UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2010

or

o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (For the transition period from        to        ).

Commission File Number: 000-31973

Beacon Power Corporation

(Exact name of registrant as specified in its charter)

(978) 694-9121

(Registrant’s telephone number, including area code)

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.  x Yes o No

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

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

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

The number of shares of the Registrant’s common stock, par value $.01 per share, outstanding as of May 6, 2010 was 182,681,995.

BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Table of Contents

iii

PART 1 — FINANCIAL INFORMATION

Item 1. Financial Statements

BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)

Consolidated Balance Sheets

See notes to unaudited consolidated financial statements.

1

BEACON POWER CORPORATION AND SUBSIDIARIES

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

See notes to unaudited consolidated financial statements.

2

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

3

See notes to unaudited consolidated financial statements.

4

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

See notes to unaudited consolidated financial statements.

5

BEACON POWER CORPORATION AND SUBSIDIARIES
(A Development Stage Company)
Notes to Unaudited 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.  Since our inception, we have been primarily engaged in the development of flywheel devices that store and recycle energy on a highly efficient basis.  In 2000, we completed an initial public offering of our common stock and raised approximately $49.3 million, net of offering expenses. Since our initial public offering, we have raised approximately $107 million as of March 31, 2010, through the sale of our stock and exercise of warrants. 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 the Financial Accounting Standards Board’s Accounting Standards Codification (ASC) Topic 915.

We expect to increase our revenues from the commercialization of our flywheel energy storage systems to supply frequency regulation services to the electricity grid in North America and from the sale of turnkey systems outright or on a fractional basis, both within the United States and on a global basis. We believe that as we expand our production capabilities and continue to lower our system costs, we will be able to market other cost-effective applications for our flywheel systems that will further expand our revenues.

On July 2, 2009 we announced that we had been notified by the Department of Energy (DOE) of a conditional commitment for a loan guarantee of approximately $43 million. The loan, which would be funded by the U.S. Treasury’s Federal Financing Bank, is expected to provide debt financing for 62.5% of the estimated $69 million total project cost of our planned 20 megawatt (MW) plant in Stephentown, New York. This plant is under construction and we expect to complete it within 12 to 18 months from the date of financial closing. Our equity contribution to the project is expected to be $26 million. We expect to close on this loan during the second quarter of 2010.  In November 2009, the DOE announced that it has awarded us a stimulus grant valued at $24 million for use in construction of our second 20 MW flywheel energy storage plant, to be located in the Chicago, Illinois area.  The grant was made to cover approximately 50% of the project’s total cost.

Operations

We are focused on commercializing our Smart Energy Matrix™ flywheel system to provide frequency regulation services and to sell turnkey systems.  In the future, as the number of our merchant regulation facilities increases and we develop sustainable cash flows from operations and the sale of turnkey plants, we expect to fund additional plants from a combination of cash flow from operations, non-recourse project financing and project equity.

We currently have 3 megawatts (MW) of our Smart Energy Matrix™ operating and generating frequency regulation revenue within the New England Independent System Operator region (ISO-NE) under its Alternative Technologies Regulation pilot program. We plan to increase our revenues by building additional facilities, including 1) the 20 MW plant in Stephentown, New York, where we have broken ground and are in the process of finalizing the $43 million Department of Energy (DOE) loan guarantee; 2)  a 20 MW plant in either Chicago, Illinois, or another location in the PJM Interconnection region (PJM) for which we have been awarded the $24 million DOE Smart Grid stimulus grant; and 3) a 20 MW facility in Glenville, New York, for which we have secured site control and filed for interconnection. We have filed interconnection applications for both the site in Chicago and an alternate site in the PJM region.  Based on our successful Phase I DOE loan application, we have been invited by the DOE to submit a Phase II application for the Glenville facility and are in the process of doing so.

We are also identifying other plant locations for future merchant facilities, as well as marketing our systems to domestic and foreign utilities that lack open-bid markets with the objective of selling our plants on a turnkey basis.  Additionally, we are exploring other potential flywheel applications, including the sale of systems for wind/diesel/flywheel energy storage hybrid power systems on islands and remote grids.

We have experienced net losses since our inception and, as of March 31, 2010, had an accumulated deficit of approximately $211.5 million.  We do not expect to have positive EBITDA (earnings before interest, taxes, depreciation and amortization) or positive cash flow from operations until we have deployed a sufficient number of merchant plants and/or sell turnkey systems. We will need to

6

raise additional capital from a combination of equity and/or project financing, the sale of our systems and/or other sources to build regulation facilities, support operations at our Tyngsboro and other facilities, implement our business plan and continue as a going concern.  Of the $17.5 million cash on hand as of March 31, 2010, $12 million represents our expected cash investment towards the construction of the Stephentown plant under the terms of the DOE loan, and thus is not available for our general corporate operating purposes. Based on our projected cash usage rates exclusive of the anticipated borrowings from the DOE loan and our equity contribution to the Stephentown project, we have sufficient cash to fund our operations into the third quarter of 2010. We estimate that we will need to raise an additional $18 - $20 million during the remainder of 2010 through the issuance of equity securities or debt in order to fund operations and have sufficient working capital to continue to execute our business plan into 2011, including ordering long-lead items required by our production plan for 2011.  Additional funding will be required in 2011.

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

Basis of Presentation.

The accompanying unaudited consolidated financial statements have been prepared using accounting principles generally accepted in the United States of America except that certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in this Form 10-Q.  We suggest that the consolidated financial statements presented herein be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.  In our management’s opinion, all adjustments consisting of normal recurring accruals considered necessary for a fair presentation have been included in the accompanying unaudited financial statements.  Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2010.

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 significant losses of approximately $211.5 million since our inception including losses during the three months ending March 31, 2010, of approximately $5.5 million.  We have approximately $17.5 million of cash and cash equivalents on hand at March 31, 2010, which we believe, in combination with the DOE loan which is expected to close during the second quarter of 2010, is adequate to complete the construction of the Stephentown facility and finance our operations into the third quarter of 2010.  Since our cash requirements for operation and construction of frequency regulation facilities beyond that point far exceed 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 raise additional capital from a combination of equity and/or project financing; and in the long term, on the successful operation of our merchant plants and on our sales of systems on a turnkey basis.  We believe that the successful achievement of these initiatives should provide us with sufficient resources to meet our long-term cash requirements.

Reclassification of prior period amounts

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

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.  In July 2009, we established two additional wholly-owned subsidiaries, Stephentown Holding LLC and Stephentown Regulation Services, LLC. As of March 31, 2010, these entities remain inactive. The frequency regulation service revenue and costs from the ISO-NE pilot program are accounted for as part of Beacon Power Corporation. All significant inter-company accounts and transactions have been eliminated in consolidation.

Loss per Share — Basic and Diluted

Basic and diluted losses per share have 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 earnings per share (EPS) only if their conversion to common shares would decrease income or increase loss per share from continuing operations.  Since the three month periods ended March 31, 2010 and 2009, reflect losses, including the potential

7

conversion of warrants and options in the diluted EPS calculation would decrease loss per share. Accordingly, they are considered anti-dilutive and are not included in the calculation of loss per share.

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.

Lease Obligation and Deferred Rent

In July 2007, we signed a seven-year operating lease with escalating payments on a 103,000 square foot 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 6: Commitments and Contingencies.)  Additionally, the landlord has reimbursed us for certain leasehold improvements we have made. In accordance with the Financial Accounting Standards Board’s (FASB’s) Accounting Standards Codification (ASC) Topic 840, “Leases,” these reimbursements have been credited to “Deferred Rent”, and we have recorded rent expense on a straight line basis. The current portion of the deferred rent is included in current liabilities, and the remainder is shown on the balance sheet as “Deferred rent — long term.”

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 ASC Topic 410, “Asset Retirement and Environmental Obligations.”  No overhead is generally applied for internally-constructed projects not directly related to our core business (e.g., leasehold improvements). Interest costs incurred during the construction of major construction projects (such as the construction of our frequency regulation plants) are capitalized in accordance with ASC Topic 835, Subtopic 20, “Interest — Capitalization of Interest.”  The interest is capitalized until the underlying asset is ready for its intended use, and is considered an integral part of the total cost of acquiring a qualifying asset.  Thus, the capitalized interest costs are included in the calculation of depreciation expense once the constructed assets are in service. 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 ASC Topic 730, “Research and Development.”

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 considered “fungible” in that they can be moved and redeployed at a different location.  Non-fungible costs are 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.

8

Deferred financing costs and other assets

Deferred financing costs represent legal, due diligence and other direct costs incurred to raise capital or obtain debt.  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. Deferred financing costs related to debt are amortized over the life of the debt. Deferred financing costs related to issuing equity are charged to Paid in Capital.  Other assets represent advance payments to suppliers for custom materials used in the manufacture of our flywheels or frequency regulation facilities and capitalized patent costs.

Loss on Contract Commitments

Our contracts have been primarily for the development of demonstration units of new products, design of a frequency regulation plant, design of a flywheel for use by the Navy in their electric ships, and other work that supports 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.  The “cost” basis allowable on these contracts is based on government-allowable overhead rates, which differ from overhead rates required by GAAP.  In particular, most of our stock compensation expense is not an allowable cost for the purposes of calculating government-allowable rates.  As a consequence, we may incur losses on our financial statements even for contracts granted on a cost-plus-fixed fee basis.  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.  Each quarter, we perform an estimate-to-complete analysis, and any changes to our original estimates are recognized in the period in which they are determined.

Stock-Based Compensation

We account for stock-based compensation for employees in accordance with ASC Topic 718, “Compensation-Stock Compensation.” Under the fair value recognition provision of ASC Topic 718, 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. The fair value of the options on their grant date is 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 ASC Topic 718 apply to grants issued since January 1, 2006 (the effective date) and to grants that were outstanding as of that date that are subsequently modified. Estimated compensation expense for grants that were outstanding as of the effective date will be recognized over the remaining vesting period.

Non-employee stock-based compensation is accounted for in accordance with ASC Topic 505, “Equity-based payments to Non-Employees.”  In accordance with this topic, cost recognized for non-employee share-based payment transactions is determined by the fair value of whichever is more reliably measurable:  (a) the goods or services received; or (b) the equity instruments issued.

Restructuring and Asset Impairment Charges

In accordance with ASC Topic 360, “Property, Plant and Equipment,” 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. 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 move and re-deploy all or part of a Smart Energy Matrix™ system installed at a given location.  When such a decision 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 associated with the non-fungible components.

No asset impairment charges were considered necessary for the three months ended March 31, 2010 or 2009.

9

Revenue Recognition

Although we have recorded revenues for our research and development contracts and frequency regulation service from the ISO-NE pilot program, and sold photovoltaic inverters, 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 ASC Topic 915, “Development Stage Entities.”

·                  Frequency Regulation Revenue

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

·                  Research and Development  Contract Revenue Recognized on the Percentage-of-Completion Method

We recognize contract revenue using the percentage-of-completion method. We use labor hours as the basis for the percentage of completion calculation, which is measured principally by the percentage of labor hours incurred to date for each contract to the estimated total labor hours for each contract at completion. Changes to total estimated contract costs or losses, if any, are recognized in the period in which they are determined. Changes in project performance and conditions, estimated profitability, and final contract settlements may result in future revisions to contract costs and revenue.  Revenues recognized in excess of amounts billed are classified as current assets, and included in “Unbilled costs on contracts in progress” in our balance sheets.  Amounts billed to clients in excess of revenues recognized to date are classified as current liabilities under “Advance billings on contracts.”  Changes in project performance and conditions, estimated profitability, and final contract settlements may result in future revisions to contract costs and revenue.

Some of our research and development contracts are subject to cost review by government agencies. Our reported results from these contracts could change adversely as a result of these reviews.

·                  Inverter Sales

Generally, revenue on inverter and related product sales is recognized on transfer of title, typically when products are shipped and all related costs are estimable.  For sales to distributors, we make an adjustment to defer revenue until the products are subsequently sold by distributors to their customers.

Cost of Goods Sold

For frequency regulation revenue, cost of goods sold represents the cost of energy. Cost of goods sold for our research and development contracts is calculated on a percentage-of-completion basis, using the same percentage of contract costs (up to the total contract revenue amount) as is used to calculate revenue. In the event that expected costs exceed total contract revenue amount, the excess costs are charged to contract loss. 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.

Fair Value of Financial Instruments

Accounting for fair value measurements involves a single definition of fair value, along with a conceptual framework to measure fair value, with a fair value defined 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. The fair value measurement hierarchy consists of three levels:

·                  Level one—quoted market prices in active markets for identical assets or liabilities;

·                  Level two—inputs other than level one inputs that are either directly or indirectly observable, and

10

·                  Level three—unobservable inputs developed using estimates and assumptions which are developed by the reporting entity and reflect those assumptions that a market participant would use.

We apply valuation techniques that (1) place greater reliance on observable inputs and less reliance on unobservable inputs and (2) are consistent with the market approach, the income approach and/or the cost approach, and include enhanced disclosures of fair value measurements in our financial statements.

The carrying values of cash and cash equivalents, accounts receivable, other current assets, accounts payable, accrued expenses, and other current liabilities approximate their fair values due to the short maturity of these instruments.  See Note 8 for debt fair value, which also approximates carrying value.

Recently Issued Accounting Pronouncements and Regulations

In January 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:

·                  A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and

·                  In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.  Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.

In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:

·                  For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and

·                  A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009 which for us was January 1, 2010 except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted.  We do not expect any significant changes to our financial accounting and reporting as a result of the issuance of ASU 2010-06.

In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-14, “Software (Topic 985)—Certain Revenue Arrangements That Include Software Elements,” which changes the accounting model for revenue arrangements that include both tangible products and software elements. Under this guidance, tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are excluded from the software revenue guidance in Subtopic 985-605, “Software-Revenue Recognition.” In addition, hardware components of a tangible product containing software components are always excluded from the software revenue guidance. ASU 2009-14 will be effective for our Company prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. Although our flywheel systems do contain a software component, because it is a tangible product, we do not expect this standard to impact our reporting for the sale of turnkey plants in the future.

In October 2009, the FASB issued ASU 2009-13, “Revenue Recognition (Topic 605)—Multiple-Deliverable Revenue Arrangements,” which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. Specifically, this guidance amends the criteria in Subtopic 605-25, “Revenue Recognition-Multiple-Element Arrangements,” for separating consideration in multiple-deliverable arrangements. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and

11

requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor’s multiple-deliverable revenue arrangements. ASU 2009-13 will apply to us prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. In the future, should we sell turnkey plants, this standard may impact our reporting for such transactions.

Recently Adopted Accounting Pronouncements and Regulations

On February 24, 2010, the FASB issued Accounting Standards Update  (“ASU”) No. 2010-09 “Subsequent Events - Amendments to Certain Recognition and Disclosure Requirements” (“ASU 2010-09”), which amends FASB ASC Topic 855, “Subsequent Events”, so that SEC filers no longer are required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements.  ASU No. 2010-09 was effective immediately and we adopted this new requirement in the first quarter of 2010.

In December 2009, the FASB issued ASU 2009-17, “Consolidations (Topic 810) - Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities”, which codifies FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” and changes how a reporting entity determines when an entity that is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things:

a)              The power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and

b)             The obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.

ASU 2009-17 also requires a reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements.  ASU 2009-17 is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009 which for us was January 1, 2010.  Early application is not permitted. In the future, should we become fractional owners of certain merchant frequency regulation plants, this standard may impact our reporting for such entities.

In December, the FASB issued ASU 2009-16, Transfers and Servicing (Topic 860) - Accounting for Transfers of Financial Assets, which formally codifies FASB Statement No. 166, Accounting for Transfers of Financial Assets. ASU 2009-16 represents a revision to the provisions of former FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. Among other things, ASU 2009-16:

·                  Eliminates the concept of a “qualifying special-purpose entity”;

·                  Changes the requirements for derecognizing financial assets; and

·                  Enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and an entity’s continuing involvement in transferred financial assets.

ASU 2009-16 is effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009 which was January 1, 2010 for us. Early application is not permitted. Our business plan anticipates the use of project financing to fund the construction of our merchant frequency regulation plants. This standard will impact our reporting for any such transactions.

Note 3.  Accounts Receivable

Our accounts receivable include amounts due from customers and are reported net of a reserve for uncollectible accounts as follows:

12

There was no allowance for doubtful accounts as of March 31, 2009 or December 31, 2009.  All accounts are expected to be collected.

Some of our research and development contracts contain holdback provisions that allow our customers to withhold 10% from each invoice payment. Our accounts receivable balance includes holdbacks of approximately $19,000 and $17,000 as of March 31, 2010 and December 31, 2009, respectively.  These holdbacks are payable once work has been satisfactorily completed and the final reports have been delivered and approved.  We believe the remaining holdbacks will be collected upon completion of the contracts and collected within one year, and therefore have not recorded any reserve against this amount.

Note 4.  Property and Equipment

Details of our property and equipment follow:

In November 2008, we deployed 1 MW of capacity under the ISO-NE Alternative Technologies pilot program (pilot program) with a system installed inside our Tyngsboro facility. We deployed a second MW of capacity under the pilot program in July 2009, and a third MW in December 2009. Both of these additional MWs are installed outside and adjacent to our facility in Tyngsboro. The Smart Energy 25 flywheels shown above represent the cost of the flywheels and electronic control modules in use for this pilot program.  In addition, the “Smart Energy Matrix™ installations — fungible” shown above represent the cost of ancillary equipment, such as chillers, installed outside our facility. This equipment is considered fungible because it can be relocated to other sites.

Under the terms of our Tyngsboro facility lease, we will incur certain exit costs at termination of our lease.  Estimated exit costs of approximately $243,000 relating to certain non-fungible equipment included in the Smart Energy Matrix™ system operating outside of our facility were expensed in 2008 and carried in accrued expenses.   Machinery and equipment and leasehold improvements include approximately $54,000 in estimated exit costs as of March 31, 2010 and December 31, 2009 that are being depreciated over the remaining life of the assets.  In addition, we have paid the Town of Stephentown, New York, $75,000, to be held in escrow to cover any land clearing or exit costs at that site.  This amount has been included in “Deferred financing costs and other assets” on our balance sheets.

13

In July 2008, we purchased land in Stephentown, New York, for the construction of a frequency regulation system, the cost of which is reflected as “Land” in the schedule shown above.  On August 31, 2009, we purchased an option to lease land in Glenville, New York, where we expect to build another 20 MW facility.  During the lease option period, we have agreed to negotiate in good faith a ground lease to be entered into upon our unilateral exercise of the lease option.  Key terms of the ground lease were substantially delineated in the executed option of the lease.  The lease option expires on August 28, 2010 but may be extended for up to two additional consecutive six-month periods.  In consideration for this option, we are paying the landlord a non-refundable fee of $4,550 per month in lease commitments.

The components of “Construction in progress,” which represent 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 March 31, 2010 and December 31, 2009, approximately $7,792,000 and $7,621,000, respectively, of the total shown as CIP represents completed flywheels not yet in service, 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™ in progress costs included in CIP at March 31, 2010 and December 31, 2009 include approximately $0 and $1,023,000 for fungible components we expect to deploy at our site in Stephentown, New York, and approximately $3,300,000 and $933,000 in site costs related to Stephentown and Glenville, respectively.

Note 5.  Deferred Financing Costs and Other Assets

Details of our deferred financing costs and other assets are as follows:

As of March 31, 2010, patents totaled approximately $143,000, of which approximately $102,000 represents deferred costs for patents that have not yet been issued and which are not yet being amortized. Amortization expense for the three months ended March 31, 2010 was $399.   Accumulated amortization as of March 31, 2010 and December 31, 2009 was $563 and $164, respectively.

Note 6.  Commitments and Contingencies

The following table summarizes our purchase obligations and the aggregate maturities and payments due for our contractual obligations as of March 31, 2010 and for the subsequent five years:

14

As of March 31, 2010, we had purchase commitments with our suppliers of approximately $28.2 million. Of this amount, approximately $13.5 million represents firm, non-cancelable commitments, against which we have made advance payments totaling $2.6 million, leaving a net non-cancelable obligation of approximately $10.8 million as of March 31, 2010.  Total purchase commitments include approximately $25.6 million for materials required to build the flywheels, electronic control modules and other ancillary equipment needed for Stephentown, of which $14.7 million are cancelable as of March 31, 2010. The remaining commitments are for other equipment needed for Stephentown, costs associated with closing the DOE loan, equipment and other operating expenses.  We have an additional $2.8 million conditional material purchase commitment to a second source supplier who is working to meet our qualification requirements.

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.  Our 103,000-square-foot facility is located at 65 Middlesex Road, Tyngsboro, Massachusetts.  We believe our facility has a capacity of approximately 600 flywheels per year, and with further capital spending for equipment our capacity will increase to approximately 1,000 flywheels per year.

We provided our landlord with an irrevocable letter of credit securing our performance under the lease with a balance at March 31, 2010 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.  Rent expense was approximately $147,000 during the three months ended March 31, 2010 and 2009.

Legal Proceedings

We may from time to time be subject to legal proceedings, often likely to involve routine litigation incidental to our business.  The outcome of any legal proceeding is not within our complete control, may often be difficult to predict and may be resolved over a very long period of time.  Estimating probable losses associated with any legal proceedings or other loss contingency is very complex and requires the analysis of many factors, including assumptions about potential actions by third parties.  A loss contingency is recorded as a liability in the consolidated financial statements when it is both (i) probable and 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. There are no material legal proceedings pending.

15

Note 7.  Accrued Contract Loss

Our contract loss reserves are as follows:

During the first quarter of 2009, we recorded a contract loss on the Tehachapi contract of approximately $133,000, which represents the difference between our overhead applied based on a “full production” rate, and the contract bid rate.  No additions to our contract loss reserve were necessary for the quarter ended March 31, 2010.

Note 8.  Long-Term Debt

Long-term debt was as follows, which approximates fair value:

On June 30, 2008, we entered into an agreement with Massachusetts Development Finance Agency (“MassDev”) pursuant to which MassDev 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 were able to request advances of up to $5 million total for the purchase of equipment and installation of certain building improvements at our Tyngsboro, Massachusetts facility. The initial advance on the loan was made in October 2008 for approximately $3.6 million. The final advance was made in October 2009 for approximately $1.0 million. The approximately $0.4 million balance of the loan commitment has expired. The note will mature 84 months after the initial advance and bears a fixed annual interest rate of 6.5%.

Payments to MassDev began in November 2008. The payments were interest only during the first twelve months. In October, 2009, and thereafter, the balance of the principal outstanding under the note is being amortized in equal monthly installments of principal and interest over the remaining term of the note. Based on the amount outstanding as of December 31, 2009, principal payments required under the loan over the next five years, excluding discount due to warrants, are as follows:

16

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 substantially funded with the proceeds of the loan with an approximate carrying value of $4,800,000 and $5,126,000 at March 31, 2010, and December 31, 2009, respectively. 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 $14,000 and $10,000 charged to interest expense during the three months ended March 31, 2010 and 2009, respectively.  The effective interest rate of the loan, including the cost of the warrants and other deferred loan costs, is approximately 8.55%.

Note 9.  Sale of Stock

On February 19, 2009, we entered into a common stock purchase agreement with Seaside 88, LP, valued at up to $18 million.  This agreement was amended on June 19, 2009.  The original agreement required Seaside to buy $1 million of common stock 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,) at a purchase price reflecting a 20% discount to the volume weighted average trading price over the five-day trading period immediately before the purchase.  The amended agreement maintained the $18 million aggregate maximum purchase price, but accelerated the purchase to 1.5 million shares twice per month at a 14% discount to the 10-day volume weighted average trading price.  The agreement was structured in three tranches, or segments, of six closings each. The first tranche ended with the July 6, 2009 stock purchase.  The second tranche ended with the October 5, 2009 closing date, and we exercised our option to extend the agreement for a third tranche, meaning that there were 18 closings over the term of the agreement. In December 2009, we issued additional shares of stock through a public offering.  As part of the underwriting conditions for that offering, we exercised our option to delay the Seaside purchases originally scheduled for December and January for a period of 60 days.   The Seaside purchases resumed on February 5, 2010 and the final purchase under this agreement was completed on March 5, 2010.

Stock sales to Seaside through the final sale in March 2010 are summarized: