<PAGE>


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

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

                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

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

                                   FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934

    For the quarterly period ended June 30, 2001

                                      OR

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
    EXCHANGE ACT OF 1934

    For the transition period from     to

                       Commission File Number: 000-31533

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

                          Proton Energy Systems, Inc.
            (Exact name of registrant as specified in its charter)

                      Delaware                        06-1461988
            (State or other jurisdiction           (I.R.S. Employer
          of incorporation or organization)     Identification Number)

                     50 Inwood Road, Rocky Hill, CT 06067
             (Address of registrant's principal executive office)

                                (860) 571-6533
             (Registrant's telephone number, including area code)

   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 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 [_]

   The number of shares of common stock outstanding as of August 9, 2001 was
33,180,442 with a par value of $.01 per share.


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

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

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

                              INDEX TO FORM 10-Q

                         PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
                                                                                                  Page
                                                                                                  -----
<S>                                                                                               <C>
Item 1--Financial Statements
   Condensed Balance Sheets--June 30, 2001 (unaudited) and December 31, 2000.....................     3
   Condensed Statements of Operations--Three Month and Six Month Periods ended June 30, 2001
   (unaudited) and June 30, 2000 (unaudited) and Cumulative Amounts from Inception through
   June 30, 2001 (unaudited).....................................................................     4
   Statement of Changes in Stockholders' Equity (Deficit) from Inception through June 30, 2001
   (unaudited)...................................................................................     5
   Condensed Statements of Cash Flows--Six Month Periods ended June 30, 2001 (unaudited) and
   June 30, 2000 (unaudited) and Cumulative Amounts from Inception through June 30, 2001
   (unaudited)...................................................................................     6
   Notes to Condensed Financial Statements.......................................................   7-9
Item 2--Management's Discussion and Analysis of Financial Condition and Results of Operations.... 10-14
Item 3--Quantitative and Qualitative Disclosures about Market Risk...............................    14
</TABLE>

                          PART II. OTHER INFORMATION

<TABLE>
       <S>                                                         <C>
       Item 1--Legal Proceedings..................................    14
       Item 2--Changes in Securities and Use of Proceeds.......... 14-15
       Item 3--Defaults upon Senior Securities....................    15
       Item 4--Submission of Matters to a Vote of Security Holders    15
       Item 5--Other Information..................................    15
       Item 6--Exhibits and Reports on Form 8-K...................    15
       Signatures.................................................    16
</TABLE>

                                      2

<PAGE>

                         Part I--FINANCIAL INFORMATION

                                    ITEM 1.

                             FINANCIAL STATEMENTS

                          PROTON ENERGY SYSTEMS, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                                BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                        June 30,     December 31,
                                                                          2001           2000
                                                                       ------------  ------------
                                                                       (Unaudited)
<S>                                                                    <C>           <C>
                               ASSETS
Current assets:
   Cash and cash equivalents.......................................... $ 19,594,065  $  1,360,127
   Marketable securities..............................................  153,426,838   173,389,002
   Inventories and deferred costs (Note 3)............................    2,378,925     1,649,674
   Other current assets...............................................    2,876,604     2,902,426
                                                                       ------------  ------------
       Total current assets...........................................  178,276,432   179,301,229
                                                                       ------------  ------------
Fixed assets, net.....................................................    1,954,752     1,204,353
Other assets..........................................................      244,295       246,889
                                                                       ------------  ------------
       Total assets................................................... $180,475,479  $180,752,471
                                                                       ============  ============

                LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Accounts payable................................................... $    434,481  $    185,733
   Accrued expenses...................................................      347,096       435,598
   Accrued compensation...............................................      340,328       507,250
   Deferred revenue...................................................    1,337,839     1,035,302
   Customer advances..................................................       43,889       156,549
   Taxes payable......................................................           --       125,000
                                                                       ------------  ------------
       Total current liabilities......................................    2,503,633     2,445,432
                                                                       ------------  ------------

Commitments and contingencies (Note 7)

Stockholders' equity (Note 5):
   Preferred stock, undesignated, $.01 par value per share; 5,000,000
     shares authorized, no shares issued or outstanding...............           --            --
   Common stock, $.01 par value; 100,000,000 shares authorized;
     33,169,941 and 33,088,043 shares issued and
     outstanding, respectively........................................      331,699       330,880
   Additional paid-in capital.........................................  242,060,759   242,092,743
   Unearned compensation..............................................   (1,888,988)   (2,374,361)
   Accumulated other comprehensive gain...............................      934,487       289,000
   Deficit accumulated during the development stage...................  (63,466,111)  (62,031,223)
                                                                       ------------  ------------
       Total stockholders' equity.....................................  177,971,846   178,307,039
                                                                       ------------  ------------
       Total liabilities and stockholders' equity..................... $180,475,479  $180,752,471
                                                                       ============  ============
</TABLE>

   The accompanying notes are an integral part of the financial statements.

                                      3

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                           STATEMENTS OF OPERATIONS
                                  (Unaudited)
<TABLE>
<CAPTION>

                                                                                                  For the period
                                                                                                       from
                                                                                                    inception
                                                                                                   (August 16,
                                          Three Months Ended June 30,  Six Months Ended June 30,  1996) through
                                          ---------------------------  -------------------------     June 30,
                                              2001          2000          2001          2000           2001
                                          ------------  -------------  -----------  ------------  --------------
<S>                                       <C>           <C>            <C>          <C>           <C>
Contract revenue.........................  $   219,818   $    131,137  $   406,952  $    187,131   $  1,984,717
Product revenue..........................      335,426             --      387,226            --        443,176
                                          ------------  -------------  -----------  ------------   ------------
       Total revenues....................      555,244        131,137      794,178       187,131      2,427,893
Costs and expenses:
   Costs of contract revenue.............      224,100         61,333      429,471        88,098      1,557,877
   Costs of production...................      571,508             --      814,928       115,936      1,216,620
   Research and development..............    1,442,209        634,488    2,479,147     1,186,466     10,226,003
   General and administrative............    1,799,736        826,835    3,395,976     1,432,291     11,467,289
                                          ------------  -------------  -----------  ------------   ------------
       Total costs and expenses..........    4,037,553      1,522,656    7,119,522     2,822,791     24,467,789
                                          ------------  -------------  -----------  ------------   ------------
Loss from operations.....................   (3,482,309)    (1,391,519)  (6,325,344)   (2,635,660)   (22,039,896)
Interest income..........................    2,311,468        647,271    4,890,456       681,856      9,248,939
                                          ------------  -------------  -----------  ------------   ------------
Net loss.................................   (1,170,841)      (744,248)  (1,434,888)   (1,953,804)   (12,790,957)
Deemed preferred dividends and
  accretion..............................           --    (51,170,154)          --   (51,430,154)   (54,191,154)
                                          ------------  -------------  -----------  ------------   ------------
Net loss attributable to common
  stockholders...........................  $(1,170,841)  $(51,914,402) $(1,434,888) $(53,383,958)  $(66,982,111)
                                          ============  =============  ===========  ============   ============
Basic and diluted net loss per
  share attributable to common
  stockholders...........................  $     (0.04)  $     (27.25) $     (0.04) $     (28.07)  $      (9.98)
                                          ============  =============  ===========  ============   ============
Shares used in computing basic and
  diluted net loss per share attributable
  to common stockholders.................   33,134,717      1,904,793   33,118,300     1,902,396      6,714,949
                                          ============  =============  ===========  ============   ============
</TABLE>

   The accompanying notes are an integral part of the financial statements.

                                      4

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.
                         (A DEVELOPMENT STAGE COMPANY)

            STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>

                                                                                                  Deficit
                                                                                   Accumulated  Accumulated       Total
                                      Common Stock      Additional                    Other     During the    Stockholders'
                                   -------------------   Paid-In       Unearned   Comprehensive Development      Equity
                                     Shares    Amount    Capital     Compensation    Income        Stage        (Deficit)
                                   ---------- -------- ------------  ------------ ------------- ------------  -------------
<S>                                <C>        <C>      <C>           <C>          <C>           <C>           <C>
Initial capitalization............  1,900,000 $ 19,000 $         --  $        --    $     --    $        ---  $     19,000
Net loss..........................                                                                  (225,466)     (225,466)
                                   ---------- -------- ------------  -----------    --------    ------------  ------------
Balance at December 31, 1996......  1,900,000   19,000           --           --          --        (225,466)     (206,466)
Accretion.........................         --       --           --           --          --        (160,000)     (160,000)
Net loss..........................         --       --           --           --          --      (1,669,763)   (1,669,763)
                                   ---------- -------- ------------  -----------    --------    ------------  ------------
Balance at December 31, 1997......  1,900,000   19,000           --           --          --      (2,055,229)   (2,036,229)
Accretion.........................         --       --           --           --          --        (441,000)     (441,000)
Net loss..........................         --       --           --           --          --      (2,681,405)   (2,681,405)
                                   ---------- -------- ------------  -----------    --------    ------------  ------------
Balance at December 31, 1998......  1,900,000   19,000           --           --          --      (5,177,634)   (5,158,634)
Unearned compensation related to
 stock option grants..............         --       --    1,099,281   (1,099,281)         --              --            --
Amortization of unearned
 compensation.....................         --       --           --      290,460          --              --       290,460
Accretion.........................         --       --     (899,000)          --          --              --      (899,000)
Net loss..........................         --       --           --           --          --      (3,289,710)   (3,289,710)
                                   ---------- -------- ------------  -----------    --------    ------------  ------------
Balance at December 31, 1999......  1,900,000   19,000      200,281     (808,821)         --      (8,467,344)   (9,056,884)
Issuance of common stock..........  8,051,950   80,519  125,768,765           --          --              --   125,849,284
Conversion of preferred stock into
 common stock..................... 22,659,093  226,591   65,862,596           --          --              --    66,089,187
Issuance of common stock upon
 exercise of warrants.............    424,689    4,247      586,111           --          --              --       590,358
Issuance of common stock upon
 exercises of stock options.......     52,311      523        8,483           --          --              --         9,006
Unearned compensation related to
 stock option grants..............         --       --    2,161,427   (2,161,427)         --              --            --
Amortization of unearned
 compensation.....................         --       --           --      595,887          --              --       595,887
Deemed preferred dividends and
 accretion........................         --       --   47,457,155           --          --     (50,074,154)   (2,616,999)
Issuance of stock option awards...         --       --       47,925           --          --              --        47,925
Change in unrealized gain on
 marketable securities (Note 2)...         --       --           --           --     289,000              --       289,000
Net loss..........................         --       --           --           --          --      (3,489,725)   (3,489,725)
                                   ---------- -------- ------------  -----------    --------    ------------  ------------
Balance at December 31, 2000...... 33,088,043 $330,880 $242,092,743  $(2,374,361)   $289,000    $(62,031,223) $178,307,039
Issuance of common stock
 (unaudited)......................      5,976       60       37,150           --          --              --        37,210
Issuance of common stock upon
 exercises of stock options
 (unaudited)......................     75,922      759       16,372           --          --              --        17,131
Unearned compensation
 (unaudited)......................         --       --      (85,506)      85,506          --              --            --
Amortization of unearned
 compensation (unaudited).........         --       --           --      399,867          --              --       399,867
Change in unrealized gain on
 marketable securities
 (unaudited) (Note 2 )............         --       --           --           --     645,487              --       645,487
Net loss (unaudited)..............         --       --           --           --          --      (1,434,888)   (1,434,888)
                                   ---------- -------- ------------  -----------    --------    ------------  ------------
Balance at June 30, 2001.......... 33,169,941 $331,699 $242,060,759  $(1,888,988)   $934,487    $(63,466,111) $177,971,846
                                   ========== ======== ============  ===========    ========    ============  ============
</TABLE>

   The accompanying notes are an integral part of the financial statements.

                                      5

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                           STATEMENTS OF CASH FLOWS
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                  Six Months Ended June 30,     Period from
                                                                ---------------------------      inception
                                                                                            (August 16, 1996)
                                                                                            through June 30,
                                                                    2001           2000            2001
                                                                -------------  ------------  -----------------
<S>                                                             <C>            <C>           <C>
Cash flows from operating activities:
 Net loss...................................................... $  (1,434,888) $ (1,953,804)   $ (12,790,957)
 Adjustments to reconcile net loss to net cash used in
   operations:
   Depreciation and amortization...............................       212,579       101,419          955,812
   Amortization (accretion) of premiums (discounts) on
     securities................................................       100,978            --         (150,022)
   Non-cash stock-based expense................................       399,867       369,780        1,656,251
   Changes in operating assets and liabilities:
     Inventories and deferred costs............................      (729,251)     (435,452)      (2,378,925)
     Other current assets......................................        25,822      (736,651)      (2,876,604)
     Other assets..............................................         2,594            --         (244,295)
     Accounts payable and accrued expenses.....................      (131,676)       16,944        1,173,607
     Deferred revenue and contract advances....................       189,877       325,891        1,381,728
                                                                -------------  ------------    -------------
       Net cash used in operating activities...................    (1,364,098)   (2,311,873)     (13,273,405)
                                                                -------------  ------------    -------------
Cash flows from investing activities:
 Purchases of fixed assets.....................................      (962,978)     (335,555)      (2,800,364)
 Purchases of marketable securities............................  (124,570,625)  (50,590,806)    (311,180,648)
 Proceeds from maturities of marketable securities.............   145,077,298     4,100,462      158,838,319
                                                                -------------  ------------    -------------
       Net cash provided by (used in) investing activities.....    19,543,695   (46,825,899)    (155,142,693)
                                                                -------------  ------------    -------------
Cash flows from financing activities
 Proceeds from sale of common stock, net.......................        37,210            --      125,905,494
 Proceeds from exercise of stock options.......................        17,131         1,933           26,137
 Proceeds from exercise of warrants............................            --            --          590,358
 Proceeds from issuance of notes payable and
 warrants......................................................            --            --        2,000,000
 Proceeds from issuance of manditorily redeemable
   convertible preferred stock and warrants....................            --    50,038,159       59,488,174
                                                                -------------  ------------    -------------
       Net cash provided by financing activities...............        54,341    50,040,092      188,010,163
                                                                -------------  ------------    -------------
Net increase in cash...........................................    18,233,938       902,320       19,594,065
Cash and cash equivalents at beginning of period...............     1,360,127       580,709               --
                                                                -------------  ------------    -------------
Cash and cash equivalents at end of period..................... $  19,594,065  $  1,483,029    $  19,594,065
                                                                =============  ============    =============
</TABLE>

   The accompanying notes are an integral part of the financial statements.

                                      6

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO (UNAUDITED) CONDENSED FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS

   Proton Energy Systems, Inc. (the "Company") was incorporated in Delaware on
August 16, 1996 to design, develop and manufacture proton exchange membrane
("PEM") electrochemical products. The Company employs PEM electrochemical
products in hydrogen generation and power generating and storage devices for
use in a variety of commercial applications. The Company manufactures products
for the domestic and international industrial gas market and operates in a
single segment. The Company is considered a development stage company, as
defined in Statement of Financial Accounting Standards ("SFAS") No. 7,
"Accounting and Reporting by Development Stage Enterprises," because its
principal operations have not yet commenced.

2. BASIS OF PRESENTATION

   The financial information as of June 30, 2001, for the three-month and
six-month periods ended June 30, 2001 and 2000, and for the period from
inception (August 16, 1996) through June 30, 2001 is unaudited. In the opinion
of management, all adjustments, which consist solely of normal recurring
adjustments, necessary to present fairly in accordance with generally accepted
accounting principles, the financial position, results of operations and cash
flows for all periods presented, have been made. The results of operations for
the interim periods presented are not necessarily indicative of the results
that may be expected for the full year.

   Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted. These condensed
financial statements should be read in conjunction with the Company's audited
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K filed on March 30, 2001.

  Marketable Securities

   The Company classifies its entire investment portfolio as available for sale
as defined in SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." As of June 30, 2001, the Company's investment portfolio
consisted of U.S. government and agency securities held by two major banking
institutions. As of June 30, 2001, the maturities of marketable securities are
as follows:

              Less than one year..................... $ 81,048,425
              One to five years......................   72,378,413
                                                      ------------
                                                      $153,426,838
                                                      ============

   Securities are carried at fair value with the unrealized gains/losses
reported as a separate component of stockholders' equity. The unrealized gain
from marketable securities was $934,487 and $289,000 at June 30, 2001 and
December 31, 2000, respectively.

                                      7

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

       NOTES TO (UNAUDITED) CONDENSED FINANCIAL STATEMENTS--(Continued)


  Comprehensive Income (Loss)

   Comprehensive income (loss) is defined as investments by owners and
distributions to owners. The following table sets forth the components of
comprehensive income:

                                                  June 30,
                                          ------------------------
                                             2001         2000
                                          -----------  -----------
                                          (unaudited)  (unaudited)
            Net loss..................... $(1,434,888) $(1,953,804)
            Unrealized gains on
              marketable securities...... $   645,487           --
                                          -----------  -----------
            Total comprehensive loss..... $  (789,401) $(1,953,804)
                                          ===========  ===========

  Reclassifications

   Certain amounts in the 2000 financial statements have been reclassified to
conform with the 2001 presentation.

3. INVENTORIES

   Inventories are stated at the lower of cost or market value. Cost is
determined by the first-in, first-out method.

<TABLE>
<CAPTION>
                                            June 30,   December 31,
                                              2001         2001
                                           ----------- ------------
                                           (unaudited)
             <S>                           <C>         <C>
             Raw materials................ $  651,064   $  545,583
             Work in process..............    470,676      133,315
             Finished goods...............  1,257,185      970,776
                                           ----------   ----------
                                           $2,378,925   $1,649,674
                                           ==========   ==========
</TABLE>

4. LOSS PER SHARE

   Net loss per share has been computed by dividing the net loss attributable
to common stockholders by the weighted average common shares outstanding. No
effect has been given to the exercise of common stock options, stock warrants,
convertible notes and redeemable convertible preferred stock, since the effect
would be antidilutive for all reporting periods.

5. CAPITAL STRUCTURE

   In April 2000, the Company issued 14,306,901 shares of Series C Preferred
Stock for $3.50 per share for gross proceeds of approximately $50 million.
Concurrent with the issuance of the Series C Preferred Stock, the Company
recorded a beneficial conversion charge. The beneficial conversion charge was
calculated in accordance with EITF 98-5, "Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios," and was the difference between the Series C Preferred Stock price and
the deemed fair market value of the Company's common stock into which the
Series C Preferred Stock was immediately convertible, limited to the total
Series C Preferred Stock proceeds. Accordingly, a deemed preferred dividend of
approximately $50 million as of the issuance date has been recognized as a
charge to accumulated deficit and net loss attributable to common stockholders,
and as an increase to additional paid-in capital.

                                      8

<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

       NOTES TO (UNAUDITED) CONDENSED FINANCIAL STATEMENTS--(Continued)


   In October 2000, the Company completed an initial public offering. Upon
closing the initial public offering, the outstanding shares of Series C
Preferred Stock and all other outstanding Preferred Stock automatically
converted into shares of Common Stock on a one-for-one basis.

6. STOCK OPTION GRANTS

   During 1999 and 2000, the Company issued common stock options at less than
the fair value of its common stock. The compensation expense for such options
is amortized over the vesting periods of the related options. Accordingly, the
Company recorded stock-based compensation expense of $186,633 and $116,935 for
the three-month periods ended June 30, 2001 and June 30, 2000, respectively,
and $377,246 and $202,744 for the six-month periods ended June 30, 2001 and
June 30, 2000, respectively.

7. COMMITMENTS AND CONTINGENCIES

   In November 1999, the Company entered into an agreement with a distributor
to develop, market and distribute hydrogen generators to be used solely in
laboratory applications. This agreement grants the distributor worldwide
exclusivity to the commercial sale of this product during the fifteen-year term
of the contract as long as the distributor meets minimum purchases, as defined
in the agreement. The Company retains the right to modify the contract once
annually by providing six months notice. In the six-month period ended June 30,
2001, the Company recorded a loss of $231,000 under this contract. Any future
loss recognition is contingent on the distributor placing additional orders and
the Company's cost per unit exceeding the related sale price per unit.

                                      9

<PAGE>

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
        of Operations

   The following discussion should be read in conjunction with the Financial
Statements and Notes thereto appearing elsewhere in this Form 10-Q and with our
Annual Report on Form 10-K filed for the fiscal year ended December 31, 2000.
This Form 10-Q contains forward-looking statements that involve substantial
risks and uncertainties. You can identify these statements by forward-looking
words such as "anticipate," "believe," "could," "estimate," "expect," "intend,"
"may," "plan," "potential," "should," "will," and "would" or similar words. You
should read statements that contain these words carefully because they discuss
our future expectations and contain projections of our future results of
operation or of our financial position or state other forward-looking
information. However, there may be events in the future that we are unable to
predict accurately or control. The factors in the section captioned "Certain
Factors That May Affect Future Results," contained in our Annual Report on Form
10-K filed for the fiscal year ended December 31, 2000, and below in this Form
10-Q under the "Legal Proceedings" caption, provide examples of risks,
uncertainties, and events that may cause our actual results to differ
materially from the expectations we describe in our forward-looking statements.

Overview

   We were founded in 1996 to design, develop and manufacture PEM
electrochemical products for commercial applications. Our proprietary PEM
technology is incorporated in two families of products: hydrogen generators,
late-stage development models of which we are currently manufacturing and
delivering to customers, and regenerative fuel cell systems, which we are
currently developing. Since our inception, we have funded our operations
through private financings that raised approximately $61.6 million, including
$50.1 million raised in a private financing in April 2000, and an initial
public offering in October 2000 which raised net proceeds of approximately
$125.8 million.

   We began delivering late-stage development models of our hydrogen generators
to customers in 1999; revenue on such transactions has generally been deferred.
Currently, recognition of product revenue is deferred until the expiration of
the product warranty period. In the future, product revenue will be recognized
at the earlier of warranty expiration or when estimates of warranty obligations
can be made. As of June 30, 2001, we have deferred revenue of approximately
$1.3 million related to the units we have delivered. In the future, we expect
to derive the majority of our revenue from the sale of the hydrogen generator
and regenerative fuel cell systems products we may develop.

   We derive contract revenue from customer-sponsored research and development
contracts related to our PEM technology. For those contracts that do not
require us to meet specific obligations, we recognize contract revenue
utilizing the percentage-of-completion method, which is based on the
relationship of costs incurred to total estimated contract costs. For those
research and development contracts that require us to meet specified
obligations, including delivery and acceptance obligations, amounts advanced to
us pursuant to the contracts are recognized as contract liabilities until such
obligations are met. Once the obligations are met, the amounts are recognized
as contract revenue. From inception through June 30, 2001, we have recognized
approximately $2.0 million in contract revenue from research and development
funding under arrangements with both government and private sources. Under
these contracts, we have delivered HOGEN(R) hydrogen generators and
demonstration regenerative fuel cell systems. We currently have ongoing
research and development projects with both NASA and the United States
Department of Energy, or DOE. Our current NASA contract extends to October 2001
and provides for total payments to us of approximately $600,000, of which we
had recognized approximately $482,000 in revenue through June 30, 2001. The DOE
contract extends to September 2002 and provides for payments to us of
approximately $1.3 million, of which we have recognized approximately $591,000
in revenue through June 30, 2001.

   During the second quarter of 2001, we entered into a contract with STM Power
to develop and deliver specialized hydrogen generators. The contracts calls for
total payments to us of approximately $395,000 of which

                                      10

<PAGE>

$44,000 has been received and is recorded in customer advances at June 30,
2001. Through June 30, 2001, no revenue has been recognized under this
contract.

   Our costs of contract revenue reflect costs incurred under specific
customer-sponsored research and development contracts. These costs consist
primarily of salaries and benefits for our research and development personnel,
materials to build prototype units, materials for testing, facility-related
costs, operating supplies and other costs associated with our research and
development contract. We expect our costs of contract revenue to increase as we
complete work under existing contracts.

   Our costs of production reflect costs incurred in the manufacture of our
products and costs incurred for warranty obligations on our products. These
costs consist primarily of product materials, fees paid to outside suppliers
for subcontracted components and services, salaries and benefits for our
manufacturing personnel, facility-related costs, operating supplies and other
costs associated with our manufacturing activities. Through June 30, 2001,
amounts reported as costs of production include costs incurred in excess of the
corresponding sales price on deferred units, costs incurred to service units in
the field and costs recognized on units upon the expiration of product
warranties.

   Our research and development expenses reflect costs incurred for internal
research and development projects conducted without specific customer-sponsored
contracts. These costs consist primarily of salaries and benefits for our
research and development personnel, materials to build prototype units,
materials for testing, consulting expenses, facility-related costs, operating
supplies and other costs associated with our internal research and development
activities. We expect our research and development expenses to increase as we
increase our internal research and product development activities.

   Our general and administrative expenses consist primarily of salaries and
benefits for sales and administrative personnel, professional fees for
recruiting, legal and accounting services, training expenses, travel costs,
rent, utilities and other general office expenses. We expect our general and
administrative expenses to increase as we continue to invest in our employees,
increase our recruiting efforts, expand our infrastructure and incur additional
costs related to the growth of our business and operations as a public company.

   We have generated cumulative losses since our inception, and as of June 30,
2001 our accumulated deficit was $63.5 million, of which $50.7 million is
attributable to deemed preferred dividends and accretion and $12.8 million is
attributable to net losses since inception. We expect to continue to make
significant investments in new product design and development for the
foreseeable future. We expect to incur operating losses in 2001 and for the
next several years and cannot predict when we will become profitable, if ever.

Results of Operations

  Comparison of the Three Months Ended June 30, 2001 and June 30, 2000

   Contract revenue. Contract revenue increased from $131,000 for the three
months ended June 30, 2000 to $220,000 for the comparable period in 2001. This
increase was due to research and development activity related to Proton's
HOGEN(R) hydrogen generator under the DOE contract. In the future, we expect
contract revenue from government-sponsored research and development contracts
to decrease as a percentage of total revenues as we begin to recognize
increasing levels of revenue from product sales.

   Product revenue. Product revenue increased from $0 in the second quarter of
2000 to $335,000 for the second quarter of 2001. The amount in 2001 relates to
previously deferred revenue on products for which warranties have expired and
from product rentals.

   Costs of contract revenue. Costs of contract revenue increased from $61,000
for the second quarter of 2000 to $224,000 for the second quarter of 2001. The
amount in 2000 reflects costs incurred on our DOE and

                                      11

<PAGE>

NASA contracts. The amount in 2001 reflects costs incurred under the DOE
contract. The increase in 2001 is due to increased activity on our cost-sharing
DOE contract coupled with lower average reimbursed billing rates.

   Costs of production. Costs of production increased from $0 for the second
quarter of 2000 to $572,000 for the second quarter of 2001. The amount in 2001
reflects costs associated with manufacturing and delivering our hydrogen
generators which is in excess of the corresponding sales price as well as
warranty costs on units in the field. In addition, cost of production also
includes approximately $307,000 of cost recognized concurrent with the
recognition of revenue upon warranty expiration. In the second quarter of 2001,
costs incurred in excess of our contracted sales price with Matheson Tri-Gas,
Inc. approximated $119,000. To date, under our initial order, we have
recognized costs in excess of our contracted sales price with Matheson Tri-Gas,
Inc. in the amount of $353,000. We expect to continue to incur costs in excess
of our sales price under our contract with Matheson Tri-Gas, Inc. as we refine
our production process.

   Under the Matheson Tri-Gas contract, Matheson has the exclusive right to
sell our hydrogen generators if it meets minimum purchase requirements
specified in the contract. Because we have not yet completed development of
commercial models of these units, no minimum purchase requirements are
applicable to Matheson prior to December 31, 2001. For periods after December
31, 2001, the contract currently provides that Matheson must purchase 1,000
units per year if it wishes to maintain exclusivity. Under the contract, we
have the right to increase prices on the units once annually by providing six
months notice, subject to either party's right to terminate the contract if
agreement on price increases is not reached. We anticipate that the terms of
the contract may be revised as commercial development is completed. Any future
recognition of losses by us under this contract will depend on the number of
orders placed by Matheson and the extent to which our cost per unit exceeds the
sale price per unit.

   Research and development expenses. Research and development expenses
increased from $634,000 for the second quarter of 2000 to $1.4 million for the
second quarter of 2001. The increase was due to an increase in our research and
development activities related to our PEM technology in our regenerative fuel
cell systems and our hydrogen generators. These research and development
activities primarily related to increased salaries and benefits for our growing
research and development staff and materials to support our research and
development projects. We expect our research and development expenses to
continue to increase in the future.

   General and administrative expenses. General and administrative expenses
increased from $827,000 for the second quarter of 2000 to $1.8 million for the
second quarter of 2001. This change reflects an increase in salaries and
benefits of $407,000, as a result of an increase in employees, an increase in
accounting and legal expenses of $161,000, an increase of $171,000 in investor
relation and annual report related expenses, and an increase of $75,000 for
state minimum capital-based taxes.

   Interest income, net. Interest income increased from $647,000 for the second
quarter of 2000 to $2.3 million for the second quarter of 2001. The increase
resulted from increased cash and marketable securities as a result of investing
the proceeds from the issuance of our series C convertible preferred stock and
initial public offering.

  Comparison of the Six Months Ended June 30, 2001 and June 30, 2000

   Contract revenue. Contract revenue increased from $187,000 for the six
months ended June 30, 2000 to $407,000 for the comparable period in 2001. This
increase was due to research and development activity related to Proton's
HOGEN(R) hydrogen generator under the DOE contract. In the future, we expect
contract revenue from government-sponsored research and development contracts
to decrease as a percentage of total revenues as we begin to recognize
increasing levels of revenue from product sales.

   Product revenue. Product revenue increased from $0 in the six months of 2000
to $387,000 for the comparable period of 2001. The amount in 2001 relates to
previously deferred revenue on products for which warranties have expired and
from product rentals.

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<PAGE>

   Costs of contract revenue. Costs of contract revenue increased from $88,000
for the first six months of 2000 to $429,000 for the comparable period of 2001.
The amount in 2000 reflects costs incurred on our DOE and NASA contracts. The
amount in 2001 reflects costs incurred under the DOE contract. The increase in
2001 is due to increased activity on our cost-sharing DOE contract coupled with
lower average reimbursed billing rates.

   Costs of production. Costs of production increased from $116,000 for the
first six months of 2000 to $815,000 for the comparable period of 2001. The
amounts in 2000 and 2001 reflect costs associated with manufacturing and
delivering our hydrogen generators which is in excess of the corresponding
sales price as well as warranty costs on units in the field. In addition, cost
of production includes cost recognized concurrent with the recognition of
revenue upon warranty expiration.

   Research and development expenses. Research and development expenses
increased from $1.2 million for the first six months of 2000 to $2.5 million
for the comparable period of 2001. The increase was due to an increase in our
research and development activities related to our PEM technology in our
regenerative fuel cell systems and our hydrogen generators. These research and
development activities primarily related to increased salaries and benefits for
our growing research and development staff and materials to support our
research and development projects. We expect our research and development
expenses to continue to increase in the future.

   General and administrative expenses. General and administrative expenses
increased from $1.4 million for the first six months of 2000 to $3.4 million
for the comparable period of 2001. This change reflects an increase in salaries
and benefits of $814,000, as a result of an increase in employees, an increase
in accounting and legal expenses of $227,000, an increase of $276,000 in
investor relation and annual report related expenses, and an increase of
$150,000 for state minimum capital-based taxes.

   Interest income, net. Interest income increased from $682,000 for the first
six months of 2000 to $4.9 million for the comparable period of 2001. The
increase resulted from increased cash and marketable securities as a result of
investing the proceeds from the issuance of our series C convertible preferred
stock and initial public offering.

Liquidity and Capital Resources

   Since our inception in August 1996 through June 2001, we have financed our
operations through the series A, A-1, B, B-1 and C convertible preferred stock
issuances and our initial public offering that raised approximately $187.4
million. As of June 30, 2001, we had $173.0 million in cash, cash equivalents
and marketable securities.

   Cash used in operating activities was $1.4 million for the six months ended
June 30, 2001 and was primarily attributable to our net loss and increases in
inventory and deferred cost as well as decreases in accrued expenses, offset by
increases in deferred revenue. Cash used in operating activities was $2.3
million for the comparable 2000 period and was primarily attributable to our
net loss and increases in inventory and other current assets, offset by
increases in deferred revenue.

   Cash provided by investing activities was $19.6 million for the six months
ended June 30, 2001 and was primarily attributable to proceeds from the
maturity of marketable securities offset by purchases of marketable securities.
Cash used in investing activities was $46.8 million for the six months ended
June 30, 2000 and was primarily attributable to purchases of marketable
securities.

   Cash provided by financing activities was $50.0 million for the six months
ended June 30, 2000 resulting from the issuance of Series C Convertible
Preferred Stock.

   We anticipate that our cash and marketable securities on hand as of June 30,
2001 will be adequate to fund our operations, working capital and capital
expenditure requirements for at least the next 12 months. We have

                                      13

<PAGE>

entered into an agreement to purchase approximately 44 acres of land in
Wallingford, CT to build our new manufacturing facility. We currently
anticipate relocating to our planned manufacturing facility in the next 12
months. We would expect to spend approximately $12 -$15 million over the next
12 to 15 months in connection with this facility. We also expect over the next
12 months to continue to fund the production and further development of our
hydrogen generators and to continue our research and development activities on
our regenerative fuel cell systems. We cannot assure you that we will not
require additional financing to fund our operations or that, if required, any
further financing will be available to us on acceptable terms, or at all. If
sufficient funds are not available, we may be required to delay, reduce or
eliminate some of our research and development or manufacturing programs. The
terms of any additional financing may require us to relinquish rights to our
technologies or potential products or other assets.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

   We hold marketable securities consisting of U.S. government obligations that
are held by two major banking institutions. We do not hold derivative financial
instruments. Interest rate risk is the major price risk facing our investment
portfolio. Such exposure can subject us to economic losses due to changes in
the level or volatility of interest rates. Generally, as interest rates rise,
prices for fixed income instruments will fall. As rates decline the inverse is
true. We attempt to mitigate this risk by investing in high quality issues of
short duration. We do not expect any material loss from our marketable
securities investments and believe that our potential interest rate exposure is
not material.

                                   PART II.

                               OTHER INFORMATION

ITEM 1. Legal Proceedings

   Between July 3, 2001 and July 13, 2001, several purported class action
lawsuits were filed in the United States District Court for the Southern
District of New York against us and several of our officers and directors as
well as against the underwriters who handled our September 28, 2000 initial
public offering ("IPO") of common stock. Although we have not been served with
all of the complaints, the complaints were filed allegedly on behalf of persons
who purchased the Company's common stock from September 28, 2000 through and
including December 6, 2000. The complaints are similar, and allege violations
of the Securities Act of 1933 and the Securities Exchange Act of 1934 primarily
based on the assertion that there was undisclosed compensation received by the
Company's underwriters in connection with our IPO.

   Although neither we nor the individual defendants have filed answers in any
of these matters, we believe that the individual defendants and we have
meritorious defenses to the claims made in the complaints and intend to contest
the lawsuits vigorously. However, there can be no assurance that we will be
successful, and an adverse resolution of the lawsuits could have a material
adverse effect on our financial position and results of operation in the period
in which the lawsuits are resolved. We are not presently able to reasonably
estimate potential losses, if any, related to the lawsuits. In addition, the
costs to us of defending any litigation or other proceeding, even if resolved
in our favor, could be substantial. Such litigation could also substantially
divert the attention of our management and our resources in general.
Uncertainties resulting from the initiation and continuation of any litigation
or other proceedings could harm our ability to compete in marketplace.

ITEM 2. Changes in Securities and Use of Proceeds

   On October 4, 2000, we closed an initial public offering of our common
stock. The effective date of the Securities Act registration statement for
which the use of proceeds information is being disclosed was September 28,
2000, and the Commission file number assigned to the registration statement is
333-39748. After deducting underwriting discounts and commissions and offering
expenses, our net proceeds from the offering

                                      14

<PAGE>

were approximately $125.8 million. The net proceeds have been allocated for
general corporate purposes and capital expenditures, including purchase of
equipment for and leasehold improvements to our planned manufacturing facility,
and the possible acquisition of businesses, products or technologies that are
complementary to our business. As of June 30, 2001, approximately $3.3 million
of the net proceeds of the offering had been used to fund operations. The
remaining net proceeds are invested in U.S. government securities and agencies.
None of the proceeds were paid directly or indirectly to any director, officer
or general partner of us or our associates, persons owning ten percent or more
of any class of our equity securities, or an affiliate of us.

ITEM 3. Default upon Senior Securities

   Not Applicable.

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


   At the Company's Annual Meeting of Stockholders ("Annual Meeting") held on
June 12, 2001, the Company's Stockholders approved the following:

   (1) To elect the following directors as Class I Directors, each to serve
       until the Company's 2004 annual meeting of stockholders and until his
       successor is duly elected and qualified:

<TABLE>
<CAPTION>
                                                                Against/  Broker
Nominee                                       For     Withheld  Abstain  NonVotes
-------                                    ---------- --------- -------- --------
<S>                                        <C>        <C>       <C>      <C>
Gerald B. Ostroski........................ 27,501,782   449,188      --     --
Philip R. Sharp........................... 27,501,782   449,188      --     --
(2) To approve the continuance
    of the 2000 Stock Incentive Plan...... 25,940,619 1,983,963  26,388     --
(3) To ratify the selection of the
    Board of Directors of
    PricewaterhouseCoopers LLP as the
    Company's independent auditors for
    the current fiscal year............... 27,934,105     7,985   8,880     --
</TABLE>

ITEM 5. Other Information

   Not Applicable.

ITEM 6. Exhibits and Reports on Form 8-K

   (a) Exhibits

       None.

   (b) Reports on Form 8-K

       None.

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<PAGE>

                                  SIGNATURES

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                          PROTON ENERGY SYSTEMS, INC.
                                          (Registrant)

                                          By:
                                             /S/ WALTER W. SCHROEDER

                                             -----------------------------------
                                             Walter W. Schroeder
                                             President and Chief Executive
                                             Officer

                                          By:
                                             /S/ JOHN A. GLIDDEN

                                             -----------------------------------
                                             John A. Glidden
                                             Vice President of Finance
                                             (Principal Financial and
                                             Accounting Officer)

Date: August 10, 2001

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