BCOND Beacon Power Corp. (MM)

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Table of Contents
Item 8. Consolidated Financial Statements and Supplementary Data

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-K

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)

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

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     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     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 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 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.

          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, 2010 the market value of the voting and non-voting common stock of the registrant held by non-affiliates of the registrant was $62,328,940. 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 14, 2011, was 25,128,828.

DOCUMENTS INCORPORATED BY REFERENCE

          Portions of the definitive Proxy Statement for Beacon Power Corporation's Annual Meeting of Stockholders, to be filed no later than April 30, 2011 for the year ended December 31, 2010, are incorporated by reference into Part III of this Form 10-K.

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Table of Contents

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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 "will," "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 our expectation. These factors include, for example: a limited commercial operating history; a history of losses and anticipated continued losses from operations; 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 able to comply with the conditions or ongoing covenants of the Federal Financing Bank loan for our Stephentown, New York, facility; our need to comply with any disbursement or other conditions under the Department of Energy (DOE) Smart Grid grant program; a need to raise additional equity to fund our projects and our other operations in uncertain financial markets; conditions in target markets, such as that some ISOs are taking longer than others to comply with FERC's requirement to update market rules to include new technology such as ours, and also such as that frequency regulation pricing is lower in the short-term than at many times in the past; our ability to obtain site interconnection approvals, 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 revenues to date; our ability to construct and operate plants in a variety of locations; our ability to make our technology fully compatible with 50 Hz. electrical design requirements for use in overseas markets; our ability to sell regulation services and plants at attractive margins; the uncertainty of the global economy; meeting the technical requirements of foreign markets based upon their specific grid and market characteristics; dependence on third-party suppliers; competition from companies with greater financial resources, especially from companies that are already in the frequency regulation market; possible government regulation that may impede the ability to market products or services or impact 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; our ability to retain key executives and continue to attract additional talented human resources; and the historical volatility of our stock price. 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 these and other risk 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.

Explanatory Note Regarding Share Amounts:

        All share amounts and per share prices in this Annual Report on Form 10-K have been retroactively adjusted to reflect the effect of our reverse stock split, on a one-for-ten basis, effective February 25, 2011, unless otherwise indicated.

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PART I

Item 1.    Business

Overview

        Beacon Power Corporation, a Delaware corporation incorporated on May 8, 1997, and its subsidiaries (collectively "Beacon," "the Company," "we," "our" or "us"), design, manufacture and operate flywheel-based energy storage systems that we have begun to deploy in company-owned merchant plants that sell frequency regulation services in open-bid markets (which we refer to as our "sale of services" or "merchant plant" model). We also intend to sell systems on a turnkey equipment basis in domestic and overseas markets that lack open-bid auction mechanisms. In addition, we may share ownership of some plants with utilities or other investors; enter into bi-lateral contracts with utilities that provide or purchase regulation services to satisfy their obligations to pay for or provide regulation services; and/or participate in pilot programs to demonstrate our technology. Our flywheel systems support stable, reliable and efficient electricity grid operation. We expect the market for our systems to benefit from increased electricity demand and the rapid expansion of intermittent renewable resources, including wind and solar.

        Since our inception, we have been primarily engaged in the development of advanced flywheel technology that stores and recycles energy on a highly efficient, emissions-free, reliable basis. We believe our technology provides more sustainable and effective frequency regulation and energy balancing services for the electricity grid, utilities, and distributed generation and renewable energy markets. Frequency regulation is an essential service that balances the flow of electricity on the grid, minimizes harmful fluctuations, and maintains proper frequency to ensure grid stability and reliability. Our constantly spinning, fast-response flywheels provide this critical service by recycling energy to and from the grid, acting as a type of "shock absorber." Because of their extremely fast speed of response, flywheels can address and correct frequency deviations more effectively than conventional regulation methods, at a lower cost of operation. Additionally, our flywheel systems make it easier for the grid to integrate intermittent renewable energy sources, such as wind and solar power, whose variability increases the amount of regulation needed. Our technology offers grid operators the benefits of greater reliability; faster response time; cleaner operation, including zero direct emissions of carbon dioxide (CO ₂ ), nitrogen oxide (NOx), sulfur dioxide (SO ₂ ) and mercury; and lower maintenance costs compared to conventional power generation facilities that also provide frequency regulation services. We believe these competitive advantages will allow us to achieve attractive operating margins and become profitable.

        Our Smart Energy 25 flywheel system includes the flywheels and their associated power electronics. A 1 megawatt (MW) Smart Energy Matrix™ is an array of ten Smart Energy 25 flywheel systems that provides 1 MW of energy storage. A frequency regulation installation includes one or more Smart Energy Matrices™, along with ancillary equipment and site work. Our typical full-scale installation is designed to have a capacity of 20 MW, capable of +/- 20 MW and a 40 MW regulation range.

        In November 2008, we began operating and earning frequency regulation revenue within the New England Independent System Operator region (ISO-NE) under its Alternative Technologies Regulation pilot program (pilot program) with a 1 MW Smart Energy Matrix™. We added a second MW of capacity in July 2009, and a third in December 2009. In August 2010, we began to redeploy a portion of the latter 2 MW to our Stephentown, New York plant. From January 2009 through September 2010, our flywheel systems have been on-line and available for providing frequency regulation service 98% of the time, on average, and have been earning revenue from providing frequency regulation services in ISO-NE. The redeployment of a portion of this regulation capacity to Stephentown beginning in August 2010 resulted in a decrease in the frequency regulation revenue earned in ISO-NE for the last half of 2010, when compared to the first half of the year.

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        We energized and interconnected 8 MW of flywheel energy storage at our Stephentown plant on January 24, 2011, and began earning frequency regulation revenue at that time. As of that date, all interconnection systems between the Stephentown plant and local utility provider, NYSEG, were operational to enable the full 20 MW plant to come online. Additional MW of energy storage capacity will be progressively energized and interconnected, thereby increasing the plant's revenue. As of this filing, 14 MW of capacity is operating and earning revenue. We anticipate all 20 MW will be on-line and earning revenue during the second quarter of 2011.

        We plan to increase our revenues by:

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Completing the Stephentown facility



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Building additional merchant plants, including a 20 MW plant in Hazle Township, Pennsylvania, for which we have been awarded a $24 million DOE Smart Grid stimulus grant; and building additional 20 MW facilities. We have sites in Chicago Heights, Illinois and Glenville, New York, where we have secured site control, filed for interconnection and completed system impact studies. We are also identifying other locations for future merchant facilities.



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Marketing to domestic and foreign utilities that lack open-bid markets with the objective of selling our plants on a turnkey basis



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Identifying other potential flywheel applications, including the sale of systems for wind/diesel/flywheel energy storage hybrid power systems on islands and remote grids, as well as for the provision of frequency response services as a secondary function of our 20 MW plant.

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

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The availability of project finance, other funding sources (including funds received from investors for the purchase of all or part of certain systems), or grants



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Comparative market pricing available for frequency regulation in different markets



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Our ability to earn appropriate revenues and payments within the market rules of the regional markets



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Our ability to interconnect at transmission voltage and obtain grid interconnection approvals



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The availability and cost of land



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Our ability to secure all necessary environmental and other permits and approvals.

        Because we have not yet generated substantial commercial revenues, we are accounted for as a development stage company under the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) Topic 915. We maintain our corporate offices, manufacturing and research and development facilities at 65 Middlesex Road, Tyngsboro, MA 01879. Our telephone number is 978-694-9121.

        For the sale of frequency regulation services in the United States, our primary market focus is on the geographic regions of the domestic grid under Federal Energy Regulatory Committee (FERC) control that provide open-bid regulation markets. These regions and their Independent System Operator (ISO) or Regional Transmission Operator (RTO) designations are: New England (ISO-NE); New York (New York ISO or NYISO); Mid-Atlantic (PJM Interconnection); California (California ISO or CAISO) and Midwest ISO (MISO). These regional ISOs/RTOs, or grid operators, purchase frequency regulation services from independent providers in open-bid markets that they manage and maintain. For example, 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

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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 selected to provide service. Each ISO may calculate payments for frequency regulation services based on formulas that yield different revenue results than other ISOs, even when there are equivalent frequency regulation clearing prices.

        We have also recently initiated market development efforts in Texas (ERCOT), which is not regulated by FERC. Consequently, ERCOT is not subject to FERC Order No. 890, which mandated that non-generation resources like ours be allowed to compete in these open-bid markets. However, we expect that as ERCOT continues to expand its wind resources in Texas, and issues related to increasing wind penetration and grid stability become better understood, the potential benefits of applying our technology in ERCOT to help balance frequency, maintain grid stability and grid reliability will increase in value. We have been working to identify and recommend market rule modifications that will be needed to allow us to enter the ERCOT market on an economically attractive basis, and when the right conditions are in place, we plan to enter the ERCOT market.

        For the sale of plants on a turnkey basis, our market focus in the United States is on geographic regions that lack open-bid markets for regulation services. Within this market segment, our primary focus will be on utilities that are experiencing or expect to experience increased requirements for regulation capacity due to current or projected impacts of increased deployment of variable wind generation in their balancing areas. Our secondary focus will be on the largest cooperative and government-owned utilities, and on islands or protectorates that are part of the United States. Internationally, we are actively pursuing opportunities for the sale of services via merchant plants and for the outright sale of plants in a number of countries, both directly and with the assistance of local marketing and distribution partners. We are currently pursuing business development activities in 12 foreign countries.

The Frequency Regulation Market

        Levels of power supply and demand on the electricity 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 operation of electrical 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 established by the North American Electric Reliability Corporation (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.

        Our Smart Energy Matrix™ stores excess energy when power on the grid exceeds demand and injects it back to the grid when demand exceeds generated power. Our systems respond up to 100 times faster than fossil fuel generators that provide frequency regulation. Certain ISOs have implemented tariff changes that provide additional or enhanced payment mechanisms ("performance pricing") to compensate resources, such as ours, for faster regulation response. On February 17, 2011, the Federal Energy Regulatory Commission (FERC) proposed a rule to make performance pricing mandatory by issuing a Notice of Proposed Rulemaking (NOPR) that would require each of the grid operators under its jurisdiction to begin the process of developing regulation market tariffs to provide pay-for-performance. Should FERC's rule requiring such pay-for-performance tariffs for frequency regulation be adopted, both the revenues earned by our merchant plants and the demand for the purchase of our flywheel technology in vertical markets could increase substantially.

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        Our flywheel systems also make it easier for the grid to integrate intermittent renewable energy sources, such as wind and solar power, whose variability increases the need for regulation. Because our flywheels recycle electricity already generated, they do not consume fossil fuel or produce CO ₂ greenhouse gas emissions or other air pollutants, such as NO _X or SO ₂ . In addition, the energy conversion efficiency of our flywheels does not significantly degrade over time or as a function of the number of charge/discharge cycles incurred. We believe that our low operating costs will allow us to participate with a favorable profit margin in the open-bid markets, and utilities in non-open bid markets will also find the attributes of our system attractive and will purchase our systems on a turnkey basis.

        In North America, the frequency regulation market in areas that are accessible via open-bid auction mechanisms (ISO-NE, NYISO, PJM, MISO, CAISO and ERCOT) was valued at approximately $495 million in 2010 versus $530 million in 2009. ERCOT, whose market is mostly structured via bilateral contracts rather than via open-bid auction, represented $108 million of this total. In 2010, the reduction in total market size was due primarily to a drop in prices in some markets. We believe that this contraction was due to lower electricity demand caused by the recession, increased energy conservation and low natural gas prices (which is the primary fossil fuel used for regulation in the U.S. market). We expect the value of the open-bid regulation market to increase as more wind generation comes online in the next several years, which we expect will significantly increase the demand for regulation services. We are also aggressively pursuing creation of a "pay-for-performance" compensation mechanism in all markets that would increase the amount our flywheels receive to provide regulation service versus other resources. (See "Regulatory and Market Affairs" section.)

        In 2010 we expanded marketing and sales activities by hiring two full-time business development executives and establishing relationships with overseas distribution partners in preparation for selling systems on a turnkey basis.

        Growth in both the US and the international markets is expected from a combination of factors, including:

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Global economic recovery



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Greater use of renewable energy sources—especially wind and solar generation



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Long-term growth in the demand for electricity



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Increased operating costs for conventional generation



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Government regulations and market forces aimed at reducing carbon dioxide emissions.

        We believe our operating cost structure will be significantly lower than that of most incumbent frequency regulation service providers. Our Smart Energy 25 flywheel has been designed to operate with low energy losses, minimal mechanical maintenance for 20 or more years and no significant degradation in energy conversion efficiency. In particular, our technology is different from most frequency regulation methods in that it does not use fossil fuel, which is the largest variable cost for most competing regulation providers. Further, while battery-based providers have entered the market for frequency regulation services, we believe we have a significant advantage because our technology can perform an extensive number of charge/discharge cycles without degradation of energy storage capacity. In contrast, the storage capacity of chemical batteries degrades as a function of cycles, which will significantly increase their lifecycle costs.

        Since our Smart Energy Matrix™ does not burn fuel, the environmental benefits of our technology are dramatic. A DOE-funded study stated that our technology may reduce CO ₂ emissions by up to 89% compared to some conventional frequency regulation service providers who burn fossil fuel to provide regulation. We believe that the cleaner performance of our flywheel systems offers significant value to regulators, grid operators, and utilities facing increasing demands to lower CO ₂ emissions. In the longer

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term, if 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 costs to carbon-intensive regulation providers will increase at a faster rate than our carbon-related costs, which are associated with the purchase of a small amount of electrical make-up energy.

        In some states, additional environmentally related revenues may be available in the form of renewable energy or other credits. Since 2009, we have earned alternative energy credits under the Massachusetts Alternative Energy Portfolio Standard (APS) program, and sold them to a power producer that needed to meet its regulatory requirements for such credits, thus creating a limited source of incremental revenue.

Regulatory and Market Affairs

        Since late 2009 we have actively promoted the adoption of performance-based payments for fast-response regulation resources. Such payments would compensate regulation resources based on actual system performance rather than nominal resource capacity. On May 26, 2010, FERC held a Technical Conference on Frequency Regulation Compensation and invited our Chief Executive Officer, F. William Capp, to present on the concept of "pay-for-performance." Subsequently, on June 16, 2010, we submitted comments to FERC reiterating our support of tariffs that compensate regulation resources based on performance. We continued throughout 2010 to engage in this dialogue in an effort to encourage the expansion of performance-based tariffs in all ISO markets. Currently, ISO-NE is the only grid operator that utilizes a performance-based tariff that rewards resources for speed of response. On January 19, 2011, PJM began the process for stakeholder consideration of a regulation market incentive payment for resources that respond more quickly and accurately to a control signal. On February 17, 2011, FERC issued a Notice of Proposed Rulemaking ("NOPR") that, if adopted, would require each ISO to implement a "pay-for-performance" compensation structure for frequency regulation, and to make market rule changes that would provide our resources full compensation for the opportunity cost component that we currently do not receive in some markets. If performance-based regulation tariffs are adopted, we believe that the economics of our plants in areas of the country managed by FERC will be significantly enhanced, and our economically addressable markets will also expand.

        We continue to make progress within each 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 their regulation markets. The ISOs have demonstrated a heightened commitment to work collaboratively with us to integrate our technology into their grids. In addition to market rule changes, several ISOs are evaluating or proposing changes to their regulation dispatch signals in order to ensure that our Smart Energy systems are deployed most efficiently and effectively for the benefit of the power grid. These changes would take greater advantage of our flywheels' fast-response capability, while recognizing that our resource has limited energy storage capacity. The proposed market rule changes, coupled with more efficient regulation dispatch signals, will allow our resource to maximize its regulation revenue while minimizing our consumption and cost of electricity. The current status of each open-bid ISO market is as follows:

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New York ISO: After extensive work with NYISO and its stakeholders, on May 15, 2009 FERC approved tariff and market rule changes to fully open the regulation services market to flywheel energy storage. Moreover, NYISO changed its regulation dispatch signal to use flywheels as "first responders" to take advantage of their speed of response to a control signal. With the advent of these market and system changes, we moved forward with construction of a 20MW flywheel energy storage plant in Stephentown, New York, and as of January 2011, we began selling regulation service to NYISO. We continue to work with NYISO to encourage the adoption of a "pay-for-performance" compensation mechanism.

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ISO New England: We have been participating in the ISO-NE market with up to 3 MW of service since its Alternative Technologies Regulation pilot program began on November 18, 2008. On November 9, 2010, ISO-NE presented its lessons learned from the pilot program and outlined a high level proposal for permanent market rules for alternative technologies. Included in the proposal was a plan to include a NYISO-style dispatch signal and a payment structure that will have the effect of compensating us for the opportunity cost component that we do not currently receive under the ISO-NE pilot program. Furthermore, the proposal would continue ISO-NE's successful "mileage" payment that compensates our fast-response regulation resource on the basis of actual system performance rather than nominal capacity. We expect that ISO-NE and its NEPOOL stakeholders will continue to work on the details of this proposal in the first quarter of 2011 before filing the proposal with FERC.



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California ISO: In 2010 CAISO initiated a stakeholder process to finalize the design elements to fully integrate flywheels into its Regulation Up and Down markets by spring 2011. FERC directed CAISO to file a report on its progress to open its regulation markets to flywheels by March 2011. We actively engaged in that FERC proceeding and in the stakeholder process at CAISO. On February 3, 2011, CAISO's Board of Governors unanimously approved a proposal to implement tariff and software changes to integrate limited energy storage resources into the regulation markets. We expect the proposal to be filed at FERC in March 2011 and implemented by CAISO by spring 2012.



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Midwest ISO: In 2008, FERC approved the creation of an Ancillary Services Market (ASM) in MISO to begin operating in January 2009. As part of its approval, FERC required MISO to make further changes to its ASM to remove barriers to new technologies to provide regulation service. In April 2008, MISO fully complied with FERC's directives by filing a request for an entirely new regulation resource category specifically designed for stored energy resources ("SER"), including our flywheel technology. FERC approved this tariff in December 2008. This was the first such tariff in the United States designed specifically to accommodate energy storage-based regulation resources. In May 2009, MISO, with the support of its market stakeholders, submitted to FERC additional tariff modifications to enhance the dispatch algorithm for SERs to better utilize their regulation capabilities and maximize their revenues in the MISO market. FERC approved these tariff modifications, and the new MISO market rules for SERs took effect on January 1, 2010.



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PJM Interconnection: PJM amended its tariff language to comply with FERC Order No. 890 and stated that its current rules allow non-generation resources like ours to fully participate in its regulation market. In the summer of 2009, PJM adopted a regulation dispatch signal for energy storage resources that takes partial advantage of our system's fast-response capability, maximizes benefits to PJM's grid and pays us for the benefits of our resource. In July 2010, PJM submitted tariff revisions to FERC for approval which clarify and amend certain aspects of PJM's tariff in order to ensure that we can net our energy consumption at wholesale rates and therefore minimize our costs to provide service in PJM. These tariff changes were unanimously endorsed by PJM's stakeholders at the June 3, 2010, Members' Committee meeting and approved by FERC on September 3, 2010. Most recently, on January 19, 2011, PJM began the process for stakeholder consideration of a pay-for-performance tariff for resources that respond more quickly and accurately to a control signal.



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ERCOT: Since ERCOT is not regulated by FERC, we have focused our efforts in the past on the other ISOs. As the amount of wind generation in Texas increases, and therefore the demand for fast-responding frequency regulation resources rises, and as we demonstrate the effectiveness of our system in other ISOs, we believe our technology will become increasingly attractive in the ERCOT market. Consequently, we have begun to focus our attention on this market. In August 2010 ERCOT launched a working group specifically focused on developing the market rule changes necessary to integrate storage into its regulation markets. We are actively participating in this initiative.

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Defense applications

        We believe that our flywheel technology is increasingly attractive as an energy storage device for U.S. Department of Defense (DoD) applications including, but not limited to, naval vessels and fixed installations. We continue to pursue teaming relationships and defense and military-related projects that we believe will provide enhanced combat capabilities, improve energy security to fixed installations, and reduce DoD's fossil fuel consumption. Funding received through these initiatives could help provide non-dilutive R&D funding for key technology innovations and advancements that may later be transferred to commercial market applications.

        In February 2009, we announced that we had 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. This contract may lead to a 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. 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, 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 have or 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 model for one or more applications. The value of the initial research and development work is estimated at $900,000. Of this, the first phase of the work, which was funded at $500,000, has already been completed. On February 17, 2011, we received a $50,000 amendment to deliver a final report on the work accomplished to date such that NAVSEA would better be able to make a determination on future funding. Subsequent phases involve work estimated at an additional $2.1 million. We anticipate, at a minimum, receiving funding in 2011 to provide NAVSEA with a final report relating to the work we previously completed so they can determine how to proceed with this project.

Other Flywheel-based Market Opportunities

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

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Frequency response for grid stability



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Short-term spinning reserve



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Ramp mitigation for wind power



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Wind/diesel/flywheel hybrid power systems



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Reactive power support (VAR support)



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Angular stability control



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Voltage support for rail systems



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Peak power support (load balancing)



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Stabilization of distributed generation systems



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Uninterruptible power supply (UPS).

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        Although our focus in the near term will be to deploy company-owned merchant flywheel installations for the frequency regulation market and sell turnkey systems for that same market, we are evaluating these additional applications to determine whether they represent commercially attractive market opportunities. We may elect to collaborate with partners to improve our ability to access to such markets through the provision of capital and/or distribution resources.

Competition

        Our existing competition consists primarily of fossil fuel generators and hydro generators, including run-of-river and pumped hydro resources. Emerging competition includes batteries, in particular batteries based on lithium ion technology. Each of these competitors is discussed in more detail below.

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 more effective than fossil-fueled generators in providing regulation because of its faster response. A study done by Pacific Northwest National Laboratory (PNNL), part of the U.S. DOE, concluded that 1 MW of fast-response regulation can be expected to deliver at least twice the system regulation value of the average conventional regulation resource in California, and up to 17 times as much regulation balancing effect compared to the slowest fossil-based generators.

        Grid operators typically allow their regulation resources at least 5 minutes to fully respond to their call for regulation. For example, a conventional fossil-based resource with a 4 MW per minute ramp rate would, by the end of the allowed 5 minute period, achieve its maximum regulation output capacity of +/- 20 MW. In contrast, our flywheel energy storage systems are capable of ramping to full rated output in less than 4 seconds. Compared to the fossil-based resource with a 4 MW per minute ramp rate, our 20 MW plant is capable of injecting (or withdrawing) twice the energy over the same 5-minute time period. The PNNL study also found that 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%. Similar savings should be possible in most other ISOs, including PJM, once fast-response regulation resources are introduced into their mix of fleet resources. We believe that this projection is supported by the experience of ISO New England, the only ISO whose regulation tariff currently provides a price incentive for fast regulation resources and favors the selection of fast resources in the bidding and selection process.

        Not all fossil-fueled generators can provide frequency regulation services. Some, such as nuclear power plants operating in North America, are unable to vary their output or are prohibited by regulators from doing so 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 because of the higher operating and maintenance costs that their type of generating equipment incurs when performing regulation. This is due to the constant up- and down-throttling required to provide fossil fuel-based frequency regulation, which reduces the economic life of conventional generating equipment.

        Storage-based regulation produces far lower emissions of CO ₂ than fossil fuel regulating generators, even when the carbon footprint of the make-up energy we must buy (due to conversion inefficiency) is factored into the analysis. Our plants do not burn fossil fuel, and therefore produce zero direct emissions of CO ₂ or other combustion gases, including sulfur dioxide, nitrogen oxide and airborne mercury. For example, over the 20-year life of our 20 MW plant, KEMA, Inc. projects that one of our flywheel regulation plants located in the PJM Interconnection would save 52% of the CO ₂ that a base-load coal plant providing regulation would produce. This equates to 159,599 tons of CO ₂ savings over 20 years. Compared to a base-load natural gas generator performing regulation, CO ₂ savings would be 23% and 45,672 tons over 20 years, respectively. Compared to pumped hydro, the

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best conventional frequency regulation resource, a flywheel plant would still save 26%, or 53,252 tons of CO ₂ , over 20 years. The reason for the improvement versus pumped hydro is the higher energy conversion efficiency of flywheel energy storage. KEMA also notes that continued reliance on thermal generating units to meet expanding regulation requirements due to growth in electricity demand and the effects of adding more wind resources to the grid would increase emissions of CO ₂ , NO _X and other pollutants, thereby dampening one of the main benefits of wind generation.

        Any type of carbon tax that may be put into place in the future can be expected to increase the cost of regulation from carbon-intensive regulation resources, especially coal-fired units. For example, a study done by the California Energy Storage Alliance (CESA) compared the economics of a Combined Cycle Gas-fired Turbine (CCGT) with flywheel energy storage performing regulation services. The study found that the internal rate of return (IRR) for a CCGT asset performing regulation in California would drop significantly if the CCGT unit had to pay a carbon tax. In contrast, the IRR of a merchant flywheel resource would remain almost unchanged.

        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. Flywheel energy storage resources can provide regulation service "à la carte". Generators must sometimes be brought online at night just to provide regulation service, which can exacerbate the problem of frequency control if the base-load energy they must also provide is not needed and cannot easily be exported from the balancing area. In fact, grid operators have faced so-called "negative clearing prices" (requiring operators to pay for others to accept their energy) during periods of relatively high wind generation and low electricity demand. Flywheels can address this issue by providing just regulation services without having to generate any base-load energy.

        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 more rapidly than a fossil-based regulating generator. The ability to site, permit and build a regulation plant quickly can be a decided advantage, especially in smaller balancing areas and where wind generators are being rapidly deployed.

Hydro Regulating Generators

        Although some hydro-powered generators are excellent regulating generators, not all existing hydro facilities were designed to provide regulation services, and existing hydro resources 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 and restore river system ecology may actually constrain some existing hydro units' supply of regulation. Hydro units that face increasing restrictions related to their provision of regulation may actually provide future sales opportunities because, as determined by PNNL, these different resources may be co-optimized to operate better in tandem than either can operate alone.

Battery-based Regulation Resources

        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 Systems, a public 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 AES Corporation, a global public utility. The 2 MW system has been installed in California for some time, but has not been in operation due to regulatory and technical issues.

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Co-located near an AES-owned generator, the system is expected to become operational in 2011 now that CAISO has agreed to adopt market rules that will allow storage-based regulation resources to compete in California. Also see "Regulatory and Market Affairs" for further information on anticipated market rule changes for storage-based regulation in California.

        In the fourth quarter of 2008, AES Corporation deployed a second lithium ion battery system, this one supplied by Altair Nanotechnologies, Inc. The 1 MW lithium-titanate system is connected to a 34 kV circuit in PJM's service territory and is providing frequency regulation. Altair Nanotechnologies is a leading provider of advanced materials and products for power and energy systems. Altair Nanotechnologies 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.

        In November 2009, AES Energy Storage and A123 Systems announced the commercial operation of a 12 MW frequency regulation and spinning reserve project in the Atacama Desert in Chile. AES Energy Storage is a subsidiary of AES. This is AES Energy Storage's first project outside the United States. Since December 2010, AES has been operating 8 MW of a planned 20 MW frequency regulation asset in Johnson City, New York.

        Our flywheel is a mechanical battery designed for a 20-year life, with virtually no maintenance required for the mechanical portion of the flywheel system over its lifetime. Of critical importance in performing frequency regulation with energy storage-based systems is their cyclic life (or charge/discharge) capability. Our experience to date in ISO-NE shows that 6,000 or more effective full charge/discharge cycles per year are required to perform frequency regulation in New England. Our flywheel systems are capable of over 125,000 equivalent charge/discharge cycles over their operating lifetime, with zero degradation in energy storage capacity over time. In comparison, battery-based systems, including Li-ion batteries, are much more limited in their cyclic capability. While the initial cost of a battery-based regulation asset is lower than a flywheel asset, we believe the reverse is true when the value of replenishment and/or replacement costs is reflected in the present value of all costs. In order to achieve 20 years of operation, we believe battery-based systems will require either significant initial over-sizing, and/or periodic battery replenishment and/or replacement over the life of the plant. For battery-based regulation resources, the value of such replenishment and/or replacement may be considerably greater than the initial capital cost of the battery asset.

        In vertical markets, characterization of battery replenishment and/or replacement costs as "operating costs" may be a disadvantage for that technology. The rate of return allowed by public utility commissions is typically based on initial capital cost, while operating costs are typically a pass-through expense that is not allowed to earn a regulated rate of return. In contrast, a greater percentage of total lifetime costs for flywheels appears as initial capital cost, thus allowing utilities to earn a higher regulated return on the purchase of flywheel assets.

        As explained in "Regulatory and Market Affairs," we expect ISOs to adopt market rules that reward the superior performance of fast-response storage-based regulation. If this happens, we believe that features of such performance-based tariffs will follow the example of ISO-NE, which utilizes a so-called mileage calculation to quantify the effectiveness of storage-based regulation resources. If a mileage calculation or similar tariff feature is adopted by other ISOs, we believe the ability of flywheels to transfer large amounts of energy to and from the grid without capacity degradation could allow flywheels to earn more revenue on a comparative basis than battery-based systems. Due to their cyclic limitations, we believe that battery-based regulation service providers may be forced to choose to respond more slowly and/or simply transfer less energy to and from the grid, resulting in lower revenue per unit of MW capacity under a performance-based tariff. We believe that this performance adjustment would be necessary to avoid excessive operating costs that would otherwise occur to battery-based systems performing regulation services due to extreme cyclic degradation.

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        In establishing supplier relationships with two lithium-ion battery manufacturers, AES Corporation has signaled its intent to bring battery-based regulation to market. AES Corporation is a Fortune 1000 company and has significant financial and other resources.

Discussion of Operations

        We have experienced net losses since our inception and, as of December 31, 2010, had an accumulated deficit of approximately $229 million. We are focused on commercializing our Smart Energy Matrix™ flywheel system for frequency regulation and the sale of turnkey systems. 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 sold turnkey systems, and we must raise additional capital from a combination of equity, debt and/or turnkey sales to execute our business plan and continue as a going concern. 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.

Revenues

        Our revenue during the three years ended December 31, 2010, 2009 and 2008, came primarily from three sources:

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Frequency regulation service revenue from the ISO-NE pilot program



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Research and development contracts and a grant, for which revenue has been recognized using the percentage-of-completion method



•

Sales of inverters, accessories and APS credits.

        Our business plan anticipates earning revenue primarily from the provision of frequency regulation service and the sale of turnkey flywheel systems. In the past, we have also earned revenue from research and development contracts with government agencies, and we continue to pursue similar contracts. Additionally, we have earned revenue from the sale of APS certificates or similar "clean energy" credits. However, revenue from such credits has not been material. Further, we have a small inventory of inverters and accessories that we sell, although that revenue is insignificant.

ISO-NE Pilot Program

        In November 2008, we began operating our first 1 MW Smart Energy Matrix™ on the electricity grid in Tyngsboro, Massachusetts. The 1 MW system was installed under ISO New England's Alternative Technologies Regulation pilot program. 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. The pilot program allows us to generate revenue for regulation services while ISO-NE develops permanent market rules that will govern application of the technology. We added a second megawatt of capacity in Tyngsboro in July 2009, and a third megawatt in December 2009, all of which have earned revenue through the pilot program. We have redeployed a portion of these 3 MW to the Stephentown site and we may also redeploy additional systems to our NorthWestern Energy project described elsewhere in this report. As available, we may operate up to 1MW of capacity from time to time in the ISO-NE pilot program.

        Revenue we have received from the pilot program is less than what we expect to receive under permanent market rules in the ISO-NE region, principally because under its pilot program rules we are not eligible for opportunity cost payments, which represent approximately one-third of the revenue

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received by conventional regulating generators. We expect that ISO-NE will develop a proposal for permanent market rules during the first quarter of 2011, to take effect by the end of 2011. These rules are expected to allow us to receive the economic equivalent of the opportunity cost payment component. Independently, in its February 2011 NOPR, FERC also proposed changes to tariffs in order to make sure that energy storage resources receive the benefit of this opportunity cost compensation feature. Additionally, we expect ISO-NE's new market rules to retain its pay-for-performance feature, whereby fast-response regulation resources, such as our flywheels, will continue to receive higher-than-average mileage payments on the basis of their greater speed and effectiveness.

        Recently, FERC has shown increasing support for the concept of paying fast-response regulation resources on the basis of actual system performance rather than nominal capacity, and in February 2011, FERC issued a notice of proposed rulemaking that proposes to require grid operators to begin the process of developing regulation market tariffs to provide such payments. We will continue to engage in this dialogue in an effort to encourage the expansion of performance-based tariffs. Currently, ISO-NE is the only grid operator that utilizes a performance-based tariff that rewards resources for speed. Other ISOs, including PJM, are considering changing their tariffs to provide higher revenues for faster performance. Should performance-based regulation tariffs be widely adopted, the economics of our plants would be enhanced and we would expect our addressable markets to expand.

20 MW Frequency Regulation Plant in Stephentown, New York

        In August 2010, Stephentown Regulation Services, LLC (SRS), a wholly-owned subsidiary of Beacon, closed on a loan guaranteed by the DOE, which, over time, will allow us to borrow up to approximately $43 million to finance 62.5% of the estimated $69 million total project cost of our 20 MW plant currently under construction in Stephentown, New York.

        On May 24, 2010, we announced that we had signed a contract with the New York State Energy Research and Development Authority (NYSERDA) relating to a $2 million grant. This grant will provide $1.5 million to pay for a portion of the interconnection and other aspects of the Stephentown facility, $100,000 for a visitor information center to be built at the Stephentown site, and $400,000 for other NYSERDA project tasks not specifically related to SRS project costs.

        We energized and interconnected 8 MW of flywheel energy storage at our Stephentown plant on January 24, 2011, and began earning frequency regulation revenue at that time. As of that date, all interconnection systems between the Stephentown plant and the local utility provider, NYSEG, were operational to enable the full 20 MW plant to come online. As of the date of this filing, 14 MW are operating and earning revenue. Additional MW of energy storage capacity will be progressively energized and interconnected, with all 20 MW expected to be operational and earning revenue during the second quarter of 2011.

$24 Million DOE Smart Grid Stimulus Grant for Second Regulation Plant

        In November 2009, the DOE announced that it had awarded us a Smart Grid Stimulus Grant valued at $24 million, for use in construction of a second 20 MW flywheel energy storage plant. The funding award is to design, build, test, commission and operate a 20 MW flywheel energy storage frequency regulation plant in the PJM Interconnection region. We currently expect that this facility will be built on a property situated in Hazle Township, Pennsylvania, for which we have entered into an option agreement with an economic development agency of the State of Pennsylvania. Under the terms of this two-year option, we are paying $2,500 for each of four six-month option periods, or until the option is converted to a lease. The option allows us to lease the property for 21 years at the rate of $3,250 per month. The site covered by this option is located in an economic development zone, which provides an exemption from the payment of state sales tax on equipment used to build the plant and an exemption from property taxes through 2017. We have filed for interconnection, and have completed the system impact study and an environmental assessment for this site.

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Site Development Efforts for Future Plants

        In April 2010, we entered a two-year option that provides the right to purchase a property in Chicago Heights, Illinois, for $1 million. The property is zoned industrial, and contains certain improvements relevant to our planned use, including equipment that may be usable for physical interconnection to 138 KVA transmission lines. In consideration for this option, we are paying the owner $2,000 per month. If we elect to purchase the land, the option payments will be applied to the purchase price. We have filed for interconnection and have completed both a system impact study and an environmental assessment for this site, and a facilities upgrade study is scheduled for completion before the end of the second quarter of 2011.

        In 2009, we entered into an option to lease land in Glenville, New York. This option was amended and extended until December 31, 2011, at a cost of $1,500 per month. We have filed for interconnection and completed a system impact study for this site.

Conclusion

        Since our inception in 1997, we have funded our development and operations primarily through the sale of stock. In November 2000, we completed our initial public offering, raising approximately $49.3 million net of offering expenses. Since our initial public offering, we have raised approximately $123.5 million as of December 31, 2010, through the sale of common stock and the exercise of warrants related to those stock sales. In December 2010, we raised approximately $8.7 million, net of offering costs, from the sale of mandatorily redeemable convertible preferred stock and associated preferred and common warrants. We estimate that to continue to implement our business plan we will need to raise approximately $15 to $20 million during 2011 in order to fund operations, $5 million of which is anticipated from the callable preferred stock warrants issued in December 2010.

        Our profit and losses as well as uses of cash may fluctuate significantly from quarter to quarter due to fluctuations in revenues, 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, our cash may fluctuate by period due to the timing of capital expenditures to expand manufacturing capabilities and/or construct 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 "Liquidity and Capital Resources" for more information concerning our access to and uses for capital.

Our Technology

        Our Smart Energy 25 flywheel is a 4th-generation advanced energy storage solution designed to meet the requirements of demanding utility grid energy-balancing applications. It features a long-life, low-maintenance design, highly cyclic (charge-discharge) capability, zero fuel consumption and produces no CO ₂ or other emissions. An array of Smart Energy flywheel units can be configured to form a Smart Energy Matrix plant, which can store and return megawatts of energy to maintain grid reliability and stability.

        The Smart Energy 25 flywheel offers many technical and performance advantages, including:

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Highly cyclic capability: Smart Energy 25 flywheels are designed for more than 125,000 equivalent charge-discharge cycles over their 20-year life, making them ideally suited to the frequency regulation function

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Smart Grid attributes: Smart Energy 25 flywheels and Smart Energy Matrix plants are interactive systems that can be monitored and operated remotely as part of an intelligent grid design



•

20-year design life: Smart Energy 25 flywheels are designed and built for 20 years of virtually maintenance-free operation



•

Sustainable technology: Smart Energy 25 flywheels are emissions-free, do not require fuel, and contain no hazardous chemical materials, simplifying permitting and avoiding potential ground contamination issues.

        The Smart Energy 25 flywheel system includes a rotating carbon-fiber composite rim, levitated on hybrid magnetic bearings operating in a near-frictionless vacuum-sealed environment. The rim is fabricated from a patented combination of high-strength, lightweight fiber composites, including carbon and fiberglass combined with resins, which allow the flywheel to rotate at high speeds (16,000 rpm) and store large amounts of energy as compared to flywheels made from metals. To reach its operational speed, the system draws electricity from the grid to power a permanent magnet motor. As the rim spins faster, it stores energy kinetically. The flywheel can spin for extended periods with great efficiency because friction and drag are reduced by the use of magnetic bearings in a vacuum-sealed environment. Because it incurs low friction, little power is required to maintain the flywheel's operating speed.

        When a grid operator signals the system to absorb power, the Smart Energy Matrix uses power from the grid to drive the motor/generator, which in turn increases the speed of the flywheel. When a signal is sent for electrical power to be provided, the momentum of the spinning flywheel drives a generator and the kinetic energy is converted into electrical energy for release to the grid.

        Our flywheel frequency regulation systems have been demonstrated to be a more responsive and environmentally friendly alternative to conventional fossil fuel-powered regulation methods. Our Smart Energy Matrix 20 MW frequency regulation plant is a commercial facility that improves the performance and reliability of the grid, while facilitating the use of renewable energy sources and reducing air pollution. Comprised of 200 high-speed, high-energy flywheels and associated electronics, a 20 MW plant provides 20 MW of "up and down" regulation—equal to a 40 MW swing.

        The Smart Energy Matrix is designed to recycle excess energy when generated power exceeds load and deliver it when load increases. Flywheel-based regulation is highly responsive, achieving full up or down power in seconds after receiving an ISO-transmitted or other control signal. Unlike conventional, fossil fuel-burning frequency regulation plants, our technology does not consume fossil fuel or produce particulates or other air emissions. This should make it possible to rapidly permit and site a 20 MW flywheel-based plant almost anywhere on the grid relatively close to a transmission line.

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 features and performance requirements to address specific ISO needs. Research and development expenses, including engineering expenses, were approximately $6,689,000 in 2010, $6,796,000 in 2009 and $15,398,000 in 2008.

Advanced Research Projects Agency—Energy (ARPA-E) Project

        In September 2010, we finalized a contract with DOE's ARPA-E to develop critical components of a highly-advanced "flying ring" flywheel energy storage system over a two-year period. ARPA-E is an agency within DOE that provides R&D funding for transformational new energy technologies and systems. The award is valued at a total of $2.8 million. ARPA-E grant recipients share a portion of the

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program cost, and we would contribute a minimum of $560,000, or 20%, of the $2.8 million program total. The actual contract net cost is expected to be higher due to the difference between contract and our GAAP overhead rates. Our proposal calls for initiating development of a next-generation flywheel energy storage module with a size of 100kWh and 100kW, capable of storing four times the energy at one-eighth the cost-per-energy-unit, as compared to our current Gen 4 flywheel. The new flywheel would be capable of more than 40,000 full charge/discharge cycles in its lifetime, thereby achieving a cost per storage cycle below ARPA-E's goal of $0.025/kWh. If we are successful in developing the initial design, additional effort would be required before this new flywheel could be commercialized.

        We expect that the ARPA-E-funded flywheel system, if carried through to a commercial product, would be suitable for a variety of other applications where the cost per unit of stored energy is the most critical factor, and the number of charge-discharge cycles is somewhat less important. One new application of particular interest to the DOE is so-called "ramping" support for wind and solar power. The goal would be to provide one hour of flywheel storage as an energy-balancing resource for intermittent renewable energy assets, and thereby reduce the amount of fossil-based backup power that might be used to provide the same effect. The benefit would be to enable significantly greater market penetration of renewable generation resources in a clean and sustainable way. Some of the technology developed under the APRA-E program may also lead to reduced costs and increased performance for our current generation of flywheels. Other potential applications include wind-diesel-storage hybrid systems that reduce diesel fuel consumption on island-based grids, uninterruptible power supply (UPS) applications that require an hour or more of assured power, and electrical demand limiting for commercial, industrial, institutional and government facilities that pay high demand charges under time-of-use electricity tariffs.

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 includes 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:

•

Controls flywheel storage technology to improve the dynamic control of wind generation resources



•

Coordinates energy production and delivery from wind generation in the Tehachapi region of California.

        The project used portions of the previously used 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 flywheel replaced the seven smaller flywheels previously used by the CEC project. Our share of the scope of work is valued at approximately $469,000, of which we will receive $250,000 from the CEC and we will provide matching funding of approximately $219,000, which was recorded as a contract loss in 2009.

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        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.

        The system was installed in 2010 and testing was completed February 11, 2011. Data analysis and a final report for the project are expected by the third quarter of 2011.

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 (PNNL), 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 energy storage and control system with the ability to help the BPA 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.

        Because 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.

        Phase II of this project was approved in 2009 and completed in 2010 under contract terms discussed with PNNL, the prime contractor. We received $104,000 in payment for our portion of the work. Phase II goals included providing numerical factors needed for the possible future design of the system architecture and completion of a technical design specification.

SmartLink™ Microgrid Control System

        During 2010, we were granted a patent on our SmartLink™ microgrid control system. The patent will be the underlying technology of our new SmartLink™ system, which we believe may be used in a broad range of existing and future distributed generation (DG) applications. The patent describes Methods and Systems for Intentionally Isolating Distributed Power Generation Sources. Our invention applies to the use of energy storage of any kind, and automatically allows DG resources to continue operating when the main power grid fails. Currently, the majority of DG resources turn off automatically when the grid fails. In contrast, when the grid fails, our invention immediately creates a DG-powered microgrid stabilized by energy storage which continues to operate without support from the primary grid.

        Inspiration for our SmartLink™ system came directly from the major northeast blackout of August 2003, in which sites with DG were left without power, even though they had on-site generation. We believe this could become an important source of revenue in addition to frequency regulation. Our SmartLink™ system may be useful whenever grid instability occurs during an outage or in support of a

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broad range of customer markets and applications. These include load reduction, standby power, peak shaving, net metering, residential solar, combined heat and power (CHP), grid support, premium power, island systems and remote agricultural markets.

        DG is considered a smart grid enabler because it places generation closer to the consumers of energy, or loads, allowing greater control, reliability, efficiency and self-reliance. Distributed generation systems can be grid-connected, grid-independent, hybrid systems, and microgrids, and may be found in the public sector, private industry, and military applications.

Manufacturing

        We moved to our corporate headquarters at 65 Middlesex Road, Tyngsboro, Massachusetts in January 2008, under a seven-year lease that began in July 2007, with options to renew for two additional seven-year periods. The 103,000 square-foot Tyngsboro facility was fully renovated and built-out to our specifications and currently has a manufacturing capacity of more than 600 flywheels per year on a multi-shift basis. The manufacturing capacity of the facility could be further expanded to over 1,000 flywheels per year if necessary.

Business Development

        Business development activities include sales, marketing, plant site identification, development of grant, loan and other potential funding opportunities, and legislative initiatives and regulatory reform activities designed to open additional markets to our merchant plants and attract customers for the sale of turnkey plants in both the United States and overseas. Since 2008, we pursued a broad and successful program of regulatory reform in a number of ISOs with the goal of opening the markets to our technology and ensuring that we will be paid on a fair and equitable basis for frequency regulation services. More recently, these regulatory activities have included efforts to promote the adoption of performance-based compensation for fast-response energy storage regulation by FERC, ISOs and PUCs. (See "Regulatory and Market Affairs" for further details on this and other regulatory reform activities.)

        Adoption of performance-based compensation, as would be required under FERC's February 2011 NOPR, would have a significant impact on our business and enterprise value. First, it would significantly increase the prices paid by ISOs to our merchant plants in open-bid markets. Second, it would influence the way that vertical utilities evaluate the purchase of new regulation assets. For example, a fast-response regulation asset deemed twice as effective compared to a conventional slow-response asset would receive a higher score in the Cost/Benefit tests typically used by public utility commissions to decide whether or not to allow a utility to make the investment and pass the cost into its rate base. PNNL has studied our technology and its impact on the grid and forecasts that our technology is 2 to 17 times more effective than conventional slower resources. We therefore expect that acceptance of the concept by FERC and the ISOs that fast-response regulation should be paid more for providing superior regulation service in the organized markets should indirectly spur demand for our technology in vertical markets both in the United States and overseas.

        In addition to our domestic activities, in 2011 we will continue to seek opportunities in Europe and Asia to demonstrate our technology and sell plants. An important part of our business development process is the completion of various grid or electrical studies that evaluate and quantify the potential economic and environmental advantages of deploying our technology in a particular country. In 2010 we completed several such major studies. They showed strong commercial potential for our flywheel technology. In preparation for potential plant sales, we are in the process of adapting our technology for use on 50 Hz grids. We will also continue to evaluate the market potential for our systems on islands, which generally require a much higher percentage of regulation resources compared to larger mainland grids. Larger islands may also utilize our fast-response storage for spinning reserve and frequency response in addition to frequency regulation, leading to an even better value proposition.

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Backlog

        At December 31, 2010, we did not have any firm commercial sales commitments for our products and services. As of the end of 2010, we had two ongoing research and development contracts and a grant from NYSERDA from which we expect to derive revenue in 2011 of approximately $2,376,000. The multi-year contract with the U.S. Naval Sea Systems Command that we were granted in February 2009 has a potential value of up to $3 million, of which $500,000 was previously funded and which has been completed. In February 2011, we received a $50,000 amendment to provide a report for work accomplished to date..

        On February 28, 2011, we announced we had signed a lease agreement with NorthWestern Corporation d/b/a NorthWestern Energy for a one-megawatt (1MW) Beacon Smart Energy Matrix flywheel energy storage system. The system will be installed by us and operated in conjunction with Mill Creek Generating Station (MCGS), a gas-fired regulating reserve plant recently commissioned in Montana and owned by NorthWestern Energy. The system is expected to be operational by the end of 2011.

        The initial term of the lease will be 15 months, which at NorthWestern Energy's option, can be extended up to two additional 12-month terms. NorthWestern Energy will pay us $500,000 for the first 15-month term and $500,000 for each subsequent term should it choose to extend the lease to a second or third term. At any point NorthWestern Energy can opt to purchase the 1 MW system outright for approximately $4 million. A portion of the lease payments already made under the agreement would be applied to the purchase, depending on when the purchase was made.

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, bearing damper, lift system, touch-down system, and SmartLink™ microgrid control system. (See Research and Development, above) We also hold one or more foreign patents on our vacuum system, co-mingled rims, metal hub, earthquake-tolerant bearings and bearing damper. Our patents expire on various dates between 2020 and 2029. We also have 25 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 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 "Defense Applications" above. 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

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properties and trade secrets as we continue developing additional Smart Energy flywheel technology. We own all technology improvements that we have developed that are based on the technology licensed from SatCon.

Government Regulation

        We operate in a heavily regulated industry. This environment presents both opportunities and challenges. The principal opportunity is that we have been able to work within the regulatory framework to gain market rule changes that allow our technology to compete in open-bid markets on a fair and equitable basis. In the future, we believe we may succeed in fostering further changes which would result in higher payments for the regulation services provided by our technology due to its fast response characteristics. A cap-and-trade program or carbon tax regulations, if enacted, would have the effect of increasing the cost of operation of our fossil fuel-based competitors, and potentially provide an additional revenue source for us. While such a cap-and-trade program or carbon tax may be unlikely in the short to medium term, we believe it is reasonably possible in the longer term.

        The primary challenge imposed by government regulation is the lead time generally required to obtain the necessary state, local and federal permits, approvals and interconnection agreements needed to construct our merchant plants. Internationally, there are a number of countries where our technology could provide regulation services without government intervention or regulatory reform; however, some overseas markets will require regulatory changes in order for us to enter the markets and compete on a fair and equitable basis.

        In July 2010, the New York State legislature passed a law that specifically exempts flywheel-based energy storage facilities of less than 80 MW from New York Public Service Commission (PSC) jurisdiction. Prior to this statute, we were required to apply for (and had obtained) PSC approval via a certificate of public convenience and necessity, or CPCN, for the Stephentown facility. The exemption relieves us from the regulatory burden of having to provide the PSC with periodic updates and obtain PSC approval of facility documents for our Stephentown plant. It will also eliminate entirely the need for us to apply for additional CPCNs, as would have been required should we decide to build a plant in Glenville, New York, or elsewhere within the NYISO region.

        See also "Regulatory and Market Affairs" for further discussion of how government regulation affects our business.

Employees

        At December 31, 2010, our headcount was 73 full-time employees, five part-time employees and a number of independent contractors and temporary employees. Our staff included 29 technical employees made up of engineers and technicians involved in research and development activities and 24 manufacturing and materials handling workers involved in production and research and development activities. We also had nine employees in sales, marketing, business development, compliance and customer service. The remaining 11 people were involved in administrative tasks. None of our employees is represented by a union and we consider our relations with employees to be good.

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 website at www.sec.gov.

        Our web 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

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amendments to those reports are made available free of charge on our website as soon as reasonably practical after being filed electronically with, or furnished to, the SEC. The content on our website does not constitute part of this annual report. We also make available our Corporate Governance policies and our Code of Conduct on our website. Additionally, paper copies of these documents may be obtained free of charge by writing our Investor Relations department at our principal executive office.

Item 1A.    Risk Factors

We have limited experience building and operating merchant frequency regulation plants. In order to be commercially-viable in the long term, we need to be competitive with respect to open-bid pricing for frequency regulation and with both conventional fossil-based regulating generators and other emerging storage technologies.

        To date, we have designed, built and operated up to 3 MW in Tyngsboro under the ISO-NE pilot program. As of March 2011, we have 14 MW of frequency regulation operating in Stephentown, New York, and expect to have all 20 MW in operation in the second quarter of 2011. We have also previously built and successfully deployed both 2 kWh and 6 kWh flywheel systems in limited volumes. The further development of our Smart Energy Matrix™ and increasing our production and deployment of our systems involves certain cost, technological and infrastructure challenges, which include:

•

The possibility of development and production delays and/or cost increases that may occur if we are unable to establish and maintain multiple source suppliers for key components that meet our engineering requirements, cost objectives and development and production schedules



•

The need to make timely improvements to the system's design in order to achieve cost reductions and/or increase the performance of our frequency regulation plants



•

The need to meet system performance and manufacturing requirements as we increase our production volume to maintain our plant deployment schedule.



•

The need to expand our manufacturing capacity and significantly increasing our production volumes



•

The need to increase our field service and installation team, management organization and infrastructure.

        We have limited experience with such a transition, and in the event we are not successful in meeting these challenges, we may not be able to bid competitively with competing technologies and therefore not achieve the revenues and margins required to become profitable. This could have a material adverse effect on our ability to continue as a going concern.

Frequency regulation service pricing is currently below the pricing that has prevailed for some years. However, if such low pricing continues for an extended period, it will adversely affect our revenue and cash flows, and if it becomes durationally significant so as to substantially threaten our Stephentown facility, it would increase the risk that the DOE may consider the pricing to constitute a material adverse effect, leading to an alleged default under our loan documentation. We regard the current pricing as anomalously low, and believe that it is likely to return to levels consistent with past history, and also be enhanced if the FERC's NOPR on performance pricing is implemented.

        Over the longer term, the market pricing for frequency regulation services has historically tended 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 revenue. Electricity prices have been below recent historical averages due in part to the economic recession, and the impact of a decrease in energy prices. Consequently, during 2010, recent frequency regulation clearing prices were significantly lower than their historical average, including in the regions where we are developing plants, with some

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markets seemingly affected more than others. During the fourth quarter of 2010 in particular, frequency regulation pricing in the New York ISO region dropped to historically low levels for that market. The reasons for historical anomalies in pricing trends can be difficult to determine, but we believe that the general reasons for pricing pressure (described above) were exacerbated in the fourth quarter of 2010 when a new market participant bid in a low manner which we believe that entrant may not be willing to sustain. We believe that the unusually low frequency regulation pricing will be temporary, and think it likely that there will be a trend back toward historical pricing levels, as predicted by an independent market report commissioned by the DOE and issued in February 2011. It found no evidence to support the position that current pricing levels represent a long-term change. Also, as mentioned elsewhere, on February 17, 2011, FERC issued a NOPR that, if adopted as proposed, would direct ISOs to implement a "pay-for-performance" compensation structure for frequency regulation which we regard as particularly helpful for fast response resources such as ours, and would significantly enhance the economics of our plants (including in Stephentown).

        However, there are no guarantees that pricing will return to historical average levels. If the lower frequency regulation pricing levels, contrary to these expectations, reflect a long-term change in the market, or if they otherwise continue indefinitely, this could have a material adverse effect on revenues, cash flow and our ability to raise equity on terms that we consider attractive, to meet our debt service obligations and to continue as a going concern. It is also possible that under our loan guarantee documentation with the DOE, the DOE could, at some point in time, take the position that durationally significant low pricing substantially threatens the Stephentown project entity, and constitutes a material adverse effect. If so, the DOE might refuse to permit additional advances under the DOE loan documents or otherwise take the position that a default has occurred under DOE loan documents.

Reductions in demand for electricity may have a negative impact on both the demand for and pricing of frequency regulation services and therefore our revenue.

        We expect the overall size of the global frequency regulation market to grow, in part due to the need for more regulation resulting from the increased 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 overall size of and rate of growth for the frequency regulation market. A reduced demand for frequency regulation could result in lower pricing, which would have a material adverse effect on our achieving our business plan.

We have to demonstrate that the performance of our 20 MW Smart Energy Matrix™ is consistent with design expectations.

        In order to achieve market acceptance, we will need to demonstrate that the actual performance of our planned 20 MW Smart Energy Matrix ^TM frequency regulation plants is consistent with projected performance. While we now have 14 MW interconnected and operating on the utility grid in Stephentown and we expect to expand to a full 20 MW during the second quarter of 2011, there remains a risk that the plant will not perform as expected, and if it does not, it could adversely affect our profitability and our ability to continue as a going concern.

We will be unable to sell plants overseas until we can demonstrate that our technology is compatible with 50 Hz electrical design requirements.

        Our technology is currently designed to meet 60 Hz electrical design requirements for North America. Failure to make our technology fully compatible with 50 Hz electrical design requirements in either a timely or correct manner will impede our ability to sell plants in regions of the world that require 50 Hz compatibility, including but not limited to Europe, China, and a portion of Japan. If adapting our flywheel system to operate at 50 Hz cannot be achieved in a time period that meets our

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planned deployment outside the United States, it could have a material adverse effect on achieving our business goals.

Our business plan includes the construction and operation of frequency regulation plants in a variety of locations, as well as the sale of turnkey systems.

        Our business development plans, which involve the construction and operation of multiple frequency regulation plants, will pose significant technological, logistical and cost challenges such as:

•

Managing large-scale construction projects, in terms of both schedule and cost



•

Managing large-scale construction projects simultaneously in multiple locations where we may not be familiar with local laws and market rules



•

Achieving planned cost reductions for our 20 MW system as we increase our production volume.

        To be profitable, we will need to obtain site interconnection approvals, landlord approval, or other zoning and construction approvals in a timely manner; obtain equity and/or project financing; 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 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 face a number of challenges related to the DOE loan guarantee on our first 20 MW plant.

        In developing the Stephentown facility, we entered into obligations that are new to us. These include the following:

•

We entered into an 18 year contractual obligation to provide operation management and maintenance to the subsidiary



•

We entered into a contract to provide administrative services



•

We will be providing a two year commercial warranty on certain components (flywheels, certain cabling, containers and electronic control modules) of the 20 MW plant



•

We were required to place sufficient technology into escrow that would allow the DOE to assume control of the plant assets for use in the project and have a third party operate and maintain it should we be unable to meet our obligations



•

The debt service obligations under the loan documents are computed in a fixed and formulaic manner, yet funded by revenues whose base is entirely variable (i.e., at prices determined by auction every day)



•

We were required to guarantee completion of the plant



•

We were required to ensure that the subsidiary will meet certain operational and financial tests and other covenants.

        There can be no assurance that we will be successful in meeting any or all of these challenges and failure to meet all of these challenges could have a material adverse effect on our financial performance.

        Some of the factors described above, such as putting our technology into escrow and other demands, guarantees and loan covenants required under the terms of the DOE loan may affect the terms of future project financing or make it more difficult to obtain such financing. There can be no assurance that we will be successful in obtaining future project financing or that that financing, if

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available, will be on terms that are economically viable and that required guarantees can be met. Failure to obtain additional financing would have a material adverse effect on our financial viability.

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

        We will require substantial funds to manufacture and deploy our systems, market our services and increase our revenue. We anticipate that such funds will be obtained from a combination of equity, debt, and/or the sale of turnkey systems. The extent of the funds needed is dependent, in part, on the volume of flywheels that we produce and deploy and/or sell as turnkey systems.

        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 in the early stages of deploying our merchant plants makes it harder to obtain project financing. Additionally, adverse conditions in the overall credit market further complicate our ability to arrange financing, at least in the near term. We have limited experience in obtaining project financing. The funding we require may not be available on favorable terms, 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 has been volatile and purchasers of our common stock could incur substantial losses.

        The market price of our common stock has historically been volatile, and fluctuates significantly in response to multiple factors, some of which are beyond our control. The stock market in general experiences wide 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 to be adversely affected and potentially incur substantial losses. The market price for our stock may be influenced by many factors, including:

•

Market conditions in the conventional or renewable energy industries, and specifically in the frequency regulation markets in which we participate or plan to participate



•

Securities analysts' reports or recommendations



•

Our ability or inability to execute our business plan



•

The dilutive effect or anticipated effect of additional equity financings



•

Investor perception of our Company and of the industry



•

The success of competitive products or technologies



•

Regulatory developments in the United States and/or foreign countries



•

Developments or disputes concerning patents or other proprietary rights



•

The recruitment or departure of key personnel



•

General economic, political and market conditions.

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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 revenue and profitability could be adversely affected.

        Various regulatory organizations, such as FERC and the North American Electric Reliability Corporation (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 to procure in order to meet NERCs requirements. This can vary based on each ISO's evaluation of its region. We cannot predict how these organizations may act in the future, and if any ISO decides to reduce its amount of regulation procurement, it would reduce the size of the market in which we compete and could have a material adverse effect on our ability to achieve our business plan.

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.

        We had approximately $10,866,000 in cash and cash equivalents on hand at December 31, 2010. We believe that our December 2010 cash balances, combined with anticipated funds from the exercise of preferred stock warrants issued in December 2010, are sufficient to fund operations into the third quarter of 2011. We have incurred significant losses from operations since our inception. As shown in our consolidated financial statements, we incurred losses from operations of approximately $22,308,000, $18,944,000 and $23,838,000, and operating cash decreases of approximately $15,613,000, $16,698,000 and $18,182,000 during the years ended December 31, 2010, 2009 and 2008, respectively. Our business model is based on owning and operating a number of 20 MW frequency regulation merchant plants, and the sale of turnkey systems. Our goal is to reduce the cost to complete these plants, and we believe we are on target to do so. However, to fund our merchant plants, we will need to sell turnkey plants to utilities or raise capital in both 2011 and 2012. In the event that we are not successful in selling turnkey plants and 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.

        Miller Wachman LLP, our independent auditor, has included an explanatory paragraph expressing uncertainty in their audit report on our consolidated financial statements for the fiscal year ended December 31, 2010, which identifies our recurring losses and negative cash flows and raises 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™ plants. 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 energy 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™ plants or become profitable. Certain commodities, such as

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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. In the past, 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.

        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 our 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 regulations may impair our ability to construct and operate our plants profitably.

        Government regulation of our services in the United States, 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 additional federal, state and local regulations governing traditional electric utilities and other regulated entities in the future. We expect that our Smart Energy Matrix™ plants 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. For example, in certain ISOs, we may require permits from state utility commissions, and could be

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subject to fines or construction delays if those commissions determined that we were not in compliance with the permits. 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 Order No. 890 or expected new market rules related to performance pricing 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.

        Similarly, in international markets, we face the need in some countries to foster regulatory changes in order to enter and compete on a fair, equitable and economic basis. Even if achieved, unforeseen adverse developments in the regulatory landscape of these countries could impair our ability to enter or operate profitably in these markets.

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, 2010, there were outstanding options to purchase an aggregate of 1,660,791 shares of our common stock at prices ranging from $2.30 per share to $93.10 per share, of which options to purchase 1,217,582 shares were exercisable as of such date. As of December 31, 2010, there were outstanding warrants to purchase 10,647,108 shares of our common stock, all of which were exercisable as of December 31, 2010.

        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.

Conversion of our outstanding preferred stock may lead to further dilution to holders of our common stock, and the outstanding preferred stock may reduce the amount available to our common stockholders in the event of a liquidation.

        We issued 10,000 shares of preferred stock at a purchase price of $1,000 per share in December 2010 as part of a financing. At the same time, we issued warrants to purchase an additional 5,000 shares of preferred stock at an exercise price of $1,000 per share, as well as common stock warrants. The preferred stock warrants can be exercised at any time by the holders, or we can force their exercise under certain circumstances. The preferred stock is currently convertible into shares of our common stock at a conversion price of $2.5234 per share, subject to adjustment (including adjustment for future dilutive issuances of common stock below that price). The conversion price may also be adjusted further as a result of our recent reverse stock split, based on the ratio of the volume weighted average trading prices of our common stock for the fifteen trading days before and after the reverse stock split. The amount of this latter adjustment, if any, has not yet been determined. We are required to make installment payments on the preferred stock in fixed dollar amounts through the scheduled maturity date of the preferred stock in February 2012. If certain equity conditions are met (including certain listing and trading volume requirements), we can pay the installment amounts, as well as dividends on the preferred stock, in shares of our common stock.

        As of March 11, 2011, there were 1,442.5 shares of preferred stock outstanding (not including 737.87 shares that were pre-redeemed on March 1, 2011 for the April 1, 2011 scheduled redemption) and unexercised warrants to purchase an additional 2,115 shares of preferred stock. The conversion of these shares of preferred stock into common stock (either by the holder or upon our payment of dividends or installment amounts in shares of our common stock) could lead to further dilution of our existing common stockholders. In the event we are unable to continue as a going concern or otherwise

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liquidate, then the outstanding preferred stock will have a liquidation preference of $1,000 per share, plus accrued and unpaid dividends, plus an amount reflecting dividends remaining to maturity, following which the holders of preferred stock will participate in distributions to holders of our common stock on an as-converted basis. In such an event, the preferred stock may significantly diminish the amounts, if any, available for distribution to holders of our common stock.

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; Mr. Lazarewicz, Vice President and Chief Technical Officer; and Ms. Judson, Vice President, Asset Management and Market Development. There can be no assurance that we will be successful in retaining our executive officers. In March 2011, we entered into employment agreements with our executive officers that continue until terminated. The executives have the right to terminate employment for "good reason", as defined in their executive agreements, and receive the compensation and benefits defined in those agreements. The executives may also elect to terminate their employment, for any reason, upon at least 90 day written prior notice to the Company.

Our financial performance could be adversely affected if we are unable to retain or attract key 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 and other staff. Competition for hiring skilled 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 a small percentage of components for our flywheels from companies outside of the United States. We expect to expand our business to other countries. 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 the United States may expose us to a variety of risks, which include:

•

Different political and economic climates which we may not fully understand or be prepared to address



•

Potential political and economic instability, including armed conflicts



•

Potential imposition of government controls, trade restrictions, or changes in tariffs that may have a negative impact on our ability to operate, our cost structure or our revenue



•

Some electrical grids in other countries have different standards than in the United States. We may be unable to successfully meet these standards, resulting in loss of revenue or increase in costs



•

Some countries have different market structures, within which we may be unable to successfully operate or which may require regulatory changes in order for us to be paid for our services



•

Exchange rates in other countries may fluctuate significantly, which could expose us to the risk of currency exchange losses



•

If the US dollar strengthens, it may make the purchase of our technology less attractive to foreign customers

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•

Some countries have different legal structures within which we may be unable to successfully enforce contracts or adequately protect our intellectual property



•

We may face difficulty in managing and operating installations located in another country, including cultural and language differences



•

We may face difficulty in repatriating funds from foreign operations due to limitations on the amounts that can be transferred to the United States, or taxes and penalties on such transfers.

        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 business.

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.

Competitors in the frequency regulation market include established utilities, independent service providers and alternative energy storage technology companies with 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 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, as was done in December 2010. 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 additional preferred stock, issuance of a substantial number of preferred shares could adversely affect the price of our common stock.

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

•

Our directors may only be removed for cause by a majority of the outstanding capital stock entitled to vote in the election of directors



•

Our stockholders do not have the power to call special meetings of stockholders



•

The provisions relating to the removal of directors and calling of special stockholder meetings may only be amended by a 66 ² / 3 % vote of the outstanding shares of common stock, voting together as a single class.

        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 initially entitles the holder to purchase 1/10 ^th  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. If the rights become exercisable, each right will entitle the holder to purchase $22.50 worth of our 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 if we do not maintain compliance with its listing rules:

        On September 14, 2010, at the end of previously applicable grace periods provided under the Nasdaq Listing Rules, we received a letter from The Nasdaq Stock Market informing us that our common shares had failed to comply with the $1.00 minimum bid price required for continued listing on The Nasdaq Capital Market under Listing Rule 5550(a)(2), and as a result, without further action our common shares would be subject to delisting. We appealed the Staff's determination, and on December 6, 2010, we announced that we had received a favorable ruling from the NASDAQ Listing Qualifications Panel which granted our request to remain listed on the NASDAQ, conditioned upon our satisfying the minimum bid price requirement by March 14, 2011, and also remaining in compliance on that date with NASDAQ's other, normal requirements for maintaining a company's continued listing. Specifically, we were required to evidence a closing bid price for our common stock of at least $1.00 per share for a minimum of ten consecutive business days by the close of business on March 14, 2011. In order to meet this requirement, we completed a reverse stock split on February 25, 2011, as discussed in our consolidated financial statement footnotes under "Subsequent Events", and thus we have regained compliance with the NASDAQ listing rules. However, should our stock price decrease in the future, there can be no assurance that we will be able to meet The Nasdaq Stock Market's minimum bid price requirements and therefore may lose our eligibility for quotation on The Nasdaq Stock Market.

Item 1B.    Unresolved Staff Comments

        None.

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Item 2.    Properties

        Since January 2008, our principal executive offices, research and development, and manufacturing facilities have been 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 approximately 600 flywheels per year on a multi-shift operating basis.

        We own land in Stephentown, New York, on which we have completed a significant portion of the construction for our first 20 MW frequency regulation facility, which became partially operational in January 2011. Additionally, we have options to lease or purchase several other properties where we may build future Smart Energy Matrix™ plants.

Item 3.    Legal Proceedings

        None.

Item 4.    (Removed and Reserved)

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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 closing sales price of the common stock for the periods indicated.

        On March 11, 2011, the last reported sale price of our common stock on The NASDAQ Capital Market was $2.60 per share, and there were 39 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 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.

        Until approximately March 25, 2011, our common stock will be quoted on the NASDAQ Capital Market with the Suffix D appended to it (BCOND) to reflect the occurrence of our one-for-ten reverse stock split on February 25, 2011, which is reflected in the above tables.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

        There was no stock repurchase activity in 2010.

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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, 2010, 2009, 2008, 2007 and 2006 and for the period from May 8, 1997, the date of Beacon's inception, through December 31, 2010.

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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 have experienced net losses since our inception and, as of December 31, 2010, had an accumulated deficit of approximately $229 million. We are focused on building, owning and operating merchant plants for frequency regulation and selling turnkey plants and systems. 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 sold turnkey systems. Moreover, we must raise additional capital from a combination of equity, debt and/or turnkey sales to execute our business plan and continue as a going concern. In the future, as we increase the number of our merchant regulation facilities 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.

        In November 2008, we began operating our first 1 MW Smart Energy Matrix™ on the electricity grid in Tyngsboro, Massachusetts. This 1 MW system was installed under ISO New England's Alternative Technologies Regulation pilot program. 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. The pilot program allows us to generate revenue for regulation services while ISO-NE develops permanent market rules that will govern application of the technology. We added a second megawatt of capacity in Tyngsboro in July 2009, and a third megawatt in December 2009, all of which have earned revenue through the pilot program. We have redeployed a portion of these three MW to the Stephentown site and we may also redeploy additional systems to our NorthWestern Energy project. As available, we may operate up to 1 MW of capacity from time to time in the ISO-NE pilot program.

        During 2010, our focus as a company has been on securing the financing to complete our Stephentown plant, ramping up production in order to build the necessary flywheels, working with NYSEG and NYISO on substation improvements required for interconnection to the grid, and completing activities required to develop the site, install, test and commission the equipment.

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        On August 6, 2010, SRS, a wholly-owned subsidiary of Beacon, closed on a loan guaranteed by the DOE, which, over time, will allow us to borrow up to approximately $43 million to finance 62.5% of the estimated $69 million total project cost of our 20 MW plant currently under construction in Stephentown, New York. At the closing of the loan, Beacon contributed the remaining 37.5% of the expected project costs in the form of $18.9 million in inventory, assets, eligible project costs and $7 million in cash, which was deposited into an SRS cash account (known as the "base equity account") controlled by the collateral agent. We expect to receive 100% reimbursement from the FFB for ongoing budgeted project costs until such time as 62.5% of the aggregate of all eligible project costs have been funded. After 62.5% of the aggregate of all eligible project costs have been funded with loan proceeds, (a) 62.5% of each request for funding will be funded with loan proceeds from the FFB, and (b) 37.5% of each request for funding will be funded with the proceeds taken from the base equity account. However, we are responsible for any cost overruns for the project. As of December 31, 2010, we have drawn down approximately $4 million of the cash that was contributed to the project, and have received advances of $22.2 million under the FFB loan for eligible project expenditures. The project is proceeding on budget, and we do not currently anticipate any cost overruns. Going forward, each monthly disbursement from the loan will be subject to the satisfaction of certain conditions. See Liquidity and Capital Resources below.

        On May 24, 2010, we announced that we signed a contract with the New York State Energy Research and Development Authority (NYSERDA) relating to a $2 million grant. This grant will provide $1.5 million to pay for a portion of the interconnection and other aspects of the Stephentown facility, which is being accounted for as a reduction of eligible project costs on a percentage-of-completion basis; $100,000 for a visitor information center to be built at the Stephentown site; and $400,000 for other project tasks not specifically related to SRS project costs, which is being accounted for as Beacon grant revenue, also on a percentage-of-completion basis.

        As of the end of 2010, more than 10 MW of energy storage capacity were installed and fully tested and ready for grid interconnection. In addition, all support systems and ancillary hardware for the plant's eventual matrix of 200 flywheels, including control software, power electronics, cooling and other equipment were in place, pending completion of work required on the local utility provider, New York State Energy and Gas (NYSEG), substation. We energized and interconnected 8 MW of flywheel energy storage and began earning frequency regulation revenue in Stephentown as of January 24, 2011. As of that date, all interconnection systems between the Stephentown plant and NYSEG were operational to enable the full 20 MW plant to come online. As of the date of this filing, 14 MW of capacity is operational and earning revenue. Additional megawatts of energy storage capacity are expected to be progressively energized, with all 20 MW expected to be operational during the second quarter of 2011.

        In 2011 and 2012, we will continue to have capital needs that will require additional funding through a combination of equity, debt and/or cash proceeds from the sale of plants to fund operations as we continue to build and deploy flywheel plants. The amount of debt and equity required will depend on the mix of merchant plants and plants sold on a turnkey basis. Our deployment plans are affected by the timing of a number of factors and activities, including but not limited to the following:

•

The timing of funds disbursement from the DOE-guaranteed loan and the DOE Stimulus Grant



•

Sale of turnkey plants and the associated margin and terms and conditions of those sales



•

Corporate or project financing and its availability



•

Equity transactions and the amounts thereof



•

Receipt of environmental and site-related permits and approvals

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•

Receipt of grid interconnection approvals



•

Cash flow generated by in-service plants.

        Our profit and losses as well as uses of cash may fluctuate significantly from quarter to quarter due to fluctuations in revenues, 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, our cash may fluctuate by period due to the timing of capital expenditures for expanding manufacturing capabilities and/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 "Liquidity and Capital Resources" for more information concerning our access to and uses for capital.

Revenue

        Our revenue during 2010 came primarily from three sources:

•

Frequency regulation service revenue from the ISO-NE pilot program



•

Research and development (R&D) contracts and a grant, for which revenue has been recognized using the percentage-of-completion method



•

Other revenue, which includes the sales of inverters, accessories and APS credits.

        Our business plan anticipates earning revenue primarily from the provision of frequency regulation service and the sale of turnkey flywheel systems. We have also earned revenue from research and development contracts, and we continue to pursue similar contracts. Additionally, we have earned revenue from the sale of APS certificates or similar "clean energy" credits. However, revenue from such credits has not been material. Further, we have a small inventory of inverters and accessories that we sell, although that revenue is insignificant.

        Revenues we have received from this pilot program are less than those that we expect to receive under permanent market rules, principally because under ISO-NE's pilot program rules, we are not eligible for opportunity cost payments, which represent approximately one-third of the revenue received by conventional regulating generators. We expect that ISO-NE will develop a proposal for permanent market rules during the first quarter of 2011, to take effect, if approved by FERC, by the end of 2011. These rules will enable us to receive the economic equivalent of this payment component. Additionally, we expect ISO-NE's new market rules to retain a pay-for-performance feature, whereby fast-response regulation resources, such as our flywheels, will continue to receive higher-than-average mileage payments on the basis of their greater speed and effectiveness.

        Revenue from frequency regulation from the pilot program decreased in the fourth quarter of 2010 from the third quarter of 2010 because we moved 2 of the 3 MW of capacity to our plant under construction in Stephentown, New York. The remaining flywheels were taken out of service temporarily to upgrade certain components in the flywheels to match more recent versions currently being installed in New York and to allow us to use the indoor facility to test new flywheels as they are produced. We have reinstalled a portion of the 1 MW previously in service inside our plant in Tyngsboro to the facility outside our building. As a result, the percentage of time in service and the amount of regulation provided in the fourth quarter of 2010 are not consistent with prior results.

        On February 17, 2011, FERC issued a NOPR that, if adopted as proposed, would direct each ISO to implement a "pay-for-performance" compensation structure for frequency regulation. Currently, ISO-NE is the only grid operator that utilizes a performance-based tariff that rewards resources for speed. Should FERC's rule requiring performance-based regulation tariffs be adopted, the economics of our plants would be significantly enhanced and our addressable markets would also significantly expand.

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        Frequency regulation revenue in 2011 is expected to be significantly higher than in 2010, as we have begun to earn revenue from our NY plant in January 2011 and anticipate having all 20 MW online during the second quarter. Additionally, we expect our R&D contract revenue to be higher in 2011 than in 2010 due to expected completion of work under the ARPA-E contract.

Cost of Goods Sold

        Our cost of goods sold (COGS) for frequency regulation services includes the cost of energy and retail transmission and distribution (T&D) charges. In 2010, approximately one third of our frequency regulation COGS represented the cost of energy; the remaining two thirds consisted of T&D charges from the local utility. We incurred the T&D charges because our pilot storage assets in Tyngsboro are connected to the grid through distribution-level power lines. Since our 20 MW facilities, including Stephentown, will be connected to the grid at transmission-level, we will not incur these T&D fees. Consequently, we expect our gross margins for our 20 MW plants to be significantly higher than they have been for the pilot program.

        Cost of goods sold for R&D contracts is being recorded on the percentage-of-completion method and consists primarily of direct labor and material, subcontracting and associated overhead costs. 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.

Operations and Maintenance

        Operations and maintenance (O&M) expenses are related to manufacturing, materials handling, purchasing, Smart Energy Matrix™ operations, and expensed non-fungible costs associated with certain installations. Since our current production levels are still well below our facility's full capacity, O&M costs for the years ended December 31, 2010 and 2009 include a significant amount of unabsorbed overhead. In addition, non-capitalizable costs associated with substation upgrades in Stephentown, costs associated with running ISO-NE pilot resources and certain non-fungible costs associated with certain Smart Energy Matrix™ installations are also included in O&M. For the year ended December 31, 2008 and prior, Operations and maintenance costs were combined with our Research and development costs. O&M expenses will increase as we ramp up our production capacity and begin to operate and maintain the Stephentown facility.

Research and Development

        Research and development (R&D) represents 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. We expect R&D expenses to decrease slightly in 2011.

        In 2008 and prior years, amounts reported as "Research and development" (R&D) included not only the cost of our engineering staff, but also the cost of unabsorbed manufacturing overhead, since most of our activities related to development of the Smart Energy 25 flywheel and Smart Energy Matrix™. 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. As of January 1, 2009, we have split the cost of Operations and maintenance (O&M) from the cost of our R&D functions.

Selling, General and Administrative Expenses

        Our selling expenses consist primarily of compensation and benefits for regulatory affairs, sales and marketing personnel and related business development expenses and regulatory compliance efforts. General and administrative expenses consist primarily of compensation and benefits related to our corporate staff, professional fees, insurance and travel. Overall, we expect our selling, general and

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administrative expenses for fiscal 2011 to be significantly lower than those in 2010, primarily because selling, general and administrative expenses for 2010 included approximately $1.2 million in direct costs associated with the preferred stock financing that was completed in December 2010.

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. 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. Each quarter we perform an estimate-to-complete analysis, and any increases to our original estimates are recognized in the period in which they are determined. Contract loss increased in 2010 over 2009 because we recorded our expected cost share on the ARPA-E contract; this was offset partially by credits resulting from lower than expected losses on other contracts completed in 2010. We expect our contract loss to be lower in 2011 than in 2010.

Depreciation and Amortization

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

Interest Income (Expense)

        Interest income is attributable to interest earned from cash deposits.

        Interest expense relates to the MassDev loan, FFB loans, "make whole" dividends paid when investors convert their preferred stock, along with the amortization of warrants issued in conjunction with the MassDev loan. A substantial portion of our interest expense relating to the MassDev and FFB loans has been capitalized. Interest expense also includes non-cash interest relating to our mandatorily redeemable convertible preferred stock, preferred stock warrants, and common stock warrant liabilities (see Debt or derivatives recorded at fair value, below). Interest expense will increase substantially in 2011 as we continue to draw down on the FFB loan. Non-cash interest may be either a charge or a credit, depending on changes in the fair value of the preferred stock and warrants and the fair value of our common stock when we redeem our preferred stock or investors exercise their warrants.

Other Income/Expense, net

        Other income/expense, net, consists primarily of currency exchange losses, gain or losses on the sale or disposition of fixed assets, and refunds received for the settlement of certain claims.

Gain (Loss) on extinguishment of debt

        Gain (loss) on extinguishment of debt is a non-cash item representing the gain or loss recognized when investors voluntarily convert their mandatorily redeemable convertible preferred stock for common stock. The gain or loss is calculated as the difference between the fair value of the common stock and the fair value of the preferred stock as of the date of the conversion. The amount of any such gain or loss in 2011 will vary based on the amount of preferred stock that is converted and the fair value of our common stock at the date of such conversion.

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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.

Debt recorded at par value or stated value

        The MassDev and FFB loans are recorded on our balance sheet at par value or stated value adjusted for unamortized discount or premium. Discounts and premiums for debt recorded at par value or stated value generally are capitalized and amortized over the life of the debt and are recorded in interest expense using the effective interest method. Such costs are amortized over the life of the debt and are recorded in depreciation and amortization expense.

Debt or derivative liabilities recorded at fair value

        Costs related to the issuance of debt for which we have elected the fair value option are recognized in current earnings. We have elected not to mark our MassDev or FFB loan to market through the income statement. However, we have three instruments that are recorded as debt or derivatives which we have elected to mark to fair value through earnings: our mandatorily redeemable convertible preferred stock, our preferred stock warrants, and the common stock warrants issued in conjunction with our preferred stock. We determine fair value for these instruments as of the end of each reporting period, and we reduce the amount outstanding for any redemptions, exercises, or conversions at the fair value determined at the end of the prior reporting period. The fair value adjustment is charged or credited to Non-cash interest.

•

Mandatorily Redeemable Convertible Preferred Stock   

The certificate of designations governing the rights and preferences of the preferred stock contains several embedded features that would be required to be considered for bifurcation. The preferred stock is mandatorily redeemable and therefore has to be recorded as a liability. We have elected the fair value option, and as such, will value the host preferred stock certificate of designations and embedded features as one instrument. Any changes in the fair value of the preferred stock is charged or credited to Non-cash interest on the consolidated statements of operations. See Notes 3 and 12 to the Consolidated Financial Statements.

•

Redemptions :    We expect to redeem our preferred stock by issuing common stock. The difference between the fair value of the preferred stock and the fair value of the common stock on the date the common stock issued is charged or credited to Non-cash interest.



•

Conversions :    Investors in the preferred stock can voluntarily convert their preferred shares to common stock at a conversion price defined in the certificate of designations for the preferred stock. The difference between the fair value of the preferred stock and the fair value of the common stock given in conversion is recognized as a non-cash gain or loss on the extinguishment of debt.



•

Dividends :    Dividends paid with scheduled redemptions are expected to be paid in common stock. However, when an investor voluntarily converts its preferred shares, we are required to pay the investor for the dividends that would have been earned had the

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shares been held to maturity. The portion of those dividends that have not been accrued must be paid in cash, and are referred to as "make whole" payments. Cash dividends are charged to Interest expense. Dividends paid in stock are valued at the fair value of the common stock as of the date of issuance, and charged to Non-cash interest.

•

Preferred Stock Warrants   

We account for freestanding warrants to purchase shares of our mandatorily redeemable convertible preferred stock as liabilities on the consolidated balance sheets at fair value upon issuance. The preferred stock warrants are recorded as a liability because the underlying shares of convertible preferred stock are mandatorily redeemable, which obligates us to transfer assets at some point in the future. (See Notes 3 and 12 to the Consolidated Financial Statements.) The warrants are subject to re-measurement to fair value at each balance sheet date and any change in fair value is recognized in Non-cash interest on the consolidated statements of operations. If the warrants are exercised, the warrant liability will be reclassified to preferred stock. The difference between the fair value of the preferred warrant and of the preferred stock as of the date of exercise is charged or credited to Non-cash interest.

•

Common Stock Warrants   

We have issued common stock warrants in connection with the December 2010 preferred stock offering. (See Notes 3 and 14 to the Consolidated Financial Statements.) Because this warrant has terms that adjust the exercise price in certain circumstances, the warrant cannot be considered indexed to our own stock and is therefore accounted for as a derivative liability at fair value. Changes in fair value of derivative liabilities are recorded in the consolidated statements of operations as Non-cash interest. The fair value of the warrant liability is determined using the Black-Scholes option-pricing model. The fair value of the warrants is subject to significant fluctuation based on changes in our stock price, expected volatility, remaining contractual life and the risk free interest rate. Upon exercise, the difference between the fair value of the common stock and the common stock warrant is charged or credited to Non-cash interest.

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 Financial Accounting Standards Board's (FASB's) Accounting Standards Codification (ASC) Topic 915, "Development Stage Entities."

•

Frequency Regulation Service Revenue   

Revenue from service transactions 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 service 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. In general, we recognize as revenue the amounts reported by the ISO.

•

Government Contract Revenue Recognized on the Percentage-of-Completion Method   

We recognize contract revenues 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

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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. Revenues recognized in excess of amounts billed are classified as current assets, and included in "Unbilled costs on contracts in process" 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 construction contract costs and revenue. In addition to our government contracts, we have a small engineering contract where we are paid on a per-hour basis for engineering services provided. Revenue on this contract is recognized as hours are worked.

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

•

Sale of Alternative Renewable Energy Credits   

Under the Massachusetts Alternative Energy Portfolio Standard (APS) program, our flywheel energy storage frequency regulation assets operating within the Commonwealth of Massachusetts are credited with producing a type of Renewable Energy Credit (REC) known as an Alternative Renewable Energy Credit. These have a market value, and we recognize revenue on the sale of such credits as revenue when sold on the open market.

•

Product Sales   

We recognize revenues in accordance with accounting principles generally accepted in the United States of America. Generally, revenue 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 products are subsequently sold by distributors to their customers.

•

Grants   

Grants that relate to revenues are recognized in the same period as the related revenues are reflected. Grants that relate to current expenses are reflected as reductions of the related expenses in the period in which they are reported. Grants that relate to depreciable property and equipment are reflected in income over the useful lives of the related assets, and those related to land are amortized over the life of the depreciable facilities constructed on it. A given grant may be parsed into various components, each of which may be treated either as current revenue, reduction of current expenses, or as deferred revenue to be amortized over the life of a fixed asset, as appropriate given the structure and nature of the grant. Grants to be recognized as current revenue will be recognized on a percentage of completion basis.

Loss on Contract Commitments

        Our contracts have been primarily for the development of demonstration units of new products, the design of a frequency regulation facility or alternative uses for our flywheels. 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.

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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, 2010 and 2009, 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 various patents, and expect to obtain other patents during 2011 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 from 2004 through 2008 related to the development of intellectual property were expensed as incurred. However, as of 2009, as we began to commercialize our technology, we again began to capitalize legal costs associated with obtaining patents which we expect to have future commercial value, and to amortize these costs over the life of the patent. We review our intangible assets periodically for impairment, and record impairment reserves as appropriate. Costs for patents that have not yet been issued are capitalized, but we do not begin to amortize them until such time as the patent is issued. If we determine that a patent will not be issued, any previously capitalized costs are expensed.

Warranty Reserves

        The solar inverters we have sold carry warranties that require us to repair or replace defective products returned to us during the 5 year 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

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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 such items as 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 capital 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. Other costs are sunk costs which would not be recovered if we redeployed the system 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 ASC Topic 360, " Property, Plant and Equipment, " 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.

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        Based on our annual analysis, no asset impairment charges were considered necessary for 2010, 2009 or 2008.

Other assets and deferred financing costs

        We will defer our direct costs incurred to raise capital. 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. For equity capital, these costs will be charged to Additional Paid in Capital when the efforts are successful, or expensed when unsuccessful. Indirect costs are expensed as incurred. Deferred financing costs related to debt are also deferred, and amortized over the term of the debt using the effective interest method.

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.

Recently Issued Accounting Pronouncements

        Recently adopted accounting pronouncements and recently issued pronouncements are discussed in Note 2 of Item 8, "Consolidated Financial Statements and Supplementary Data" of our Annual Report on Form 10-K, and are incorporated herein by reference.

Results of operations

Comparison of Years ended December 31, 2010 and 2009

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