-based RSUs for which management no longer believes achievement is probable.Other


31

Includes higher costs of repair and maintenance, software and outside testing.Moving-related costs


(287
)
Primarily costs associated with moving our facility from Wilmington to Tyngsboro, Massachusetts, which were incurred in late 2007, and to a lesser extent, in early 2008.Period Ended December 31, 2008

$
15,398


For
the year ended December 31, 2008, research and development expenses increased by approximately $7 million or 84%, in comparison to the equivalent period in 2007. See
the table above for explanations of the factors which were responsible for the most significant changes to research and development
spending. We expect research and development costs during 2009 to be lower than in 2008 due to lower legal costs, along with lower expense material and subcontractor costs.

Loss on Contract Commitments

Our contracts have been primarily for the development of demonstration units of new products and the design of a frequency regulation
plant. As such, the work has supported our core research and

43

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development
efforts. Most of these contracts have been structured on a cost-share basis, for which the expected cost-share has been recorded as a contract loss.

We
recorded contract commitment losses on our research and development contracts in 2005 and 2006, which we reduced in 2007 by approximately $578,000 as we completed all but one contract
for amounts which were less than previously estimated. In April 2008 we were awarded a subcontract to provide a flywheel energy storage system in support of a wind integration research and development
(R&D) project sponsored by the California Energy Commission. We will receive approximately $250,000 to offset R&D expenses and will contribute an additional $87,000 of engineering resources for the
project, bringing the R&D total to approximately $337,000. In addition to the California Energy Commission, which is funding the project, other leading stakeholders include Southern California Edison
and the California ISO. The flywheel system will be installed in Tehachapi, California, a high-potential wind resource area where, according to a report from the California ISO, up to
4,200 megawatts of wind power may be added in the coming years. Our flywheel energy storage systems may also have the potential to address shortages in transmission line capacity, which this wind
power integration project is intended to prove. The primary goal of the project is to demonstrate that advanced control technology with energy storage can help expand the delivery of renewable wind
energy by effectively increasing the capacity of constrained transmission facilities in the Tehachapi area. This project supports California's goal to upgrade and expand its electricity transmission
and distribution infrastructure per the state's Energy Action Plan of 2003. We recorded a charge of approximately $87,000 during the second quarter of 2008 to reflect the expected "cost share" portion
of the Tehachapi contract.

Depreciation and Amortization

Depreciation and amortization expense increased from approximately $145,000 during the year ended December 31, 2007 to
approximately $1,295,000 for the same period in
2008, an increase of approximately $1,150,000, or 793%. The increase is primarily due to capital expenditures relating to leasehold improvements at our new manufacturing and office facility in
Tyngsboro, as well as the purchase of machinery and equipment required to begin commercial production. As of December 31, 2008, we had approximately $11.6 million in "Construction in
progress", of which approximately $6.6 million are materials to build flywheels and approximately $4.5 million are costs related to the construction of Smart Energy Matrix
systems. We expect depreciation expense to continue to increase during 2009 as we build and place our frequency regulation facilities into commercial operation.

Interest and Other Income / (Expense), net

Average cash balances during 2008 were lower than during the same periods in 2007, as were interest rates. In addition, in 2008, we
obtained a loan from Mass Development, for which we began paying interest in October 2008. These factors contribute to a reduction of net interest and other income of approximately $432,000, or 62%,
over the equivalent period last year.

Net Loss

As a result of the changes discussed above, the net loss for the year ended December 31, 2008, was approximately $23,568,000, as
compared to a net loss during the same period in 2007 of approximately $12,918,000. This represents an increase in net loss of approximately $10,650,000, or 82%. The increase in the loss for the year
is due primarily to the factors discussed above.

44

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Comparison of Year ended December 31, 2007 and 2006

Twelve months ended December 31,2007

2006

$ Change

% Change(in thousands)Revenue

$
1,389

$
969

$
420


43
%Cost of goods sold


1,248


845


(403
)

48
%Gross margin


141


124


17


14
%Selling, general and administrative


5,876


6,508


632


10
%Research and development


8,387


4,748


(3,639
)

77
%Loss on contract commitments


(578
)

1,385


1,963


142
%Depreciation and amortization


145


96


(49
)

51
%Casualty loss (recovery)


(69
)

69


138


200
%Interest and other income (expense), net


702


519


183


35
%Net loss

$
(12,918
)
$
(12,163
)
$
(755
)

6
%


Revenue

The following table provides details of our revenues for the twelve months ended December 31, 2007 and 2006.

Year ended December 31,

Cumulative
Contract
Value
Earned as
of 2007Percent
complete

Total Contract Value2007

2006(dollars in thousands)CEC


100
%
$
78

$
226

$
1,233

$
1,233NYSERDA PON 846


100
%

81


235


646


646NYSERDA PON 800


82
%

(1
)

32


51


63Air Force Research Laboratory


100
%

488


263


750


750Sandia DOE Earmark


100
%

677


75


752


752Total Contract Revenue





1,323


831


3,432


3,444Inverters and accessories





66


138





Total




$
1,389

$
969

$
3,432

$
3,444


In
the year ended December 31, 2007, we completed all but one of our research and development contracts, and recorded revenue using the percentage of completion method of
approximately $1,323,000. In addition, we recorded revenue of approximately $66,000 from the sale of Smart Power M5 inverter systems and related products. In 2006 we recorded revenue from
flywheel-related government contracts of approximately $831,000 and approximately $138,000 from the sale of Smart Power M5 inverter systems and related products. Contract revenue was higher in 2007
compared to 2006 by approximately $492,000, or 59%, primarily the result of the completion of our contracts with the Air Force Research Laboratory and with the U.S. Department of Energy (DOE),
(administered by Sandia National Laboratories). The purpose of the Sandia DOE contract was to design a 20-megawatt Smart Energy Matrix frequency regulation facility. This
project directly supported our plan to develop a commercial-scale flywheel-based frequency regulation facility in 2008.

45

---





Cost of Goods Sold

Cost of goods sold in 2007 includes costs incurred in performance of government contracts calculated on the percentage of completion
method in the amount of approximately $1,247,000 and the cost of materials, labor, overheads and warranty accruals for inverter products sold in the amount of approximately $1,000.

Selling, general and administrative expenses

Year ended
December 31,

Comment(in thousands)Period Ended December 31, 2006

$
6,508Increases (decreases):Salaries and benefits


216

Increased headcountFacility costs


90Hiring expenses


23Travel


20Telephone


16Reduction of bad debt reserve


(22
)Audit fees


(26
)Trade shows


(27
)Other


(23
)Office upgrades and equipment repairs


(45
)Subcontractors and consultants


(122
)
Less use of consultantsPublic company expenses


(142
)Allocation of overhead to contracts


(160
)
Represents allocation of G&A overhead to the Sandia contract; our other contracts did not allow us to allocate G&A overhead.Stock compensation expense


(430
)
Mainly due to a decrease in the Black Scholes value of options issued in 2007 compared to the valuation for options issued during the prior year.Period Ended December 31, 2007

$
5,876


Selling,
general and administrative expenses totaled approximately $5,876,000 and $6,508,000 for the years ended December 31, 2007, and 2006, respectively. The most significant
factors associated with the increase in costs is shown in the table above.

46

---



Research and Development Expenses

Year ended
December 31,

Comment(in thousands)Period Ended December 31, 2006

$
4,748Increases (decreases):Salaries and benefits


1,214

Increased expenses resulting from the hiring of engineering personnel during the latter half of 2006 to support our flywheel development and testingFacility costs


681

Increase primarily due to the cost of operating facilities in both Tyngsboro and Wilmington as we prepared the Tyngsboro facility for occupancyConsultants and subcontractors


414

Increased use of consultantsAllocation of overhead to contracts


326

Lower allocation of overhead to contractsCosts related to facility move


299

Costs associated with relocating our facility from Wilmington to Tyngsboro, MassachusettsExpense materials


419

Increased use of materials in the development of our Smart Energy 25 flywheelLegal


239

Legal expenses charged to manufacturing represents primarily cost of developing and protecting our patents and in defending against Arete patent infringement claim.Hiring expenses


41Outside testing


41Travel


20Other


10Stock compensation expense


(65
)
Lower Black Scholes valuation for options issued during the early portion of 2007Period Ended December 31, 2007

$
8,387


For
the year ended December 31, 2007, research and development expenses increased by approximately $3.6 million or 77%, in comparison to the equivalent period in 2006. In
addition to the comments shown above explaining the fluctuation in costs, in December 2006, we experienced a flywheel malfunction during testing in one of our test cells which resulted in damage to
some research and development materials, test equipment, facility and the prototype flywheel being tested. During 2007 we recovered essentially all of the costs associated with the malfunction from
our insurance carriers. The insurance proceeds were used to offset previously recorded casualty losses and to offset the costs of expensed materials used to build the prototype flywheel. In addition
to costs associated with the malfunction, we spent approximately $61,000 to investigate the cause of the malfunction and

47

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to
insure that the necessary modifications were implemented to prevent similar malfunctions in the future. These costs are included in the increased cost shown for consultants and subcontractors,
above.

Loss on Contract Commitments

Our contracts have been primarily for the development of demonstration units of new products and the design of a frequency regulation
installation. As such, the work has supported our core research and development efforts. Most of these contracts have been structured on a cost-share basis, for which the expected
cost-share has been recorded as a contract loss. We recorded contract commitment losses on our research and development contracts in 2005 of $1,535,000 based on expected cost overruns
related to material, labor and overhead required to complete the contracts. During 2006, we recorded additional charges totaling approximately $1,385,000 to the contract loss reserve. This amount
consisted of net increases in estimated material, labor, overhead and travel costs expected to complete existing contracts along with our expected cost share portion of the Sandia contract. By the end
of 2007, all but one smaller government contract was complete. We recorded a reduction to the losses on contract commitments of approximately $578,000, based on the actual cost to complete these
contracts, which was less than previously estimated. This amount consisted of net decreases in material, labor, overhead and travel costs required to complete existing contracts of approximately
$465,000. In addition, since our actual overhead rate was lower than forecasted at the beginning of the fiscal year, we reduced the overhead applied to the contracts and our contract loss reserve by
an additional $113,000.

Depreciation and Amortization

The increase in depreciation expense for the year ended December 31, 2007 as compared to the same period in 2006 of
approximately $49,000, or 51%, was primarily attributable to depreciation on new assets acquired during 2007 and the latter half of 2006.

Interest and Other Income / (Expense), net

Interest income for the year ended December 31, 2007, was approximately $188,000 greater than for the equivalent period in 2006.
The primary reason for this difference is that cash balances available for investing were on average higher than during the same period in the prior year, primarily as a result of the cash obtained
through the sale of stock and warrants at various times during 2007. The increased interest income was offset by decreases in other income of approximately $5,000.

Net Loss

As a result of the changes discussed above, the net loss for the year ended December 31, 2007, was approximately $12,918,000, as
compared to a net loss during the same period in 2006 of approximately $12,163,000. This represents an increase in net loss of approximately $755,000, or 6%. The increase in the loss for the year is
due primarily to the factors discussed above, particularly increased spending on Research and Development activities, facility costs related to the move to the Tyngsboro facility and the temporary
maintenance of two facilities, partially offset by decreases in Selling, General and Administrative expenses and the reduction in Contract Loss recorded during 2007.

48

---



Liquidity and Capital Resources

Twelve months ended
December 31,2008

2007(in thousands)Cash and cash equivalents

$
14,357

$
30,417Working capital


6,501


28,820Cash provided by (used in)Operating activities


(13,859
)

(11,282
)Investing activities


(17,146
)

(6,930
)Financing activities


14,946


43,378Net increase (decrease) in cash and cash equivalents

$
(16,059
)
$
25,166Current ratio


1.7


9.1


Our
cash requirements depend on many factors including, but not limited to, cost to build our flywheels and frequency regulation facilities, research and development activities, facility
costs as well as general and administrative expenses. Since we are still in the development stage and have not yet generated significant revenue from our principal operations, we do not generate
enough cash from operations to satisfy our working capital requirements. We expect to make significant expenditures to fund our operations, develop technologies and explore opportunities to find and
develop additional markets to sell our products. In previous years, we took significant actions to reduce our cash expenditures for product development, infrastructure and production readiness by
reducing headcount, development spending and capital expenditures. However, as we completed development of the Smart Energy Matrix and began commercial activity aimed at revenue
generation in 2009, we increased our headcount and spent additional funds on production materials, capital equipment, market analyses and the pursuit of regulatory relief to modify market rules in a
way that ensures our ability to enter markets on a timely and profitable basis. We expect to require significant cash resources during
2009 through 2011 as we increase capacity to manufacture our Smart Energy 25 flywheels and build frequency regulation facilities.

Due
to uncertainty and volatility in the equity markets, we only deployed one MW capacity through the ISO-NE Pilot Program in 2008. We plan to re-deploy the additional
megawatts originally planned for the Pilot Program to our site in Stephentown. In volume production, our goal is to complete a 20 MW facility at an approximate cost of $25 to
$30 million, while the first 20 MW plant will cost approximately $60 million. In 2009 our business plan is to deploy 5 MW of capacity at our first 20MW site and an additional megawatt in
Ohio through AEP; however the number of megawatts we will be able to deploy is dependent on obtaining sufficient funding for these capital outlays. We expect to fund the construction of our first 20
MW plant from a combination of debt and equity. Our ability to obtain sufficient funding will pace our ability to produce flywheel systems and deploy them. In 2010 and 2011, we will continue to have
capital needs that will require additional equity and debt to fund the ongoing deployment of frequency regulation facilities.

We
must raise additional equity and/or project financing to execute our business plan. Based on our rate of expenditure of cash and the additional expenditures expected to support our
business plan, we have sufficient cash to fund operations through the second quarter of 2009. We need to obtain additional cash during 2009 to 2011 to fund:



49

---





On
February 20, 2009, we entered into a common stock purchase agreement with Seaside 88, LP, valued at up to $18 million. The agreement requires Seaside to buy
$1 million of common stock from us once each month for up to 18 months, beginning on February 20, 2009, and on the 20th day of each month thereafter (or the
next closest business day.) The agreement is structured in three six-month tranches, or segments, each covering monthly closings of $1 million each, for up to $6 million
total. We are committed to only the first six-month tranche, but we have the option, exercisable at our sole discretion, to extend the agreement for up to two additional
six-month periods (each for up to $6 million), for a total of up to $18 million over the three tranches. Under the terms of this agreement, on February 20, 2009, we
issued 2,656,184 shares to Seaside at a price per share of $0.37648 for an aggregate value of $1,000,000.

In
order to implement our business plan to build, operate and receive fees for frequency regulation services and have sufficient working capital to continue to execute our business plan
through 2009, in addition to the funds expected from the sale of stock to Seaside, we will need to raise funds though a combination of debt and equity during 2009. Also, to achieve our
out-year deployment plan for additional frequency regulation facilities, we will need to raise additional capital beyond 2009 either from project finance or additional equity transactions.

Operating activities

Net cash used in operating activities was approximately $13,859,000, $11,282,000 and $8,441,000 for the twelve months ended
December 31, 2008, 2007 and 2006, respectively. The primary component to the negative cash flow from operations is from net losses. Net loss for 2008 was approximately $23,568,000. The net
operating loss was partially offset by non-cash charges of approximately $859,000 for stock compensation expense, $1,295,000 for depreciation, approximately $518,000 related to the
issuance of stock to settle a lawsuit, deferred rent of approximately $85,000 and approximately $10,000 interest expense related to the issuance of
warrants issued in conjunction with the MassDev loan. Changes in operating assets and liabilities generated approximately $5,512,000. In addition, we received $1,430,000 from our landlord as a credit
for certain building improvements.

Net
loss for 2007 was approximately $12,918,000. Cash used by operations was partially reduced by an insurance recovery of approximately $336,000 relating to a malfunction that occurred
in December 2006 during testing of a prototype flywheel. In addition, the net operating loss was partially offset by non-cash charges of approximately $1,838,000 and $144,000 for stock
compensation expense and depreciation, respectively. Changes in operating assets and liabilities generated approximately $521,000 in cash which were more than offset by deferred rent of approximately
$517,000, expenses paid against a previously-recorded restructuring reserve of approximately $347,000 and a gain on sale of fixed assets of approximately $3,000.

Net
loss for 2006 was approximately $12,163,000. This loss was offset by non-cash charges of approximately $2,333,000, $96,000 and $18,000 for stock compensation expense,
depreciation and an increase in the asset impairment reserve, respectively. Changes in operating assets and liabilities generated approximately $1,641,000 of cash, which was partially offset by
expenses paid against a previously-recorded restructuring reserve of approximately $366,000.

50

---



Investing Activities

Net cash used in investing activities was approximately $17,146,000, $6,930,000 and $272,000 for 2008, 2007 and 2006, respectively. The
primary use of cash for 2008 was the purchase and construction of property and equipment of approximately $17,315,000. The 2008 capital additions include approximately $11,630,000 which is classified
as "Construction in Progress" as of the end of December 2008, most of which consisted of completed flywheels, trailers housing electronic components, along with material, labor and overhead. In 2008,
we reduced restricted cash by $174,000 due to the completion of the Wilmington lease. This amount was partially offset by a requirement from ISO-NE to implement a restricted cash account
for financial assurance purposes in the amount of approximately $5,000.

The
primary use of cash from investing activities for 2007 was the purchase and construction of property and equipment of approximately $6,734,000. The 2007 capital additions include
approximately $5,782,000 which is classified as "Construction in Progress" as of the end of December 2007, most of which relates to the build-out of our Tyngsboro headquarters.
Approximately $453,000 of
the additions relate to production material was purchased to build flywheels for commercial use in our Smart Energy Matrices. In 2007, we increased restricted cash by $200,000 as a requirement under
our Tyngsboro lease. Proceeds from the sale of equipment provided approximately $4,000 in cash in 2007.

The
primary use of cash for 2006 was the purchase of property and equipments of approximately $317,000. The capital additions were partially offset by reductions of restricted cash of
approximately $45,000.

Financing Activities

Net cash generated by financing activities was approximately $14,946,000, $43,378,000 and $75,000 for 2008, 2007 and 2006,
respectively. During 2008, we raised approximately $11,264,000 from the sale of our stock and warrants, net of expenses, approximately $3,572,000 from a loan from MassDev, approximately $15,000 for
the exercise of employee stock options and approximately $98,000 for the issuance of stock to our employees under the employee stock purchase plan, offset by approximately $3,000 paid for financing
costs.

During
2007, we raised approximately $42,550,000 from the sale of our stock, approximately $717,000 for stock and warrants issued to the landlord, approximately $85,000 for the exercise
of employee stock options and approximately $26,000 for the issuance of stock to our employees under the employee stock purchase plan.

For
2006, approximately $54,000 in cash was provided by the exercise of employee stock options, along with approximately $21,000 received for shares issued under the employee stock
purchase plan.

As
part of our new business development, we may evaluate possible acquisitions of enterprises or technologies that we consider synergistic from a market, technology or product
perspective. We may make investments in companies for strategic business reasons. Because our primary motivation in making these investments may not be to realize a profit on the investment itself,
but rather to expand our business prospects, these investments may lack any financial return to the Company and may result in a loss of principal and may impair our liquidity.

51

---



The
following table summarizes our commitments at December 31, 2008:

Description of CommitmentOperating
lease

Purchase
Obligations

TotalPeriod ending:December 31, 2008

$


$
6,846,297

$
6,846,297December 31, 2009


701,687





701,687December 31, 2010


727,437





727,437December 31, 2011


753,188





753,188December 31, 2012


778,937





778,937December 31, 2013


804,689





804,689Thereafter


618,000





618,000Total Commitments

$
4,383,938

$
6,846,297

$
11,230,235


At
December 31, 2008, we had firm purchase commitments with our suppliers of approximately $6.8 million. These commitments are for components for our commercial flywheel
systems, completion of the build-out of the Tyngsboro facility, and to satisfy contractual obligations for our research and development programs, among other things. In addition, we have a
commitment of approximately $2.2 million to purchase a key component from a supplier who has not yet been able to meet our technical specifications. We do have another supplier for this
component. However, since our objective is to have at least two suppliers for all key components, we are working closely with the supplier to resolve this from a technical perspective. If not,
however, the contract will be cancelled due to the supplier's inability to perform.

In
July 2007, we signed a seven-year lease on a new corporate headquarters that significantly expanded our manufacturing capacity and provides sufficient space to continue
our research and development activities. The amounts listed for operating leases represent payments for the occupancy of our principal executive offices, laboratory and manufacturing facilities
located at 65 Middlesex Road Tyngsboro, Massachusetts. This 103,000 square foot facility has manufacturing capacity for the production of up to 600 flywheels per year. We have a second phase
manufacturing build-out planned that will increase annual manufacturing capacity to more than 1,000 flywheels. The lease on our previous facility in Wilmington, MA expired at the end of
November 2007.

As
part of the Tyngsboro lease agreement, we issued to the landlord 150,000 shares of our common stock pursuant to our registration statement on Form S-3 filed on
August 17, 2007, which became effective on August 28, 2007, and a warrant exercisable for 500,000 shares of our common stock pursuant to an exemption from registration under the
Securities Act of 1933, as amended, in return for lower cash payments payable by us under the lease. We have provided the Wilmington and Tyngsboro lessors with irrevocable letters of credit securing
our performance under these leases with a balance at December 31, 2008 and 2007 of $200,000 and $374,346, respectively, which are reduced periodically during the lease terms. These letters of
credit are secured by a cash deposit, which is included in restricted cash in the accompanying consolidated balance sheets. In addition, we are responsible for real estate taxes and all operating
expenses of the Tyngsboro facility.

In
the future, additional capital expenditures may be required for a phase two build-out of manufacturing capacity. The amount and timing of these expenditures are dependent
on requirements of equipment needed to meet production schedules as well as having sufficient funding.

52

---



Financing

On December 24, 2008, we sold 8,966,000 units of the Company at a purchase price of $0.50 per unit for a total of approximately
$4.1 million, net of expenses. Each unit consisted of one share of our common stock, par value $0.01 per share, and a warrant to purchase one share of common stock at an exercise price of $0.74
per share, for a total of 8,966,000 warrants. The warrants become exercisable six months and one day after their issuance, and expire five and one half years after their issuance. The units were
issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with a registration statement on Form S-3 filed with the Securities and
Exchange Commission that became effective on July 29, 2008.

On
October 15, 2008, we sold 8,700,000 units of the Company at a purchase price of $0.91 per unit for a total of approximately $7.2 million, net of expenses. Each unit
consisted of one share of our common stock, par value $0.01 per share, and a warrant to purchase one share of common stock at an exercise price of $1.20 per share, for a total of 8,700,000 warrants.
The warrants become exercisable six months and one day after their issuance, and expire five and one half years after their issuance. The units were issued pursuant to a prospectus supplement filed
with the Securities and Exchange Commission in connection with a registration statement on Form S-3 filed with the Securities and Exchange Commission that became effective on
July 29, 2008.

On
June 30, 2008, we entered into an agreement with Massachusetts Development Finance Agency ("MassDev") pursuant to which MassDev agreed to lend us up to $5 million. This
loan derives from a funding collaboration between the Emerging Technology Fund of MassDev and the Massachusetts Technology Collaborative's Business Expansion Initiative. The MassDev loan is evidenced
by a promissory note under which we may make one or more requests for advances of up to an aggregate of $5 million for the purchase of equipment and installation of certain tenant improvements
at our Tyngsboro, Massachusetts facility. We have one year following the date of the initial advance to draw on the loan. The initial advance on the loan was made on October 1, 2008 for
approximately $3.5 million. The note will mature 84 months after the initial advance and bears a fixed annual interest rate of 6.5%. As partial consideration for the loan, on
June 30, 2008, we issued MassDev two warrants. Each warrant provides for the purchase of 85,979 shares of our common stock at an exercise price of $1.89 per share, subject to any adjustments as
set forth in the warrants. The warrants are exercisable for seven years commencing on June 30, 2008 and provide for registration rights for the resale of the shares issued upon their exercise.
MassDev assigned one of the warrants to the Massachusetts Technology Park Corporation ("MTPC"), as part of MTPC's participation under the Massachusetts Technology Collaborative's Business Expansion
Initiative. The fair value of the warrants is being amortized over the term of the loan.

In
October 2007, we sold 11,911,852 units of the Company at a purchase price of $2.10 per unit, for a total of approximately $23.8 million, net of expenses. Each unit consisted of
one share of our common stock, par value $0.01 per share, and a warrant to purchase 0.95 shares of common stock at an exercise price of $2.97 per share, for a total of 11,316,260 warrants. The units
were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with our
registration statement on Form S-3 for $50 million filed on August 6, 2007, which became effective on August 15, 2007.

In
September 2007, we sold 5,102,041 units of the Company at a purchase price of $1.96 per unit. Each unit consisted of one share of our common stock, par value $0.01 per share, and a
warrant to purchase 1.2 shares of common stock at an exercise price of $1.99 per share, for a total of 6,122,449 warrants. In addition, 153,061 warrants were issued to the placement agents at the same
price per share. The units were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with our registration statement on
Form S-3 for $50 million filed on August 6, 2007, which became effective on August 15, 2007.

53

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In
July 2007 we entered into a lease for a new facility in Tyngsboro, MA. We agreed under the terms of the lease to issue to the landlord pursuant to an exemption from registration under
the Securities Act of 1933, as amended, a warrant exercisable for 500,000 shares of our common stock at an exercise price of $1.77 per share. The warrant and the shares issuable upon exercise of the
warrant are restricted securities and may not be sold without registration under the Securities Act of 1933, as amended, and applicable state securities laws or an exemption there from. In addition,
we issued the landlord 150,000 shares of common stock.

In
February 2007, we sold 11,814,687 units of the Company at a purchase price of $0.90 per unit. Each unit consisted of one share of our common stock, par value $0.01 per share, and a
warrant to purchase 0.5 shares of common stock at an exercise price of $1.33 per share, for a total of 6,261,786 warrants. As part of the transaction, 354,441 warrants were issued to the placement
agent. The units were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with an effective registration statement on Form S-3
previously filed with the Securities and Exchange Commission.

There
were no significant financing activities during 2006.

Inasmuch
as we are not expecting to become cash flow positive until at least 2011, our ability to continue 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 we are able to do so, it may be on terms that are adverse to shareholders. We believe that project debt financing may be available to us to meet
some portion of our cash requirements for 2009.

Inflation

Our operations have not been materially affected by inflation.

Off-balance Sheet Arrangements

We have no off-balance sheet arrangements.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

Our cash equivalents and investments, all of which have maturities of less than ninety days, could expose us to interest rate risk. At
December 31, 2008, we had approximately $109,000 of cash equivalents that were held in a non-interest bearing checking account. Also at December 31, 2008 we had approximately
$14.2 million of cash equivalents that were held in interest-bearing money market accounts at high-quality financial institutions, some of which are invested in
off-shore securities. The fair value of these investments approximates their cost. A 10% change in interest rates would change the investment income realized on an annual basis by
approximately $10,000, which we do not believe is material. The funds invested in money market accounts may not be covered under FDIC Insurance, and therefore may be at some risk of loss.
Approximately $6 million of our cash on hand at December 31, 2008 was invested in a mutual fund that was enrolled in the U.S. Treasury Department's Temporary Guarantee Program for money
market funds. Under the Guarantee Program, the U.S. Treasury guarantees the $1.00 per share value of funds outstanding as of September 19, 2008, subject to certain terms and limitations. The
program has been extended by the Treasury Department until April 30, 2009, but may be further extended by the Treasury Department to terminate no later than September 18, 2009. The
guarantee will be triggered if the market-based net asset value of the fund is less than $0.995, unless promptly cured.

54

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Item 8.    Consolidated Financial Statements and Supplementary Data

BEACON POWER CORPORATION AND SUBSIDIARIES  (A Development Stage Company)  Index to Consolidated Financial Statements



PageReport of Independent Registered Public Accounting Firm

56Consolidated Balance Sheets at December 31, 2008 and 2007

58Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006 and
for the period from May 8, 1997 (date of inception) to December 31, 2008

59Consolidated Statements of Stockholders' Equity for the years ended December 31, 2008, 2007
and 2006 and for the period from May 8, 1997 (date of inception) to December 31, 2008

60Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006
and for the period from May 8, 1997 (date of inception) to December 31, 2008

68Notes to Consolidated Financial Statements

70


55

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Report of Independent Registered Public Accounting Firm

To
the Stockholders and Board of Directors
Beacon Power Corporation:

We
have audited the accompanying consolidated balance sheets of Beacon Power Corporation and Subsidiaries (the "Company") (a development stage company) as of December 31, 2008 and
2007, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2008 and for the
period from May 8, 1997 (date of inception) through December 31, 2008. We have also audited the Company's internal control over financial reporting as of December 31, 2008
based on criteria established inInternal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its
assessment of the effectiveness of internal control over financial reporting appearing under Item 9A, included in the accompanying Management's Report on Internal Controls Over Financial
Reporting. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and an
opinion on the Company's internal control over financial reporting based on our integrated audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material
respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control
based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our
opinions.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

56

---



In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Beacon Power Corporation and Subsidiary as of
December 31, 2008 and 2007 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008 and the period from
May 8, 1997 (date of inception) through December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Beacon Power
Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal
ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

The
accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated
financial statements, the Company's recurring losses from operations and negative operating cash flows raise substantial doubt about its ability to continue as a going concern. Management's plans
concerning these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ MILLER WACHMAN LLP


Boston,
Massachusetts
March 12, 2009

57

---







BEACON POWER CORPORATION AND SUBSIDIARIES  (A Development Stage Company)  Consolidated Balance Sheets

December 31,
2008

December 31,
2007AssetsCurrent assets:Cash and cash equivalents

$
14,357,475

$
30,417,095Accounts receivable, trade, net


11,840


424,788Unbilled costs on contracts in progress


16,804


82,195Prepaid expenses and other current assets


976,762


1,475,084Total current assets


15,362,881


32,399,162Property and equipment, net


23,027,909


7,004,021Restricted cash


205,020


374,346Total assets

$
38,595,810

$
39,777,529Liabilities and Stockholders' EquityCurrent liabilities:Accounts payable

$
3,825,520

$
296,463Accrued compensation and benefits


1,410,038


1,024,874Other accrued expenses


3,253,407


2,183,217Advance billings on contracts


10,811


7,222Accrued contract loss


132,526


67,419Deferred rentcurrent


112,808


Current portion of long term debt


117,023


Total current liabilities


8,862,133


3,579,195Long term liabilities:Deferred rentlong term


885,076


Long term debt, net of unamortized discount of $217,909


3,237,061


Total long term liabilities


4,122,137


Commitments and contingencies (Note 4)Stockholders' equity:Preferred Stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding





Common stock, $.01 par value; 200,000,000 shares authorized; 107,433,190 and 88,658,967 shares issued and outstanding at December 31, 2008 and
December 31, 2007, respectively


1,074,332


886,590Additional paid-in-capital


212,145,254


199,351,427Deficit accumulated during the development stage


(186,895,207
)

(163,326,844
)Treasury stock, 421,692 shares at cost


(712,839
)

(712,839
)Total stockholders' equity


25,611,540


36,198,334Total liabilities and stockholders' equity

$
38,595,810

$
39,777,529


See
notes to consolidated financial statements.

58

---







BEACON POWER CORPORATION AND SUBSIDIARIES  (A Development Stage Company)  Consolidated Statements of Operations

2008

2007

2006

Cumulative from
May 8, 1997
(date of inception)
through
December 31,
2008Revenue

$
68,131

$
1,388,834

$
968,577

$
4,788,678Cost of goods sold


53,005


1,248,048


845,102


5,179,264Gross profit (loss)


15,126


140,786


123,475


(390,586
)Operating expenses:Selling, general and administrative


7,074,211


5,875,827


6,508,375


58,048,606Research and development


15,398,374


8,387,025


4,747,685


83,816,862Loss on contract commitments


86,601


(577,789
)

1,384,978


2,804,062Depreciation and amortization


1,294,532


144,424


95,669


5,755,622Casualty loss (recovery)





(69,084
)

69,084


Restructuring charges











2,159,280Loss on impairment of assets











4,663,916Total operating expenses


23,853,718


13,760,403


12,805,791


157,248,348Loss from operations


(23,838,592
)

(13,619,617
)

(12,682,316
)

(157,638,934
)Other income (expense):Interest income


341,479


688,621


500,468


5,575,487Interest expense


(71,452
)







(1,165,155
)Gain on sale of investment











3,562,582Other income (expense)


202


13,091


18,410


(222,993
)Total other income (expense), net


270,229


701,712


518,878


7,749,921Net loss


(23,568,363
)

(12,917,905
)

(12,163,438
)

(149,889,013
)Preferred stock dividends











(36,825,680
)Accretion of convertible preferred stock











(113,014
)Loss to common shareholders

$
(23,568,363
)
$
(12,917,905
)
$
(12,163,438
)
$
(186,827,707
)Loss per share, basic and diluted

$
(0.26
)
$
(0.18
)
$
(0.21
)Weighted-average common shares outstanding


90,866,039


73,604,198


59,080,224


See
notes to consolidated financial statements.

59

---





BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity

Class A
Preferred Stock

Class C
Preferred StockCommon StockDeferred
Consulting
Expense

Deferred
Stock
CompensationDescription

Shares

Amount

Shares

Amount

Shares

AmountBALANCE 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























Issuance of non-employee stock options


























See
notes to consolidated financial statements.

60

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Class A
Preferred Stock

Class C
Preferred StockCommon StockDeferred
Consulting
Expense

Deferred
Stock
CompensationDescription

Shares

Amount

Shares

Amount

Shares

AmountAmortize Deferred Stock Compensation and issue RSUs




$





$



1,236,240

$
12,362

$


$
2,705,927Issuance of warrants























Proceeds from stock offering, net of related expenses














22,520,802


225,208





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














2,007,091


20,071





Exercise of Stock Options














2,447,843


24,478





Shares issued through ESPP














117,888


1,180





Option extension for CEO























Option extension for severed employees























Purchase of Treasury Stock























Deferred Stock Compensation revaluation























18,412Issuance of restricted stock units for bonus























(2,470,147
)


See
notes to consolidated financial statements.

61

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Class A
Preferred Stock

Class C
Preferred StockCommon StockDeferred
Consulting
Expense

Deferred
Stock
CompensationDescription

Shares

Amount

Shares

Amount

Shares

AmountStock 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























1,063,145Shares 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





Issuance of restricted stock units for bonus























Issuance of officer restricted stock units














32,074


320





Shares issued through ESPP














33,416


334





Stock-based compensation























Executive performance-based RSU compensation expense























Exercise of stock options














90,210


901





Stock and warrants issued for lease














150,000


1,500





Issuance of stock for cash, net of issuance costs














28,828,580


288,288





Net loss























Balance, December 31, 2007














88,658,967


886,590








See
notes to consolidated financial statements.

62

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Class A
Preferred Stock

Class C
Preferred StockCommon StockDeferred
Consulting
Expense

Deferred
Stock
CompensationDescription

Shares

Amount

Shares

Amount

Shares

AmountIssuance of officer restricted stock units




$





$



52,178

$
521

$


$
Amortize deferred stock compensation and issue RSUs























Shares issued through ESPP














111,795


1,118





Stock-based compensation























Executive performance-based RSU compensation expense























Exercise of stock options














19,250


192





Warrants issued in conjunction with MassDev loan























Stock issued to settle lawsuit














925,000


9,250





Issuance of stock for cash, net of issuance costs














17,666,000


176,661





Net loss























Balance, December 31, 2008




$





$



107,433,190

$
1,074,332

$


$



See
notes to consolidated financial statements.

63

---





BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Treasury StockAdditional
Paid-in
Capital

Stock
Subscription
Receivable

Retained
Deficit

Total
Stockholders'
EquityDescription

Shares

AmountBALANCE AT MAY 8, 1997 (DATE OF INCEPTION)

$


$


$





$


$
Issuance of Founder's Shares








(67,500
)







Issuance of Class A preferred stock





(5,000,000
)










387,500Recapitalization

















Rounding for fractional shares

















Issuance of Class C preferred and common stock

















30,000Deferred Consulting

















773,284Series A Issuance for Consulting


496,939














Repayment of subscription receivable





5,000,000











5,000,000Issuance of Series A preferred stock for services and interest on loans

















11,485Dividend 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














303,160Issuance of non-employee stock options


16,288














16,288


See
notes to consolidated financial statements.

64

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Treasury StockAdditional
Paid-in
Capital

Stock
Subscription
Receivable

Retained
Deficit

Total
Stockholders'
EquityDescription

Shares

AmountAmortize Deferred Stock Compensation and issue RSUs

$
(73,042
)
$


$





$


$
2,645,247Issuance of warrants


36,520,366





(34,580,000
)







1,940,366Proceeds from stock offering, net of related expenses


66,224,806














66,450,014Conversion of Series A preferred stock


5,646,093














Conversion of Series C preferred stock


29,866














Conversion of convertible preferred stock


36,496,431














36,694,668Payment of accrued dividend


1,077,714














1,086,307Cashless Warrant exercise


(20,071
)













Exercise of Stock Options


2,124,743














2,149,221Shares issued through ESPP


130,886














132,066Option extension for CEO


315,394














315,394Option extension for severed employees


31,197














31,197Purchase of Treasury Stock











132,000


(99,660
)

(99,660
)Deferred Stock Compensation revaluation


(18,412
)













Issuance of restricted stock units for bonus


2,470,147








212,940


(455,838
)

(455,838
)


See
notes to consolidated financial statements.

65

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Treasury StockAdditional
Paid-in
Capital

Stock
Subscription
Receivable

Retained
Deficit

Total
Stockholders'
EquityDescription

Shares

AmountStock buyback to pay officer loan

$


$


$



76,752

$
(157,341
)
$
(157,341
)Net loss








(101,239,307
)







(101,239,307
)Balance, December 31, 2005


153,089,842





(138,245,501
)

421,692


(712,839
)

13,655,357Issuance of restricted stock units for bonus


(6,961
)













Issuance of officer restricted stock units


(106
)













Amortize deferred stock compensation and issue RSUs

















1,063,145Shares issued through ESPP


20,096














20,276Stock-based compensation


906,488














906,488Executive performance-based RSU compensation expense


363,636














363,636Exercise of stock options


53,400














54,400Net loss








(12,163,438
)







(12,163,438
)Balance, December 31, 2006


154,426,395





(150,408,939
)

421,692


(712,839
)

3,899,864Issuance of restricted stock units for bonus

















Issuance of officer restricted stock units


(320
)













Shares issued through ESPP


25,229














25,563Stock-based compensation


1,293,094














1,293,094Executive performance-based RSU compensation expense


545,456














545,456Exercise of stock options


84,386














85,287Stock and warrants issued for lease


715,114














716,614Issuance of stock for cash, net of issuance costs


42,262,073














42,550,361Net loss








(12,917,905
)







(12,917,905
)Balance, December 31, 2007


199,351,427





(163,326,844
)

421,692


(712,839
)

36,198,334


See
notes to consolidated financial statements.

66

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Consolidated Statements of Stockholders' Equity (Continued)

Treasury StockAdditional
Paid-in
Capital

Stock
Subscription
Receivable

Retained
Deficit

Total
Stockholders'
EquityDescription

Shares

AmountIssuance of officer restricted stock units

$
(521
)
$


$





$


$
Amortize deferred stock compensation and issue RSUs

















Shares issued through ESPP


96,799














97,917Stock-based compensation


1,767,784














1,767,784Executive performance-based RSU compensation expense


(909,090
)













(909,090
)Exercise of stock options


14,990














15,182Warrants issued in conjunction with MassDev loan


227,946














227,946Stock issued to settle lawsuit


508,750














518,000Issuance of stock for cash, net of issuance costs


11,087,169














11,263,830Net loss








(23,568,363
)







(23,568,363
)Balance, December 31, 2008

$
212,145,254

$


$
(186,895,207
)

421,692

$
(712,839
)
$
25,611,540


See
notes to consolidated financial statements.

67

---





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

Cumulative from
May 8, 1997
(date of inception)
through
December 31,
2008Twelve months ended December 31,2008

2007

2006Cash flows from operating activities:Net loss

$
(23,568,363
)
$
(12,917,905
)
$
(12,163,438
)
$
(149,889,013
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


1,294,533


144,424


95,669


5,755,624Loss (gain) on sale of fixed assets


132


(3,223
)




193,078Impairment of assets, net





553


18,567


4,551,147(Expenses paid) restructuring charge





(347,408
)

(366,061
)

Interest expense relating to issuance of warrants


10,039








381,039Non-cash charge for change in option terms











346,591Non-cash charge for settlement of lawsuit


518,000








821,160Amortization of deferred consulting expense, net











1,160,784Amortization of deferred stock compensation








1,063,145


3,699,721Options and warrants issued for consulting services











1,585,654Services and interest expense paid in preferred stock











11,485Gain on sale of investments











(3,562,582
)Stock-based compensation


858,694


1,838,550


1,270,124


3,967,368Deferred rent


85,193


(517,310
)




(432,117
)Deferred rentcash received from landlord


1,430,000








1,430,000Changes in operating assets and liabilities:Accounts receivable


412,948


81,614


82,038


(11,840
)Unbilled costs on government contracts


65,391


51,045


304,519


(16,804
)Prepaid expenses and other current assets


(18,989
)

(180,498
)

109


(1,076,423
)Accounts payable


3,529,057


(156,614
)

315,787


3,825,520Accrued compensation and benefits


385,164


568,799


304,757


1,410,038Advance billings on contracts


3,589


(438,497
)

370,899


10,811Accrued interest











275,560Accrued loss on contract commitments


65,107


(753,613
)

272,418


132,526Other accrued expenses and current liabilities


1,070,190


1,348,385


(9,910
)

3,262,077Net cash used in operating activities


(13,859,315
)

(11,281,698
)

(8,441,377
)

(122,168,596
)


68

---



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

Cumulative from
May 8, 1997
(date of inception)
through
December 31,
2008Twelve months ended December 31,2008

2007

2006Cash flows from investing activities:Purchase of investments











(1,190,352
)Sale of investments











4,752,934Restricted cash


169,326


(200,000
)

45,222


(205,020
)Increase in other assets











(412,072
)Purchases and construction of property and equipment


(17,315,405
)

(6,734,446
)

(317,346
)

(32,861,601
)Sale of property and equipment





4,077





202,674Net cash used in investing activities


(17,146,079
)

(6,930,369
)

(272,124
)

(29,713,437
)Cash flows from financing activities:Initial public stock offering, net of expenses











49,341,537Stock offerings, net of expenses


11,263,830


42,550,361





70,922,668Payment of dividends











(1,159,373
)Shares issued under employee stock purchase plan


97,917


25,563


20,276


275,821Exercise of employee stock options


15,182


85,287


54,400


2,304,091Issuance of debt


3,571,993








3,571,993Warrants issued in relation to lease





716,614





716,614Cash paid for financing costs


(3,148
)







(3,148
)Issuance of preferred stock











32,868,028Repayment of subscription receivable











5,000,000Proceeds from capital leases











495,851Repayment of capital leases











(1,031,395
)Repurchase company stock











(613,179
)Proceeds from notes payable issued to investors











3,550,000Net cash provided by (used in) financing activities


14,945,774


43,377,825


74,676


166,239,508(Decrease) increase in cash and cash equivalents


(16,059,620
)

25,165,758


(8,638,825
)

14,357,475Cash and cash equivalents, beginning of period


30,417,095


5,251,337


13,890,162


Cash and cash equivalents, end of period

$
14,357,475

$
30,417,095

$
5,251,337

$
14,357,475Supplemental disclosure of cash flow information:Cash paid for interest

$
59,294

$


$


$
547,420Cash paid for taxes

$


$


$


$
32,750Assets acquired through capital lease

$


$


$


$
535,445Warrants issued in relation to loan (non-cash)

$
227,946

$


$


$
227,946


See
notes to consolidated financial statements.

69

---







BEACON POWER CORPORATION AND SUBSIDIARIES  (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 development stage company) was incorporated on
May 8, 1997 as a wholly owned subsidiary of SatCon Technology Corporation ("SatCon"). Since our inception, we have been primarily engaged in the development of flywheel devices for storing and
transmitting kinetic energy. As discussed in Note 7, during the fourth quarter of 2000, we completed an initial public offering of our common stock and raised approximately
$49.3 million, net of offering expenses. Since 2000, we have raised additional funds through the sale of our stock and warrants, as follows:



70

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 1. Nature of Business and Operations (Continued)



Because
we have not yet generated a significant amount of revenue from our principal operations, we are accounted for as a development stage company under Statement of Financial
Accounting Standards No. 7.

We
have a single operating segment. Our organizational structure has no divisions or subsidiaries dictated by product lines, geography or customer type. In 2007 we derived approximately
95% of our revenue from our research and development contracts; two of those contracts accounted for 84% of our total revenue. In 2008, our revenue, in total, was substantially less than
in 2007 because most of our research and development contracts were completed in 2007. Although the loss of any single contract may have a material impact on our financial statements, it
would not have a material impact on our business since we derive most of our working capital from equity offerings in order to develop our flywheel systems.

We
do not expect to become profitable or cash flow positive until at least 2011 and must raise additional equity to execute our business plan and continue as a going concern.

Based
on our current cash usage rates and additional expenditures expected in support of our business plan, and including the approximately $11.3 million equity we raised in 2008,
net of expenses, we have enough cash to fund operations through approximately the second quarter of 2009. In February 2009, we executed a Stock Purchase Agreement with an investor who has agreed to
purchase $1 million of our stock each month for up to eighteen months. However, we will require additional funds to complete research and development, build and deploy our systems and increase
our revenues. We anticipate that such funds will be obtained from external sources and intend to seek additional equity or debt to fund future operations. We estimate that we will need to raise an
additional $30 million during 2009 through the issuance of equity securities in order to build and operate seven MW of frequency regulation capacity and have sufficient working capital to
continue to execute our business plans through the end of 2009, including ordering long-lead items required by our production plan for 2010.

Operations

We have experienced losses since our inception and, as of December 31, 2008, had an accumulated deficit of approximately
$186.9 million. We are focused on the commercialization of our Smart Energy Matrix flywheel system for frequency regulation and completion of our government research and
development contracts. This commercialization will require substantial additional outlays of capital. We have also continued, at a reduced level, to sell our inverter product for solar energy
applications. Although we are continuing to support the product, we do not believe that inverters will be a significant portion of our business going forward.

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

Basis of Presentation

Going concern

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of
assets and the satisfaction of liabilities in the normal course of business. As shown in our consolidated financial statements, we had minimal revenues, and incurred

71

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

significant
losses of approximately $23,568,000, $12,918,000 and $12,163,000 and cash decreases from operations of approximately $13,859,000, $11,282,000 and $8,441,000 during the years ended
December 31, 2008, 2007 and 2006, respectively. We have approximately $14,357,000 of cash and cash equivalents on hand at December 31, 2008, which is adequate to finance our business
plan through approximately the second quarter of 2009. Since our cash requirements for operation and construction of frequency regulation facilities far exceeds the cash generated from operations, we
may be unable to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be
necessary should we be unable to continue as a going concern.

We
recognize that our continuation as a going concern is dependent upon our ability to generate sufficient cash flow to allow us to satisfy our obligations on a timely basis. The
generation of sufficient cash flow is dependent, in the short term, on our ability to obtain adequate equity and/or debt financing, and in the long term, on the successful commercialization of our
Smart Energy Matrix and our ability to provide frequency regulation services to the electricity grid. We believe that the successful achievement of these initiatives should provide us
with sufficient resources to meet our long-term cash requirements. In addition we are also considering a number of other strategic financing alternatives and have incurred substantial
costs in these efforts; however, no assurance can be made with respect to the success of these efforts or the viability of our company.

Accounting Principles

The accompanying consolidated financial statements have been prepared using accounting principles generally accepted in the United
States of America.

Consolidation

The accompanying consolidated financial statements include the accounts of Beacon Power Corporation and our subsidiary Beacon Power
Securities Corporation. In September 2008, we established two wholly-owned subsidiaries, Tyngsboro Regulation Services LLC and Tyngsboro Holding LLC. As of December 31, 2008, both
entities were inactive. Our other subsidiary, Beacon Acquisition Co. was inactive in 2005 and was dissolved in 2006. All significant inter-company accounts and transactions have been eliminated
in consolidation.

Recapitalization

The accompanying financial statements reflect a recapitalization of the Company in 1997 when one shareholder exchanged shares of common
stock for Class A preferred stock.

Recently Adopted Accounting Pronouncements and Recent Pronouncements

Recently adopted accounting pronouncements and recent pronouncements are discussed in Part II, Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operation" of our Annual Report on Form 10-K, and are incorporated in these financial statements by reference.

72

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

Summary of Significant Accounting Policies

Use of Estimates

The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include demand deposits and highly liquid investments with maturities of three months or less when acquired.
Cash equivalents are stated at cost, which approximates market value.

Accounts Receivable and Allowance for Doubtful Accounts

We evaluate the collectability of our open receivables on an ongoing basis. Specific reserves for bad debt are recorded based on the
age of receivables, and when we are notified of a customer's inability to satisfy its debt obligations, such as in the event of a bankruptcy filing. We provide an allowance for doubtful accounts equal
to the estimated uncollectible amounts due from our customers. Our estimate is based on limited historical collection experience and a review of the current status of trade accounts receivable.
Accounts receivable are presented in our balance sheets net of an allowance for doubtful accounts of $0 and $2,568 at December 31, 2008 and 2007, respectively.

Two
of our research and development contracts contain holdback provisions that allow our customers to withhold 10% from each invoice payment. As of December 31, 2008 and 2007,
approximately $6,000 and $68,000, respectively, of our accounts receivable balance represented holdbacks. These holdbacks are payable once the final reports have been received and approved. We believe
the remaining holdback will be collected upon completion of the contract, and therefore have not recorded any reserve against this amount.

Inverter Inventory

We have a limited amount of inventory related to our inverter product line, which we value at the lower of actual cost or the current
estimated market value. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory. Since we have not had substantial revenues from our inverter product
line and we were uncertain of future revenues, we recorded a full reserve for the total value of the inventory in a prior year. Accordingly, for the years ended December 31, 2008, 2007 and
2006, the value of our inverter product line inventory was fully-offset by these reserves.

Unbilled costs on contracts in process

Contract costs that we incur in advance of billings to customers, such as material purchases, direct labor and overhead are reflected
as a current asset on our balance sheet as "Unbilled costs on contracts in process."

73

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

Prepaid Expenses and Other Current Assets

Prepaid expenses at December 31, 2008 consist primarily of prepaid insurance premiums (primarily related to directors' and
officers' liability insurance) of approximately $381,000, and other prepaid expenses of approximately $489,000, which consist primarily of advances to vendors for long-lead orders and
prepaid maintenance agreements. Prepaid expenses at December 31, 2007 consist primarily of deferred lease payments of approximately $517,000, prepaid insurance premiums (primarily related to
directors' and officers' liability insurance) of approximately $368,000, and other prepaid expenses of approximately $590,000, which consist primarily of advances to vendors for long-lead
orders and prepaid maintenance agreements.

Lease Obligation and Deferred Rent

During July 2007, we signed a seven-year operating lease with escalating payments on a new facility in Tyngsboro,
Massachusetts. As part of this lease agreement, we issued to the landlord 150,000 shares of our common stock and a warrant exercisable for 500,000 shares of our common stock in return for lower cash
payments under the lease. (See Note 4: Commitments and Contingencies.) Additionally, the landlord reimbursed the Company for certain leasehold improvements in the amount of $1,430,000 during
2008. We have recorded rent expense on a straight line basis in accordance with SFAS No. 13, "Accounting for Leases." Lease liability as of
December 31, 2008 was approximately $998,000, of which approximately $113,000 was included in "Deferred rentcurrent". Prior to our receipt of the landlord leasehold improvement
reimbursements in the first quarter of 2008, deferred rent had a debit balance and was included in "Prepaid expenses and other current assets." The amount in Prepaid expenses as of December 31,
2007 was approximately $517,000.

Property and Equipment

Property and equipment in service is stated at cost and depreciated using the straight-line method over the estimated
useful lives of the assets. Property and
equipment are defined as tangible items with unit costs exceeding our capitalization threshold that are used in the operation of the business, are not intended for resale and which have a useful life
of one year or more. The cost of fixed assets is defined as the purchase price of the item, as well as all of the costs necessary to bring it to the condition and location necessary for its intended
use. These costs include labor, overhead, capitalized interest and, if applicable, exit costs. Exit costs for which we are obligated are accounted for in accordance with SFAS No. 143,
"Accounting for Asset Retirement Obligations." No overhead is generally applied for internally-constructed projects not directly related to our core
business (e.g., leasehold improvements.) Repair and maintenance costs are expensed as incurred. Materials used in our development efforts are considered research and development materials, and
are expensed as incurred in accordance with Statement of Financial Accounting Standards No. 2 "Accounting for Research and Development Costs."

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

Materials
purchased to build flywheels, power electronics and other components used in our frequency regulation installations are classified as CIP, along with the related labor and
overhead costs. Some components of the Smart Energy Matrix, such as the flywheels and power electronics, are

74

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

considered
"fungible" in that they can be moved and redeployed at a different location. Other costs are sunk costs which would not be recovered if we redeployed the matrix or portions thereof. In some
cases, we may elect to deploy a Smart Energy Matrix system at a location for the purpose of demonstrating our technology or gaining experience operating in that particular market. In
these instances, the costs of the fungible components are capitalized, and the remaining costs, which may include such costs as site preparation, interconnection costs, capitalized interest and
estimated exit costs, are expensed.

Loss on Contract Commitments

Our contracts have been primarily for the development of demonstration units of new products and the design of a frequency regulation
plant. As such, the work has supported our core research and development efforts. We establish reserves for anticipated losses on contract commitments if, based on our cost estimates to complete the
commitment, we determine that the cost to complete the contract will exceed the total expected contract revenue. Most of our contracts have been granted on a cost-share basis, for which
the expected cost-share is recorded as a contract loss. Additionally, each quarter we perform an evaluation of expected costs to complete our in-progress contracts and adjust
the contract loss reserve accordingly.

We
recorded charges of approximately $1,385,000 during 2006 for anticipated losses on our research and development contracts. Approximately $240,000 of this charge in 2006 relates to the
cost share portion of 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 Matrix frequency regulation power plant. The remainder of the 2006 charge relates to a revision of our labor and overhead rates and other estimated
costs to complete our remaining contracts based upon current forecasts. During 2007, we completed all but one contract at an actual cost that was less than previously estimated. Accordingly, we
reduced our contract loss reserve by approximately $578,000.

In
April 2008 we were awarded a subcontract to provide a flywheel energy storage system in support of a wind integration research and development (R&D) project sponsored by the
California Energy Commission. We will receive approximately $250,000 to offset R&D expenses and will contribute an additional $87,000 of engineering resources for the project, bringing the R&D total
to approximately $337,000. We recorded a charge of approximately $87,000 during the second quarter of 2008 to reflect the expected "cost share" portion of this contract.

Impairment of Long-Lived Assets

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

75

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

In
certain instances, we may determine that it is in the best interest of the Company to move and re-deploy all or part of a Smart Energy Matrix System installed
at a given location. When such a determination has been made, we will determine which costs are associated with the movable (fungible) components, and which costs are non-fungible. We will
record a period expense for the net book value not associated with the fungible components.

Based
on our annual analysis, no asset impairment charges were considered necessary for 2007 or 2008. Certain long-lived assets were damaged in December 2006 and we
recognized an asset impairment charge of approximately $18,600 in 2006.

Other assets and deferred financing costs

We will defer our direct costs incurred to raise capital or to acquire an entity in a business combination. Direct costs include only
"out-of-pocket" or incremental costs directly related to the effort, such as a finder's fee and fees paid to outside consultants for accounting, legal or engineering
investigations or for appraisals. These costs will be capitalized if the efforts are successful, or expensed when unsuccessful. Indirect costs are expensed as incurred.

Advance billings on contracts

We may receive performance-based payments and progress payments from customers which may exceed costs incurred on certain contracts,
including contracts with agencies of the U.S. Government. Such advances are classified as current liabilities.

Restructuring and asset impairment charges

We periodically evaluate all of our property and equipment as required by Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," and record an impairment loss when appropriate. We have reviewed our
property and equipment as of December 31, 2008 and determined that no impairment exists.

Revenue Recognition

Although we have sold photovoltaic inverters, and recorded revenues for flywheel development and frequency regulation service from the
ISO-NE Pilot program, our operations have not yet reached a level that would qualify us to emerge from the development stage. Therefore we continue to be accounted for as a development
stage company under Statement of Financial Accounting Standards No. 7, "Accounting and Reporting by Development Stage Enterprises."



76

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)



77

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)



Twelve months ended
December 31,2008

2007Beginning balance

$
67,419

$
821,032Charges for the period


86,601


(577,789
)Reductions


(21,494
)

(175,824
)Ending balance

$
132,526

$
67,419


Cost of Goods Sold

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

We
provide a five-year limited product warranty for our Smart Power M-series inverter product line and accrue for estimated future warranty costs in the period in
which the revenue is recognized. In 2004, we established a reserve for our Smart Power M-series inventory as a result of lower than anticipated sales volumes. During 2008, 2007 and 2006 we
continue to have very limited sales of our inverter products. The costs related to these sales are not fully reflected in the cost of goods sold as 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 these revenues.

For
government contracts, cost of sales is calculated on the same percentage of contract costs (up to the total contract revenue amount) as is used to calculate revenue. Costs in excess
of the total contract revenue amount are charged to contract loss.

For
frequency regulation revenue, cost of goods sold represents the cost of energy. We pay for energy we take off the grid and store on our flywheels, and are paid for this energy when
we discharge the stored energy from our flywheels back onto the grid. Because the 1 MW pilot resource is connected to a distribution level power line, we are paying the retail price for all the
electricity that we withdraw from the grid instead of paying the wholesale price of electricity for the net electricity that we withdraw from the grid (withdrawals minus injections). The price of
electricity at the distribution level is determined by the retail tariff of the local distribution company versus the ISO wholesale tariff. The retail price of electricity includes charges for both
the delivery of electricity and the electricity commodity itself, and is about twice the price of wholesale electricity. Furthermore, the retail tariff does not have a provision for netting the
electricity withdrawn and injected to the grid by our flywheels. We have been working with ISO-NE and our local distribution company to change how we are being charged for electricity for
the Pilot Program. The parties have agreed to allow the 1 MW pilot resource to net its electricity commodity costs at the wholesale rate, a change that we expect will be implemented late in the first
quarter of 2009. We are working to reduce the electricity delivery charges as well.

78

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

However,
even though this change will reduce our operating expenses for the 1 MW, we do not expect to be profitable under the Pilot Program because revenues earned are less than those
that we would expect to earn under permanent market rules for two reasons. First, under pilot program market rules, we are not eligible for opportunity cost payments, which represent approximately
one-third of the revenue received by conventional regulating generators; and second, the frequency regulation signal we are receiving from ISO-NE does not take full advantage
of our speed of response, and thus our mileage revenue is lower than we would otherwise expect.

Twelve months ended
December 31, 2008

Twelve months ended
December 31, 2007Revenue

Cost of Sales

Margin

Revenue

Cost of Sales

MarginFrequency regulation

$
10

$
41

$
(31
)
$


$


$
Contract


12


12





1,323


1,247


76Inverters and related


46





46


66


1


65Total

$
68

$
53

$
15

$
1,389

$
1,248

$
141


Stock-Based Compensation

During the first quarter of 2006, we adopted the provisions of, and accounted for, stock-based compensation in accordance with the
Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123R ("SFAS 123R"), "Share-Based Payment."
Under the fair value recognition provisions of SFAS 123R, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as an expense as it
is earned over the requisite service period, which is the vesting period. To implement this standard, we elected the modified-prospective transition method, under which prior periods are not revised
for comparative purposes. The fair value of the options on their grant date was measured using the Black-Scholes option-pricing model, which we believe yields a reasonable estimate of the fair value
of the grants made. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation
expense for grants that were outstanding as of the effective date will be recognized over the remaining vesting period using the compensation cost estimated for the SFAS 123R pro forma
disclosures.

The
adoption of SFAS 123R had a material impact on our consolidated financial position and results of operations. See Note 9 for further information regarding our
stock-based compensation assumptions and expenses, including pro forma disclosures for prior periods as if we had recorded stock-based compensation expense during such periods.

We
granted Restricted Stock Units to employees for services performed in 2005 that vested quarterly during 2006. In addition, our officers were granted restricted stock units as part of
their compensation agreements in 2008, 2007 and 2006. Our Restricted Stock Unit Deferred Compensation Plan is described in more detail in Note 9.

79

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

Income Taxes

Deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of
assets and liabilities and tax loss and credit carry forwards using the currently enacted tax rates and laws. A valuation allowance has been provided because realization of deferred tax assets is
uncertain (see Note 10).

Advertising

Advertising expense was approximately $8,000, $1,000 and $10,000 in 2008, 2007 and 2006 respectively, and is expensed as incurred.

Research and Development

Research and development costs are expensed as incurred, except costs that relate to our government contracts. Those expenses are
capitalized as "Unbilled costs on contracts in progress" and charged to Cost of Goods Sold once the revenue is recognized under the percentage of completion method, or charged against the Contract
Loss Reserve as incurred if the costs are not recoverable under the terms of the contract agreement or if the costs exceed the total revenue expected for the contract.

Casualty loss

On December 28, 2006, a malfunction occurred during the testing of a Smart Energy 25 flywheel which resulted in the loss of the
flywheel and other inventory (which had previously been expensed), as well as minor damage to the building improvements and other equipment. A casualty loss of approximately $69,000 was recorded in
2006 for the estimated cost of repairs to the building improvements, repairs to fixed assets, replacement of damaged supplier equipment and to perform necessary clean up. Additional costs to complete
the building clean up, assess the cause of the failure, repair damaged equipment and replace previously-expensed inventory and materials that were damaged or destroyed was approximately $345,000.
During 2007, we recovered
approximately $336,000 of these costs from insurance. There were no casualty losses or recoveries in 2008.

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, accounts receivable, inventory, accounts payable, accrued expenses, and other current
assets and liabilities approximate their fair values.

Concentration of Credit Risk

Financial instruments that potentially subject us to significant concentration of credit risk consist primarily of cash and cash
equivalents. We keep our cash investments with high-credit-quality financial institutions or Treasury funds. At December 31, 2008 substantially all of our cash and cash equivalents
were held in interest bearing accounts at financial institutions earning interest at varying rates from 0.13% to 1.84%. At December 31, 2008 and 2007, we had cash balances at a financial
institution in excess of federally insured limits. However, we do not believe that it is subject to unusual credit risk beyond the normal credit risk associated with commercial banking relationships.
Approximately

80

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 2. Basis of Presentation and Summary of Significant Accounting Policies (Continued)

$6 million
of our cash on hand at December 31, 2008 was invested in a mutual fund that was enrolled in the U.S. Treasury Department's Temporary Guarantee Program for money market funds.
Under the Guarantee Program, the U.S. Treasury guarantees the $1.00 per share value of funds outstanding as of September 19, 2008, subject to certain terms and limitations. The program has been
extended by the Treasury Department until April 30, 2009, but may be further extended by the Treasury Department to terminate no later than September 18, 2009. The guarantee will be
triggered if the market-based net asset value of the fund is less than $0.995, unless promptly cured.

Comprehensive Loss

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

Loss per ShareBasic and Diluted

Basic loss per share has been computed using the weighted-average number of shares of common stock outstanding during each period.
Warrants, options and other securities exercisable for common shares are used in the calculation of fully-diluted EPS only if their conversion to common shares would decrease income or increase loss
per share from continuing operations. Since the years ended December 31, 2008, 2007 and 2006 reflect losses, including the potential conversion of warrants and options in the diluted EPS
calculation would decrease loss per share. Thus, they are considered anti-dilutive and are not included in the calculation of earnings per share.

Note 3. Property and Equipment

Property and equipment consisted of the following:

As of:Estimated
Useful Lives

December 31,
2008

December 31,
2007Construction in Progress

Varied

$
11,629,918

$
5,782,127Land




192,487


Smart Energy Matrix flywheels

20 years


2,009,419


Machinery and equipment

5 - 10 years


2,600,410


1,137,946Service vehicles

5 years


16,763


16,763Furniture and fixtures

7 years


634,294


603,382Office equipment

3 years


1,028,037


828,918Leasehold improvements

Lease term


7,572,244


Equipment under capital lease obligations

Lease term


700,517


700,516Total



$
26,384,089

$
9,069,652Less accumulated depreciation and amortization




(3,356,180
)

(2,065,631
)Property and equipment, net



$
23,027,909

$
7,004,021


In
2008, we deployed 1 MW of capacity under the ISO-NE Alternative Energy Storage Technology Pilot Program (Pilot Program) with a system installed inside our Tyngsboro
facility. The Smart Energy

81

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 3. Property and Equipment (Continued)

25
flywheels shown above represent the cost of the flywheels and electronic control modules in use for this pilot program.

In
July 2008, we exercised our option to purchase land in Stephentown, NY, for the construction of a frequency regulation system, the cost of which is reflected as "Land" in the schedule
shown above.

The
components of "Construction in progress", which represents costs related to assets that have not yet been placed into service and for which no depreciation expense has been taken,
were as follows:

As of:December 31,
2008

December 31,
2007Materials to build production flywheels

$
6,553,828

$
453,192Smart Energy 25 flywheels


2,199,164


9,527Smart Energy Matrix in progress


2,296,608Deposits and other costs related to the acquisition of land for frequency regulation systems





17,123Machinery and equipment


302,267


85,725Office equipment





115,647Leasehold improvements


278,051


5,100,913Construction in progress

$
11,629,918

$
5,782,127


Approximately
$11,000,000 of the total shown as "Construction in Progress" (CIP) represents completed flywheels, materials to build flywheels and other costs related to the Smart Energy
Matrix installations under construction outside our Tyngsboro and Stephentown sites. The Smart Energy Matrix installation costs included in CIP include approximately
$1,900,000 for fungible components we expect to deploy at either our site in Stephentown, New York or in Ohio, and approximately $385,000 in site costs related to Stephentown.

As
of December 31, 2007, CIP included approximately $5,101,000 in leasehold improvements related to the build-out of the Tyngsboro facility (most of which was placed
into service during January, 2008), approximately $453,000 in materials purchased to build production flywheels to be used in our frequency regulation facility, and approximately $17,000 for an option
to purchase land in New York to be used as a site for our frequency regulation facility. The remaining costs in CIP, approximately $211,000 relate to various machinery, equipment, tooling, software
and computer equipment which were not in service as of December 31, 2007.

82

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 4. Commitments and Contingencies

The following table summarizes our purchase obligations and the aggregate maturities and payments due for our contractual obligations for the five years following December 31,
2008:

Description of CommitmentOperating
lease

Purchase
Obligations

TotalPeriod ending:December 31, 2008

$


$
6,846,297

$
6,846,297December 31, 2009


701,687





701,687December 31, 2010


727,437





727,437December 31, 2011


753,188





753,188December 31, 2012


778,937





778,937December 31, 2013


804,689





804,689Thereafter


618,000





618,000Total Commitments

$
4,383,938

$
6,846,297

$
11,230,235


At
December 31, 2008, we had firm purchase commitments with our suppliers to acquire components for these commercial flywheel units, complete the build-out of the
Smart Energy Matrix outside the Tyngsboro facility, and to satisfy contractual obligations for our research and development programs in the amount of approximately $6.8 million. In
addition, we have a commitment of approximately $2.2 million to purchase a key component from a supplier who has not yet been able to meet our technical specifications. We do have another
supplier for this component. However, since our objective is to have at least two suppliers for all key components, we are working closely with the supplier to resolve this from a technical
perspective. If not, however, the contract will be cancelled due to the supplier's inability to perform.

In
July 2007, we signed a seven-year lease on our current corporate headquarters, and relocated all of our operations to this facility in January 2008. This facility
significantly expands our manufacturing capacity and provides sufficient space to continue our research and development activities. Our facility is located at 65 Middlesex Road, Tyngsboro, MA. The
103,000-square-foot facility, which has manufacturing capacity that will allow production of more than 1,000 flywheels per year, has been renovated and built-out to
our specifications.

We
provided our landlord with an irrevocable letter of credit securing our performance under the lease with a balance at September 30, 2008 of $200,000, which is reduced
periodically over the lease term. This letter of credit is secured by a cash deposit, which is included in restricted cash in the accompanying consolidated balance sheets. In addition to our rent
payments, we are responsible for real estate taxes and all operating expenses of the Tyngsboro facility.

Additional
capital expenditures will be required in the future to optimize the plant for maximum capacity. The amount and timing of these expenditures are dependent on requirements of
equipment needed to meet production schedules as well as having sufficient funding.

Rent
expense was $585,451, $732,534 and $237,695 during 2008, 2007 and 2006, respectively net of restructuring reserves applied of $0, $253,491 and $337,988, respectively. Rent expense
in 2007 included rent on both the Tyngsboro and Wilmington facilities between July and November.

83

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 4. Commitments and Contingencies (Continued)

Legal Proceedings

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

On
October 9, 2007, Arete Power, Inc. filed a complaint against the Company, claiming damages from alleged willful infringement of U.S. Patent No. 6,710,489,
entitled "Axially Free Flywheel System." On November 21, 2008, Beacon and Arete reached a settlement that ends the litigation and includes an assignment of the '489 Patent to Beacon with a
limited license back to Arete. The settlement also includes a covenant not to sue, whereby Arete Power has agreed not to bring any new complaint against Beacon alleging infringement of Arete's other
flywheel patents. There are no legal proceedings pending.

Note 5. Long-Term Debt

Long-term debt was as follows:

As of December 31,2008

20076.5% Note Payable to MassDev, due November 2015

$
3,571,993

$
Less unamortized discount (warrants)


(217,909
)

Total


3,354,084


Less current portion of long-term debt


(117,023
)

Net long-term debt

$
3,237,061

$



On
June 30, 2008, we entered into an agreement with Massachusetts Development Finance Agency ("MassDev") pursuant to which MassDev has agreed to lend to the Company up to
$5 million. This loan derives from a funding collaboration between the Emerging Technology Fund of MassDev and the Massachusetts Technology Collaborative Business Expansion Initiative. The loan
proceeds were used to help fund the expansion of our production facility.

The
MassDev loan is evidenced by a promissory note under which we may make one or more requests for advances of up to an aggregate of $5 million for the purchase of equipment and
installation of certain building improvements at our Tyngsboro, Massachusetts facility. We have one year following the date of the initial advance to draw on the loan, should we choose to do so. The
initial advance on the loan was made on October 1, 2008 for approximately $3.5 million. The note will mature 84 months after the initial advance and bears a fixed annual interest
rate of 6.5%.

84

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 5. Long-Term Debt (Continued)

Loan
repayments began in November 2008. The payments will be of interest only during the first twelve months and thereafter, the balance of the principal outstanding under the note shall
be amortized in monthly payments of principal and interest in equal monthly installments over the remaining term of the note.

Based
on the amount currently outstanding, principal payments required under the loan over the next five years, excluding discount due to warrants, are as follows:

AmountPeriod ending:December 31, 2009

$
118,749December 31, 2010


494,718December 31, 2011


527,851December 31, 2012


563,202December 31, 2013


600,920Thereafter


1,266,553Total Payments

$
3,571,993


Pursuant
to the note, we entered into a security agreement which grants to MassDev an exclusive first priority security interest in all equipment and tenant improvements funded with the
proceeds of the loan with an approximate carrying value of $2,800,500 at December 31, 2008. We also entered into a collateral assignment of lease agreement as additional security for the
repayment of borrowings. This agreement grants MassDev all rights, title and interest in and to our lease for the Tyngsboro facility in the event that we default on our obligations.

As
partial consideration for the loan, on June 30, 2008, we issued MassDev two warrants. Each warrant provides for the purchase of 85,979 shares of our common stock at an exercise
price of $1.89 per share, subject to any adjustments as set forth in the warrants. The warrants are exercisable for seven years commencing on June 30, 2008 and provide for registration
rights for the resale of the shares issued upon their exercise. MassDev assigned one of the warrants to the Massachusetts Technology Park Corporation ("MTPC"), as part of MTPC's participation under
the Massachusetts Technology Collaborative Business Expansion Initiative. The Black-Scholes fair value of the warrants is shown as a discount against the loan, and is being amortized over the life of
the loan using the effective interest method at an imputed interest rate of 1.124%. The amortization of this discount resulted in approximately $10,000 charged to interest expense during 2008. The
effective interest rate of the loan, including the cost of the warrants and other deferred loan costs, is approximately 8.4%.

Additional
capital expenditures will be required in the future to optimize the plant for maximum manufacturing capacity. The amount and timing of these expenditures are dependent on
requirements for equipment needed to meet production schedules as well as having sufficient funding.

Note 6. Preferred Stock

As a result of the initial public offering of our common stock and the conversion of all outstanding shares of all classes of the preferred stock, we amended our charter and cancelled
all our classes of preferred stock. We then added a new class of preferred stock that can be issued in the future by filing

85

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 6. Preferred Stock (Continued)

a
Certificate of Designations with the specific terms as set by our Board of Directors. At December 31, 2008 and 2007, there are 10 million shares of $.01 par value preferred stock
authorized with none outstanding.

Note 7. Common Stock

On December 24, 2008, we sold 8,966,000 units of the Company at a purchase price of $0.50 per unit, for a total of approximately $4.1 million, net of expenses. Each unit
consisted of one share of our common stock, par value $0.01 per share, and a warrant to purchase one share of common stock at an
exercise price of $0.74 per share, for a total of 8,966,000 warrants. The units were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with a
shelf takedown from our registration statement that became effective on July 29, 2008.

On
October 15, 2008, we sold 8,700,000 units of the Company at a purchase price of $0.91 per unit, for a total of approximately $7.2 million, net of expenses. Each unit
consisted of one share of our common stock, par value $0.01 per share, and a warrant to purchase one share of common stock at an exercise price of $1.20 per share, for a total of 8,700,000 warrants.
The units were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with a shelf takedown from our registration statement that became effective on
July 29, 2008.

On
October 31, 2007, we sold 11,911,852 units of the Company at a purchase price of $2.10 per unit, for a total of approximately $23.8 million, net of expenses. Each unit
consisted of one share of our common stock, par value $0.01 per share, and a warrant to purchase 0.95 shares of common stock at an exercise price of $2.97 per share, for a total of 11,316,260
warrants. The units were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with our registration statement on Form S-3 for
$50 million filed on August 6, 2007, which we amended on August 14, 2007 and became effective on August 15, 2007.

On
September 10, 2007, we sold 5,102,041 units of the Company at a purchase price of $1.96 per unit for a total of approximately $9.2 million, net of expenses. Each unit
consisted of one share of our common stock, par value $0.01 per share, and a warrant to purchase 1.2 shares of common stock at an exercise price of $1.99 per share, for a total of 6,122,449 warrants.
In addition, 153,061 warrants were issued to the placement agents at the same price per share. The units were issued pursuant to a prospectus supplement filed with the Securities and Exchange
Commission in connection with our registration statement on Form S-3 for $50 million filed on August 6, 2007, which we amended on August 14, 2007 and became
effective on August 15, 2007.

On
July 23, 2007 we entered into a lease for a new facility in Tyngsboro, MA. We agreed under the terms of the lease to issue to the landlord pursuant to an exemption from
registration under the Securities Act of 1933, as amended, a warrant exercisable for 500,000 shares of our common stock at an exercise price of $1.77 per share. In addition, we issued the landlord
150,000 shares of common stock.

On
February 15, 2007, we issued 11,814,687 units for $0.90 per unit, each of which consists of one share of our common stock, par value $0.01 per share, and a warrant to purchase
0.5 shares of our common stock at an exercise price of $1.33 per share for a total of 5,907,345 warrants. In addition, 354,441 warrants were issued to the placement agents at the same price per share.
We received net

86

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 7. Common Stock (Continued)

proceeds
of approximately $9.8 million after deducting placement agency fees and estimated offering expenses.

On
November 8, 2005 we completed the private placement of 9,868,421 shares of our common stock at a price of $1.52 per share, for an aggregate offering price of approximately
$15 million to certain institutional investors. We also offered these investors and placement agents warrants to purchase 2,960,527 and 450,000 shares, respectively, of our common stock at an
exercise price of $2.21 per share. In connection with this transaction we paid placement agent fees and expenses of approximately $1 million. We agreed to register for resale under the
Securities Act all the shares issued in this offering as well as the shares issuable upon exercise of the warrants. On March 2, 2006, we filed a registration statement on
Form S-3 with the Securities and Exchange Commission (File No. 333-130207) that was declared effective on March 7, 2006. These proceeds have been and will
continue to be used for working capital purposes. In February 2007, we issued stock at a price that triggered the warrants' anti-dilution provisions, resulting in the exercise price of the
warrants issued to the investors being adjusted from $2.21 to $1.99 and 327,294 additional warrants being issued to the investors.

On
May 24, 2005 and July 26, 2005 we issued 1,666,667 and 1,785,714 shares of common stock, respectively pursuant to an investment agreement dated April 22, 2005. In
exchange, we received $3 million in the aggregate from Perseus 2000 Expansion, L.L.C. We also issued a warrant for the purchase of 800,000 shares of our common stock at an exercise price of
$1.008 and an extension for two years of an existing warrant already owned by Perseus which expired on May 23, 2007. We agreed to register for resale under the Securities Act all the shares
issued in this offering as well as the shares issuable upon exercise of the warrants. On March 2, 2006, we filed a registration statement on Form S-3 with the Securities and
Exchange Commission (File No.333-130208) that was declared effective on March 7, 2006. These proceeds have been and will be used for working capital purposes.

Initial Public Offering

During the fourth quarter of 2000, we sold 9,200,000 shares of our common stock, inclusive of the underwriters' overallotment, at an
initial public offering price of $6 per share. Net proceeds as a result of the stock offering totaled approximately $49.3 million reflecting gross proceeds of $55.2 million net of
underwriter commissions of approximately $3.9 million and other estimated offering costs of approximately $2.0 million.

Shareholder Rights Agreement

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

87

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 7. Common Stock (Continued)

On
February 18, 2009, the Company entered into Amendment No. 4 (the "Amendment") to the Rights Agreement between the Company and Computershare Trust Company, N.A. (fka
Equiserve Trust Company, N.A.), as Rights Agent, as previously amended by Amendment No. 1 dated as of December 27, 2002, Amendment No. 2 dated as of August 8, 2007 and
Amendment No. 3 dated as of October 24, 2007 (as amended, the "Rights Agreement"). Amendment No. 4 excludes Seaside 88, LP from the beneficial ownership computations used
to determine whether a person has become an Acquiring Person (as defined in the Rights Agreement) of securities solely because the person has a right to acquire the securities but has not in fact
acquired them.

Reserved Shares

At December 31, 2008, 67,091,394 shares of our common stock were reserved for issuance under our stock option plan, employee
stock purchase plan and outstanding warrants.

Note 8. Stock Warrants

Warrants outstanding as of December 31, 2008:

Description

Grant
Date

Expiration
Date

Strike
Price

Issued and
OutstandingMay 24, 2005 Financing


5/24/2005


5/25/2010

$
1.008


800,000November 8, 2005 Financing (Investors)


11/8/2005


5/9/2011

$
1.66


3,941,425February 15, 2007 Shelf Issue


2/15/2007


2/15/2012

$
1.33


6,261,786GFI Tyngsboro Lease


7/23/2007


7/22/2014

$
1.77


500,000September 10, 2007 Shelf Issue (Investors)


9/10/2007


3/10/2013

$
1.99


6,122,449September 10, 2007 Shelf Issue (Placement Agents)


9/10/2007


3/10/2013

$
1.99


153,061October 31, 2007 Shelf Issue


10/31/2007


5/1/2013

$
2.97


11,316,260June 30, 2007 Massachusetts Development Loan


6/30/2008


6/30/2015

$
1.89


171,958October 15, 2008 Shelf Issue


10/15/2008


4/16/2014

$
1.20


8,700,000December 24, 2008 Shelf Issue


12/24/2008


6/25/2014

$
0.74


8,966,000Total warrants outstanding











46,932,939


We
have outstanding several series of warrants to purchase our common stock. Holders of the warrants are not entitled to receive dividends, vote, receive notice of any meetings of
stockholders or otherwise have any right as stockholders with respect to their warrant shares.

May 2005 Financing Warrant

In connection with the investment by Perseus 2000 Expansion, L.L.C., we issued a warrant for 800,000 shares of our common stock at an
exercise price of $1.008.

88

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 8. Stock Warrants (Continued)

November 2005 Financing Warrants

As part of a financing transaction in November 2005, we issued warrants to purchase an aggregate of 2,960,527 shares of our common
stock to ten accredited investors. In addition, 450,000 warrants were issued to the placement agents. Each warrant was exercisable for a period of five years and the per-share exercise
price for the warrant shares was $2.21. The terms of the investor warrants included anti-dilution provisions which required us to adjust the exercise price and the number of shares of our
common stock to be issued upon exercise of the warrants under certain circumstances, which include:



We
have issued stock at a price per share below the $1.85 threshold noted above. Based on the warrants' anti-dilution provisions, the exercise price of the investor warrants
was adjusted as shown below. Warrants issued to the placement agent were not subject to adjustment.

# Warrants

Revised Exercise PriceOriginal Warrant


2,960,527

$
2.21Adjustment based on anti-dilution provision:Financing February 2007


327,294

$
1.99Financing October 2008


248,808

$
1.85Financing December 2008


404,796

$
1.66Adjusted Warrant:


3,941,425

$
1.66


Subsequent
to the end of the fiscal year, on February 20, 2009, we entered into a common stock purchase agreement with Seaside 88, LP (Seaside), which requires Seaside to
purchase $1 million of our common stock at a 20% discount once each month for up to 18 months, beginning on February 20, 2009, and on the 20th day of each
month thereafter. Since our common stock is selling substantially below the $1.85 threshold, the warrants noted above were adjusted again in February 2009, and are likely to be adjusted monthly during
the course of this purchase agreement until such time as our stock price increases substantially.

February 2007 Shelf Warrants

In February 2007, we sold 11,814,687 units of the Company at a purchase price of $0.90 per unit. Each unit consisted of one share of
our common stock, par value $0.01 per share, and a warrant to purchase 0.5 shares of common stock at an exercise price of $1.33 per share, for a total of 5,907,345 warrants. In addition, we issued
354,441 warrants to the placement agents at the same price per share. These warrants became exercisable as of August 16, 2007, and expire five years from date of issue. The

89

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 8. Stock Warrants (Continued)

units
were issued pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with our registration statement on Form S-3 filed on
September 1, 2006, which became effective on December 14, 2006. We filed a request with the Securities and Exchange Commission on August 1, 2007 that this registration statement
on Form S-3 be withdrawn and the unsold securities deregistered, and filed a new shelf registration statement on Form S-3 for $50 million on
August 6, 2007, which we amended on August 14, 2007 and became effective on August 15, 2007.

July 2007 Warrants

In July 2007 we entered into a lease for a new facility in Tyngsboro, MA. We agreed under the terms of the lease to issue to the
landlord pursuant to an exemption from registration under the Securities Act of 1933, as amended, a warrant exercisable for 500,000 shares of our common stock at an exercise price of $1.77 per share.
This warrant became exercisable as of July 23, 2007, may be exercised at any time over the term of the lease and expires on July 22, 2014. The warrant and the shares issuable upon
exercise of the warrant are restricted securities and may not be sold without registration under the Securities Act of 1933, as amended, and applicable state securities laws or an exemption therefrom.

September 2007 Shelf Warrants

In September 2007, we sold 5,102,041 units of the Company at a purchase price of $1.96 per unit. Each unit consisted of one share of
our common stock, par value $0.01 per share, and a warrant to purchase 1.2 shares of common stock at an exercise price of $1.99 per share, for a total of 6,122,449 warrants. In addition, 153,061
warrants were issued to the placement agents at the same price per share. The warrants become exercisable as of March 10, 2008, and expire on March 11, 2013. The units were issued
pursuant to a prospectus supplement filed with the Securities and Exchange Commission in connection with our registration statement on Form S-3 for $50 million filed on
August 6, 2007, which we amended on August 14, 2007 and became effective on August 15, 2007.

October 2007 Shelf Warrants

In October 2007, we sold 11,911,852 units of the Company at a purchase price of $2.10 per unit. Each unit consisted of one share of our
common stock, par value $0.01 per share, and a warrant to purchase 0.95 shares of common stock at an exercise price of $2.97 per share, for a total of 11,316,260 warrants. The warrants become
exercisable six months and one day after their issuance, and expire five and one half years after their issuance. The units were issued pursuant to a prospectus supplement filed with the Securities
and Exchange Commission in connection with our registration statement on Form S-3 for $50 million filed on August 6, 2007, which we amended on August 14, 2007
and became effective on August 15, 2007.

90

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BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 9. Stock-Based Compensation

Description of Plans

Stock Option Plan

Our Third Amended and Restated 1998 Stock Incentive Plan allows for the granting of stock options to purchase up to 23,000,000 shares
of our common stock. Options may be granted to our employees, officers, directors, consultants and advisors. Under the terms of the option plan, incentive stock options are to be granted at the fair
market value of our common stock at the date of grant, and nonqualified stock options are to be granted at a price determined by our Board of Directors. In general, our Board has authorized vesting
periods of one to three years and terms of varying length but in no case more than 10 years. Our stock option program is a long-term retention program that is intended to attract,
retain and provide incentives for talented employees, officers and directors, and to align stockholder and employee interests. We consider our option program critical to our operation
and productivity; essentially all of our employees
participate. At December 31, 2008 we had 12,637,891 shares reserved for issuance under this plan, net of outstanding options and RSUs.

Employee Stock Purchase Plan

Our Employee Stock Purchase Plan (the "ESPP") allows substantially all of our employees to purchase shares of our common stock at a
discount through payroll deductions. Participating employees may purchase our common stock at a purchase price equal to 85% of the lower of the fair market value of our common stock at the beginning
of an offering period or on the exercise date. Employees may designate up to 10% of their base compensation for the purchase of common stock under this plan. The ESPP provides for the purchase of up
to 2,000,000 shares of our common stock. Shares purchased under the Plan in 2008, 2007 and 2006 totaled 111,795, 33,416 and 17,958, respectively and the weighted average purchase price of the shares
purchased was $0.874 in 2008, $0.765 in 2007 and $1.129 in 2006. At December 31, 2008, we had 1,718,947 shares reserved for issuance under this plan.

Restricted Stock Unit Arrangements

Our Third Amended and Restated 1998 Stock Incentive Plan permits the grant of restricted stock units ("RSUs") to (i) align our
employees' interests with those of the Company, (ii) motivate our employees to achieve key product development milestones and thus create stockholder value, (iii) retain key employees by
providing equity to such employees and (iv) conserve cash by paying bonuses in the form of RSUs rather than in cash, but with the number of such RSUs calculated on a discounted basis to
compensate for the reduced liquidity as compared to cash. With respect to the RSUs that are granted in lieu of cash bonuses, the number of RSUs granted are based on performance, and are automatically
converted into shares of common stock in four equal tranches in the fiscal year following the year of performance. Certain other RSUs are granted to our officers as a form of equity incentive, are not
tied to performance, and vest over three-year periods in equal quarterly installments. There are also other performance-based RSU's granted to our officers that cliff-vest upon
the achievement of certain Company-specific milestones including earnings levels and revenue goals such that our company is no longer treated as a development stage company for accounting purposes.
Both such vesting events require the recipient officer to be employed by us during the period ending with the milestones. The unvested portion of any RSU grant is subject to forfeiture upon the
holder's resignation or termination for cause. As of December 31, 2008 and 2007, certain

91

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 9. Stock-Based Compensation (Continued)

RSUs
granted under the officer employment agreements were vested but stock was not issued because the vesting date, December 31, fell during our holiday shut-down period or when the
trading window for insiders was closed.

Activity
related to the RSU agreements is as follows:

Year ended December 31,2008

2007

2006(number of shares)Shares issued related to vested RSUs:Based on prior year grants


38,084


14,044


108,786Based upon current year executive officer agreement


14,094


18,030


10,533Vested RSUs not yet converted to stock


14,228


9,521


3,511RSU's granted but not vested:Related to 2006 executive officer agreement





14,053


28,097Related to 2007 executive officer agreement


24,068


48,108


Related to 2008 executive officer agreement


37,602





Related to performance-based executive plan*


1,265,823


1,265,823


1,265,823


---

92

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 9. Stock-Based Compensation (Continued)

Stock
option activity since inception is as follows:

Number of
Shares

Weighted-Average
Exercise Price

Weighted-Average
Fair ValueOutstanding at inception


Granted


15,096,499

$
1.71

$
0.88Exercised


(1,457,987
)
$
0.92Canceled, forfeited or expired


(7,440,937
)
$
2.20Outstanding, December 31, 2004


6,197,575

$
1.59Granted


429,168

$
1.88

$
1.33Exercised


(965,856
)
$
0.74Canceled, forfeited or expired


(79,084
)
$
1.74Outstanding, December 31, 2005


5,581,803

$
1.18Granted


1,104,671

$
1.48

$
0.98Exercised


(100,000
)
$
0.54Canceled, forfeited or expired


(39,588
)
$
2.08Outstanding, December 31, 2006


6,546,886

$
1.23Granted


2,434,343

$
1.05

$
0.61Exercised


(90,210
)
$
0.95Canceled, forfeited or expired


(178,531
)
$
1.46Outstanding, December 31, 2007


8,712,488

$
1.18Granted


2,659,898

$
1.17

$
0.72Exercised


(19,250
)
$
0.79Canceled, forfeited or expired


(14,666
)
$
1.19Outstanding, December 31, 2008


11,338,470

$
1.18


The
following table summarizes information about stock options outstanding at December 31, 2008:

Exercise Price

Number of Options Outstanding

Weighted-Average Remaining Contractual Life (Years)

Weighted-Average Exercise Price

Vested Number of Options

Vested Weighted-Average Exercise Price$0.26$0.74


3,553,233


5.99

$
0.69


3,181,138

$
0.70$0.82$1.46


5,792,517


7.35

$
1.06


3,347,751

$
0.98$1.51$2.19


1,535,470


6.74

$
1.82


1,409,627

$
1.82$2.50$3.10


130,000


1.35

$
2.64


130,000

$
2.64$4.10$5.27


222,250


2.16

$
4.40


222,250

$
4.40$6.00$9.31


105,000


1.81

$
6.40


105,000

$
6.40Total


11,338,470








8,395,766


93

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 9. Stock-Based Compensation (Continued)

Included
in the schedules above are grants of options to purchase 60,000 and 25,000 shares made to non-employee consultants in 2007 and 2004, respectively. The
non-employee consultant to whom the options were granted in 2007 was subsequently hired as an employee in January 2008. There were no grants made to non-employee consultants in
2008, 2006 or 2005.

Stock Compensation

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

We
estimate the volatility of our common stock by using historical volatility. We estimate the expected term of the share or option grant, and determine a risk-free interest
rate based on U.S. Treasury issues with remaining terms similar to the expected term of the options. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an
expected dividend yield of zero in our valuation model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods. All stock-based payment awards
are amortized as they are earned over the requisite service periods of the awards, which are generally the vesting periods.

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

Since
the adoption of SFAS 123R, the compensation cost of RSUs is based on the fair value of the stock as of the date of grant, net of expected forfeitures. This cost is
expensed ratably over the performance period (for performance-based RSUs) or vesting period (for all other RSUs). The number of performance-based RSUs for which stock compensation expense is
calculated is based upon management's assessment of the likelihood of achieving the performance targets.

The
assumptions used to value stock option grants for the year ended December 31, 2008, 2007 and 2006, respectively, are as follows:

Year ended December 31,2008

2007

2006Risk-free interest rate

1.16%3.33%

3.22%5.05%

4.43%5.13%Expected life of option

3.5 years

33.5 years

3 yearsExpected dividend payment rate, as a percentage of the stock price on the date of grant

0%

0%

0%Assumed volatility

78%98%

90%101%

93%129%Expected forfeitures

8.3%

10%

10%


94

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 9. Stock-Based Compensation (Continued)

Stock-based
compensation expense recognized on our consolidated statement of operations for the years ended December 31, 2008, 2007 and 2006, respectively, is as follows:

Year Ended December 31,2008

2007

2006Selling, general and administrative

$
123,962

$
1,179,085

$
1,609,178Research and development


734,732


659,465


724,091Total stock compensation expense

$
858,694

$
1,838,550

$
2,333,269Components of stock compensation expense:Amortization of deferred compensation from restricted stock units (RSUs)

$


$


$
1,104,261Compensation expense related to other RSUs


(840,565
)

605,033


407,614Compensation expense related to stock options


1,699,259


1,233,517


821,394Total stock compensation expense

$
858,694

$
1,838,550

$
2,333,269


As
of December 31, 2008, there was approximately $862,000 of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based
payments granted to our employees and directors. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures and recognized over the remaining vesting periods of
the stock grants.

Note 10. Income Taxes

The components of the provision (benefit) for income taxes consisted of the following:

Cumulative from
May 8, 1997
(Date of Inception)
to December 31,
2008Year ended December 31,2008

2007

2006Statecurrent

$
3,804

$
3,506

$
2,137

$
30,059U.S. Federaldeferred


(8,287,246
)

(3,972,977
)

(2,759,406
)

(53,743,646
)Statedeferred


184,112


1,032,833


(1,074,671
)

(5,702,149
)Increase in valuation allowance


8,103,134


2,940,144


3,834,077


59,445,794Provision (benefit) for income taxes

$
3,804

$
3,506

$
2,137

$
30,058


A
reconciliation of the statutory 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


40Effective rate



%


95

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 10. Income Taxes (Continued)

We adopted the provisions of FIN48 on January 1, 2007. Under FIN 48, the impact of an uncertain
income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing
authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition. The implementation of FIN 48 did not result in a change to the estimated liability for
unrecognized tax benefits at January 1, 2007. At December 31, 2008 and 2007, we had no unrecognized tax positions that would have an impact on our effective tax rate.

The
significant components of our deferred tax assets and liabilities consisted of the following at December 31:

2008

2007Long-term assets:Net operating loss carryforwards

$
51,734,255

$
43,799,785Research and development credits


3,776,079


3,717,311Restructuring reserves


424,925


426,499Other


231,667


120,19756,166,926


48,063,792Less valuation allowance


(56,166,926
)

(48,063,792
)Net deferred tax assets

$


$



The
valuation allowance increased by $8,103,134 in 2008, $2,940,144 in 2007 and $3,834,077 in 2006, primarily due to the generation of net operating loss carry forwards and research and
development credits for which realization is not reasonably assured.

96

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 10. Income Taxes (Continued)

The
following approximates the net operating loss carry forwards and business credits we have available in the future for federal and state tax purposes:

As of December 31,2008

2007Net operating loss carry forwards available in the future:Federal

$
141,287,000

$
118,056,000State


61,609,000


61,014,000Total net operating loss carry forwards available

$
202,896,000

$
179,070,000Business credits available in the future:Federal

$
2,508,000

$
2,213,000State


1,268,000


1,504,000Total business credits available

$
3,776,000

$
3,717,000Beginning expiration date for net operating loss carry forwards


2017Federal research and development credits beginning expiration date


2017Income tax paid from inception

$
30,058

$
26,254


The
net operating loss carry forwards will begin to expire in 2017 for federal tax purposes and began to expire in 2002 for state tax purposes. The federal research and development
credits begin to expire in 2017.

Since
the Company's formation, we have raised capital through the issuance of capital stock on several occasions, as well as transfers of common stock, which resulted in changes of
control as defined by
Section 382 of the Internal Revenue Code. We performed an analysis of our net operating losses and determined that, as of December 31, 2008, none of our loss carryforwards is subject to
the annual limitation under Section 382. Subsequent ownership changes, could further limit the amount of net operating loss carryforwards and research and development credits that we can
utilize annually to offset future taxable income.

We
have excess tax deductions related to equity compensation of approximately $0.7 million and $1.7 million in 2008 and 2007, respectively, of which the benefit will be
realized when it results in a reduction of taxable income in accordance with SFAS 123R.

We
file tax returns in the federal as well as several state tax jurisdictions. As of December 31, 2008, tax years subject to examination by taxing authorities in the federal
jurisdiction are 1997 and forward. The most significant state tax jurisdiction for the company is Massachusetts, and tax years subject to examination by taxing authorities in that jurisdiction are
2004 and forward. These tax years are still open to audit as our net operating losses incurred in those years may be subject to examination. The Company is currently not under any income tax
examinations.

Note 11. Related Party Transactions

There were no related party transactions during 2007 or 2008.

97

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 12. Quarterly Results (Unaudited)

In management's opinion, this unaudited information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information for
the quarters presented. The operating results for any quarter are not necessarily indicative of results for any future quarters.

2008First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

Total
YearRevenue

$
20,204

$
28,188

$
4,390

$
15,349

$
68,131Gross profit (loss)

$
20,148

$
24,072

$
(1,373
)
$
(27,721
)
$
15,126Loss from operations

$
(5,467,597
)
$
(5,507,822
)
$
(5,675,300
)
$
(7,187,873
)
$
(23,838,592
)Net (loss) income

$
(5,287,336
)
$
(5,431,837
)
$
(5,620,733
)
$
(7,228,457
)
$
(23,568,363
)Loss per sharebasic and diluted

$
(0.06
)
$
(0.06
)
$
(0.06
)
$
(0.08
)
$
(0.26
)Weighted-average common shares outstanding


88,668,383


88,712,016


88,754,642


97,281,814


90,866,039




2007First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

Total
YearRevenue

$
392,706

$
449,328

$
372,515

$
174,285

$
1,388,834Gross profit (loss)

$
460

$
29,784

$
21,204

$
89,338

$
140,786Loss from operations

$
(3,207,368
)
$
(3,205,731
)
$
(2,944,650
)
$
(4,261,868
)
$
(13,619,617
)Net (loss) income

$
(3,089,618
)
$
(3,066,126
)
$
(2,813,791
)
$
(3,948,370
)
$
(12,917,905
)Loss per sharebasic and diluted

$
(0.05
)
$
(0.04
)
$
(0.04
)
$
(0.05
)
$
(0.18
)Weighted-average common shares outstanding


65,432,694


71,360,328


72,661,975


84,759,765


73,604,198


Note 13. Subsequent Events

On January 21, 2009, The Quercus Trust transferred its interest in 5,884,455 warrants issued October 31, 2007 back to us for $100. These warrants had an exercise price of
$2.97.

On
February 3, 2009, we announced that we had signed a contract with the U.S. Naval Sea Systems Command (NAVSEA) to evaluate the use of flywheel energy storage technology for
multiple shipboard applications that will lead to a final conceptual design of a flywheel system for future naval surface combatants. Under terms of this multiyear contract, we will perform an
analysis of future shipboard energy storage needs; identify several flywheel applications that could offer the greatest benefit to future naval combatants; assist the Navy's power plant upgrade
development team by characterizing the flywheel applications under consideration and assisting in system-level studies; and validate the results of those studies. Based on the results, we will develop
a conceptual flywheel design and simulation models for one or more applications. The value of the initial research and development work is estimated at $900,000, $500,000 of which has already been
appropriated. The subsequent phases involve work estimated at up to an additional $2.1 million.

98

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 13. Subsequent Events (Continued)

On
February 20, 2009, we entered into a common stock purchase agreement with Seaside 88, LP, valued at up to $18 million. The agreement requires Seaside to buy
$1 million of common stock from us once each month for up to 18 months, beginning on February 20, 2009, and on the 20th day of each month thereafter (or the
next closest business day.) The agreement is structured in three six-month tranches, or segments, each covering monthly closings of $1 million each, for up to $6 million
total. We are committed to only the first six-month tranche, but we have the option, exercisable at our sole discretion, to extend the agreement for up to two additional
six-month periods (each for up to $6 million), for a total of up to $18 million over the three tranches. We have paid Seaside $100,000 for the right to exercise the first
optional extension (although we have not actually exercised that extension), and would pay an additional $50,000 if we wish to exercise the second such extension. Additionally, at our sole discretion,
we can freeze the monthly transactions for up to six months by paying a fee to Seaside of $100,000. At each monthly closing, the number of shares of common stock to be issued will be determined by
applying a 20% discount to the weighted average trading price during the five trading days preceding the closing. If in any month the five-day weighted average trading price of our common
stock is below $0.25, then the closing for that month will not occur and will not be made up. There are no warrants associated with this agreement. Shareholder approval will be required before we can
issue shares that would constitute more than 19.9% of the total shares outstanding as of February 20, 2009. Under the terms of this agreement, on February 20, 2009, we
issued 2,656,184 shares to Seaside at a price per share of $0.37648 for an aggregate value of $1,000,000.

Because
the stock was sold at a price below $1.85 per share, certain warrants issued in November 2005 are subject to adjustment according to the terms of those warrants.

On
February 23, 2009, we announced that we had signed a contract with American Electric Power (AEP), one of the largest generators of electricity in the U.S., and one of its
operating subsidiaries, Columbus Southern Power Company. The contract will entail building a 1-megawatt Smart Energy Matrix regulation facility at an AEP site in Groveport,
Ohio. The system, which will be connected to the grid within the operating region of the PJM Interconnection (PJM), will provide flywheel-based frequency regulation services.

When
the 1-megawatt flywheel system is installed and connected, we will begin providing regulation services directly to PJM and earning commercial revenue from such services.
AEP will provide the site and certain integration services in support of the project, and in exchange gain in-depth knowledge about the performance of our system and its impact on
frequency regulation and grid stability. We are unsure if this installation will be profitable. The profitability of this installation will depend of a variety of factors, including the price paid in
the PJM ISO for frequency regulation, whether this installation will be connected to the grid at a distribution or at a transmission level and the type of signal we receive from AEP for the operation
of the system.

The
agreement calls for us to deliver, install, test and operate, at our expense, a 1-megawatt Smart Energy Matrix. AEP will provide and/or install
materials and services needed to interconnect our system to PJM, including the foundation, electrical transformer, associated wiring and connection to power lines. AEP has already completed the
necessary system impact study and executed an interconnection agreement. Installation of the Smart Energy Matrix is scheduled to begin in mid-year 2009. Because the duration
of
this agreement is for a period of less than two years, all non-fungible costs related to this installation will be expensed as incurred.

99

---



BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Consolidated Financial Statements (Continued)

Note 14. Schedule II Valuation and Qualifying Accounts

2008Description

Balance at
1/1/2008

Charged
to costs
and expenses

Charged
to other
accounts

Deductions

Balance at
12/31/2008Product warranty

$
35,672







$
(460
)
$
35,212Accounts receivable reserve


2,568








(2,568
)

Inverter Inventory reserve


1,367,280








(472,686
)

894,594




2007Description

Balance at
1/1/2007

Charged
to costs
and expenses

Charged
to other
accounts

Deductions

Balance at
12/31/2007Product warranty

$
36,527

$
4,263




$
(5,118
)
$
35,672Accounts receivable reserve


18,868


(16,300
)







2,568Inverter Inventory reserve


1,808,801


(202,176
)

(153,099
)

(86,246
)

1,367,280Asset impairment reserve


3,699,656


16,254





(2,649,664
)

1,066,246


Product warrantyDeductions include amounts paid for materials, consultants, travel and freight costs to repair/replace our
inverter systems under our five-year warranty.

Accounts receivable reserveIn 2006 we recorded a reserve for certain accounts which we deemed to be doubtful. In 2007, we
received payments against previously reserved accounts. In 2008, we wrote off an amount that had previously been reserved.

Inverter Inventory reserveOur inverter inventory is fully reserved.

Asset impairment reserveIn 2002, we recorded an asset impairment reserve for underutilized plant and equipment. In 2007 and
2006, we sold or disposed of certain assets and reduced the associated reserve. We increased this reserve by approximately $18,600 included in casualty loss based upon damage to certain assets during
the prototype malfunction that occurred in December 2006.

100

---





Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None

Item 9A.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the evaluation,
both the Chief Executive Officer and the
Chief Financial Officer concluded that our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, were effective
as of December 31, 2008.

Management's Report on Internal Control over Financial Reporting

Our Management is responsible for establishing adequate internal control over financial reporting, as that term is defined in Exchange
Act rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer,
we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2008 based on the framework in internal controlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting
was effective as of December 31, 2008, and that there was no change in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, such
internal control during the quarter ended on that date.

Management's
assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by Miller Wachman LLP, an independent
registered public accounting firm, as stated in their report which is included elsewhere herein.

Item 9B.    Other Information

None

PART III

Item 10.    Directors, Executive Officers and Corporate Governance

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the end of our fiscal year.

Item 11.    Executive Compensation

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the end of our fiscal year.

101

---



Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the end of our fiscal year.

Item 13.    Certain Relationships and Related Transactions and Director Independence

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the end of our fiscal year.

Item 14.    Principal Accounting Fees and Services

Information with respect to this item is incorporated by reference from our definitive Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the end of our fiscal year.

102

---





PART IV

Item 15.    Exhibits, Financial Statement Schedules



Schedules
for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because the information is disclosed in the Consolidated
Financial Statements or because such schedules are not required or not applicable.



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



Exhibit
Number

Ref

Description of Document3.1

(23)

Sixth Amended and Restated Certificate of Incorporation,3.2

(23)

Certificate of Amendment of the Sixth Amended and Restated Certificate of Incorporation, dated June 25, 2007.3.3

(23)

Certificate of Amendment of the Sixth Amended and Restated Certificate of Incorporation, dated June 26, 2007.3.4

(18)

Amended and Restated Bylaws.3.5

(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

(20)

Amendment No. 2 to Rights Agreement dated as of August 8, 2007.4.4

(21)

Amendment No. 3 to Rights Agreement dated as of October 24, 2007.4.5

(25)

Amendment No. 4 to Rights Agreement dated as of February 18, 2009.4.5

(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.10.1.3

(15)

Third Amended and Restated 1998 Stock Incentive Plan of the Company.10.1.4

(16)

Form of Incentive Stock Option Agreement of the Company.10.1.5

(16)

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

(1)

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

(15)

Employee Stock Purchase Plan of the Company.10.1.8

(1)

Amended and Restated License Agreement dated October 23, 1998 between the Company and SatCon Technology Corporation10.1.9

(22)

Lease dated as of July 23, 2007 between the Company and GFI Tyngsboro, LLC.10.1.10

(5)

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

(16)

Form of Restricted Stock Unit Agreement of the Company.10.1.12

(14)

Sandia Labs Purchase Order.


103

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Exhibit
Number

Ref

Description of Document10.1.13

(6)

Agreement dated January 31, 2005 between the Company and the New York State Energy Research and Development Authority.10.1.14

(7)

Agreement dated January 31, 2005 between the Company and California State Energy Resources Conservation and Development Commission.10.1.15

(8)

Investment Agreement dated April 22, 2005 among the Company, Perseus 2000 Expansion, L.L.C. and Perseus Capital, L.L.C.10.1.16

(9)

Common Stock Purchase Warrant dated May 24, 2005 issued by the Company to Perseus 2000 Expansion, L.L.C.10.1.17

(9)

Amended and Restated Common Stock Purchase Warrant dated May 24, 2005 issued by the Company to Perseus Capital, L.L.C.10.1.18

(9)

Registration Rights Agreement dated May 24, 2005 among the Company, Perseus 2000 Expansion, L.L.C. and Perseus Capital L.L.C.10.1.19

(10)

Option Agreement dated July 25, 2005 between the Company and Lisa Zappala.10.1.20

(11)

Agreement dated October 7, 2005 between the Company and the Air Force Research Laboratory.10.1.21

(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.10.1.22

(12)

Form of Warrant of the Company issued pursuant to the November 2005 financing.10.1.23

(19)

Performance-based Restricted Stock Unit Agreement dated May 8, 2006 between the Company and F. William Capp.10.1.24

(19)

Performance-based Restricted Stock Unit Agreement dated May 8, 2006 between the Company and James M. Spiezio.10.1.25

(19)

Performance-based Restricted Stock Unit Agreement dated May 8, 2006 between the Company and Matthew L. Lazarewicz.10.1.26

(19)

Restricted Stock Unit and Option Agreement dated May 8, 2006 between the Company and F. William Capp.10.1.27

(19)

Restricted Stock Unit and Option Agreement dated May 8, 2006 between the Company and James M. Spiezio.10.1.28

(19)

Restricted Stock Unit and Option Agreement dated May 8, 2006 between the Company and Matthew L. Lazarewicz.10.1.29

(17)

Amended and Restated Employment agreement dated February 14, 2008 between the Company and F. William Capp10.1.30

(17)

Employment agreement dated February 14, 2008 between the Company and James M. Spiezio10.1.31

(17)

Employment agreement dated February 14, 2008 between the Company and Matthew L. Lazarewicz10.1.32

(17)

Restricted Stock Unit and Option Agreement dated March 2, 2007 between the Company and F. William Capp.10.1.33

(17)

Restricted Stock Unit and Option Agreement dated March 2, 2007 between the Company and James M. Spiezio.


104

---



Exhibit
Number

Ref

Description of Document10.1.34

(17)

Restricted Stock Unit and Option Agreement dated March 2, 2007 between the Company and Matthew L. Lazarewicz.10.1.35

(17)

Restricted Stock Unit and Option Agreement dated February 14, 2008 between the Company and F. William Capp.10.1.36

(17)

Restricted Stock Unit and Option Agreement dated February 14, 2008 between the Company and James M. Spiezio.10.1.37

(17)

Restricted Stock Unit and Option Agreement dated February 14, 2008 between the Company and Matthew L. Lazarewicz.10.1.38

(24)

Promissory Note dated June 30, 2008 issued by Beacon Power Corporation to Massachusetts Development Finance Agency.10.1.39

(24)

Security Agreement dated June 30, 2008 between Beacon Power Corporation and Massachusetts Development Finance Agency.10.1.40

(24)

Collateral Assignment of Lease Agreement dated June 30, 2008 between Beacon Power Corporation and Massachusetts Development Finance Agency.10.1.41

(24)

Form of Warrants issued on June 30, 2008 to Massachusetts Development Finance Agency.14.1

(23)

Corporate Code of Conduct21.1

+

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 200232.2

+

Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002


---

(1)

Incorporated by reference from the Form S-1 filed on November 16, 2000 (File No. 333-43386).(2)

Incorporated by reference from the Form 8-K filed on October 4, 2002 (File No. 001-16171).(3)

Incorporated by reference from the Form 10-K filed on March 31, 2003 (File No. 001-16171).(4)

Incorporated by reference from the Form S-3/A filed on January 23, 2006 (File No. 333-130207).(5)

Incorporated by reference from the Form 8-K filed on May 10, 2005 (File No. 001-16171).(6)

Incorporated by reference from the Form 8-K filed on February 14, 2005 (File No. 001-16171).(7)

Incorporated by reference from the Form 8-K filed on February 16, 2005 (File No. 001-16171).(8)

Incorporated by reference from the Form 8-K filed on April 25, 2005 (File No. 001-16171).(9)

Incorporated by reference from the Form 8-K filed on May 26, 2005 (File No. 001-16171).(10)

Incorporated by reference from the Form 8-K filed on July 29, 2005 (File No. 001-16171).(11)

Incorporated by reference from the Form 8-K filed on October 13, 2005 (File No. 001-16171).(12)

Incorporated by reference from the Form 8-K filed on November 7, 2005 (File No. 001-16171).(13)

Incorporated by reference from the Form 8-K filed on December 19, 2007 (File No. 000-31973).(14)

Incorporated by reference from the Form 8-K filed on September 7, 2006 (File No. 000-31973).(15)

Incorporated by reference from the Form S-8 filed on March 22, 2006 (File No. 333-132638).(16)

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


105

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(17)

Incorporated by reference from the Form 8-K filed on February 21, 2008 (File No. 000-31973).(18)

Incorporated by reference from the Form 8-K filed on October 1, 2007 (File No. 000-31973)(19)

Incorporated by reference from the Form 10-Q filed on May 9, 2006 (File No. 000-31973).(20)

Incorporated by reference from the Form S-3 filed on August 17, 2007 (Fine No. 333-145165).(21)

Incorporated by reference from the Form 8-K filed on October 26, 2007 (File No. 000-31973).(22)

Incorporated by reference from the Form 8-K filed on July 23, 2007 (File No. 000-31973.)(23)

Incorporated by reference from Form 10-K filed on March 17, 2008 (File No. 000-31973).(24)

Incorporated by reference from the Form 8-K filed on July 7, 2008 (File No. 000-31973).(25)

Incorporated by reference from the Form 8-K filed on February 20, 2009 (File No. 000-31973).+

Filed herewith.


106

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SIGNATURES

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

BEACON POWER CORPORATIONBy:

/s/ F. WILLIAM CAPP F. William Capp President and Chief Executive OfficerDate:

March 10, 2009


Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on
the dates indicated.

Signature

Title

Date/s/ F. WILLIAM CAPP F. William Capp

President and Chief Executive Officer, and Director (Principal Executive Officer)

March 13, 2009/s/ JAMES M. SPIEZIO James M. Spiezio

Vice President of Finance, Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer and Principal Accounting Officer)

March 13, 2009/s/ STEPHEN P. ADIK Stephen P. Adik

Director

March 13, 2009/s/ DANIEL E. KLETTER Daniel E. Kletter

Director

March 13, 2009/s/ VIRGIL G. ROSE Virgil G. Rose

Director

March 13, 2009/s/ JACK P. SMITH Jack P. Smith

Director

March 13, 2009/s/ EDWARD A. WEIHMAN Edward A. Weihman

Director

March 13, 2009


107

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