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Beacon Power 10-K 2006

UNITED STATES SECURITIES AND

EXCHANGE COMMISSION

Washington, D.C. 20549

----------------------

FORM 10-K/A

(Amendment No. 1)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2004

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _____ to _____

 

Commission file number 001-16171

 

Beacon Power Corporation

(Exact name of registrant as specified in its charter)

 

Delaware 04-3372365

(State or other jurisdiction of (I.R.S. Employer

incorporation or organization) Identification No.)

 

234 Ballardvale Street

Wilmington, Massachusetts 01887-1032

(Address of principal executive offices) (Zip code)

 

(978) 694-9121

(Registrant's telephone number, including area code)

------------------------

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

 

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

 

Common Stock, par value $.01 per share

------------------------

(Title of class)

 

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 _X_ No ___

 

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/A or any amendment to this Form 10-K/A _____

 

Indicate by check mark whether the registrant is an accelerated filer (as defined by rule 12b-2 of the Act). ___ Yes _X_ No

 

 

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As of June 28, 2004 the market value of the voting stock of the registrant held by non-affiliates of the registrant was $14,557,694. 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 30, 2005 was 43,665,143.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The Exhibit Index (Item No. 15) located on pages 49 and 50 incorporates several documents by reference as indicated therein.

 

 

Table of Contents

 

 

Page

PART I

Item 1.

Business

1

Item 2.

Properties

10

Item 3.

Legal Proceedings

10

Item 4.

Submission of Matters to a Vote of Security Holders

10

 

 

PART II

Item 5.

Market for Registrant's Common Equity, Related Stockholder Matters and

 

 

Issuer Purchases of Equity Securities

10

Item 6.

Selected Consolidated Financial Data

12

Item 7.

Management's Discussion and Analysis of Financial

 

 

Condition and Results of Operations

14

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

32

Item 8.

Financial Statements and Supplementary Data

33

Item 9.

Changes in and Disagreements with Accountants on

 

 

Accounting and Financial Disclosure

60

Item 9A.

Controls and Procedures

60

Item 9B

Other Information

60

 

PART III

Item 10.

Directors and Executive Officers of the Registrant

61

Item 11.

Executive Compensation

66

Item 12.

Security Ownership of Certain Beneficial Owners

 

 

and Management and Related Stockholder Matters

70

Item 13.

Certain Relationships and Related Transactions

72

Item 14.

Principal Accountant Fees and Services

74

 

PART IV

Item 15.

Exhibits and Financial Statement Schedules

75

 

Signatures

79

 

 

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Note Regarding Forward Looking Statements:

 

This Annual Report on Form 10-K/A 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 view about future events and financial performance, including among other things, its expected future revenues, costs of operations and capital expenditures, estimates of the potential markets for its products, the rate of growth in those markets and the competitive advantage that the Company’s products has that will result in gaining market share. Such statements made by the Company fall within the meaning of 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 achieved by the Company may differ materially from these estimates due to a number of factors as discussed in the section entitled "Item 7. Management’s Discussion and Analysis of Financial Condition” and “Results of Operations - Certain Factors Which May Affect Future Results” of this Form 10-K/A.

 

EXPLANATORY NOTE REGARDING THIS FORM 10-K/A

 

Beacon Power Corporation (“the Company”) is filing this Amendment No. 1 (“Amendment”) to its annual report on Form 10-K for the fiscal year ending December 31, 2004 to update and clarify certain disclosure matters in its 2004 Annual Report on Form 10-K originally filed on March 31, 2005. This Amendment makes no changes to the Company’s originally filed consolidated balance sheets and consolidated statements of operations.

 

The Company engaged its independent registered public accountants, Miller Wachman LLP (“Miller Wachman”), to perform a re-audit of its financial statements for the prior years ending December 31, 2003 and December 31, 2002, and for the period from inception May 8, 1997 through December 31, 2004, after the resignation of Deloitte & Touche, LLP the Company’s former independent accountants. This Amendment updates certain disclosure items that occurred subsequent to the filing of the original Form 10-K and through the end of Miller Wachman’s field work, February 3, 2006. No changes were made to Company’s originally filed consolidated balance sheets and consolidated statements of operations contained therein as a result of these audits.

 

Miller Wachman’s Audit Report originally filed with the Company’s 2004 Annual Report on Form 10-K contained a typographical error in reference to the standards of the Public Company Accounting Oversight Board (United States). This Amendment corrects that error.

 

The Company has amended the language in Part II, Item 9A, Controls and Procedures clarifying management’s conclusions on the effectiveness of the Company’s disclosure controls and procedures and its internal control over financial reporting, pursuant to Item 307 and Item 308(a)(3) of Regulation S-K.

 

As a result of the above amendments, the certifications filed as Exhibits 31 and 32 have been re-executed as of the date of this Amendment.

 

 

 

 

 

PART I

 

Item 1. Business

 

Overview

 

Beacon Power Corporation is a development stage company that was incorporated in Delaware on May 8, 1997. The Company’s principal offices and research and development laboratory are located at 234 Ballardvale Street, Wilmington, Massachusetts, 01887-1032. Beacon’s telephone number is 978-694-9121. The Company’s web address is www.beaconpower.com. Investors can obtain copies of SEC filings from this site free of charge, as well as from the SEC web site at www.sec.gov, or by contacting Investor Relations at the Company’s principal offices.

 

The Corporation and its subsidiaries (collectively “Beacon” or “the Company”) design, develop, configure and offer for sale, advanced products and services to support more reliable electricity grid operation. Its sustainable energy storage and power conversion solutions can help provide reliable electric power for the utility, renewable energy, and distributed generation markets. The Company’s Smart Energy Matrix is a design concept for a megawatt-level, utility-grade flywheel-based energy storage solution that would provide sustainable power quality services for frequency regulation, and support the demand for reliable, distributed electrical power. The Company has the following products, which are in varying stages of development, production readiness or low volume production:

 

Smart Energy( Matrix – A design concept for a high-power flywheel-based system combining several flywheels with power electronics. The Company believes the Smart Energy Matrix can provide frequency regulation services for use by independent system operators and regional transmission operators to regulate electrical power. The Company also believes that the Smart Energy Matrix can regulate the frequency of electricity produced by a distributed generation facility and compensate for temporary differences between the demand for electricity and the amount being produced. The Company has a preliminary design for the Smart Energy Matrix and has been awarded contracts by the California State Energy Resources Conservation and Development Commission (CEC) and the New York State Energy Research and Development Authority (NYSERDA) for programs demonstrating the viability of the Company’s flywheel based system for frequency regulation of electricity on the power grid. The Company has shifted virtually all of its development spending towards meeting the requirements of these two programs. To successfully provide frequency regulation, the Company will need to obtain sufficient funding to complete design of the matrix, develop the flywheel components and power electronics, integrate and test the matrix and establish manufacturing capability to produce commercial products.

 

Smart Energy system - High-energy flywheel-based systems of 2kWh and 6kWh that store electricity for telecommunications, cable systems, computer networks, and Internet market applications have been produced in limited quantities and the Company has sufficient capacity to return to production if market demand occurs. The Company believes that, based on existing Smart Energy technology, it could develop a higher energy 25kWh flywheel system for renewable applications if market interest is sufficient to justify development. The Company has been unable to successfully market its Smart Energy 2kWh and 6kWh at commercially acceptable prices. At this time, the Company expects to use the results of its Smart Energy Matrix demonstration unit to assess market interest in its 25kWh design product and determine whether there is sufficient market demand at prices that would support the additional development activity required for the Company to bring this high energy product to market.

 

Smart Power™ M5 inverter system - An electronic system that converts direct current electricity produced by photovoltaic panels into alternating current electricity for residential and commercial use. This product is in low volume production and the Company has sufficient capacity and resources to ramp production if market demand increases. As a result of the increased market interest in the Company’s Smart Energy Matrix design, the Company has redeployed virtually all of

 

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its research and development effort from further inverter development to its Smart Energy Matrix flywheel technologies. As a result of this change in focus and lower than anticipated sales volumes of the Smart Power M5, the Company has also reduced its marketing efforts on the Smart Power M5 and has established reserves on its balance sheet for inventories and open purchase commitments. Although it is continuing to support the product, the Company does not believe that inverters will be a significant portion of the Company’s business going forward.

 

From the Company’s inception through December 31, 2004, it has incurred losses of approximately $129 million. The Company does not expect to obtain positive cash flow before 2009. This expectation is based on a business plan that includes full scale development of its Smart Energy Matrix beginning in the first quarter of 2006. If capital to fund full scale development of the Smart Energy Matrix is constrained, the time to achieve positive cash flow would be extended.

 

On May 24, 2005 and July 26, 2005 Perseus 2000 Expansion, L.L.C., an affiliate of one of the Company’s then largest shareholders, invested $2.9 million and received 3,452,381 shares of the Company’s Common Stock, and a warrant to purchase 800,000 shares of the Company’s Common Stock at $1.008, and another affiliate, Perseus Capital, L.L.C., paid $0.1 million for an extension to an existing warrant extending its term for two additional years.

 

On November 8, 2005, the Company distributed 9,868,421 newly issued shares of its common stock to ten "accredited investors", as defined in the Securities Act of 1933, as amended. The number of shares was determined by dividing the gross proceeds of $15 million by a share price of $1.52, derived by applying a 20% discount to the five-day volume weighted average price just prior to the closing date. The Company also issued warrants to purchase an additional 2,960,527 shares of common stock at an exercise price of $2.21. Each warrant is exercisable for a period of five years but may not be exercised until six months and one day after the closing of the transaction. This transaction resulted in net proceeds to the Company of approximately $14 million net of expenses and commissions in the amount of approximately $1 million. The Company has agreed to use these proceeds for working capital purposes only. For further details, please see the Securities Purchase Agreement which was filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 7, 2005.

 

Even with these investments, the Company must raise additional equity to complete the development of its Smart Energy Matrix and therefore execute its business plan. Based on the Company’s rate of expenditure of cash and the additional expenditures expected in support of its business plan the Company has sufficient cash to fund operations into the first quarter of 2007. The Company will seek to obtain an equity investment during 2006 to fund:

 

continuing as a going concern;

 

ongoing research and development of the Smart Energy Matrix;

working capital requirements; and

 

developing new business.

 

 

The Company’s losses and uses of cash may fluctuate significantly from quarter to quarter as sales (if any), costs of development, inventories and receivables fluctuate. These fluctuations in cash requirements could put additional pressure on the Company’s cash position. There can be no assurance that the Company will be able to raise the required capital or that sufficient funds will be available to it on terms that it deems acceptable, if they are available at all.

 

The Company continues to be accounted for as a development stage company under Statement of Financial Accounting Standards No. 7 “Accounting and Reporting by Development Stage Enterprises.”

 

 

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Products and Markets

 

Smart Energy Matrix

 

The Company has identified an application for its Smart Energy Matrix in a well-established market with attractive pricing characteristics. This market is the sale of frequency regulation services for the electrical power grid. In order to maintain a constant frequency alternating current, the power grid must continuously balance the supply of power generated with the varying demand for it. This balance is maintained today by constant, small adjustments in the output of some of the generators operating on the grid. Not all generators can be successfully operated with constantly varying output, but all generators that are able to operate this way incur higher operating costs due to increased fuel consumption and maintenance. Using the Company’s Smart Energy Matrix, frequency regulation can, for the first time, be provided separately with higher performance and lower operating costs. The Smart Energy Matrix is the first product specifically designed to address this application.

 

The requirements of the frequency regulation application are well matched with the characteristics of the Smart Energy Matrix, which is designed to draw excess energy when generated power exceeds demand and deliver it when demand exceeds supply. Unlike generator-based frequency regulation, no fuel is consumed and no emissions are generated. The Smart Energy Matrix’s characteristics should simplify and accelerate the process for utilities to establish new sites and obtain required permits for new facilities. The Smart Energy Matrix can also be located nearly anywhere advantageous to the power grid, even within distribution systems.

 

The Company has been awarded development contracts with CEC and NYSERDA for demonstrating the viability of the Company’s flywheel technologies for frequency regulation. The demonstrations will be conducted using one-tenth-power prototypes of Beacon’s planned megawatt-level system known as the Smart Energy Matrix. Under these contracts, the Company expects to develop and install a system in both California and New York during 2005 to demonstrate the benefits of using flywheel energy storage to provide frequency regulation of the grid; a service required by all grid operators. Successful demonstrations of frequency regulation with CEC and NYSERDA may also demonstrate the system’s technical and market feasibility in other large, important, growing markets related to the North American grid.

 

From an environmental perspective, the Company’s Smart Energy Matrix will reduce fuel consumption by generators because they will be able to operate at greater efficiency. In addition, during peak output requirements, widespread use of the Company’s Smart Energy Matrix to provide frequency regulation would avoid the need to utilize the most inefficient generators. Both of these changes in the way generators are used would reduce carbon dioxide and other emissions.

 

Separate from the frequency regulation of the power grid market identified above, the Company has identified an additional application for its Smart Energy Matrix. That application is providing a high-power, flywheel-based system that continuously regulates the frequency of electricity produced by a distributed generation facility and compensates for temporary differences between the demand for electricity and the amount being produced. A distributed generation facility is any electrical power source other than the power grid, including advanced generators such as fuel cells, natural gas engines, wind turbines, photovoltaic arrays and microturbines which usually supply local power to facilities such as hospitals or manufacturing plants. The Company’s Smart Energy Matrix can be used to regulate the frequency of the distributed generation facility’s power in the same way it regulates the frequency of the power grid as described above. The Smart Energy Matrix, because of its fast response time, can also compensate for the slow response characteristics of generators and thus provide stability to these micro-grid facilities. In distributed generation, demand fluctuations are a much higher percentage of power production than is experienced in the power grid, which adversely affects the distributed generator’s ability to match supply and demand.

 

The Smart Energy Matrix is being designed to store enough energy to deliver one megawatt for 15 minutes and can be ganged to deliver ten or more megawatts. Each Smart Energy Matrix will consist of a container housing multiple flywheels and the necessary power electronics to connect to the grid. The Smart Energy Matrix, because of its container design, will be able to be quickly deployed and could be easily relocated.

 

 

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The Company has finished the preliminary designs for the Smart Energy Matrix and has begun full scale development of the 25 kWh flywheel, the core component of the Smart Energy Matrix. The development cycle for completion of this product is expected to be 18 to 24 months and achieving significant volume production capability will take an additional six to 12 months. Therefore, the Company will not generate significant revenues from this product for approximately two to three years after development has commenced.

 

Smart Power M5

The Smart Power M5 inverter system for the photovoltaic energy market converts direct current generated by solar cells from sunlight into alternating current required by residential and commercial users for operating electrical devices and reducing the amount of purchased power when it is connected to a power grid. Solar cells contain semi-conducting material that converts sunlight into direct current electricity. The Company’s Smart Power M5 inverter system has the capacity to convert direct current electricity into up to 5,000 watts of alternating current.

 

The Company began delivering its Underwriters Laboratory approved Smart Power M5 inverter systems in December 2003. The Smart Power M5 has been designed for use in North American grid-connected solar power applications. If the Company determines that there is sufficient market demand outside of North America, the Company could develop on and off grid inverters for use throughout the world. The Company also could develop inverters for use in low power wind turbine applications if there were ample market interest.

 

The Company has not been successful in selling a significant number of units of its Smart Power M5 and therefore has shifted virtually all of its development and sales activities from the Smart Power M5 to its flywheel based products. The Company does not believe that inverters will be a significant portion of the Company’s business going forward and is uncertain as to when or at what price it will be able to sell its inventories. In 2004, the Company established a reserve for its Smart Power M5 inventory.

 

Smart Energy

 

The Company has offered for sale its Smart Energy flywheel products, which deliver a low level of power for a long period of time (typically measured in hours). These products include the 2kWh and 6kWh Smart Energy systems, which have demonstrated quality performance and reliability at numerous sites. The Smart Energy products are tailored to the telecommunications, cable systems, computer networks, and Internet markets. The Company believes that its Smart Energy products offer life cycle cost advantages and significant performance improvements over conventional, battery-based back-up power sources. At this time, the Company does not have orders for its Smart Energy products or any inventory of finished products and does not have purchase orders in place with vendors for components. In the event that the Company receives significant customer orders for these products, it will need to place orders for components with vendors and hire and train manufacturing personnel to assemble, inspect and assist in the installation of deliverable units.

 

The Company’s Smart Energy systems have approximately 450,000 hours of operation in customer sites without failure of mechanical system, which the Company believes verifies the reliability of its technologies. The Company has successfully maintained power with no degradation of service in planned and unplanned losses of utility power at several telecom and cable sites. Also, the Company’s systems can be adapted to deliver the amount of power and back-up time required to meet specific needs of customers by integrating multiple flywheel systems in parallel. This has been successfully demonstrated at several sites.

 

The Company believes that its Smart Energy technology is an excellent base to begin development of a higher energy 25kWh flywheel system for renewable applications.

 

 

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Approvals and Certifications

 

The Company has obtained Underwriters Laboratory approval for its existing 2kWh and 6kWh Smart Energy products. The Company has also designed and certified its Smart Energy systems in accordance with Telcordia standards, which are the baseline for performance and safety standards established by the telecommunications industry. The Company’s Smart Energy products are the only flywheel products that have passed a Zone 4 earthquake test while operating, making them suitable for use anywhere in the United States. The Company’s Smart Energy flywheel systems have also been successfully tested for concurrence with the Institute of Electrical and Electronics Engineers (IEEE) 587 standard, which is the required standard for all Uninterruptible Power Supply systems.

 

The Company has obtained Underwriters Laboratory approval for its Smart Power M5 inverter system. The California Energy Commission and New York’s Public Service Commission have also approved this product for on-grid applications.

 

The Company’s Technology

 

Flywheel-based products

 

Since the Company’s formation, it has been attempting to develop flywheel energy storage products that offer superior reliability and performance at competitive costs. The Company’s composite flywheel is a rotating wheel on hybrid, magnetic bearings that operates in a near-frictionless vacuum environment. When the rim spins, it stores kinetic energy. The flywheel is powered up to its operational speed using electricity from an external power source. The flywheel is able to spin for extended periods with great efficiency because friction and drag are virtually eliminated by employing magnetic bearings and a vacuum environment. Because it has very low friction, little power is required to maintain the flywheel's operating speed. When electrical power is needed, the spinning flywheel drives a generator and its bi-directional inverter converts the kinetic energy into electrical energy.

 

Steel flywheels have been used since the industrial revolution in applications such as piston engines to store energy during the power stroke for release during the compression stroke. These applications are limited by the revolutions per minute at which steel flywheels are able to operate and by the limited density of storage of energy by volume of steel. The products the Company has designed and offers employ new enabling materials such as high-strength fiber, efficient electric drives, and low-loss, long-life bearings to create new generations of flywheel products. The Company's composite flywheels are fabricated from high-strength, lightweight fiber composites, such as graphite and fiberglass combined with resins, which allow the flywheel to rotate at high speeds and store large amounts of energy relative to similar size and weight flywheels made from metals. For example, a 600-pound steel flywheel running at 8,000 revolutions per minute will store approximately 900 watt-hours of energy and can deliver up to 850 watt-hours of energy. In contrast, The Company's 500-pound 6kWh composite flywheel running at 22,500 RPM stores 7,200 watt-hours of energy and delivers 6,000 watt-hours of energy. On a per-pound basis, The Company's composite flywheel technology delivers nearly 10 times the energy of the best steel flywheels.

 

The Company’s proprietary technology enables the design of maintenance-free flywheel products in that its products employ an internal rather than external vacuum system and its bearing systems have been designed and developed to need no scheduled replacement or maintenance. Competing flywheel products rely on bearings and external vacuum systems that require periodic maintenance and replacement. The Company’s Smart Energy flywheel systems have dramatically longer discharge times than any other flywheel energy storage systems; this is possible because the Company’s technologies result in higher amounts of stored energy and minimal energy losses during operation.

 

 

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Inverter Products

 

The Company began developing its Smart Power M5 inverter system for photovoltaic applications during 2003. This product is based on intellectual property the Company acquired, and has significantly enhanced, in the areas of performance, ease of installation, software integration, and reliability.

 

The Company’s Smart Power M5 inverter system is designed for use in grid-connected solar applications. When AC power is interrupted, the Smart Power M5 inverter system immediately converts to an independent battery back-up mode, continuing to provide electricity to critical loads. This product is the most compact, easy-to-install and efficient product available for solar on-grid applications with back-up capability. The Company has developed designs to expand its product offering to include systems for use in solar off-grid applications as well as high voltage on-grid and off-grid domestic applications. The Company could develop international configurations for those applications if it believes they can be successfully marketed in sufficient volumes to be a viable commercial product. Although it is continuing to support the Smart Power M5, the Company does not believe that inverters will be a significant portion of the Company’s business going forward.

 

Research and Development

 

The Company believes that its research and development efforts are essential to its ability to successfully design and deliver products, as well as to modify and improve its existing products to reflect the evolution of markets and customer needs. The Company has worked closely with potential customers to define product features and performance requirements to address specific needs for both flywheel based solutions and renewable energy applications. Research and development expenses, including engineering expenses, were approximately $3,532,000 in 2004, $3,550,000 in 2003, and $7,130,000 in 2002. The Company expects research and development expenses in 2005 to be somewhat higher than those in 2004 due primarily to the costs of development for the Smart Energy Matrix. If the Company is able to validate market opportunities for its inverter products, it may choose to make significant levels of research and development expenditures in order to pursue those markets. At December 31, 2004, the Company employed 16 engineers and technicians full time and had three independent contractors engaged in research and development. At December 31, 2003, the Company employed 18 engineers and technicians.

 

Manufacturing

 

The Company assembles and tests Smart Power M5 inverters at its facility. The Company has design drawings and process specifications to ensure the quality of components manufactured by its suppliers. The Smart Power M5 inverter system is a combination of off-the-shelf components and components produced to specifications developed by the Company. The Company believes it has adequate vendor sources for all the components for the Smart Power M5 inverter systems. The Company has sufficient inventories to satisfy expected unit sales for the remainder of this year. Although the Company is continuing to support its inverter product, the Company does not believe that inverters will be a significant portion of the Company’s business going forward and is uncertain as to when or at what price it will be able to sell its inventories. In 2004, the Company established a reserve for its inverter inventory as a result of lower than anticipated sales volumes of the Smart Power M5,

 

The Company’s facility was designed for the assembly and test of flywheel systems and this capability continues to be available in the event that its designs gain market acceptance and the Company begins production.

 

The Company’s facility continues to be underutilized as a result of reductions in development work and a lack of customer orders for its flywheel and inverter systems. The Company maintains a limited manufacturing staff, many of whom are skilled in Six-Sigma cost and quality control techniques. If customers begin to order flywheel systems, the Company expects to establish assembly and test capabilities using outside suppliers to provide components to meet product demand. The suppliers of the Company’s mechanical flywheel and the control electronics are both single-source suppliers. The loss or interruption of supply from either of these suppliers would adversely affect the Company’s ability to deliver these products.

 

 

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Sales and Marketing

 

The Company’s sales and marketing efforts for its flywheel-based frequency regulation product have been focused on regional transmission operators and the energy research organizations in California and New York. The initial concept for the Smart Energy Matrix was developed in collaboration with the PJM Interconnect system, which is the nation’s first federally regulated regional transmission operator. PJM has worked closely with the Company to evaluate the performance characteristics of its product. PJM has informed the Company that it believes the Company’s Smart Energy Matrix flywheel system could be added to PJM’s power grid and bid into the frequency regulation market. The Company has more recently worked with the California Independent System Operator (CAISO) to evaluate the potential of the Smart Energy Matrix, and the support from CAISO was an important factor in the contract award from the CEC. The Company is presenting its Smart Energy Matrix product to other regional transmission operators and power utilities to further establish interest.

 

The Company’s sales and marketing efforts in renewable energy are focused on the sale of its Smart Power M5 inverter systems for North American solar power applications. For the renewable energy market the Company is marketing its Smart Power M5 inverter system to distributors in North America who provide products to residential and commercial installers. The Company is attempting to build market interest through advertising, trade press articles, participating in industry conferences, technical presentations to installers, trade shows and homeowner shows.

 

Marketing efforts for the Company’s Smart Energy flywheel products have been limited to providing support for its field trial systems and identifying key prospects and working with those companies to demonstrate the Company’s product advantages, which include, life cycle cost benefits and high reliability. The Company has installed on-site, working demonstration units of both its Smart Energy products at various major telecommunications and cable companies. Although sales efforts for these products have been limited, the Company plans to continue to perform market analysis to identify opportunities for installations that require the unique characteristics of these products and to emphasize their value proposition and greater technical benefits. The Company believes that its products will also be attractive to customers with power sources that are very expensive to replace or maintain due to their location or other factors, or power sources located where there are high or low prevailing temperatures or dramatic changes in temperature. And from an environmental perspective, the Company believes its flywheel products, which contain no hazardous chemicals, are more attractive to customers when compared to lead-acid batteries. During 2004, the Company also placed a 6kWh Smart Energy flywheel in a Navy research facility for evaluation as a potential technology to be used in the Navy’s next generation electric ship program.

 

Backlog

 

At December 31, 2004, the Company did not have any firm sales commitments for its products.

 

Customer Service

 

The Company intends to provide maintenance and support for its products by utilizing its own customer service personnel as well as support as needed from its engineering organization. In the future, the Company may elect to contract all or part of the customer service activities to outside sources as it deems it effective from both a customer satisfaction and Company cost perspective. The Company’s Smart Power M5 inverter system is sold with a five-year warranty.

 

Competition

 

The Company believes its Smart Energy Matrix will offer superior performance and cost benefits over fossil fuel generators. The Company believes that, given the demands of the frequency regulation market, batteries, metal flywheel and other alternative energy technologies, such as fuel cells and ultra capacitors, will not compete with the Smart Energy Matrix. This market is being served by well-known utilities and independent service providers that use conventional generators and that have far greater resources than the Company. These utilities and independent service providers are primarily focused on the sale of energy and provide frequency regulation services as a

 

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secondary source of revenue. Companies that are currently providing frequency regulation include Allegheny Energy Supply Company, Commonwealth Chesapeake Company, Dominion Virginia Power, Ingenco Wholesale Power, NRG Power Marketing and Reliant Energy Services.

 

Substantially all of the high-energy, uninterrupted power supply markets that the Company’s 2kWh and 6kWh Smart Energy flywheel systems compete in are dominated by battery-based products, rather than battery-free technologies. These markets are intensely competitive, with the principal bases for competition being system first cost, brand recognition, quality and reliability.

 

The Company’s 2kWh and 6kWh Smart Energy flywheel systems provide back-up power and compete on the basis of life-cycle cost and value to the customer. Although the Company’s products offer attractive performance to cost benefit when viewed on a life-cycle cost basis, customers are more focused on first cost, which makes it very difficult for the Company to effectively compete with battery based systems. The Company plans to continue to emphasize the value proposition of its products such as increased dependability, environmental benefits, and their long maintenance-free lives.

 

The Company believes that its high-energy flywheel systems provide significant advantages to potential customers due to the numerous problems associated with lead-acid batteries, including:

 

Reliability. Batteries are not only prone to multiple problems leading to battery failure, but when they are repeatedly used at close to their maximum energy capacity their output capability can rapidly decrease, reducing the batteries' effectiveness over time. Also, the amount of energy available in battery systems may not readily be monitored and, therefore, the amount of remaining energy cannot be assured.

 

Life-Cycle Cost. The use of batteries has both direct and indirect costs. In addition to bearing the initial purchase costs of the batteries, a user must allocate significant space to large battery arrays (space that could otherwise be allocated to revenue-generating equipment), must inspect and test them on site every few months (as their power output degrades over time), must cool them with costly air conditioning (if the user wishes to avoid the rapid degradation in performance and life that results with temperature variations), and must replace them every two to six years (depending on type of use, environment and other factors).

 

Life. In applications where discharges consume all or most of the battery’s available reserve, or where the batteries are used in facilities that are not air-conditioned, the life of batteries is significantly reduced.

 

Environmental. Batteries contain toxic materials such as lead and sulfuric acid. They are considered hazardous waste and their disposal entails rigorous environmental regulations. Facilities with spent batteries must make arrangements with hazardous waste handlers for disposal. Both the costs associated with disposal and the complexity of compliance for proper handling, permitting and regulatory requirements continue to increase and may accelerate sharply as pressure increases to curb such hazardous wastes. There are companies working to offer lead free chemical batteries such as nickel metal hydride and lithium ion, as well as alternative technologies such as super capacitors and super conductive magnetic energy storage.

 

Additional alternative energy products that are potentially competitive include ultra capacitors and fuel cells with integrated hydrogen generation and storage. There are other companies selling diesel generators and micro turbines that are competitors in the broadest sense, although the Company believes that in most cases, its flywheel systems will be complementary to that equipment.

 

There are several products that compete with the Smart Power M5 inverter system sold by companies with greater experience in the solar power conversion market. This market is intensely competitive, with the principal

 

8

 

 

bases for competition being system reliability, quality, brand recognition, and price. The Company believes that its product has a competitive advantage due to its reliability, ability to continue to provide power when the grid fails, improved design and efficiency benefits.

 

Intellectual Property

 

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

 

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

 

The intellectual property rights of the Company’s flywheel-based products are based upon a combination of SatCon Technology Corporation's flywheel technologies and patents that the Company is licensed to use, in perpetuity, and patents that the Company holds or which are pending. The Company was issued by SatCon a perpetual, exclusive, royalty-free, worldwide right and license to use SatCon’s flywheel technologies and patents for stationary terrestrial flywheel applications. Those rights include eleven issued U.S. patents and eleven U.S. and foreign patent applications that expire on various dates between 2012 and 2021. This license covers SatCon's technologies and patents and all improvements made by SatCon through November 16, 2000, the date of Beacon’s initial public offering. The Company is not entitled to any improvements to the flywheel technology that SatCon develops subsequent to that date. The Company expects to develop additional intellectual properties and trade secrets as it continues developing additional Smart Energy and Smart Power flywheel systems. The Company owns all technology improvements it has developed that are based on the technology licensed from SatCon. The Company also holds patents on its flywheel vacuum system, heat pipe cooling system, output paralleling algorithm, metal hub, low-loss motor, co-mingled rims and earthquake-tolerant bearings and has 16 pending U.S. and foreign patent applications, and one other application being prepared for filing.

 

The intellectual property rights for the Company’s Smart Power M5 inverter systems are based on the intellectual property assets acquired from Advanced Energy Systems, Inc., that the Company purchased in March 2003. These assets are wholly-owned by the Company and include anti-islanding software, which ensures safe grid utility interconnection and reliable transition to stand-by power when the grid fails, as well as drawings, source code, production know-how, and all associated documentation. The Company has made substantial improvements to these assets including the user interface, thermal performance, general reliability and ease of manufacture.

 

Government Regulation

 

The Company does not believe that it’s Smart Energy Matrix or other flywheel products will be subject to existing federal and state regulatory commissions governing electric utilities and other regulated entities. The Company believes that its products and their installation will be subject to oversight and regulation at the local level in accordance with state and local ordinances relating to building codes, safety, pipeline connections and related matters. The Company intends to encourage the standardization of industry codes to avoid having to comply with differing regulations on a state-by-state or locality-by-locality basis.

 

Employees

 

At December 31, 2004, the Company’s headcount was 24 full-time employees, one part-time employee and four independent contractors, of which approximately 19 were engineers and technicians involved in research and development and three were in sales, marketing and customer service. The remaining seven people were

 

9

 

 

involved in administrative tasks. None of the Company’s employees are represented by a union and the Company considers its relations with employees to be satisfactory.

 

Item 2. Properties

 

The Company’s principal executive offices, laboratory and manufacturing facilities are located at a single location in Wilmington, Massachusetts. This 51,650 square foot facility operates under a lease that expires on September 30, 2007. The Company’s facility was designed for the assembly and test of flywheel systems and this capability continues to be available in the event that its designs gain market acceptance and the Company begins production. Currently, the facility is substantially underutilized.

 

Item 3. Legal Proceedings

 

The Company is not involved in any legal proceedings that are considered material; however, it may from time to time be involved in legal proceedings in the ordinary course of its business.

 

On August 16, 2004, Ricardo and Gladys Farnes, and TLER Associates, Ltd. a Bahamas corporation ("TLER"), delivered a complaint to the Company, naming as defendants, the Company, John Doherty, Richard Lane, and unidentified individuals and corporations.  The case was filed in District Court in Clark County, Nevada on or about June 1, 2004, and later was removed to the United States District Court for the District of Nevada.  The complaint alleged that in 2001, defendants (a) forged the signature of plaintiff Ricardo Farnes (a principal of TLER) to a document purporting to extend the performance period on a purchase order issued by TLER to the Company, and (b) thereafter, posted on the internet defamatory and personal information concerning the plaintiffs.  The plaintiffs did not allege any specific amount of damages, and instead asserted that damages exceed $10,000.  The Company answered the complaint and denied its material allegations.  On July 31, 2005 the Company agreed to make a payment in final settlement of this suit in the amount of $5,000.

 

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

 

The Company held its 2004 annual meeting of shareholders on December 9, 2004. At the meeting, the Company’s stockholders voted on the following two proposals, both of which were approved. The shareholder votes were cast as follows:

 

Proposal 1: To elect the following nominees as directors:

 

Nominee

Votes for

Votes withheld

Stephen P. Adik

31,910,462

110,796

Jack P. Smith

31,880,306

140,952

Kenneth M. Socha

31,508,834

512,424

 

Proposal 2: To ratify the appointment of Miller Wachman, LLP as independent accountants for the Company for the year ending December 31, 2004:

 

Votes for

Votes against

Votes abstain

Votes withheld

31,916,786

60,488

43,984

0

 

 

PART II

 

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

 

 

10

 

 

 

The Company’s Common Stock is quoted on the NASDAQ SmallCap Market under the symbol "BCON". The following table sets forth the high and low sales price of the common stock for the period indicated.

 

 

High

Low

Twelve months ended December 31, 2004

Fourth quarter

$1.44

$0.36

Third quarter

$0.62

$0.25

Second quarter

$0.90

$0.27

First quarter

$1.72

$0.71

 

 

 

Twelve months ended December 31, 2003

Fourth quarter

$1.54

$0.70

Third quarter

$1.34

$0.24

Second quarter

$0.48

$0.16

First quarter

$0.30

$0.16

 

On March 7, 2005 the last reported sale price of the Company’s common stock on the NASDAQ SmallCap Market was $1.17 per share, and there were 314 holders of record of common stock. The number of record holders does not include shares held in “street name” through brokers.

 

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

 

Equity Compensation Plan Information. The following table gives information about equity awards under the Company’s stock option plan and employee stock purchase plan, as of December 31, 2004.

 

Plan category

Number of securities to be issued upon exercise of outstanding options, warrants and rights

Weighted average exercise price of outstanding options, warrants and rights

Number of securities remaining available for future issuance

 

(a)

(b)

(c)

Equity compensation plans approved by security holders

-

$ -

-

Equity compensation plans not approved by security holders

6,217,575

$ 1.06

-

Total

6,217,575

$ 1.06

-

 

For additional information concerning the Company’s equity compensation plans, see discussion in footnotes 8, 9 and 10 to the Company’s consolidated financial statements, Stock Options, Employee Stock Purchase Plan and Restricted Stock Units.

 

Recent Sales of Unregistered Securities

 

During 2004, the Company issued no unregistered securities.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

During the fourth quarter of 2004, there were no purchases made by or on behalf of the Company or any affiliated purchaser of shares of the Company's common stock.

 

11

 

 

 

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/A.

 

The following tables present selected historical financial data for the years ended December 31, 2004, 2003, 2002, 2001 and 2000, and for the period from May 8, 1997, the date of the Company’s inception, through December 31, 2004.

 

 

 

 

 

 

 

 

Period from Date

 

 

 

 

 

 

 

of Inception

 

 

Year ended December 31,

(May 8, 1997) to

 

 

2004

2003

2002

2001

2000

December 31, 2004

 

 

(in thousands, except per share data)

Consolidated Statements of Operations Data:

 

 

 

 

 

 

Revenues

$ 325

$ -

$ -

$ -

$ 50

$ 876

Cost of goods sold

1,458

-

-

-

-

1,458

Gross margin

(1,133)

-

-

-

50

(582)

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

Selling, general and administrative

4,196

4,936

5,637

8,940

4,631

32,255

 

Research and development

3,532

3,550

7,130

17,628

12,715

53,876

 

Loss on sales commitments

-

-

-

-

51

376

 

Depreciation and amortization

187

285

1,644

1,324

401

4,138

 

Restructuring charges

-

-

2,159

-

-

2,159

 

Loss on impairment of assets

-

367

4,297

-

-

4,664

 

 

 

 

 

 

 

 

Total operating expenses

7,915

9,138

20,867

27,892

17,798

97,468

 

 

 

 

 

 

 

 

Loss from operations

(9,048)

(9,138)

(20,867)

(27,892)

(17,748)

(98,050)

Interest and other income (expense), net

3,719

520

28

1,746

330

6,124

 

 

 

 

 

 

 

 

Net loss

(5,329)

(8,618)

(20,839)

(26,146)

(17,418)

(91,926)

 

 

 

 

 

 

 

 

Preferred stock dividends

-

-

-

-

(35,797)

(36,826)

Accretion of redeemable convertible preferred stock

-

-

-

-

(64)

(113)

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

Loss to common shareholders

(5,329)

(8,618)

(20,839)

(26,146)

(53,279)

(128,865)

Net loss per share, basic and diluted

($0.12)

($0.20)

($0.49)

($0.61)

($10.77)

 

Shares used in computing net loss per share, basic and diluted

43,453

42,886

42,797

42,551

4,946

 

 

 

 

 

 

As of December 31,

 

 

2004

2003

2002

2001

2000

 

 

(in thousands)

Balance Sheet Data:

 

 

 

 

 

Cash and cash equivalents

$5,097

$8,909

$17,867

$34,201

$62,051

Working capital

4,213

8,838

16,865

32,383

58,778

Total assets

7,086

12,067

20,906

42,131

67,738

Total stockholders' equity

$5,110

$9,692

$18,075

$38,981

$63,308

 

 

13

 

 

 

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

 

The following discussion of the Company’s financial condition and results of operations should be read in conjunction with its 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 "Certain Factors Which May Affect Future Results " section and contained elsewhere in this Form 10-K/A.

 

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 the Company's estimates and assumptions including but not limited to those related to revenue recognition, asset impairments, inventory valuation, warranty reserves and other assets and liabilities. Management bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Revenue Recognition. Although the Company has shipped products, and recorded contract revenues, its operations have not yet reached a level that would qualify it to emerge from the development stage. Therefore it continues to be accounted for as a development stage company under Statement of Financial Accounting Standards No. 7 “Accounting and Reporting by Development Stage Enterprises.”

 

The Company recognizes 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, the Company makes an adjustment to defer revenue until they are subsequently sold by distributors to their customers.

 

Government Contract Revenue Recognized on the Percentage-of-Completion Method. The Company recognizes contract revenues using the percentage-of-completion method, based primarily on contract costs incurred to date compared with total estimated contract costs. 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 “Prepaid expenses and other current assets” in the Company’s 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.

 

Inventory Valuation. The Company values its inventory at the lower of actual cost or the current estimated market value. It regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on historical usage for the prior twelve month period and future sales forecasts. Although the Company makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of its inventory and its reported operating results.

 

Patent Costs. The Company will capitalize external legal costs incurred in the defense of its patents where it believes that the future economic benefit of the patent will be increased. The Company monitors 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.

 

 

14

 

 

 

Warranty Reserves. The Company's warranties require it to repair or replace defective products returned to it during the applicable warranty period at no cost to the customer. It records an estimate for warranty-related costs based on actual historical return rates, anticipated return rates, and repair costs at the time of sale. A significant increase in product return rates, or a significant increase in the costs to repair products, could have a material adverse impact on future operating results for the period or periods in which such returns or additional costs materialize and thereafter.

 

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 carryforwards 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 the Company's estimates of taxable income and the period over which its deferred tax assets will be recoverable. In the event that actual results differ from these estimates or the Company adjusts these estimates in future periods it may need to establish an additional valuation allowance or reduce its current valuation allowance which could materially impact its tax provision.

 

Long-Lived Assets. In accordance with Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”, long-lived assets to be held and used by the Company 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, or whether external market circumstances indicate that the carrying amount may not be recoverable. When appropriate the Company recognizes a loss for the difference between the estimated fair value of the asset and the carrying amount. The fair value of the asset is measured using either available market prices or estimated discounted cash flows. The Company's analyses indicate that there was an impairment of long-lived assets and recognized an asset impairment charge of $0 in 2004, $366,788 in 2003 and restructuring and asset impairment charges of $2,159,280 and $4,297,128, respectively, in 2002.

 

Overview

 

The Company’s initial product strategy was to develop high energy, composite flywheels for back-up powering of telecommunications applications. With the collapse of the telecommunications market, which began in 2001, the Company recognized that its Smart Energy flywheel products as alternative backup solutions to the telecommunications industry were not on a path to produce meaningful revenues. With that recognition, the Company initiated a series of cost cutting measures throughout 2002 and 2003. The focus of these efforts was to reduce cash usage while preserving the Company’s intellectual properties and maintaining the integrity of its public company requirements while evaluating all potential product markets for the Company’s technologies and considering acquisitions or mergers that could lead to increased shareholder value. The Company has:

 

(i)

identified promising applications for its Smart Energy Matrix design in the electric utility power grid marketplace. In the first quarter of 2005 the Company was awarded development contracts by CEC and NYSERDA to demonstrate the viability of the Company’s flywheel technologies for frequency regulation by grid operators. The demonstrations will be a one-tenth-power prototype of the Smart Energy Matrix;

(ii)

pursued additional development and design contracts for a variety of applications by federal agencies. The Company has been successful in obtaining two small contracts and is continuing its efforts to obtain additional research and development funding; and

(iii)

introduced its Smart Power M5 inverter system into the renewable energy market in December of 2003. The Company has not been able to gain market share with this product and has discontinued development of further inverter products but is continuing to offer the product for sale through its distributor network. Although it is continuing to support the product, the

 

15

 

 

Company does not believe that inverters will be a significant portion of the Company’s business going forward.

 

The Company must raise additional equity to complete the development of its Smart Energy Matrix and therefore execute its business plan. Based on the Company’s rate of expenditure of cash and the additional expenditures expected in support of its business plan the Company has sufficient cash to fund operations into the first quarter of 2007. The Company will seek to obtain an equity investment during 2006 to fund:

 

continuing as a going concern;

 

ongoing research and development of the Smart Energy Matrix;

working capital requirements; and

 

developing new business.

 

 

 

As part of the Company’s new business development, it is actively evaluating possible acquisitions of enterprises or technologies that it would consider synergistic from a market, technology or product perspective. Efforts to identify opportunities and perform due diligence including legal and audit fees will continue to be a use of cash in 2005 and beyond.

 

From inception through December 31, 2004, the Company has incurred losses of approximately $128.9 million. The Company expects to continue to incur losses as it expands its product development, commercialization program, and expansion of its manufacturing capabilities.

 

The Company recognized an asset impairment charge in 2003 and restructuring and asset impairment charges in 2002. The Company, as required by Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” periodically evaluates all of its property and equipment in light of facts and circumstances and the outlook for future cash flows. As a result of its ongoing evaluations, in 2003 the Company took a non-cash charge of approximately $0.4 million representing the impairment of capitalized costs of internally developed intellectual property including various patents and patents pending relating to the Company’s flywheel technology. In 2002 the Company took a non-cash charge of $6.5 million of which $4.3 million represented impaired capital equipment and leasehold improvements, $1.9 million related to a reserve against future lease payments and related facility costs and $0.3 million relating to severance costs. These charges related to a substantial portion of the Company’s long-term assets being idled, including machinery and equipment, tooling, office furniture and fixtures and leasehold improvements. The portion of the reserve that relates to future lease payments is classified as “Restructuring reserve” in the current liabilities section of the balance sheet.

 

Revenues. Although the Company has shipped commercial products and has performed development and proof of concept work on several government contracts, its operations have not yet reached a level that would qualify it to emerge from the development stage. Therefore it continues to be accounted for as a development stage company under Statement of Financial Accounting Standards No. 7 “Accounting and Reporting by Development Stage Enterprises.” The Company sells its Smart Power M5 inverter system in the solar renewable energy market through domestic distributors who in turn sell the Company’s products to installers who then make sales to residential homeowners or commercial customers. The Company will recognize revenues on its inverter products based on the sales by its distributors to their customers. The Company has received fixed price demonstration contracts from government agencies and is pursuing similar contracts from other government agencies. The Company has determined that it will recognize revenues on the percentage of completion basis for such contracts. The Company is continuing to evaluate markets for its flywheel systems but has not recognized revenues from these products. The Company has placed development prototype flywheels with potential customers and shipped pre-production units. These flywheel products were provided to potential customers without charge or on a demonstration basis to allow the Company access to field test information and to demonstrate the application of the technologies.

 

Cost of Goods Sold. The Company’s cost of good sold for inverters consists primarily of the cost of manufacture of its Smart Power M5 inverter system, inventory and warranty reserves and period costs relating to production

 

16

 

 

over-capacity. Cost of goods sold on fixed price flywheel development contracts are being recorded on the percentage of completion basis and consist of direct labor and material, subcontracting and associated overhead costs.

 

In 2004, the Company established a reserve for its Smart Power M5 inventory as a result of lower than anticipated sales volumes of the Smart Power M5. Although the Company is continuing to support its inverter product, the Company does not believe that inverters will be a significant portion of the Company’s business going forward and is uncertain as to when or at what price it will be able to sell its inventories. The charge to Cost of Goods Sold was approximately $1,025,000, which includes accrued purchase commitments of approximately $45,000.

 

Selling, General and Administrative Expenses. The Company’s sales and marketing expenses consist primarily of compensation and benefits for sales and marketing personnel and related business development expenses. During 2003, the Company increased its sales and marketing efforts for its flywheel based products, to introduce its concepts for frequency regulation applications. In 2004 the Company expanded its sales and marketing effort into the renewable energy market for its Smart Power M5 inverter product. The Company continues to rely on engineering personnel to provide technical specifications and product overviews to its potential customer base. The Company expects sales and marketing expenses to continue to increase as it expands efforts to define new markets for its products. General and administrative expenses consist primarily of compensation and benefits related to the Company’s corporate staff, professional fees, insurance and travel. The Company expects its selling, general and administrative expenses to increase in 2005 over 2004 due primarily to the implementation and reporting expenses associated with compliance with the Sarbanes-Oxley Act of 2002, fundraising activities, and marketing and sales expenses associated with flywheel products.

 

Research and Development. The Company’s cost of research and development consists primarily of the cost of compensation and benefits for research and development, and support staff, as well as materials and supplies used in the engineering design and development process. These costs are expected to increase in 2005 as compared to 2004. Although the Company does not expect to incur significant additional costs for its existing flywheel products or renewable energy products, the Company does expect to incur higher costs for design and development activities of the Smart Energy Matrix. The costs of development of the Smart Energy Matrix will be significant if the Company initiates full scale development.

 

Loss on Sales Commitments. The Company will establish reserves for anticipated losses on sales commitments if, based on cost estimates to complete the commitment, it is determined that a loss will be incurred. The Company did not accrue such losses during 2004 or 2003. In the second half of 2001 the Company reversed projected losses contemplated and recognized during 2000 and early 2001. The Company is most likely to recognize probable losses on sales commitments early in a product’s introduction prior to being able to realize expected decreases in cost per unit through engineering design changes, operating efficiencies, and volume purchasing discounts. On government contracts, the Company will, on a quarterly basis, evaluate its estimated costs to complete and establish reserves when appropriate.

 

Restructuring and asset impairment charges. The Company did not recognize any asset impairment charges in 2004, but did record asset impairment charges during 2003. The Company’s initial products were focused on the telecom industry. As a result of the overall economic downturn and in particular the significant decline in capital and maintenance spending in telecom as well as the low price of lead-acid batteries, the Company has not been successful in selling products into this market and therefore recorded non-cash asset impairment charges of $0.4 million in 2003, pursuant to Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

Depreciation and Amortization. The Company’s depreciation and amortization is primarily related to depreciation on capital expenditures and the amortization of lease and leasehold costs related to its facilities. The Company has intellectual property in the form of patents on its flywheel vacuum system, its heat pipe cooling systems, DC output paralleling, metal hub, low-loss motor, co-mingled rims and earthquake-tolerant bearings on its flywheel products, and anti-islanding software, drawings, source code, and production know-how on its Smart Power M5 inverter system, and expects to obtain other patents during 2005 and beyond. These costs were being

 

17

 

 

amortized during 2003 and 2004, but the Company recorded impairment charges to write down these assets to zero on the balance sheet at December 31, 2004. These impairment charges were made due to the uncertainty of realizing any future value from this property mainly due the lack of substantial revenues.

 

Interest and Other Income/Expense, net. The Company’s non-operating income and expenses are primarily attributable to realized gains on the sale of its available-for-sale securities and a warrant, the write-back resulting from loan payments of a reserved loan to a former officer of the Company, interest income resulting from cash on hand, accrued dividends receivable and the 7% conversion premium from the conversion of the Company’s holdings of Series A Preferred Stock of Evergreen Solar, Inc., partially offset by interest expense associated with its capital leases.

 

Recent Accounting Pronouncements

 

Share-Based Payments

 

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (FAS 123R) that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions using the intrinsic value method as prescribed by Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in the statement of operations. The statement requires companies to assess the most appropriate model to calculate the value of the options. The Company currently uses the Black-Scholes option pricing model to value options and is currently assessing whether an alternative model will be more appropriate. The use of a different model to value options may result in a different fair value than the Black-Scholes option pricing model. In addition, there are a number of other requirements under the new standard that will result in differing accounting treatment than currently required. These differences include, but are not limited to, the accounting for the tax benefit on employee stock options and for stock issued under the Company’s employee stock purchase plan. In addition to the appropriate fair value model to be used for valuing share-based payments, companies will also be required to determine the transition method to be used at date of adoption. The allowed transition methods include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of FAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The effective date of the new standard is as of the beginning of the first interim or annual reporting period that begins after June 15, 2005.

 

Upon adoption, this statement may have a significant impact on the Company’s consolidated financial statements as it will be required to expense the fair value of its stock option grants and stock purchases under its employee stock purchase plan rather than disclose the impact on the Company’s consolidated net income within the footnotes as is the current practice (see Note 8 of the notes of the consolidated financial statements contained herein). The amounts disclosed within the Company’s footnotes are not necessarily indicative of the amounts that will be expensed upon the adoption of FAS 123R due to possible changes in the fair value of the Company’s common stock, changes in the number of options granted or the terms of such options, the treatment of tax benefits and changes in interest rates or the Company may choose to use a different valuation model to value the compensation expense associated with employee stock options.

 

Inventory Costs

 

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter 4,” which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). Adoption of SFAS No. 151 is required in 2006 and the Company does not expect the adoption to have a significant impact on its results of operations or financial condition.

 

18

 

 

 

Results of operations.

 

Comparison of Year ended December 31, 2004 and 2003

 

Year ended December 31,

 

2004

2003

$ Change

% Change

 

(in thousands)

Revenues

$ 325

$ -

$ 325

n/a

Cost of goods sold

1,458

-

1,458

n/a

Gross margin

(1,133)

-

(1,133)

n/a

Selling, general and administrative

4,196

4,937

(741)

15%

Research and development

3,532

3,550

(18)

1%

Depreciation and amortization

187

285

(98)

34%

Restructuring and impairment of assets

-

367

(367)

100%

Interest and other income (expense), net

3,719

520

3,199

615%

Net loss

5,330

8,618

(3,288)

38%

 

Revenue. In 2004 the Company recorded revenue from the sale of its Smart Power M5 inverter systems and related products in the amount of approximately $204,000. Revenue from flywheel related government contracts was approximately $121,000. Also in 2004, the Company provided $42,000 of engineering consulting services to third parties; these services were recorded as a reduction to research and development expense. In 2003, the Company reported no revenue. Proceeds from the sale of demonstration and test of 2kWh and 6kWh Smart Energy flywheel units as well as engineering services performed for other companies during 2003 was applied as a reduction against research and development expense. These amounts were approximately $130,000.

 

Cost of Goods Sold. Cost of goods sold includes the cost of materials, labor and overheads for inverter products sold in the amount of approximately $235,000 and costs incurred in performance of government contracts calculated on the percentage of completion method in the amount of approximately $170,000. The Company established a reserve for its Smart Power M5 inventory of $1,025,000 as a result of lower than anticipated sales volumes of the Smart Power M5 and uncertainty as to when or at what price it will be able to sell its inventories. In addition to this charge to Cost of Goods Sold, the Company recorded an additional reserve for future warranty expenditures relating to the Smart Power M5 inverter of approximately $28,000. There was no cost of goods sold during 2003.

 

Selling, General and Administrative Expenses.

 

Selling, general and administrative expenses.

 

 

(in thousands)

December 31, 2003

 

$ 4,937

Reductions:

 

 

Directors & officers insurance premium

 

(972)

Consultants

 

(109)

Reverse accruals

 

(216)

 

 

 

Increases:

 

 

Bonus expenses based on RSU plan

 

364

Merit increases, headcount increase

 

50

Benefits including health

 

37

Legal & audit

 

105

December 31, 2004

 

$ 4,196

 

 

19

 

 

 

The decrease from 2003 to 2004 of approximately $741,000 was primarily the result of significantly reduced premiums for directors and officers insurance in the amount of approximately $972,000, a reduction in accrued expenses for contingencies that did not materialize of approximately $216,000, and lower spending on subcontractors and consultants in the amount of approximately $109,000 in 2004 compared to the prior year. These reductions were partially offset by increases in stock compensation expense due to the Company’s restricted stock unit program of approximately $364,000, higher legal and audit fees of approximately $105,000, increases in payroll costs as a result of 2004 merit increases and changes in headcount of approximately $50,000 and benefits cost increases of approximately $37,000. The Company expects its selling, general and administrative expenses to increase in 2005 over 2004 due primarily to the implementation and reporting expenses associated with compliance with the Sarbanes-Oxley Act of 2002, fundraising activities, and marketing and sales expenses associated with flywheel products.

 

Research and Development Expenses.

 

Research and development expenses:

 

(in thousands)

December 31, 2003

 

$ 3,550

Reductions:

 

 

Salaries and benefits due to reduction in force

(295)

R&D materials

 

(205)

Other reductions

 

(10)

 

 

 

Increases:

 

 

Stock compensation based on RSU plan

 

356

Patent legal expenses

 

89

Subcontractors

 

47

December 31, 2004

 

$ 3,532

 

The decrease from 2003 to 2004 of approximately $18,000 is primarily due to reduction in headcount during 2003 and lower purchases of research and development materials in 2004 and other reductions in 2004 of approximately $295,000, $205,000 and $10,000, respectively. This was partially offset by increases in stock compensation expenses due to the Company’s restricted stock unit program, increased legal expenses relating to patents on the Company’s flywheel systems, and increased use of subcontractors while developing the next-generation Smart Power M5 inverter of approximately $356,000, $89,000 and $47,000, respectively. The Company expects cost of research and development in 2005 to be somewhat higher than 2004 due to design and development activities of the Smart Energy Matrix. The costs of research and development in 2005 will be significantly higher if the Company begins full scale development of the Smart Energy Matrix.

 

Depreciation and Amortization. The decrease from 2003 to 2004 of approximately $98,000 is primarily attributable to the write-off of the Company’s patent technologies at December 31, 2003, and continuing reductions in the depreciable base of the Company’s assets caused by budgetary restrictions on capital expenditures during 2004. Depreciation in 2005 will be higher than 2004 if the Company begins full scale development of the Smart Energy Matrix.

 

Restructuring and asset impairment charges. The Company recognized an asset impairment charge for its flywheel patents and patents pending in 2003 of approximately $367,000. The Company did not recognize any restructuring or asset impairment charges during 2004 and does not expect to recognize any like charges in 2005.

 

 

20

 

 

 

Interest and Other Income/ (Expense), net.

 

Interest and Other Income (Expense), net

 

December 31, 2003

 

$ 520

Reductions:

 

 

Officer loan repayments

 

(291)

Interest from cash holdings

 

(115)

Loss on disposal of assets

 

(25)

 

 

 

Increases:

 

 

Gain on sale of investment

 

3,563

Conversion of Evergreen to common

 

60

Interest expense

 

7

December 31, 2004

 

$ 3,719

 

The increase from 2003 to 2004 of approximately $3,199,000 is primarily attributable to gains from the sale of an investment in Evergreen Solar, Inc. of approximately $3,563,000, premium received on conversion of Evergreen Series A Preferred Stock to common of approximately $60,000 and lower interest expense associated with capital leases that expired during the second half of 2003 of approximately $7,000, partially offset by lower officer loan repayments in 2004 of approximately $291,000, a decrease in interest income earned due to lower cash balances in the amount of approximately $115,000 and a loss on the disposal of capital assets of approximately $25,000.

 

Net Loss. As a result of the changes discussed above, the net loss for 2004 was approximately $5,330,000 which compares to a net loss in 2003 of approximately $8,618,000, a decrease of $3,288,000 or 38%.

 

Comparison of Year ended December 31, 2003 and 2002

 

Year ended December 31,

 

2003

2002

$ Change

% Change

 

(in thousands)

Revenues

$ -

$ -

$ -

n/a

Selling, general and administrative

4,937

5,637

(700)

12%

Research and development

3,550

7,130

(3,580)

50%

Depreciation and amortization

285

1,644

(1,359)

83%

Restructuring and impairment of assets

367

6,456

(6,089)

94%

Interest and other income (expense), net

520

28

492

1757%

Net loss

8,618

20,839

(12,221)

59%

 

Revenue. Proceeds from the sale of demonstration and test of 2kWh and 6kWh Smart Energy flywheel units as well as engineering services performed for other companies has been applied as a reduction against research and development expense and has not been recorded as revenue. These amounts were approximately $130,000 and $79,000 for 2003 and 2002, respectively. The Company did record deferred revenue for the first time during the fourth quarter of 2003 for shipments to distributors of its Smart Power M5 inverter systems.

 

Selling, General and Administrative Expenses. The decrease from 2002 to 2003 of approximately $700,000 was primarily the result of lower consulting expenditures in 2003 than the prior year.

 

Research and Development Expenses. The decrease from 2002 to 2003 of approximately $3,580,000 is primarily due to decreased compensation and benefit costs related to significant reductions in the number of engineering and manufacturing personnel as well as lower expenditures on development materials.

 

 

21

 

 

 

Depreciation and Amortization. The decrease from 2002 to 2003 of approximately $1,359,000 is primarily attributable to the reduction in the depreciable base of the Company’s assets that resulted from the restructuring and asset impairment charges recorded in 2002.

 

Restructuring and Asset Impairment Charges. The Company recognized an asset impairment charge for its flywheel patents and patents pending in 2003 of approximately $367,000. In 2002, the Company recognized both restructuring and asset impairment charges of approximately $2,200,000 and $4,300,000, respectively.

 

Interest and Other Income/ (Expense), net. The increase from 2002 to 2003 of approximately $492,000 is primarily attributable to the reversal of a reserve for loans to officers taken in the prior year as a result of payments on those loans being received, a decrease in interest income earned due to lower cash balances, accrued dividends on the Company’s investment in the Series A Preferred Stock of Evergreen Solar, Inc., and lower interest expense associated with smaller capital leases, which expired during the second half of 2003.

 

Net Loss. As a result of the changes discussed above, the net loss for 2004 was approximately $8,618,000 compared to $20,839,000 for 2003, a decrease of $12,221,000 or 59%.

 

Liquidity and Capital Resources

 

 

 

 

Year ended December 31,

 

 

 

2004

 

2003

 

2002

 

 

 

(in thousands)

Cash and cash equivalents

 

$ 5,097

 

$ 8,909

 

$ 17,867

Working capital

 

4,213

 

8,838

 

16,865

Cash provided by (used in)

 

 

 

 

 

 

 

Operating activities

 

(8,165)

 

(7,701)

 

(15,541)

 

Investing activities

 

4,650

 

(1,291)

 

(466)

 

Financing activities

 

(297)

 

35

 

(327)

Net decrease in cash and cash equivalents

 

$ (3,812)

 

$ (8,957)

 

$ (16,334)

Current ratio

 

3.1

 

4.7

 

7.0

 

The Company’s cash requirements depend on many factors, including but not limited to, research and development activities, continued efforts to commercialize its products, facilities costs as well as general and administrative expenses. The Company expects to make significant expenditures to fund its operations, complete the development of its Smart Energy Matrix, develop technologies and explore opportunities to find and develop additional markets to sell its products. The Company has taken significant actions to reduce its cash expenditures for product development, infrastructure and production readiness by significantly reducing headcount, development spending and capital expenditures over the last two years. The Company has focused its activity on market analysis in terms of size of markets, competitive aspects and advantages that its products could provide. The Company has continued to do preliminary design of potential products for markets under consideration for its flywheel systems and has purchased intellectual properties and incurred development costs for its products in the renewable energy market.

 

Net cash used in operating activities was approximately ($8,165,000) and ($7,701,000) for the twelve months ended December 31, 2004 and 2003, respectively. The primary component to the negative cash flow from operations is from net losses. For 2004, the Company had a net loss of approximately ($5,330,000). This included facility related cash payments charged against restructuring reserves of approximately ($343,000), gain on the sale of investments of approximately ($3,563,000), reductions to the asset impairment reserve for disposed fixed assets of approximately ($10,000), a reversal of a portion of the reserved note to its former CEO of approximately ($22,000) net of accrued interest reserved of $4,000, offset by employee stock compensation of approximately $701,000, compensation expense from stock options issued for consulting services of approximately $16,000, loss on the sale or disposal of fixed assets of approximately $25,000, a reduction in restricted cash related to (i) the lease of the Company’s facility $45,000 and (ii) the expiration of a vendor

 

22

 

 

contract of approximately $50,000, and depreciation and amortization of approximately $187,000. Changes in operating assets and liabilities generated approximately $75,000 of cash during 2004. For 2003, the Company had a net loss of approximately ($8,618,000). This included a reversal of a portion of the reserved note to its former CEO of approximately ($323,000) net of interest reserved of approximately $15,000, facility related cash payments charged against restructuring reserves of approximately ($344,000), an increase in restricted cash from a vendor agreement of ($50,000), a reserve against the Company’s patent assets of approximately $367,000 and depreciation and amortization of approximately $285,000. Changes in operating assets and liabilities generated approximately $967,000 of cash during 2003.

 

Net cash generated/(used) in investing activities was approximately $4,650,000 and $(1,291,000) for 2004 and 2003, respectively. The principal source of cash during 2004 was proceeds from the sale of the Company’s investment in Evergreen Solar, Inc. of approximately $4,753,000 and the sale of capital equipment of approximately $18,000, partially offset by the receipt of dividends from the Evergreen investment, paid in stock, of approximately $(90,000) and the purchase of capital equipment of approximately ($31,000). The principal uses of cash during 2003 were primarily related to an investment in Evergreen of ($1,100,000), increases in other assets totaling approximately ($236,000), purchase of capital equipment of approximately ($8,000) and the principal sources of cash were from the sale of certain impaired machinery and equipment of the Company in the amount of approximately $53,000.

 

Net cash generated/(used) by financing activities was approximately ($297,000) and $35,000 for 2004 and 2003, respectively. For 2004, the cash used by financing activities included prepaid financing costs related to the Company’s financing activities of approximately $(328,000), offset by cash generated of approximately $27,000 related to the exercise of stock options and approximately $4,000 for shares issued under the employee stock purchase plan. For 2003, the cash used in financing activities related to repayment of capital leases of approximately ($200,000), offset by cash proceeds from the exercise of employee stock options of approximately $234,000 and the issuance of stock under the employee stock purchase plan of approximately $1,000.

 

The Company must raise additional equity to complete the development of its Smart Energy Matrix and therefore execute its business plan. Based on the Company’s rate of expenditure of cash and the additional expenditures expected in support of its business plan, the Company has sufficient cash to fund operations into the first quarter of 2007. The Company will seek to obtain further equity investment during 2006 to fund:

 

continuing as a going concern;

 

ongoing research and development of the Smart Energy Matrix;

working capital requirements; and

 

developing new business

 

 

As part of the Company’s new business development, it is actively evaluating possible acquisitions of enterprises or technologies that it would consider synergistic from a market, technology or product perspective. Efforts to identify opportunities and perform due diligence including legal and audit fees on acquisition possibilities will continue to be a use of cash in 2005 and beyond.

 

Inasmuch as the Company is not expecting to become cash flow positive until at least 2009, its ability to continue as a going concern will depend on its ability to raise additional capital. The Company may not be able to raise this capital at all, or if it is able to do so, it may be on terms that are adverse to shareholders. The Company believes that it cannot use debt financing to meet its cash requirements.

 

 

 

Cash Payments Due During the Year Ended December 31,

 

 

Description of Commitment

 

2005

 

2006

 

2007

 

Thereafter

 

Total

Operating leases

 

500,359

 

529,413

 

397,059

 

-

 

1,426,831

Purchase obligations

 

252,275

 

-

 

-

 

-

 

252,275

Total Commitments

 

752,634

 

529,413

 

397,059

 

-

 

1,679,106

 

 

23

 

 

 

The amounts listed for operating leases represent payments for the occupancy of the Company’s principal executive offices, laboratory and manufacturing facilities located in Wilmington, Massachusetts. The Company’s commitment on this lease is secured by an irrevocable letter of credit in the amount of $310,011. A cash deposit secures this letter of credit. The Company also has non-cancelable purchase obligations that include firm orders with vendors for materials relating to its inverter products.

 

Investments

 

The Company may make investments in companies for strategic business reasons. Because the Company’s primary motivation in making these investments may not be to realize a profit on the investment itself, but rather to expand its business prospects, these investments may lack any financial return to the Company, may result in a loss of principal and may lack liquidity.

 

On March 24, 2003, the Company purchased, for approximately $146,000, the inverter electronics technologies of Advanced Energy Systems, Inc. to strengthen its entry into the renewable energy market.

 

On May 15, 2003, the Company invested $1,000,000 in Series A Preferred Stock of Evergreen Solar, Inc., a public company that specializes in renewable energy sources, in order to develop a strategic relationship with that company. The Company’s investment was part of a larger financing provided by several investors. The Company made its investment on the same terms as the other investors in this financing, except that the Company was permitted to purchase a three-year warrant for $100,000 exercisable for 2,400,000 shares of Evergreen’s common stock. Evergreen’s financing was a private placement of $29,475,000 of Series A Preferred Stock and the above warrant. Perseus 2000, L.L.C., an affiliate of one of the Company’s stockholders, Perseus Capital, L.L.C., invested $3 million in Evergreen’s Series A Preferred Stock in this financing. Mr. Philip J. Deutch and Mr. Kenneth M. Socha, members of the Board of Directors of the Company, are Managing Director and Senior Managing Director, respectively, of Perseus, L.L.C., and Mr. Deutch led the Evergreen Solar Series A Preferred financing and is one of four individuals from the Evergreen investor group to be added to the Board of Directors of Evergreen. During 2004, the Company sold its Evergreen Solar, Inc. investment for approximately $4,753,000. Messrs. Deutch and Socha disclosed their possible conflict relating to these transactions and abstained from voting on the purchase or sale of Evergreen’s securities. In addition, Mr. Deutch has not taken part in any discussions concerning the purchase or sale of the Evergreen investment. Beacon’s participation in the transaction was evaluated, debated and approved by all the disinterested directors of the Company, after full disclosure of relevant facts and circumstances.

 

Investments such as those made in Evergreen and the acquisition of the intellectual properties of Advanced Energy Systems may accelerate the Company’s need to raise capital. The Company may not be able to raise this capital at all, or if it is able to do so, it may be on terms that are extremely dilutive to shareholders.

 

Inflation

 

The Company’s operations have not been materially affected by inflation.

 

Certain Factors Which May Affect Future Results

 

The Company has a history of losses and anticipates future losses.

 

As shown in the consolidated financial statements, the Company incurred significant losses from operations of $5,330,000, $8,618,000, and $20,839,000 and cash decreases of $3,812,000, $8,957,000, and $16,379,000, during the years ended December 31, 2004, 2003, and 2002, respectively. The Company has incurred net losses in each year since its inception in 1997. The Company is unsure if or when it will become profitable. The size of its net losses will depend, in part, on the growth rate of its revenues and the level of its expenses.

 

The Company expects future revenues to come from services related to its Smart Energy Matrix, for which it has no revenues to date. The timing of future revenues, if any, is uncertain.

 

24

 

 

 

The Company expects that it will be several years, if ever, before it will recognize significant revenues from the products it intends to offer and the services it intends to provide. A large portion of its expenses are fixed, including expenses related to facilities, equipment and personnel. In addition, the Company expects to spend significant amounts to fund product development based on its core technologies. The Company also expects to incur substantial expenses to manufacture its Smart Energy Matrix product in the future. As a result, operating expenses may increase significantly over the next several years and, consequently, it may need to generate significant additional revenue to achieve profitability. Even if the Company does achieve profitability, it may not be able to sustain or increase profitability on a consistent basis.

 

The Company will have limited revenues in the near term. Unless it raises additional capital to operate its business, it may not be able to continue as a going concern, as its cash balances are sufficient to fund operations into the first quarter of 2007.

 

The Company intends to focus on further development of the Smart Energy Matrix to provide frequency regulation services and this product will not be available for revenues in the near-term. For the foreseeable future, the Company will have limited revenues, if any, since the Company has not generated any revenue from the Smart Energy Matrix. The Company has incurred significant losses from operations since its inception. The Company had approximately $5,097,000 of cash and cash equivalents on hand at December 31, 2004. During 2005 the Company obtained approximately $17 million through new investments. The Company believes it has sufficient cash to meet its working capital and capital expenditure needs into the first quarter of 2007.

 

Thereafter, the Company will require substantial funds to conduct research and development activities, market its products and services, and increase its sales. The Company anticipates that such funds will be obtained from external sources and intends to seek additional equity or debt to fund future operations. However, the Company’s actual capital requirements will depend on many factors. If the Company experiences unanticipated cash requirements, it may need to seek additional sources of funding, which may not be available on favorable terms, if at all. Such additional funding may only be available on terms that may, for example, cause dilution to common stockholders, and/or have liquidation preferences and/or pre-emptive rights. If the Company does not succeed in raising additional funds on acceptable terms, it may be unable to complete planned development for its products and services. In addition, the Company could be forced to take unattractive steps, such as discontinuing product development, limiting the services it can offer, reducing or foregoing sales and marketing efforts and attractive business opportunities, or discontinuing operations entirely.

 

Miller Wachman, LLP, the Company’s independent auditors, have included an explanatory paragraph related to a going concern uncertainty in their audit report on the Company’s consolidated financial statements for the fiscal year ended December 31, 2004, which states that “the Company’s recurring losses from operations and negative cash flows raise substantial doubt about its ability to continue as a going concern.”

 

The Company’s 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. The Company has not made any adjustments to its financial statements as a result of the going concern uncertainty. If the Company cannot continue as a going concern, it may have to liquidate its assets and may receive significantly less than the values at which they are carried on its financial statements. Any shortfall in the proceeds from the liquidation of the Company’s assets would directly reduce the amounts that holders of its common stock could receive in liquidation.

 

The Company’s ability to continue as a going concern may negatively impact the Company’s ability to obtain customers.

 

The uncertainty of the Company’s ability to continue as a going concern may negatively impact the Company’s ability to successfully attract customers for its products. Even if customers find the Company’s products attractive from a performance and price analysis, the warranty and support activities that the Company’s long-life products feature may prevent customers from making purchases in sufficient quantities for the Company to be able to function as a going concern.

 

25

 

 

 

The Company’s stock may be removed from the SmallCap Market System of Nasdaq.

 

Their can be no assurance that the Company will continue to meet Nasdaq’s SmallCap listing requirements in the future and therefore would no longer be eligible for quotation on the Nasdaq SmallCap Market. Should the Company’s stock lose its eligibility to be quoted on the SmallCap Market, it will seek to have its stock quoted on the OTCBB. While the Company knows of no reason that its stock will not be accepted for quotation on OTCBB, it cannot guarantee that acceptance. If the Company’s stock is not accepted for listing on the OTCBB, it will be listed on the pink sheets.

 

The Company is a development stage company with a limited operating history, and is deploying unproven technologies. It may never be able to develop any of its products or services.

 

The Company has no history of being able to complete development of designs into economically competitive commercially viable products. Examples of the Company’s challenges in developing its technologies into commercial products are the following:

 

it may take longer than anticipated to develop these services and products;

as there is a cost associated with the development of these technically challenging products the economic return may not be adequate to pay for these costs;

it must reduce manufacturing costs for its products to increase the Company’s chances of achieving profitability;

it must use design, quality control and careful management of its suppliers to ensure that warranty expenses are kept to a minimum; and

it will not be able to develop its services and products if it cannot raise the necessary financing.

 

There can be no assurance that the Company will be successful to allow it to offer its products at prices that will be considered competitive by its potential customers which may prevent widespread market acceptance of its products or services and thereby not generate sufficient margins to cover its cost of operations.

 

The Company may fail to develop its 25kWH generation flywheel system which is a critical requirement for the development of the Smart Energy Matrix.

 

Although the Company has successfully developed two high energy systems (the 2kWH and 6kWH) that had similar technical challenges, there can be no assurance that the Company will be able to successfully develop the 25kWH system. The successful development of the Company’s new 25kWh flywheel system, which is the flywheel system that will be used in the Smart Energy Matrix, involves significant technological and cost challenges, including:

 

it may take longer to develop the software and key hardware components such as the rim, motor, and bearing system;

the Company is relying on single-source suppliers to supply key components to meet the Company’s engineering requirements, cost objectives and development and production schedules. Specifically:

 

the composite rim, which has four times more volume than the rim in the 6kWh flywheel product;

 

a high speed, vacuum friendly, permanent magnet, high power motor with overall dimensions that will not adversely affect rotor dynamics; and

 

an active magnetic bearing system that supports the rotor over the entire speed range.

the Company’s ability to develop cost effective designs on schedule for:

 

 

rotor-cooling scheme to abate overheating during operation.

 

 

cost effective balance procedure to ensure acceptable vibration levels at all speeds.

 

touchdown bearing system to stabilize the rotor during abnormal conditions such as an earthquake.

the ability to ramp up and maintain production rates.

 

 

26

 

 

 

the cost of developing key components that have significant technical risk.

the quality and cost control from key suppliers.

 

the manufacturing costs for the flywheel’s rotor assembly (shaft, hub, and rim), bearing system, and related control electronics must be cost reduced to increase the Company’s chance of profitability.

 

There can be no assurance that the Company will be successful. If the Company is not successful it will not be able to develop its Smart Energy Matrix.

 

The Company may fail to develop the Smart Energy Matrix.

 

The Company’s Smart Energy Matrix will integrate up to ten 25kWh flywheels into a common 40 foot shipping container. This effort will pose significant technological and cost challenges. Major risks include:

 

locating a suitable supplier to modify the structure of a standard ocean shipping container to the Company’s engineering requirements;

locating contract manufacturing capability to install the flywheels, control electronics, and ancillary equipment, then perform final test and deliver completed Smart Energy Matrix to the end user;

containing the cost of modifying the ocean container and assembly and test of components;

resolving flywheel vibration transference from one flywheel to another;

 

transporting the Smart Energy Matrix safely over the open road to customer locations;

 

meeting the technical requirements for interconnection to the utility grid;

 

developing a communication and control system adequate to meet the performance standards of the grid managers;

ensuring consistent quality from key suppliers;

designing flywheel accessibility in the Smart Energy Matrix for repair and cost of field service; and

reducing the cost of transportation to customer site.

 

Although the market for frequency regulation services is large and growing the Company has not demonstrated its ability to sell into that market.

 

The Company believes that the use of its Smart Energy Matrix will be successful in the frequency regulation market. However, this market is being served by well-known utilities and independent service providers that use conventional generators and that have far greater resources than the Company. These utilities and independent service providers are primarily focused on the sale of energy and provide frequency regulation services as a secondary source of revenue. Companies that are currently providing frequency regulation include Allegheny Energy Supply Company, Commonwealth Chesapeake Company, Dominion Virginia Power, Ingenco Wholesale Power, NRG Power Marketing and Reliant Energy Services.

 

Although the Company believes that the products and services it plans to provide by using its products offer greater effectiveness than generators and could produce positive investment returns for the Company and perhaps other independent service providers, there can be no assurance that the Company will be able to establish its products or services in that market. To date, the Company has not completed any services or product sales of the Smart Energy Matrix.

 

There may be only a modest number of potential customers for the Company’s products and services.

 

There may only be a limited number of potential customers for the Company’s products and services, in which case the Company will be subject to the risk that the loss of, or reduced purchases by, any single customer could adversely affect its business.

 

The Company may not be able to reduce its product and service cost enough to make its prices competitive and may not be able to realize needed volumes with sufficient margins to cover its costs of operations.

 

 

27

 

 

 

There can be no assurance that the Company will be successful in lowering its production costs through improved product designs or volume discounts to allow it to offer its products at prices that will be considered competitive by its potential customers. If the Company is not able to offer its products or services at competitive prices this may prevent widespread market acceptance of its products or services and thereby not generate sufficient margins to cover its cost of operations.

 

The Company’s stockholders may be adversely affected if the Company issues additional equity securities to obtain financing.

 

If the Company raises additional funds by issuing additional equity securities, existing stockholders may be adversely affected because new investors may have superior rights than current shareholders and current shareholders may be diluted.

 

If the Company is unable to increase its sales of inverter products, it may not recover the capital that it has invested in developing these products.

 

The Company has invested considerable capital in the development of its inverter products, including the Smart Power M5. To date, the Company has generated limited revenue based on low volume sales of these products. If the Company is unable to increase sales of its inverter products in the near future, it may be forced to abandon these products, and may consequently not be able to recover the full amount of capital it has invested in developing inverter products.

 

The Company has limited experience manufacturing flywheel energy storage systems on a commercial basis. In the event of significant sales, the Company will need to develop or obtain manufacturing capacity for its products.

 

Should the Company experience significant customer demand for its products or services, it will need to develop or obtain manufacturing capacity to meet quality, profitability and delivery schedules. The Company may need to establish additional manufacturing facilities, expand its current facilities or expand third-party manufacturing. The Company has limited experience in the manufacture of flywheel or inverter systems and there can be no assurance that it will be able to accomplish these tasks, if necessary, on a timely basis to meet customer demand or at all. The Company has taken actions to conserve cash including idling its manufacturing capabilities through headcount reduction, delaying the development of its manufacturing process documentation and halting capital build-out. The Company will not achieve profitability if it cannot develop or obtain efficient, low-cost manufacturing capabilities and processes, and locate suppliers that will enable the Company to meet the quality, price, engineering, design and production standards or volumes required to meet its product commercialization schedule, if any, or to satisfy the requirements of its customers or the market generally.

 

It is difficult to evaluate the Company and to predict its future performance because of its short operating history and the fact that it is a development stage company.

 

The Company is a development stage entity and has a limited operating history. Unless the Company can achieve significant market acceptance of its current or future products at volumes and with margins that allow it to cover its costs of operations, the Company may never advance beyond the start-up phase.

 

See "Business," "Selected Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."

 

Because the Company depends on third-party suppliers for the development and supply of key components for its products, it could experience disruptions in supply that could delay or decrease its revenues.

 

The Company’s business, prospects, results of operations, or financial condition could be harmed if it is unable to maintain satisfactory relationships with suppliers. To accelerate development time and reduce capital investment, the Company relies on third-party suppliers for several key components of its systems. The Company does not have contracts with all of these suppliers. If these suppliers should fail to timely deliver components that meet the Company’s quality, quantity, or cost standards, then the Company could experience production delays or cost

 

28

 

 

increases. Because certain key components are complex and difficult to manufacture and require long lead times, the Company may have difficulty finding alternative suppliers on a timely or cost effective basis. As a result, the Company could experience shortages in supply or be unable to be cost competitive in the markets it is pursuing.

 

The Company’s financial performance could be adversely affected by its need to hire and retain key sales personnel.

 

Because the Company’s future success depends to a large degree on the success of its sales organization, the Company’s ability to meet its business plan will depend significantly on whether it can attract and retain sales personnel. Competition for skilled sales people is intense and the Company may not be successful in attracting and retaining the sales talent necessary to develop markets and achieve sufficient sales volume to operate profitably.

 

The Company’s financial performance could be adversely affected if it is unable to retain key executive officers.

 

Because the Company’s future success depends to a large degree on the management provided by the executive officers, the Company’s competitiveness will depend significantly on whether it can retain members of its executive team. The Company has employment agreements with Messrs. Spiezio, Vice President of Finance, Chief Financial Officer, Treasurer and Secretary; and Lazarewicz, Vice President and Chief Technical Officer. The employment agreement between the Company and Mr. Capp, CEO and President, expired on December 31, 2004. Negotiations between Mr. Capp and the Company are ongoing. There can be no assurance that an agreement will be reached with Mr. Capp.

 

The Company’s ability to effectively implement its business plan depends, to a significant extent, on its ability to retain its executive officers. There can be no assurance that the Company will be successful in retaining its other executive officers.

 

If the Company cannot reach agreement with Mr. Capp and he elects to leave the Company, pursuant to the terms of the expired employment agreement, if he ceases to be an employee following December 31, 2004, the Company is obligated to pay him a monthly amount until December 31, 2005, equal to the sum of one-twelfth of his base salary at the time of expiration plus one-twelfth of his bonus for the most recent fiscal year. No monthly payment is required after December 31, 2005. If the at-will employment continues after December 31, 2005 but then terminates, no such monthly amount will be paid. As of December 31, 2004, Mr. Capp’s base salary was $240,000 annually. Based on the closing bid price of the Company’s common stock as of December 31, 2004 as reported on The NASDAQ SmallCap Market, Mr. Capp received a bonus in the amount of $236,800, paid in the form of a grant of 251,391 restricted stock units, pursuant to the Company’s Second Amended and Restated 1998 Stock Incentive Plan.

 

The Company’s financial performance could be adversely affected by its need to retain and attract technical personnel.

 

The Company’s future success depends to a large degree on the technical skills of its engineering staff and its ability to attract technical personnel. Competition for skilled technical professionals is intense and the Company may not be successful in attracting and retaining the talent necessary to design, develop and manufacture its flywheel products.

 

Failure to protect the Company’s intellectual property could impair its competitive position.

 

The Company cannot provide assurance that it has or will be able to maintain a significant proprietary position on the basic technologies used in its flywheel systems. The Company’s ability to compete effectively against alternative technologies will be affected by its ability to protect proprietary technology, systems designs and manufacturing processes. The Company does not know whether any of its pending or future patent applications under which it has 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 the Company’s technology or processes from competitors. Even if all the Company’s patent applications are issued and are sufficiently broad, they may be challenged or invalidated. The

 

29

 

 

Company could incur substantial costs in prosecuting or defending patent infringement suits, and such suits would divert funds and resources that could be used in the Company’s business. The Company does not know whether it has been or will be completely successful in safeguarding and maintaining its proprietary rights.

 

Further, the Company’s competitors or others may independently develop or patent technologies or processes that are substantially equivalent or superior to those of the Company. If the Company is found to be infringing on third-party patents, the Company does not know whether it will be able to obtain licenses to use such patents on acceptable terms, if at all. Failure to obtain needed licenses could delay or prevent the development, manufacture or sale of the Company’s systems.

 

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

 

The share prices of companies in the Company’s sector have been highly volatile and the Company’s share price could be subject to extreme price fluctuations.

 

The markets for equity securities of high technology companies, including companies in the power reliability and power quality markets, have been highly volatile recently and the market price of the Company’s common stock has been, and may continue to be, subject to significant fluctuations. This could be in response to operating results, announcements of technological innovations or new products by the Company, or its competitors, patent or proprietary rights developments, energy blackouts and market conditions for high technology stocks in general. In addition, stock markets in recent years have experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies. These market fluctuations, as well as general economic conditions, may adversely affect the market price of the Company’s common stock, which could affect its ability to attract additional capital to fund operations.

 

There may be other technologies under development that could prevent the Company from achieving or sustaining its ability to sell products or to do so at prices that will yield profits.

 

There are a number of technology companies in various stages of development, there may be emerging technologies that the Company is unaware of and there may be combinations of technologies in the future. The Company cannot give assurance that some or all of its target markets and pricing plans will not be displaced by these emerging technologies.

 

The Company may invest cash in other companies in its sector to increase shareholder value through strategic alliances or return on investment which do not create gains and therefore reduce shareholder value.

 

Given the Company’s financial position, its ability to make cash investments in other companies is very limited at this time. However, in the future, the Company may make cash investments in other companies in its sector to gain strategic alliances, channels to market or appreciation in stock value. These investments may not increase shareholder value. Given the volatility of share prices for companies in this sector, general economic conditions and market fluctuations in general, the market price of investments may decrease and reduce shareholder value.

 

The Company may make acquisitions or mergers that do not produce revenues and cash flow as expected and may therefore further the Company’s need for addition cash to sustain its operations.

 

The Company may identify acquisitions or mergers that it believes will provide revenues and cash flow. There can be no assurance that these acquisitions or mergers will be completed and if completed be successful.

 

 

30

 

 

 

The Company may make acquisitions or mergers that reduce the Company’s ability to obtain additional capital to sustain the combined operations.

 

The Company may make acquisitions or mergers that it believes will provide improved ability to obtain additional capital to sustain the combined operations. There can be no assurance that these acquisitions or mergers will be perceived as positive by investors and therefore investments necessary to sustain operations may not be realized.

 

The Company has limited experience in acquisitions and mergers and may not be successful in identifying appropriate acquisitions or mergers or be unsuccessful in integrating these entities.

 

The Company and its management have limited experience in evaluating, integrating and coordinating the acquisition or merger of companies and therefore may not be successful in this effort.

 

Any weaknesses identified in the Company’s internal controls as part of the evaluation being undertaken by the Company and its independent public accountant pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 could have an adverse effect on the Company’s business.

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies evaluate and report on their systems of internal control over financial reporting. In addition, the independent accountants must report on management's evaluation. The Company is in the process of documenting and testing its system of internal control over financial reporting to provide the basis for its report. At this time, the Company is aware that its financial reporting information systems and point-of-sale information systems require a significant level of manual controls to ensure the accurate reporting of its results of operations and financial position. Upon the completion of its review, certain deficiencies may be discovered that will require remediation. This remediation may require the implementation of certain information systems operating protocols and/or additional manual controls, the costs of which could have a material adverse effect on the Company’s business, financial condition and results of operations. Due to the ongoing evaluation and testing of The Company's internal controls, there can be no assurance that there may not be significant deficiencies or material weaknesses that would be required to be reported. In addition, the Company expects the evaluation process and any required remediation, if applicable, to increase its accounting, legal and other costs and divert management resources from core business operations.

 

Ongoing compliance with the Sarbanes-Oxley Act of 2002 may require additional personnel or systems changes.

The Company’s business plan may not have sufficient resources identified to insure ongoing compliance with the Sarbanes-Oxley Act of 2002. Given the limited size of the Company and its cash position the Company may not have sufficient resources to satisfy the segregation of duties required for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 or to be compliant the Company may need to obtain additional funding and cash flow positive timing may need to be extended.

 

Government regulation may impair the Company’s ability to market its products.

 

Government regulation of the Company’s products, whether at the federal, state or local level, including any change in regulations, on tariffs, product buy downs or tax rebates relating to purchase and installation of its products, may increase the cost and price of its systems, and may have a negative impact on the Company’s revenue and profitability. The Company cannot provide assurance that its products will not be subject to existing or future federal and state regulations governing traditional electric utilities and other regulated entities. The Company expects that its products and their installation will be subject to oversight and regulation at the local level in accordance with state and local ordinances relating to building codes, safety and related matters. The Company does not know the extent to which any existing or new regulations may impact its ability to distribute, install and service its products. Once the Company’s products reach the commercialization stage, federal, state or local government entities may seek to impose regulations.

 

 

31

 

 

 

Terrorist attacks have contributed to economic instability in the United States; continued terrorist attacks, war or other civil disturbances could lead to further economic instability and depress the Company’s stock price.

On September 11, 2001, the United States was the target of terrorist attacks of unprecedented scope. These attacks have caused instability in the global financial markets, and have contributed to volatility in the stock prices of United States publicly traded companies, such as The Company. These attacks may lead to armed hostilities or to further acts of terrorism and civil disturbances in the United States or elsewhere, which may further contribute to economic instability in the United States and could have a material adverse effect on the Company’s business, financial condition and operating results.

 

Product liability claims against the Company could result in substantial expenses and negative publicity that could impair successful marketing of products.

 

The Company’s business exposes it to potential product liability claims that are inherent in the manufacture, marketing and sale of electro-mechanical products, and as such, the Company may face substantial liability for damages resulting from the faulty design or manufacture of products or improper use of products by end users. The Company cannot provide assurance that its product liability insurance will provide sufficient coverage in the event of a claim. Also, the Company cannot predict whether it will be able to maintain such coverage on acceptable terms, if at all, or that a product liability claim would not materially adversely affect its business, financial condition or the price of its common stock. In addition, negative publicity in connection with the faulty design or manufacture of the Company’s products would adversely affect its ability to market and sell its products.

 

Safety failures by the Company’s flywheel products or those of its competitors could reduce market demand or acceptance for flywheel services or products in general.

 

A serious accident involving either the Company’s flywheels or competitors' similar products could be a significant deterrent to market acceptance and adversely affect the Company’s financial performance. There is the possibility of accident with any form of energy storage. In particular, if a metal flywheel fails and the stored energy is released, the flywheel could break apart into fragments that could be ejected at a high rate of speed. However, the Company’s flywheels are based on a composite design so that in the event of a failure, its flywheel will fail in a more benign manner.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

The Company’s cash equivalents and investments, all of which have maturities of less than one year, could expose the Company to interest rate risk. At December 31, 2004, the Company had approximately $60,000 of cash equivalents that were held in a non-interest bearing checking account. Also at December 31, 2004, the Company had approximately $5,037,000 of cash equivalents that were held in interest-bearing money market accounts at high-quality financial institutions. The fair value of these investments approximates their cost. A 10% change in interest rates would change the investment income realized on an annual basis by approximately $5,000, which the Company does not believe is material.

 

 

32

 

 

 

Item 8. Financial Statements and Supplementary Data

 

BEACON POWER CORPORATION AND SUBSIDIARIES

(A Development Stage Company)

Index to Consolidated Financial Statements

 

Page

 

 

Report of Independent Registered Public Accounting Firm

34

 

Consolidated Balance Sheets at December 31, 2004 and 2003

35

 

Consolidated Statements of Operations for the years ended December

 

 

31, 2004, 2003 and 2002 and for the period May 8, 1997 (date of

 

 

inception) to December 31, 2004

36

 

Consolidated Statements of Stockholders' Equity for the years

 

 

ended December 31, 2004, 2003 and 2002 and for the period

 

 

May 8, 1997 (date of inception) to December 31, 2004

37

 

Consolidated Statements of Cash Flows for the years ended December

 

 

31, 2004, 2003 and 2002 and for the period May 8, 1997 (date of

 

 

inception) to December 31, 2004

41

 

Notes to Consolidated Financial Statements

43

 

 

33

 

 

 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of

Beacon Power Corporation:

 

We have audited the accompanying consolidated balance sheets of Beacon Power Corporation and Subsidiary (the "Company") (a development stage company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2004 and for the period from May 8, 1997 (date of inception) through December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Beacon Power Corporation and subsidiary as of December 31, 2004 and 2003 and the results of their operations and their cash flows for the three years in the period ended December 31, 2004 and the period from May 8, 1997 (date of inception) through December 31, 2004 in conformity with U.S generally accepted accounting principles.

 

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

 

/s/ Miller Wachman, LLP

 

Boston, Massachusetts

February 3, 2006

 

34

 

 

 

BEACON POWER CORPORATION AND SUBSIDIARIES

(A Development Stage Company)

Consolidated Balance Sheets

 

 

 

 

December 31,

 

 

 

 

2004

 

2003

Assets

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$ 5,097,188

 

$ 8,909,261

 

Accounts receivable, trade

 

52,105

 

128,133

 

Inventory

 

222,593

 

238,684

 

Prepaid expenses and other current assets

 

817,396

 

773,226

 

Investments in available-for-sale securities

 

-

 

1,163,758

 

 

Total current assets

 

6,189,282

 

11,213,062

 

 

 

 

 

 

 

Property and equipment, net

 

258,647

 

357,180

Restricted cash

 

310,011

 

405,232

Other assets and deferred financing costs

 

327,646

 

91,325

 

 

 

 

 

 

 

Total assets

 

$ 7,085,586

 

$ 12,066,799

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$ 389,189

 

$ 148,075

 

Accrued compensation and benefits

 

130,609

 

156,000

 

Other accrued expenses

 

393,569

 

664,527

 

Restructuring reserve

 

1,062,644

 

1,406,191

 

 

Total current liabilities

 

1,976,011

 

2,374,793

 

 

 

 

 

 

 

Commitments and contingent liabilities (Note 4)

 

 

 

 

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

Preferred Stock, $.01 par value; 10,000,000 shares

 

 

 

 

 

authorized; no shares issued or outstanding

 

-

 

-

 

Common stock, $.01 par value; 110,000,000 shares

 

 

 

 

 

authorized; 43,788,810 and 43,107,526 shares issued and

 

 

 

 

 

outstanding at December 31, 2004 and 2003, respectively

 

437,888

 

431,075

 

Deferred stock compensation

 

(707,167)

 

(832,639)

 

Additional paid-in-capital

 

134,411,911

 

133,796,667

 

Deficit accumulated during the development stage

 

(128,933,397)

 

(123,603,437)

 

Treasury stock, 132,000 shares, at cost

 

(99,660)

 

(99,660)

 

 

Total stockholders' equity

 

5,109,575

 

9,692,006

 

 

 

 

 

 

 

Total liabilities and stockholders' equity

 

$ 7,085,586

 

$ 12,066,799

 

See notes to consolidated financial statements.

 

35

 

 

 

BEACON POWER CORPORATION AND SUBSIDIARIES

(A Development Stage Company)

Consolidated Statements of Operations

 

 

 

 

 

 

 

 

 

 

 

Cumulative from

 

 

 

 

 

 

 

 

 

 

 

May 8, 1997

 

 

 

 

 

 

 

 

 

 

 

(date of inception)

 

 

 

 

 

 

 

 

 

 

 

through December 31,

 

 

 

 

 

2004

 

2003

 

2002

 

2004

Revenue

 

$ 324,694

 

$ -

 

$ -

 

$ 875,878

Cost of goods sold

 

1,457,869

 

-

 

-

 

1,457,869

Gross profit

 

(1,133,175)

 

-

 

-

 

(581,991)

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

4,196,371

 

4,936,575

 

5,636,903

 

32,255,974

 

Research and development

 

3,532,059

 

3,549,592

 

7,129,880

 

53,875,545

 

Loss on sales commitments

 

-

 

-

 

-

 

375,974

 

Depreciation and amortization

 

187,230

 

284,733

 

1,644,230

 

4,137,966

 

Restructuring charges

 

-

 

-

 

2,159,280

 

2,159,280

 

Loss on impairment of assets

 

-

 

366,788

 

4,297,128

 

4,663,916

 

 

 

Total operating expenses

 

7,915,660

 

9,137,688

 

20,867,421

 

97,468,655

 

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(9,048,835)

 

(9,137,688)

 

(20,867,421)

 

(98,050,646)

 

 

 

 

 

 

 

 

 

 

 

 

Other income:

 

 

 

 

 

 

 

 

Interest income

 

102,908

 

217,964

 

504,034

 

3,882,875

Interest expense

 

-

 

(6,713)

 

(41,932)

 

(1,093,703)

Gain on sale of investment

 

3,562,582

 

-

 

-

 

3,562,582

Other income (expense)

 

53,385

 

308,424

 

(433,933)

 

(228,311)

 

Total other income (expense), net

 

3,718,875

 

519,675

 

28,169

 

6,123,443

Net loss

 

(5,329,960)

 

(8,618,013)

 

(20,839,252)

 

(91,927,203)

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividends

 

-

 

-

 

-

 

(36,825,680)

Accretion of convertible preferred stock

 

-

 

-

 

-

 

(113,014)

Loss to common shareholders

 

$(5,329,960)

 

$(8,618,013)

 

$ (20,839,252)

 

$ (128,865,897)

 

 

 

 

 

 

 

 

 

 

 

 

Loss per share, basic and diluted

 

$ (0.12)

 

$ (0.20)

 

$ (0.49)

 

 

Weighted-average common shares outstanding

43,452,727

 

42,885,675

 

42,797,072

 

 

 

See notes to consolidated financial statements.

 

36

 

 

 

BEACON POWER CORPORATION AND SUBSIDIARIES

(A Development Stage Company)

Consolidated Statements of Stockholders' Equity

 

Class A

Class C

 

 

Deferred

 

Preferred Stock

Preferred Stock

Common Stock

Consulting

 

Shares

Amount

Shares

Amount

Shares

Amount

Expense

 

 

 

 

 

 

 

 

BALANCE AT MAY 8, 1997 (DATE OF INCEPTION)

-

$ -

-

$ -

-

$ -

$ -

 

 

 

 

 

 

 

 

Issuance of Founder’s Shares

-

-

-

-

6,750,000

67,500

-

Issuance of Class A preferred stock

1,390,000

5,662,500

-

-

-

-

(275,000)

Recapitalization

3,373,313

67,466

-

-

(6,746,626)

(67,466)

-

Rounding for fractional shares

-

-

-

-

(2)

-

-

Issuance of Class C preferred and common stock

-

-

6

29,866

13,476

134

-

Deferred Consulting

-

-

-

-

-

-

773,284

Series A Issuance for Consulting

-

-

-

-

134,464

1,345

(498,284)

Repayment of subscription receivable

-

-

-

-

-

-

-

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

4,594

11,485

-

-

-

-

-

Dividend on preferred stock

-

-

-

-

-

-

-

Accretion of redeemable preferred stock to redemption value

-

-

-

-

-

-

-

Deferred Stock Compensation

-

-

-

-

-

-

-

Issuance of stock options for consulting services

-

-

-

-

-

-

-

Issuance of Stock Options to settle lawsuit

-

-

-

-

-

-

-

Amortization of Deferred Stock Compensation

-

-

-

-

-

-

-

Issuance of warrants

-

-

-

-

-

-

-

Proceeds from stock offering, net of related expenses

-

-

-

-

9,200,000

92,000

-

Conversion of Series A preferred stock

(4,767,907)

(5,741,451)

-

-

9,535,814

95,358

-

Conversion of Series C preferred stock

-

-

(6)

(29,866)

12

-

-

 

 

37

 

 

 

 

Conversion of convertible preferred stock

-

-

-

-

19,823,704

198,237

-

Payment of accrued dividend

-

-

-

-

859,330

8,593

-

Cashless Warrant exercise

-

-

-

-

1,982,876

19,829

-

Exercise of Stock Options

-

-

-

-

1,162,852

11,629

-

Shares issued through ESPP

-

-

-

-

54,956

550

-

Option extension for CEO

-

-

-

-

-

-

-

Option extension for severed employees

-

-

-

-

-

-

-

Net loss

-

-

-

-

-

-

-

Balance, December 31, 2001

-

$ -

-

$ -

42,770,856

$ 427,709

$ -

 

 

 

 

 

 

 

 

Deferred Stock Compensation revaluation

-

-

-

-

-

-

-

Amortization of Deferred Stock Compensation

-

-

-

-

-

-

-

Shares issued through ESPP

-

-

-

-

42,041

420

-

Purchase of Treasury Stock

-

-

-

-

-

-

-

Net loss

-

-

-

-

-

-

-

Balance, December 31, 2002

-

$ -

-

$ -

42,812,897

$ 428,129

$ -

 

 

 

 

 

 

 

 

Deferred Stock Compensation revaluation

-

-

-

-

-

-

-

Issuance of restricted stock units for bonus

-

-

-

-

-

-

-

Shares issued through ESPP

-

-

-

-

5,494

54

-

Exercise of Stock Options

-

-

-

-

289,135

2,892

-

Net loss

-

-

-

-

-

-

-

Balance, December 31, 2003

-

$ -

-

$ -

43,107,526

$ 431,075

$ -

 

 

 

 

 

 

 

 

Deferred Stock Compensation revaluation

-

-

-

-

-

-

-

Issuance of restricted stock units for bonus

-

-

-

-

-

-

-

Amortize deferred stock compensation

-

-

-

-

643,160

6,431

-

Shares issued through ESPP

-

-

-

-

8,124

82

-

Issuance of non-employee stock options

-

-

-

-

-

-

-

Exercise of Stock Options

-

-

-

-

30,000

300

-

Net loss

-

-

-

-

-

-

-

Balance, December 31, 2004

-

$ -

-

$ -

43,788,810

$ 437,888

$ -

 

 

38

 

 

 

 

 

Deferred

Additional

Stock

 

 

 

Total

 

Stock

Paid-in

Subscription

Retained

Treasury Stock

Stockholders'

 

Compensation

Capital

Receivable

Deficit

Shares

Amount

Equity

 

 

 

 

 

 

 

 

BALANCE AT MAY 8, 1997 (DATE OF INCEPTION)

$ -

$ -

$ -

$ -

-

$ -

$ -

 

 

 

 

 

 

 

 

Issuance of Founder’s Shares

-

-

-

(67,500)

-

-

-

Issuance of Class A preferred stock

-

-

(5,000,000)

-

-

-

387,500

Recapitalization

-

-

-

-

-

-

-

Rounding for fractional shares

-

-

-

-

-

-

-

Issuance of Class C preferred and common stock

-

-

-

-

-

-

30,000

Deferred Consulting

-

-

-

-

-

-

773,284

Series A Issuance for Consulting

-

496,939

-

-

-

-

-

Repayment of subscription receivable

-

-

5,000,000

-

-

-

5,000,000

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

-

-

-

-

-

-

11,485

Dividend on preferred stock

-

-

-

(2,245,680)

-

-

(2,245,680)

Accretion of redeemable preferred stock to redemption value

-

-

-

(113,014)

-

-

(113,014)

Deferred Stock Compensation

(1,443,061)

1,443,061

-

-

-

-

-

Issuance of stock options for consulting services

(47,892)

47,892

-

-

-

-

-

Issuance of Stock Options to settle lawsuit

-

303,160

-

-

-

-

303,160

Amortization of Deferred Stock Compensation

1,279,389

-

-

-

-

-

1,279,389

Issuance of warrants

-

36,520,366

-

(34,580,000)

-

-

1,940,366

Proceeds from stock offering, net of related expenses

-

49,249,537

-

-

-

-

49,341,537

Conversion of Series A preferred stock

-

5,646,093

-

-

-

-

-

Conversion of Series C preferred stock

-

29,866

-

-

-

-

-

Conversion of convertible preferred stock

-

36,496,431

-

-

-

-

36,694,668

Payment of accrued dividend

-

1,077,714

-

-

-

-

1,086,307

Cashless Warrant exercise

-

(19,829)

-

-

-

-

-

Exercise of Stock Options

-

1,164,041

-

-

-

-

1,175,670

Shares issued through ESPP

-

109,394

-

-

-

-

109,944

 

 

39

 

 

 

 

Option extension for CEO

-

315,394

-

-

-

-

315,394

Option extension for severed employees

-

31,197

-

-

-

-

31,197

Net loss

-

-

-

(57,139,978)

-

-

(57,139,978)

Balance, December 31, 2001

$ (211,564)

$ 132,911,256

$ -

$ (94,146,172)

-

$ -

$ 38,981,229

 

 

 

 

 

 

 

 

Deferred Stock Compensation revaluation

173,616

(173,616)

-

-

-

-

-

Amortization of Deferred Stock Compensation

19,535

-

-

-

-

-

19,535

Shares issued through ESPP

-

12,885

-

-

-

-

13,305

Purchase of Treasury Stock

-

-

-

-

132,000

(99,660)

(99,660)

Net loss

-

-

-

(20,839,252)

-

-

(20,839,252)

Balance, December 31, 2002

$ (18,413)

$ 132,750,525

$ -

$ (114,985,424)

132,000

$ (99,660)

$ 18,075,157

 

 

 

 

 

 

 

 

Deferred Stock Compensation revaluation

(87,031)

87,031

-

-

-

-

-

Issuance of restricted stock units for bonus

(727,195)

727,195

-

-

-

-

-

Shares issued through ESPP

-

911

-

-

-

-

965

Exercise of Stock Options

-

231,005

-

-

-

-

233,897

Net loss

-

-

-

(8,618,013)

-

-

(8,618,013)

Balance, December 31, 2003

$ (832,639)

$ 133,796,667

$ -

$ (123,603,437)

132,000

$ (99,660)

$ 9,692,006

 

 

 

 

 

 

 

 

Deferred Stock Compensation revaluation

78,083

(78,083)

-

-

-

-

-

Issuance of restricted stock units for bonus

(679,807)

679,807

-

-

-

-

-

Amortize deferred stock compensation

727,196

(33,022)

-

-

-

-

700,605

Shares issued through ESPP

-

3,854

-

-

-

-

3,936

Issuance of non-employee stock options

-

16,288

-

-

-

-

16,288

Exercise of Stock Options

-

26,400

-

-

-

-

26,700

Net loss

-

-

-

(5,329,960)

-

-

(5,329,960)

Balance, December 31, 2004

$ (707,167)

$ 134,411,911

$ -

$ (128,933,397)

132,000

$ (99,660)

$ 5,109,575

 

See notes to consolidated financial statements.

 

 

 

40

 

 

 

BEACON POWER CORPORATION AND SUBSIDIARIES

(A Development Stage Company)

Consolidated Statement of Cash Flows

 

 

 

 

 

 

Cumulative from

 

 

 

 

 

 

May 8, 1997

 

 

 

 

 

 

(date of inception)

 

 

 

 

 

through December

 

 

 

2004

2003

2002

31, 2004

Cash flows from operating activities:

 

 

 

 

 

Net (loss)

$ (5,329,960)

$ (8,618,013)

$ (20,839,252)

$ (91,927,203)

 

Adjustments to reconcile net loss to net cash used in

 

 

 

 

operating activities:

 

 

 

 

 

 

Depreciation and amortization

187,230

284,734

1,644,230

4,137,967

 

 

Loss on sale of fixed assets

25,301

-

14,481

196,169

 

 

Impairment of assets

(9,703)

366,788

4,297,128

4,654,213

 

 

Restricted cash

95,221

(50,000)

45,222

(310,011)

 

 

(Expenses paid) restructuring charge

(343,547)

(343,547)

1,749,738

1,062,644

 

 

Reserve for officers note

(17,931)

(308,423)

428,398

102,044

 

 

Interest expense relating to issuance of warrants

-

-

-

371,000

 

 

Non-cash charge for change in option terms

-

-

-

346,591

 

 

Non-cash charge for settlement of lawsuit

-

-

-

303,160

 

 

Amortization of deferred consulting expense, net

-

-

-

1,160,784

 

 

Amortization of deferred stock compensation

700,605

-

19,534

1,990,858

 

 

Options and warrants issued for consulting services

16,288

-

-

1,585,654

 

 

Services and interest expense paid in preferred stock

-

-

-

11,485

 

 

Gain on sale of investments

(3,562,582)

-

-

(3,562,582)

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

76,028

(128,133)

-

(52,105)

 

 

Inventory

16,091

(238,684)

-

(222,593)

 

 

Prepaid expenses and other current assets

(26,239)

1,310,652

(1,172,448)

(1,019,100)

 

 

Accounts payable

241,114

70,749

(834,139)

389,189

 

 

Accrued compensation and benefits

(25,391)

(70,623)

(494,507)

130,609

 

 

Accrued interest

-

-

-

275,560

 

 

Dividend receivable

63,758

(63,758)

-

-

 

 

Due to related party

-

-

(35,532)

-

 

 

41

 

 

 

 

 

 

Other accrued expenses and current liabilities

(270,958)

87,646

(364,219)

402,239

 

 

Net cash used in operating activities

(8,164,675)

(7,700,612)

(15,541,366)

(79,973,428)

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of investments

(90,352)

(1,100,000)

-

(1,190,352)

 

Sale of investments

4,752,934

-

-

4,752,934

 

Increase in other assets

-

(236,854)

-

(412,072)

 

Purchases of property and equipment

(30,845)

(7,993)

(466,081)

(8,452,553)

 

Sale of property and equipment

17,875

53,365

-

71,240

 

 

Net cash provided by (used in) investing activities

4,649,612

(1,291,482)

(466,081)

(5,230,803)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Initial public stock offering, net of expenses

-

-

-

49,341,537

 

Payment of dividends