<PAGE>

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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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

                                   FORM 10-K

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X]FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE
   SECURITIES EXCHANGE ACT OF 1934

  For the fiscal year ended December 31, 2000

                                       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)

<TABLE>
<CAPTION>
                  Delaware                                       06-1461988
<S>                                            <C>
       (State or Other Jurisdiction of                        (I.R.S. Employer
       Incorporation or Organization)                       Identification No.)
</TABLE>

                      50 INWOOD ROAD, ROCKY HILL, CT 06067
                    (Address of principal executive offices)

                                 (860) 571-6533
               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, $.01 par value

   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 the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

   The aggregate market value of the voting stock held by non-affiliates of the
Registrant on March 23, 2001 was approximately $248,300,000 based on the price
of the last reported sale as reported by The Nasdaq Stock Market on March 23,
2001. The number of shares outstanding of the Registrant's Common Stock on
March 23, 2001 was 33,109,836.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Portions of the registrant's definitive proxy statement in connection with
the annual meeting of stockholders to be held on June 12, 2001 are incorporated
by reference in Part III hereof.

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--------------------------------------------------------------------------------
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

                                     INDEX

<TABLE>
<CAPTION>
 Description                                                        Page Number
 -----------                                                        -----------
                                     PART I

 <C>         <S>                                                    <C>
 Item 1      Description of Business.............................         3
 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 Stock and Related
              Stockholder Matters ...............................        13
 Item 6      Selected Financial Data.............................        14
 Item 7      Management's Discussion and Analysis of Financial
              Condition and Results of Operations................        14
 Item 7A     Quantitative and Qualitative Disclosures About
              Market Risk........................................        27
 Item 8      Financial Statements and Supplementary Data.........        27
 Item 9      Changes in and Disagreements with Accountants on
              Accounting and Financial Disclosure................        44

                                    PART III

 Item 10     Directors and Executive Officers of the Registrant..        45
 Item 11     Executive Compensation..............................        45
 Item 12     Security Ownership of Certain Beneficial Owners And
              Management ........................................        45
 Item 13     Certain Relationships and Related Transactions......        45

                                    PART IV

 Item 14     Exhibits, Financial Statement Schedules and Reports
              on Form 8-K........................................        46
 Signatures.......................................................       48
</TABLE>
<PAGE>

   This report contains forward-looking statements for purposes of the safe
harbor provisions under The Private Securities Litigation Reform Act of 1995.
Statements contained herein that are not statements of historical fact may be
deemed to be forward-looking information. Without limiting the foregoing, words
such as "anticipates," "believes," "could," "estimate," "expect," "intend,"
"may," "might," "should," "will" and "would" and other forms of these words or
similar words are intended to identify forward-looking information. You should
read these statements carefully, because Proton's actual results may differ
materially from those indicated by these forward-looking statements as a result
of various important factors. Proton disclaims any obligation to update these
forward-looking statements. Our actual results could differ significantly from
those anticipated in these forward looking statements as a result of certain
factors, including those set forth below under "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Certain Factors That
May Affect Future Results." You should also carefully review the risks outlined
in other documents that we file from time to time with the Securities and
Exchange Commission, including our Quarterly Reports on Form 10-Q that we file
in 2001.

   HOGEN(R), PROTON(R), UNIGEN(R), and FUELGEN(TM) are trademarks or service
marks of Proton. Chrysalis(TM) is a trademark of Matheson Tri-Gas, Inc. Other
trademarks or service marks appearing in this report are the property of their
respective holders.

                                     PART I

ITEM 1. Description of Business

The Company

   We were founded in 1996 to design, develop and manufacture proton exchange
membrane, or PEM, electrochemical products. Our proprietary PEM technology is
embodied in two families of products: hydrogen generators and regenerative fuel
cell systems. Our hydrogen generators produce hydrogen from electricity and
water in a clean and efficient process. We are currently manufacturing and
delivering late-stage development models of our hydrogen generators to
customers for use in commercial applications. Our regenerative fuel cell
systems, which we are currently developing, will combine our hydrogen
generation technology with a fuel cell power generator to create an energy
device that is able to produce and store the hydrogen fuel it can later use to
generate electricity. By providing the hydrogen fuel used by fuel cells, our
core technology can enable fuel cells to function not only as power generating
devices, but also as energy storage devices.

   We are designing our products to meet the needs of attractive near-term and
longer-term markets. Our hydrogen generators have been designed to address the
existing demand for on-site hydrogen gas generation in a variety of
manufacturing and laboratory applications which we believe will provide a
lower-cost, safer and more convenient alternative to conventionally delivered
hydrogen. In the longer term, as fuel cell markets develop, we believe our
hydrogen generators can be a key component of the hydrogen supply
infrastructure that will be needed to provide the hydrogen used by fuel cells
in transportation, stationary power generation and portable power generation
applications. We are developing our regenerative fuel cell systems to address
the demand for highly reliable backup power systems. In particular, the
increased use of computers, computer networks and communications networks in
the Internet economy, as well as the increased use of sensitive electronics in
manufacturing, are all creating an increase in the demand for highly reliable
backup power to avoid the costs and lost revenue associated with power
disruptions. In addition, we believe that in the longer term our regenerative
fuel cell systems may enable renewable energy solutions by facilitating the
storage of energy produced by non-depleting, non-polluting energy sources, such
as solar, wind and hydroelectric power.

   We believe we are among the first companies to manufacture and deliver
systems incorporating PEM technology for use in commercial applications. In the
first quarter of 2000, we began shipping late-stage development models of our
hydrogen generators to customers for use in industrial applications. The goal
of our development program for 2001 is to finalize the commercial design of our
hydrogen generators and deliver additional units to customers seeking
alternatives to conventionally delivered hydrogen. We also have an

                                       3
<PAGE>

agreement with a leading supplier of laboratory gases under which it plans to
distribute our line of smaller scale hydrogen generators for laboratory use. In
the longer term, we also intend to develop commercial applications for our
regenerative fuel cell technology. We manufactured and delivered two
demonstration regenerative fuel cell systems in 1999 and have entered into an
agreement with NASA to develop a larger, second-generation regenerative fuel
cell system to be delivered in 2001. This next-generation system is being
designed to have the scale and technical attributes necessary to serve a broad
range of commercial applications. Our goal is to deliver our first commercially
configured regenerative fuel cell system for field-testing in late 2002.

   In October 2000, we completed an initial public offering of 8,050,000 shares
of common stock, including 1,050,000 shares sold pursuant to the underwriters'
exercise of their over-allotment option (the "Offering"), at an offering price
of $17.00 per share.

Products

 Hydrogen Generators

   Our HOGEN hydrogen generators convert water and electricity into high
purity, pressurized hydrogen gas, using PEM electrolysis. PEM electrolysis is a
process in which water is divided into its component elements to produce pure
hydrogen gas, with oxygen and heat as the only by-products. Users can connect
our hydrogen generators directly to existing water and electrical sources,
allowing them to be installed and used in a wide range of locations.

   We have shipped late-stage development models of our HOGEN hydrogen
generators with 20 and 40 cubic feet per hour hydrogen production capacities,
and have shipped alpha versions of our 380 cubic feet per hour capacity unit.
Our HOGEN 20 and HOGEN 40 units are freestanding, roughly the size of a
household washing machine, and are intended for indoor use. Our HOGEN 380 is a
larger freestanding unit with a weatherized design for outdoor use. We are
continuing testing of and preparing to manufacture hydrogen generators to be
marketed under the Chrysalis brand name by Matheson Tri-Gas, Inc. under a long-
term agreement for use in laboratory applications. These units are compact and
designed to sit on a laboratory countertop.

   Our FUELGEN high pressure hydrogen production and refueling system currently
under development, is being designed to produce high purity hydrogen for
vehicular and portable power applications.

 Regenerative Fuel Cell Systems

   The UNIGEN regenerative fuel cell systems we are developing will integrate
PEM hydrogen generation technology with PEM fuel cell technology to create a
power generation device that produces hydrogen from water and electricity,
stores the hydrogen and later uses the hydrogen as fuel for the production of
electricity. In the hydrogen generation mode, the regenerative fuel cell works
exactly like a hydrogen generator, producing hydrogen at pressures suitable for
storage without compressors. In the power generation mode, the process is
reversed and the stored hydrogen is combined with air to produce electricity
instantaneously, efficiently and without any harmful by-products. We believe
that our regenerative fuel cell architecture can also be used by other fuel
cell manufacturers to enable their fuel cells to become energy storage devices.

   We currently have ongoing research programs related to our regenerative fuel
cell systems with both the United States Department of Energy, or DOE, and NASA
for use in ongoing research programs. The DOE program is focused on hydrogen
generation and storage from renewable energy sources. The NASA program is
concentrated on advanced fuel cell and system integration hardware for a
second-generation regenerative fuel cell system. We believe that as a result of
our involvement in these programs, we will be well positioned to develop
regenerative fuel cell systems that address the 0.5 to 25 kilowatt commercial
backup power market.

   For those research and development programs that require us to meet specific
obligations as defined in the agreements (including delivery and acceptance of
units), amounts advanced pursuant to contracts are recognized as liabilities
until such obligations are met. Once the obligations are met, the amounts are

                                       4
<PAGE>

recognized as contract revenue. For those research and development programs
which do not require us to meet specific obligations, we recognize customer
funding as contract revenue utilizing the percentage of completion method,
which is based on the relationship of costs incurred to total estimated
program costs.

   For the years ended December 31, 2000 and 1999, contract revenue recognized
from ongoing government research programs comprised approximately 92% and 60%
of total revenue, respectively. The research programs are expected to be
completed by the fourth quarter of 2002. In the future, we anticipate our
involvement in government research programs to decline and expect to derive
the majority of our revenue from the sale of hydrogen generators and
regenerative fuel cell system products.

Product Milestones

   The following are major milestones we have achieved in developing and
commercializing our technology:

<TABLE>
<CAPTION>
 Date                   Milestone
 ----                   ---------
 <C>                    <S>
 September 1996         Built proof-of-concept demonstration models of our
                        hydrogen generator and regenerative fuel cell system
                        technology.

 May 1998               Delivered prototype HOGEN hydrogen generator to NASA.

 April 1999             Commenced field testing of our HOGEN 380 hydrogen
                        generator.

 June 1999              Delivered prototype 50 watt UNIGEN regenerative fuel
                        cell system to NASA.

 September 1999         Delivered prototype 250 watt UNIGEN regenerative fuel
                        cell system to EPRI.

 October 1999           Demonstrated our renewable energy storage concept using
                        our HOGEN hydrogen generator in a DOE sponsored
                        program.

 November 1999          Delivered late-stage development model of our HOGEN 20
                        hydrogen generator to a customer for commercial
                        application.

 November 1999          Signed our agreement with Matheson Tri-Gas, Inc. for
                        distribution of our laboratory hydrogen generators
                        under the Chrysalis brand name.

 January 2000           Delivered late-stage development model of our HOGEN 40
                        hydrogen generator to a customer for commercial
                        application.

 August 2000            Achieved ISO9001 registration.

 November 2000          Joined California Fuel Cell Partnership as Associate
                        Member.

 January--December 2000 Delivered additional late-stage development models of
                        our HOGEN 40 series hydrogen generators to nine
                        customers for commercial applications.
</TABLE>

Our Strategy

   Our objective is to be a leader in harnessing PEM technology for a number
of commercial applications. Our strategy for achieving this objective includes
the following elements:

 Leverage Technological Position

   In developing PEM technology, we have focused on two key areas: the
development of PEM hydrogen generators and the development of regenerative
fuel cell systems. We believe these technologies provide us with the
opportunity to develop innovative products that address attractive markets. In
addition, our technology is complementary to other fuel cell technologies and
could enable the commercial use of other fuel cell products, such as vehicular
fuel cells, by providing a hydrogen delivery infrastructure. For example, our
hydrogen generators could be deployed at refueling sites to provide hydrogen
for fuel cell vehicle fleets. As a

                                       5
<PAGE>

result, we believe we are also well positioned to benefit from further
developments by other fuel cell developers and from increases in demand for
their fuel cell products. We intend to maintain our technology leadership in
PEM-based hydrogen generation and regenerative fuel cell system technology by
continuing to develop our core technology, develop our commercial manufacturing
processes and improve the design and features of our products.

 Focus on Near-Term Market Opportunities

   We believe we are among the first companies to manufacture and deliver
systems incorporating PEM technology for use in commercial applications. We
intend to focus on designing and marketing our products in the near term for
two primary markets: hydrogen generation for industrial applications and backup
power for communications network-related applications. We believe the
industrial gas market is an attractive market for us because it is well
developed and our hydrogen generator products will offer cost and safety
advantages to users that currently rely on conventionally delivered hydrogen.
We believe the backup power market for the communications industry is also
attractive given its large size and the advantages our regenerative fuel cell
systems are being designed to offer over existing products. Our focus on near-
term market opportunities will continue to reinforce our emphasis on the
commercial application of PEM technology.

 Continue Focus on Cost Reduction

   Given our focus on commercial applications for PEM technology, manufacturing
improvements are a critical element of our product development and design
efforts. We intend to continue to focus on reducing the cost of manufacturing
our products. We will seek to reduce costs in part through the simplification
of our product designs, identification and use of lower cost materials and
components, development of long-term relationships with third-party component
and raw material suppliers and construction of larger-scale manufacturing
facilities that will use higher volume, streamlined processes.

 Develop Key Strategic Relationships

   We intend to establish strategic relationships with leading companies in our
target markets. The strategic relationships we develop may include joint
development efforts and sales and marketing agreements. At present, we are in
various stages of discussions with potential partners, including industrial gas
suppliers and distributors, energy producers, backup power providers and
renewable energy companies. Beyond the marketing agreement with Matheson Tri-
Gas for our laboratory generators, we do not have definitive, binding
agreements with any of these parties. In seeking to develop strategic
relationships, we will focus on partners that can provide us with distribution
channels for our products and assist us in the design, development and
manufacture of new products. We believe that our demonstrated capabilities in
PEM technology and our focus on creating commercial applications make us an
attractive potential partner for many established companies seeking to gain
access to fuel cell-related technology.

 Position Our Technology for Longer-Term Opportunities

   We believe we are well positioned to take advantage of growth in the markets
for fuel cell applications and renewable power technologies. If fuel cell
applications achieve commercial acceptance, our hydrogen generators can be a
key component of the hydrogen supply infrastructure that will be required. We
intend to work with leading energy and power companies to position our hydrogen
generators for automotive refueling applications. With respect to renewable
power, as developers of renewable technologies, especially wind and solar
power, achieve cost and performance improvements, the need to overcome the
intermittent characteristics of renewable power will become even more
important. Accordingly, we plan to work with renewable energy companies to
explore and develop energy storage applications using our regenerative fuel
cell architecture.

                                       6
<PAGE>

Our Technology

 PEM-Based Hydrogen Generators

   Our hydrogen generators are electrochemical devices that convert water and
electricity into hydrogen gas using a process known as PEM electrolysis. The
core of a PEM hydrogen generator is an electrolysis cell consisting of a solid
electrolyte proton exchange membrane. Catalyst material is bonded to both sides
of the membrane, forming two electrodes. To generate hydrogen, water is
introduced to one side of the membrane and voltage is applied to the
electrodes. This process divides the water into protons, electrons and oxygen.
The protons are drawn through the proton exchange membrane and recombined with
the electrons at the opposite side of the membrane to form hydrogen. The oxygen
is removed from the cells with the excess water flow. This process produces
hydrogen with a high level of purity and at significant pressures.

   A single electrolysis cell is typically integrated into a complete cell
assembly that includes flowfield structures that provide mechanical support,
conduct current and provide a means to introduce water and remove gases. These
cell assemblies are stacked and compressed between two end plates along with
other support components to form a complete cell stack. The hydrogen production
capability of a cell stack is approximately proportional to the area of each
cell, the number of cells in the stack and the electric current supplied.

   We have delivered several late-stage development units of our HOGEN 20 and
40 hydrogen generators. The Chrysalis hydrogen generator is currently in the
market introduction phase. In some cases, these units have not met product
specifications for applications requiring very low water vapor levels in the
product gas however, we have refined certain components of our product to
mitigate this situation. In addition, some of our HOGEN 20 and 40 units have
not achieved satisfactory hydrogen sealing performance when operated at full
output over extended trials. We currently are evaluating and testing technical
solutions to these issues.

   Our HOGEN 380 model has successfully completed prototype testing and our
plan is to continue field-testing in 2001. To date, our prototypes have
demonstrated successful integration of system fluids, electrical and control
elements as well as effective electrochemical performance. We are currently
working to improve long-term sealing of the individual cell stack components,
system thermal regulation and product gas dryer control.

 PEM-Based Fuel Cell Power Generators

   In our PEM fuel cell, which uses technology similar to our PEM electrolysis
cell, the opposite reaction occurs. To generate electricity, hydrogen and air,
or oxygen, are introduced to opposite sides of the cell. The hydrogen passes
over an electrode structure adjacent to the proton exchange membrane, where it
is divided into its component protons and electrons. When the electrons are
separated from the protons, the electrons are conducted in the form of a usable
electric current. The protons travel through the proton exchange membrane and
recombine with the electrons and oxygen to produce electricity and water.

   To form a complete fuel cell stack, individual PEM fuel cells are stacked
and compressed between two end plates. The electrical power production of a
cell stack is approximately proportional to the area of each cell and the
number of cells in the stack.

   Our regenerative fuel cell systems incorporate the ability to support both
an electrolysis reaction and a fuel cell reaction. Our proprietary design
allows a single cell to operate as an electrolysis cell using water and
electricity to generate hydrogen and oxygen at elevated pressure and then
reverse the process and consume the hydrogen to generate electricity. The
resulting product functions like a rechargeable battery in which hydrogen is
produced through electrolysis, stored and then used for power generation.
Unlike one-way fuel cells, because our regenerative fuel cell systems use
hydrogen produced through electrolysis rather than extracted from hydrocarbon
fuels, electricity can be produced at room temperature, without lengthy start-
up times or

                                       7
<PAGE>

carbon-based emissions and in areas where fossil fuels such as natural gas,
propane or gasoline are not available. These fuel cell systems operate on pure
hydrogen, rather than impure reformate, improving their potential power output
and reducing the risk of contamination.

   Through our internal research and development activity and efforts under our
NASA and EPRI contracts, we have successfully demonstrated our regenerative
fuel cell technology at levels ranging from 50 to 500 watts in various proof-
of-concept hardware configurations. As part of this effort, we have developed
proprietary reversible electrode materials and structures, developed high
performance flow field technology, incorporated high pressure sealing features
into the cell architecture and performed comprehensive systems integration. We
have also demonstrated automated reversible systems in the laboratory.

   We are currently developing prototype units having a power capacity of one
to two and one half kilowatts. We believe these units will serve as a building
block for scale-up to multikilowatt products for backup power applications. We
must do additional work to verify the impact of large numbers of reversible
cycles on cell and system architecture, to simplify the system design to
provide higher reliability and lower product costs, and to develop and
implement low cost cell materials.

Research and Development

   A portion of our research and development has been funded by customer-
sponsored research programs, and is classified as costs of contract revenue in
our financial statements. For the years ended December 31, 2000, 1999, and
1998, total research and development expenses, excluding amounts received from
customer-sponsored research programs, were $3.2 million, $2.2 million and $1.3
million, respectively.

Proprietary Technology

   We have developed proprietary technology relating to various aspects of our
electrolysis cells, regenerative fuel cell systems and related systems. These
include:

  . membrane processing technology;

  . electrolysis catalytic electrode formulation;

  . reversible fuel cells;

  . high-pressure cell structures that simplify overall system
    implementation; and

  . integrated system designs for both hydrogen generators and regenerative
    fuel cell systems.

Distribution and Marketing

   We plan to sell our hydrogen generators primarily through distribution
arrangements with third parties and secondly through a limited direct sales
force. Because small- and medium-volume hydrogen users generally buy hydrogen
from industrial gas suppliers and distributors, we intend to focus our
marketing efforts on sales to these companies for resale to end users. By
focusing on industrial gas suppliers and distributors, we intend to maximize
our sales by leveraging their established marketing, distribution and service
channels. We currently have a development, marketing and distribution agreement
with Matheson Tri-Gas, Inc. under which Matheson has exclusive distribution
rights for hydrogen generators for the laboratory market bearing Matheson's
Chrysalis trademark or other designated commercial names. In addition, we have
a distribution agreement with Diamond Lite S.A. for distribution of our
hydrogen generators in France, Germany, Italy and 16 other countries in Western
and Central Europe. We intend to establish additional sales and distribution
arrangements with industrial gas suppliers and distributors, as well as
meteorology equipment providers and original equipment manufacturers.

   As the market to supply hydrogen fuel for fuel cell vehicles develops, we
also plan, where possible, to focus on existing distribution channels. We
believe that existing energy suppliers are likely to begin supplying new forms
of automotive fuel as they come to market. Accordingly, we intend to establish
relationships with

                                       8
<PAGE>

major energy companies to explore ways of supplying our hydrogen generators for
installation at local service stations. In addition, we believe that automobile
manufacturers providing introductory and fleet fuel cell vehicles will be
interested in our refueling technology and therefore we will seek to establish
relationships with these manufacturers.

   Currently, backup power equipment is sold by a few large manufacturers to
commercial end users through diverse reseller networks, including integrators
and qualified resellers. We plan to sell our backup power products to these
existing manufacturers, integrators and qualified resellers.

Manufacturing

   We are currently manufacturing hydrogen generators at our facility in Rocky
Hill, Connecticut. Key aspects of this process include formulation of our
proprietary catalysts, deposition of the catalyst on the proton exchange
membrane and fabrication of cells into cell stacks. The balance of the
manufacturing process consists of integrating cell stacks into systems that
perform fluids and electrical management of the electrochemical process.

   Approximately 35% of the cost of our hydrogen generation systems is
associated with our cell stack, with the balance of costs associated with
system components and assembly. We purchase raw proton exchange membrane
material from Dupont, although we have identified other companies we believe
capable of providing suitable membrane material. We purchase the other
components used in our systems from third-party suppliers. We regularly consult
with our suppliers to evaluate ways to lower the cost of other components or
subassemblies while meeting the performance needs of our products. In this
regard, we have considered and will continue to evaluate the option of having
subassemblies that we currently produce in-house produced to our specifications
by others if lower costs can be achieved. We anticipate continuing to integrate
and assemble our products at our Rocky Hill facility through at least 2001.

   In August 2000, we achieved ISO9001 registration. We believe that this
registration, a quality assurance model for companies that design, produce,
install and inspect items as part of their business will provide us with an
advantage over competitors that are not ISO9001 registered, and, in some cases,
this registration is a condition of doing business with customers.

Intellectual Property

   We rely on patent, trade secret, trademark and copyright law to protect our
intellectual property. We have four issued U.S. patents, covering a low cost
hydrogen electrochemical system design and low cost electrochemical cell
components. These patents expire on various dates between 2020 and 2021. We
also have over 35 U.S. and international patent applications on file. We seek
to protect our proprietary intellectual property, including intellectual
property that may not be patented or patentable, in part by confidentiality
agreements with our strategic partners and employees. We cannot assure you that
these agreements will not be breached, that we will have adequate remedies for
any breach or that such persons or institutions will not assert rights to
intellectual property arising out of these relationships.

Competition

   Our hydrogen generators will compete with delivered hydrogen, and with
alternative equipment used to manufacture pure hydrogen or hydrogen-rich gas.
Competitors in the delivered hydrogen market include Air Liquide, Air Products
and Chemicals, Linde and Praxair. Our hydrogen generators will also compete
with electrolysis-based hydrogen generation equipment that uses customary
liquid electrolytes sold by Stuart Energy Systems, Norsk Hydro, Teledyne-Brown
and other companies. These systems are generally larger in size, require manual
operation and supervision, contain hazardous liquid electrolyte and require the
assistance of mechanical compressors to produce hydrogen at pressure.

                                       9
<PAGE>

   In backup power applications, our products may compete against:

  . battery-based, uninterruptible power supply systems, which are widely
    manufactured and used around the world;

  . ultracapacitors, which store energy as an electrostatic charge;

  . internal combustion engine generator sets;

  . microturbines;

  . superconducting energy storage systems, which store energy within a
    superconducting magnet kept at extremely low temperatures;

  . flywheels, which store energy in the form of a continuously spinning
    wheel, the kinetic energy of which can be converted into electrical
    energy; and

  . other fuel cells using alternative hydrogen supply applications.

   There are a number of companies located in the United States, Canada and
abroad that are developing PEM fuel cell technology. These companies include
Avista Labs, Ballard Power Systems, General Motors, Giner, H-Power, Idacorp,
Nuvera, Plug Power, Toyota and United Technologies. Although we believe these
companies are currently primarily targeting vehicular and residential
applications, some of them have announced plans to enter the hydrogen
generation and backup power markets we intend to address. We may also encounter
competition from companies that have developed or are developing fuel cells
based on non-PEM technology, as well as other distributed generation
technologies.

   Many of our competitors have substantially greater financial, research and
development and marketing capabilities than we do. In addition, as the backup
power and hydrogen fuel markets develop, other large industrial companies may
enter these fields and compete with us.

Employees

   As of December 31, 2000 we had a total staff of approximately 50 employees,
of which approximately 35 were engineers, scientists, and other degreed
professionals. We consider our relations with our employees to be excellent.

ITEM 2. Properties

   Our principal executive offices are located in Rocky Hill, Connecticut. We
currently lease two facilities totaling approximately 28,000 square feet that
house all of our research, product development, manufacturing and office
activities and staff. These facilities will be sufficient to accommodate our
anticipated growth through 2001.

   In March 2001, we entered into a fully assignable purchase and sale
agreement for approximately 44 acres of land located in Wallingford,
Connecticut. It is our intention to assign our rights under this contract to a
developer and simultaneously enter into a lease covering both the land and a
100,000 square foot facility. We expect to relocate our operations to
Wallingford in 2002.

ITEM 3. Legal Proceedings

   Not applicable.

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

   Not applicable.

                                       10
<PAGE>

Executive Officers and Directors

   Our executive officers and directors, and their ages as of December 31,
2000, are as follows:

<TABLE>
<CAPTION>
         Name            Age                           Title
         ----            ---                           -----
<S>                      <C> <C>
Walter W. Schroeder.....  52 President, chief executive officer and director


Robert J. Friedland.....  35 Vice president of operations


Trent M. Molter.........  38 Vice president of engineering and technology and director


Lawrence C. Moulthrop,    44
 Jr.....................     Vice president of product engineering


William F. Smith........  49 Vice president of business development


David E. Wolff..........  43 Vice president of sales and marketing


John A. Glidden.........  37 Vice president of finance


Robert W. Shaw, Jr. ....  59 Chairman of the board of directors


Richard A. Aube.........  32 Director


Gerald B. Ostroski......  59 Director


Philip R. Sharp.........  58 Director
</TABLE>

   Walter W. Schroeder, one of our founders, has served as our president and
chief executive officer, and as a director, since our founding in August 1996.
From 1991 to August 1996, Mr. Schroeder served as an officer of AES Corp., an
independent power company. From 1986 to 1991, Mr. Schroeder was a vice
president in the investment banking division of Goldman Sachs & Co. Mr.
Schroeder holds BS and MS degrees from Massachusetts Institute of Technology.

   Robert J. Friedland, one of our founders, has served as our vice president
of operations since our founding in August 1996. From 1995 to August 1996, Mr.
Friedland served as a program operations manager for United Technologies
Corporation, a diversified aerospace and building systems company. Mr.
Friedland holds a BS in mechanical engineering from Syracuse University and an
MBA from Rennselaer Polytechnic Institute.

   Trent M. Molter, one of our founders, has served as our vice president of
engineering and technology since our founding in August 1996, and as a director
since 1997. From 1984 to August 1996, Mr. Molter served as an advanced
technology engineer and a project manager in PEM products for United
Technologies. Mr. Molter holds a BS in chemical engineering from Clarkson
University and an MS in metallurgy from Rennselaer Polytechnic Institute.

   Lawrence C. Moulthrop, Jr., one of our founders, has served as our vice
president of product engineering since our founding in August 1996. From 1994
to August 1996, Mr. Moulthrop served as the PEM technology engineering manager
for United Technologies. From 1978 to 1984 and from 1984 to 1994, Mr. Moulthrop
served in various other PEM engineering positions for General Electric and
United Technologies, respectively. Mr. Moulthrop holds a BS in chemical
engineering from the University of New Hampshire.

   William F. Smith, one of our founders, has served as our vice president of
business development since our founding in August 1996. From 1986 to August
1996, Mr. Smith served as a business development program manager for United
Technologies. Mr. Smith holds a BA in physics from the University of
Connecticut and an MBA from the University of Massachusetts.

   David E. Wolff has served as our vice president of sales and marketing since
March 1999. From 1992 to March 1999, Mr. Wolff served in various capacities for
MG Industries, a subsidiary of the Messer Group, a supplier of industrial gas.
From 1979 to 1992 Mr. Wolff served in various sales positions for Air Products
and Chemicals. Mr. Wolff holds an AB in engineering science from Dartmouth
College.

                                       11
<PAGE>

   John A. Glidden has served as our vice president of finance since January
2001. From November 1997 through January 2001, Mr. Glidden served as our vice
president and controller. From July 1996 to November 1997, Mr. Glidden served
as a financial manager for United Technologies. From 1987 to July 1996, Mr.
Glidden served as a senior financial planning analyst for United Technologies.
Mr. Glidden holds a BS in business administration from Central Connecticut
State University and an MS in international management from Rensselaer
Polytechnic Institute.

   Robert W. Shaw, Jr. has served as our chairman of the board of directors
since our founding in August 1996. Dr. Shaw has served as president of Arete
Corporation, a private investment firm, since March 1997. From 1983 to 1997,
Dr. Shaw served as president of Arete Ventures, Inc., a private investment firm
he founded to invest in the fields of modular/dispersed power generation,
renewable power generation and specialty materials. Prior to that time, Dr.
Shaw was a senior vice president and director of Booz Allen & Hamilton, a
consulting firm, where he founded the firm's energy division. Dr. Shaw holds
BEP and MS degrees from Cornell University, an MPA from American University and
a PhD in applied physics from Stanford University. He serves as a director of
Evergreen Solar, Inc., a public company which makes photo voltaic products, and
CellTech Power, Inc., H2Gen Innovations, Inc. and Northern Power Systems, Inc.,
each a private power technology company.

   Richard A. Aube has served as a director since April 2000. Mr. Aube is
currently a general partner of The Beacon Group Energy Funds, a private
investment firm and affiliate of JP Morgan Partners. Prior to that time, Mr.
Aube was an investment banker in the natural resources group at Morgan Stanley
& Co. Incorporated. Mr. Aube holds a BA from Dartmouth College. He serves as a
director of Capstone Turbine Corporation, a public company which makes
microturbine generation systems, and STM Power Inc. and Powercell Corporation,
each a private power technology company.

   Gerald B. Ostroski has served as a director since February 1999. Mr.
Ostroski has served as vice president of Minnesota Power, Inc. since January
1982. Since 1991, Mr. Ostroski has also served as president of Minnesota
Power's Synertec subsidiary and currently serves as a director or officer of
several other Minnesota Power subsidiaries. Mr. Ostroski is a registered
professional engineer, licensed in Minnesota. Mr. Ostroski holds a BSEE from
the University of Wisconsin.

   Philip R. Sharp has served as a director since March 1999. Dr. Sharp has
served as a lecturer at the John F. Kennedy School of Government of Harvard
University since February 1995. From July 1995 to February 1998, Dr. Sharp also
served as director of Harvard University's Institute of Politics, and is
currently a member of the Institute's senior advisory board. From 1975 to 1995,
Dr. Sharp served as a member of the United States House of Representatives,
representing the second district of Indiana. He was a member of the House
Energy and Commerce Committee and the Interior Committee. Dr. Sharp also
chaired the Subcommittee on Fossil and Synthetic Fuels and the Energy and Power
Subcommittee. Dr. Sharp holds a BSFS in foreign service and a PhD in government
from Georgetown University. He serves as a director of Cinergy Corp. and New
England Power Co.

   Each executive officer serves at the discretion of the board of directors
and holds office until his successor is elected and qualified or until his
earlier resignation or removal. There are no family relationships among any of
our directors or executive officers.

                                       12
<PAGE>

                                    PART II

ITEM 5. Market for Registrant's Common Stock and Related Stockholder Matters

   The range of high and low sales prices per share of our common stock as
reported by The Nasdaq Stock Market under the symbol PRTN since the Offering is
shown below:

<TABLE>
<CAPTION>
                                                                     High   Low
                                                                    ------ -----
       <S>                                                          <C>    <C>
       Period
       Fiscal Year Ended December 31, 2000
         Fourth Quarter (from October 2, 2000)..................... $33.25 $5.25
</TABLE>

   We have never declared or paid any cash dividends on our common stock and
currently intend to retain any future earnings for the future operation and
expansion of our business. Accordingly, we do not anticipate that any cash
dividends will be declared or paid on our common stock in the foreseeable
future.

   As of March 20, 2001, there were approximately 9,500 stockholders of record.

 Use of Proceeds

   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 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 December
31, 2000, approximately $1.8 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. 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.

                                       13
<PAGE>

ITEM 6. Selected Financial Data

   The data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
our financial statements and notes thereto included elsewhere in this report.

<TABLE>
<CAPTION>
                                                                   Period from
                                                                    Inception
                                                                   (August 16,
                                 Year Ended December 31,          1996) through
                             -----------------------------------  December 31,
                               2000     1999     1998     1997        1996
                             --------  -------  -------  -------  -------------
                                  (in thousands, except per share data)
<S>                          <C>       <C>      <C>      <C>      <C>
Statement of Operations
 Data:
Revenue:
  Contract revenue.......... $    644  $   934  $   --   $   --      $  --
  Product revenue...........       56      --       --       --         --
                             --------  -------  -------  -------     ------
    Total revenue...........      700      934      --       --         --
Costs and expenses:
  Costs of contract
   revenue..................      396      355      377      --         --
  Costs of production.......      248      154      --       --         --
  Research and development..    3,227    2,182    1,323      963         51
  General and
   administrative...........    4,392    1,705      950      735        164
                             --------  -------  -------  -------     ------
                                8,263    4,396    2,650    1,698        215
  Loss from operations......   (7,563)  (3,462)  (2,650)  (1,698)      (215)
  Interest income (expense),
   net......................    4,199      172      (31)      28        (10)
                             --------  -------  -------  -------     ------
  Net loss before taxes.....   (3,364)  (3,290)  (2,681)  (1,670)      (225)
  Provision for taxes.......      126      --       --       --         --
                             --------  -------  -------  -------     ------
  Net loss..................   (3,490)  (3,290)  (2,681)  (1,670)      (225)
  Deemed preferred dividends
   and accretion............  (52,691)    (899)    (441)    (160)       --
                             --------  -------  -------  -------     ------
  Net loss attributable to
   common stockholders...... $(56,181) $(4,189) $(3,122) $(1,830)    $ (225)
                             ========  =======  =======  =======     ======
Basic and diluted net loss
 per share attributable to
 common stockholders........ $  (5.92) $ (2.20) $ (1.64) $ (0.96)    $(0.12)
                             ========  =======  =======  =======     ======
Shares used in computing
 basic and diluted net loss
 per share attributable to
 common stockholders........    9,484    1,900    1,900    1,900      1,900
                             ========  =======  =======  =======     ======
Balance Sheet Data:
  Cash, cash equivalents and
   marketable securities.... $174,749  $ 3,131  $ 3,228  $ 2,990     $  293
  Working capital...........  176,856    3,225    3,274    2,925        272
  Total assets..............  180,752    5,000    4,870    3,664        323
  Long-term liabilities.....      --       --       --       --         500
  Mandatorily redeemable
   convertible preferred
   stock....................      --    13,136    9,237    5,571        --
  Total stockholders' equity
   (deficit)................  178,307   (9,057)  (5,159)  (2,036)      (206)
</TABLE>

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

   You should read the following discussion and analysis in conjunction with
our financial statements and the related notes included elsewhere in this
report. This discussion and analysis contains forward-looking statements that
involve risks and uncertainties. Our actual results may differ materially from
those anticipated in these forward-looking statements as a result of several
factors, including, but not limited to, those set forth under "Certain Factors
That May Affect Future Results" and elsewhere in this report.


                                       14
<PAGE>

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 for which revenue 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 such estimates of warranty obligations
can be made. As of December 31, 2000, we have deferred revenue of approximately
$1,035,000 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 which 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 which 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 December 31, 2000, we have
recognized approximately $1.6 million in contract revenue from research and
development funding under arrangements with both government and private
sources. Under these contracts, we have delivered HOGEN 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 $455,000 in revenue through December 31, 2000. The
DOE contract extends to September 2002 and provides for payments to us of
approximately $1.3 million, of which we have recognized approximately $218,000
in revenue through December 31, 2000.

   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 contracts. We expect our costs of contract revenue to decrease 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 December 31, 2000,
amounts reported as costs of production reflect costs incurred in excess of the
corresponding sales price as well as costs incurred to service units in the
field.

   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

                                       15
<PAGE>

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 December
31, 2000 our accumulated deficit was $62.0 million, of which $50.7 million is
attributable to deemed preferred dividends and accretion and $11.4 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 Years 2000 and 1999

   Contract revenue. Contract revenue decreased from $934,000 in 1999 to
$644,000 in 2000. This decrease was due to research and development activity
related to regenerative fuel cell systems under the NASA and DOE contracts as
well as the completion of the Electric Power Research Institute (EPRI) contract
in 1999. In the future, we expect contract revenue from government sponsored
research and development contracts to decrease as a percentage of total
revenues once we begin to recognize revenue from product sales.

   Product revenue. Product revenue increased fom $0 in 1999 to $56,000 in
2000. The amount in 2000 relates to revenue recognized upon expiration of the
product warranty and for product rentals.

   Costs of contract revenue. Costs of contract revenue increased from $355,000
in 1999 to $396,000 in 2000. The amount in 1999 reflects costs incurred on the
first phase of both our DOE and NASA contracts and on our EPRI contract, for
which contract revenue was deferred until specific obligations were met in the
fourth quarter of 1999. The amount in 2000 reflects costs incurred under the
second phase of both our DOE and NASA contracts.

   Costs of production. Costs of production increased from $154,000 in 1999 to
$248,000 in 2000. The amount in 1999 reflects costs associated with
manufacturing and delivering our hydrogen generators in excess of the
corresponding sales price. The amount in 2000 reflects costs associated with
manufacturing and delivering our hydrogen generators in excess of the
corresponding sales price as well as warranty costs on units in the field. 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
this 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 reviewed 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 $2.2 million in 1999 to $3.2 million in 2000. 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

                                       16
<PAGE>

research and development activities primarily related to increased salaries and
benefits for our growing research and development staff. We expect our research
and development expenses to continue to increase in the future.

   General and administrative expenses. General and administrative expenses
increased from $1.7 million in 1999 to $4.4 million in 2000. This change
reflects an increase in salaries and benefits of $1,052,000, as a result of an
increase in the number of employees, an increase in legal expenses of $
410,000, primarily for patent application costs, an increase in recruiting and
relocation of $119,000 and an increase of $353,000 of non-cash compensation
expense associated with stock option grants.

   Interest income (expense), net. Interest income increased from $172,000 in
1999 to $4.2 million in 2000. 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 Years 1999 and 1998

   Contract revenue. Contract revenue increased from $0 in 1998 to $934,000 in
1999. The amount in 1999 includes revenue related to our DOE contract for
approximately $400,000 and to our EPRI contract for approximately $350,000.

   Costs of contract revenue. Costs of contract revenue decreased from $378,000
in 1998 to $355,000 in 1999. The amounts in 1998 reflect costs incurred on the
first phase of our DOE contract and on our EPRI contract for which revenue
recognition was deferred until specific obligations were met. The decrease in
1999 was due to slightly lower activity on the first phase of our DOE contract
and on our EPRI contract. Our obligations under both these contracts were met
in the fourth quarter of 1999.

   Costs of production. Costs of production increased from $0 in 1998 to
$154,000 in 1999. The amount in 1999 reflects costs associated with
manufacturing and delivering our hydrogen generators in excess of the
corresponding sales price.

   Research and development expenses. Research and development expenses
increased from $1.3 million in 1998 to $2.2 million in 1999. These increases
were due to increases in our research and development activities related to our
PEM technology in our regenerative fuel cell systems and our hydrogen
generators.

   General and administrative expenses. General and administrative expenses
increased from $950,000 in 1998 to $1.7 million in 1999. This increase reflects
an increase in salaries and benefits of $138,000 as a result of an increase in
our number of employees and an increase in legal expenses of $136,000. The
amount in 1999 also includes $290,000 of non-cash compensation expense
associated with stock option grants.

   Interest income (expense), net. Interest expense was $31,000 in 1998.
Interest income in 1999 was $172,000, primarily the result of interest earned
on higher cash balances from the funds raised by us through private financings.

Liquidity and Capital Resources

   Since our inception in August 1996 through December 2000, 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 December 31, 2000, we had $174.7 million in cash, cash
equivalents and marketable securities.

   Cash used in operating activities was $4.8 million for the year ended
December 31, 2000 and was primarily attributable to our net loss and increases
in inventory and other current assets, offset by increases in deferred revenue,
accounts payable and accrued expenses. Cash used in operating activities was
$2.9 million in

                                       17
<PAGE>

1999 and was primarily attributable to our net loss, an increase in inventory
and a decrease in contract advances and deferred revenue, offset by increases
in accounts payable and accrued expenses.

   Cash used in investing activities was $171.0 million for the year ended
December 31, 2000 and was primarily attributable to purchases of marketable
securities offset by maturities of marketable securities. Cash used in
investing activities was $14,000 in 1999 and was primarily attributable to
purchases of equipment, offset by maturities of marketable securities exceeding
reinvestments of marketable securities.

   Cash provided by financing activities was $176.5 million for the year ended
December 31, 2000 and was attributable to the receipt of proceeds from the sale
of our series C convertible preferred stock and our initial public offering.
Cash provided by financing activities was $3.0 million in 1999 and was
attributable to the receipt of proceeds from the sale of our series B-1
convertible preferred stock.

   We anticipate that our cash and marketable securities on hand as of December
31, 2000 will be adequate to fund our operations, working capital and capital
expenditure requirements for at least the next 12 months. We currently
anticipate we will spend approximately $5.0 million in 2001 to purchase
equipment for and to make leasehold improvements to our planned manufacturing
facility. We also expect over the next 12 months to continue to fund the
production 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.

Certain Factors That May Affect Future Results

 Our future success is uncertain because we have a limited operating history.

   As a development stage company, we face many risks and uncertainties. If we
are unsuccessful in addressing these risks and uncertainties, we may be unable
to generate revenue and grow our company. We were formed in 1996 to research
and develop PEM electrochemical products. We began shipping late-stage
development models of our hydrogen generators in the first quarter of 2000 and
have not yet manufactured commercial regenerative fuel cell systems.
Accordingly, there is only a limited basis upon which you can evaluate our
business and prospects and our future success is uncertain. In addition, until
we have adequate information to estimate warranty obligations relating to our
product sales, we are deferring recognition of revenue on product sales. You
should consider the challenges, expenses, delays and other difficulties
typically involved in the establishment of a new business, including the
continued development of our products, development of fully functioning
manufacturing operations, refinement of processes and components for our
commercial products, recruitment of qualified personnel, and achievement of
market acceptance for our products.

 We have incurred, and expect to continue to incur, substantial losses, and we
 may never become profitable.

   We have incurred substantial losses since we were founded and we anticipate
we will continue to incur substantial losses in the future. As of December 31,
2000, we had an accumulated deficit of $62.0 million. We cannot predict when we
will operate profitably, if ever. We expect to continue to incur increased
expenses related to research and development activities, expansion of our
manufacturing facilities and general administrative functions. As a result, we
anticipate that we will continue to incur losses until we can cost-effectively
produce and sell our hydrogen generators and regenerative fuel cell systems in
substantial quantities. Even if we do achieve profitability, we may be unable
to sustain or increase our profitability in the future.

                                       18
<PAGE>

 If we fail to retain our key personnel and attract and retain additional
 qualified personnel, we may be unable to develop our products and generate
 revenue.

   Our success depends upon the continued service of our executive officers
and other key employees such as manufacturing and research and development
personnel. The loss of any of our executive officers or key employees,
especially Walter W. Schroeder, president and chief executive officer, Trent
M. Molter, vice president of engineering and technology, and Lawrence C.
Moulthrop, Jr., vice president of product engineering, could impair our
ability to pursue our growth strategy and slow our product development
processes. We do not have employment agreements with any of our key
executives. Furthermore, we must continue to hire large numbers of highly
qualified individuals, including researchers, engineers and manufacturing
professionals. Competition for these individuals is intense, and we may not be
able to attract, assimilate or retain additional highly qualified personnel in
the future.

 We may not be able to generate revenue in the future if we do not complete
 the development of our hydrogen generators and regenerative fuel cell
 systems.

   Our hydrogen generators and regenerative fuel cell systems are still in the
development stage. We do not know when or whether we will successfully
complete research and development of commercial hydrogen generators or
regenerative fuel cell systems. If we are unable to develop commercial
hydrogen generators or commercial regenerative fuel cell systems, we may not
be able to generate future revenue and we may not recover the losses we have
incurred in attempting to develop these products. If we experience delays in
meeting our development milestones or if our hydrogen generators and
regenerative fuel cell systems exhibit technical defects or cannot meet cost
or performance goals, including output, useful life and reliability goals,
potential purchasers of our products may decline to purchase them or choose
alternative technologies. We may be unable to make the substantial
technological advances necessary to produce commercial hydrogen generators and
regenerative fuel cell systems that provide the features and performance
specifications required by customers at a competitive price. For example, we
must identify improved hydrogen storage technologies and fuel cell module
structures. In addition, in order to commercially market our smaller scale
hydrogen generators, we need to develop a reliable, long term method of
removing water vapor from the hydrogen produced. If we are unable to
successfully complete these development activities, we may be unable to
commercially market our products. In some cases, we are attempting to expedite
our development efforts by utilizing third parties for important engineering
work. These third parties include vendors of hydrogen storage, purification
systems, power supply and control components. If these third parties are
unable to successfully complete their development activities on our behalf, we
may be unable to commercially market our products.

 We will not be able to grow our business if we do not achieve widespread
 commercial acceptance of our hydrogen generators in the market for delivered
 hydrogen.

   We intend to market our hydrogen generators to small- and medium-volume
users of delivered hydrogen. Our business depends on the widespread commercial
acceptance of our hydrogen generators and we may be unable to grow our
business if our targeted customers do not purchase substantial numbers of our
hydrogen generators. Our targeted customers, or the distributors who we intend
to use to market to these customers, may not purchase our hydrogen generators
at all or in sufficient quantities to support the growth of our business. Our
hydrogen generators will require our target customers to make a substantial
initial investment, currently ranging from approximately $50,000 to $200,000
per unit for our HOGEN models. Our method of supplying hydrogen by producing
it on-site using PEM electrolysis represents a significant departure from
conventional means of supplying hydrogen to end users. PEM electrolysis is a
new and unproven technology in the markets we are targeting, and we do not
know if our targeted customers will accept our product. In addition, we have
not demonstrated that we can supply hydrogen to our targeted customers at a
lower cost than conventionally delivered hydrogen.

                                      19
<PAGE>

 The success of our hydrogen generators as a fuel source for PEM fuel cells
 depends upon the development of a mass market for PEM fuel cells, and we may
 not be able to generate revenue in the future if this market does not
 develop.

   We also intend to market our hydrogen generators for use as fuel generators
for PEM fuel cells in a variety of applications, in particular fuel cell
vehicles. If a mass market for PEM fuel cells fails to develop or develops
more slowly than we anticipate, we may be unable to generate revenue in the
future and recover the losses we will have incurred in the development of our
hydrogen generators. PEM fuel cells represent an emerging commercial market,
and we do not know whether end-users will want to use them. The development of
a mass market for PEM fuel cells may be affected by many factors outside of
our control, including

  . the emergence of newer, more competitive technologies;

  . the cost competitiveness of PEM fuel cells compared to existing and new
    technologies;

  . the future cost of hydrogen;

  . regulatory requirements;

  . consumer perceptions of the safety, reliability and functionality of PEM
    fuel cells; and

  . consumer willingness to try a new product.

   In addition, the sole market for vehicular PEM fuel cells is and will
continue to be car, bus and other vehicle manufacturers. Automobile
manufacturers' interest in vehicular PEM fuel cells has been driven in large
part by environmental laws and regulations concerning vehicle emission
requirements that have been enacted in California and some northeastern
states. If these laws and regulations are not kept in force or do not become
widely adopted, the demand for vehicular PEM fuel cells may be limited.
Further, automobile manufacturers may be able to use other technologies to
meet their regulatory requirements, such as batteries, low emission internal
combustion engines and hybrid internal combustion/battery engines. Even if
automobile manufacturers decide to develop vehicles powered by PEM fuel cells,
it may be many years before substantial numbers of vehicles powered by PEM
fuel cell systems are manufactured. Further, there are several other
technologies that may be used to generate hydrogen, such as hydrocarbon
reforming, and there remains a strong possibility that our means of generating
hydrogen will not be used to supply fuel to fuel cells.

 We may be unable to increase our revenue in the future if the use of
 renewable energy does not increase.

   We anticipate that one of the primary uses of our regenerative fuel cell
systems will be for storing energy produced by renewable power sources, such
as solar, wind and hydroelectric power. If the demand for renewable energy
develops more slowly than we anticipate, our ability to sell our regenerative
fuel cell systems could be impaired and we may be unable to grow our business.
The market for renewable energy is still in an early stage of development and
the demand for renewable energy will remain limited until the cost of
producing energy from renewable sources is substantially reduced. Power from
renewable energy sources currently costs significantly more than power derived
from nonrenewable sources, such as coal and oil. The growth of the renewable
energy market will be dependent on many factors that are outside of our
control, such as the emergence of new, more cost-effective power technologies
and products, and domestic and international regulatory requirements.

 We expect to incur significant expenses in expanding our manufacturing
 facilities and production and we may not be successful in these efforts.

   We will be expanding our manufacturing facilities in anticipation of
increased demand for our products. If this demand does not materialize, we
will not generate sufficient revenue to offset the costs of developing and
operating these facilities, which could increase our losses and prevent us
from growing our business. We currently anticipate we will spend approximately
$10 million over the next two years to purchase equipment and make leasehold
improvements for our planned manufacturing facility. We have not yet finalized
plans or

                                      20
<PAGE>

executed contracts for this expansion, and actual costs may be significantly
in excess of our estimates. In addition, we expect to expand our production
and may experience delays or problems in our expected expansion that could
compromise our ability to increase our sales and grow our business. Factors
that could delay or prevent our expected production expansion include:

  . the inability to purchase parts or components in adequate quantities or
    sufficient quality;

  . the cost of raw materials;

  . the failure to increase our assembly and test operations;

  . the failure to hire and train additional manufacturing personnel;

  . the failure to develop and implement manufacturing processes and
    equipment; and

  . the inability to acquire new space for additional production capacity.

 If we fail to successfully manufacture our products in commercial quantities,
 we may not be able to increase our revenue.

   To be financially successful, we will have to manufacture our products in
commercial quantities at acceptable costs while also preserving the quality
levels achieved in manufacturing these products in limited quantities. This
presents a number of technological and engineering challenges for us. We may
not be successful in developing product designs and manufacturing processes
that permit us to manufacture our hydrogen generators and regenerative fuel
cell systems in commercial quantities at commercially acceptable costs while
preserving quality. Currently, we sell some of our products for less than it
costs us to produce them. In addition, we will incur significant start-up
costs and may experience unforeseen delays and expenses in our product design
and manufacturing efforts. If the commercialization of our products is
delayed, potential purchasers may also decline to purchase them or choose
alternative technologies, both of which could impair our ability to generate
revenue in the future.

 If our suppliers do not supply us with a sufficient amount and quality of
 components at acceptable prices, we may not be able to manufacture our
 products commercially.

   Although we generally attempt to use standard components for our products,
the proton exchange membrane material and hydrogen purification system used in
our products are currently available only from limited sources. Also, we may
be unable to purchase components of adequate quality or that meet our cost
requirements. In addition, to the extent these components are proprietary
products of our suppliers, or the processes used by our suppliers to
manufacture these components are proprietary, we may be unable to obtain
comparable components from alternative suppliers. We may experience delays in
production of our products and our business and financial results would suffer
if we fail to identify alternate suppliers, or if our supply is interrupted or
reduced or there is a significant increase in cost.

   In addition, platinum is a key component of our PEM fuel cells. Platinum is
a scarce natural resource and we are dependent upon a sufficient supply of
this commodity. We may not be able to produce commercial products, or the cost
of producing our products may significantly increase, if there are any
shortages in the supply of platinum.

 We may be unable to sell our products and generate revenue if we fail to
 establish distribution relationships.

   Because we intend to sell our products primarily through third-party
distributors, the financial benefits to us of commercializing our products
will be dependent on the efforts of others. We intend to enter into additional
distribution agreements or other collaborative relationships to market and
sell our products. If we are unable to enter into additional distribution
agreements, or if our third-party distributors do not successfully market and
sell our products, we may be unable to generate revenue and grow our business.
We may seek to

                                      21
<PAGE>

establish relationships with third-party distributors who also indirectly
compete with us. For example, we have targeted industrial gas suppliers as
potential distributors of our hydrogen generators. Because industrial gas
suppliers currently sell hydrogen in delivered form, adoption by their
customers of our hydrogen generation products could cause them to experience
declining demand for delivered hydrogen. For this reason, industrial gas
suppliers may be reluctant to become distributors of our hydrogen generators.
In addition, our third-party distributors may require us to provide volume
price discounts and other allowances, or customize our products, either of
which could reduce the potential profitability of these relationships.

 We have historically focused on research and development activities and have
 limited experience in marketing, selling and servicing our products.

   We have primarily focused on the research and development of our hydrogen
generators and regenerative fuel cell systems. Consequently, our management
team has limited experience directing the commercialization efforts that are
essential to our future success. To date, we only have limited experience
marketing, selling and servicing our hydrogen generators, and no experience
marketing, selling or servicing our regenerative fuel cell systems.
Furthermore, there are very few people anywhere who have significant experience
marketing, selling or servicing PEM electrochemical products. We will have to
expand our marketing and sales organization and will have to create a
maintenance and support capability. We may not be successful in our efforts to
market and service our products, which would compromise our ability to increase
our revenue.

 Our plans to market, distribute and service our products internationally
 subject our business to additional risks, which could prevent us from growing
 our business.

   We intend to market, distribute and service our products internationally and
we may derive a significant portion of our revenue from international sales. If
we fail to successfully sell our products internationally, our ability to
increase our future revenue and grow our business would be impaired. We have
limited experience developing, and no experience manufacturing, our products to
comply with the commercial and legal requirements of international markets. Our
success in those markets will depend on our ability to secure relationships
with foreign resellers and our ability to manufacture products that meet
foreign regulatory and commercial requirements. In addition, our planned
international operations may be subject to a variety of additional risks,
including:

  . difficulties in collecting international accounts receivable;

  . increased costs associated with maintaining international marketing
    efforts;

  . compliance with U.S. Department of Commerce export controls;

  . increases in duty rates;

  . the introduction of non-tariff trade barriers;

  . fluctuations in currency exchange rates;

  . political and economic instability; and

  . difficulties in enforcing intellectual property rights.

 We currently face and will continue to face significant competition, which
 could cause us to lose sales or render our products uncompetitive or obsolete.

   The markets for delivered hydrogen and reliable backup power are highly
competitive. There are a number of companies located in the United States,
Canada and abroad that deliver hydrogen, sell hydrogen generation equipment or
are developing PEM fuel cell technology. Many of these companies have
substantially greater resources than we do. Each of these companies has the
potential to capture market share in the markets we intend to address, which
could cause us to lose sales and prevent us from growing our business. New

                                       22
<PAGE>

developments in technology may also delay or prevent the development or sale of
some or all of our products or make our products uncompetitive or obsolete. If
this were to occur, we would not be able to generate sufficient revenue to
offset the cost of developing our hydrogen generators and regenerative fuel
cell systems.

   Our regenerative fuel cell systems are one of a number of power technology
products being developed today to provide high quality, highly reliable backup
power to the existing electric transmission system, or grid. These products
include advanced batteries, ultracapacitors, microturbines, flywheels, internal
combustion generator sets, superconducting magnetic energy storage devices and
other fuel cells using alternative hydrogen supply applications. Improvements
are also being made to the existing electric grid. Technological advances in
power technology products and improvements in the electric grid may reduce the
attractiveness of our regenerative fuel cell systems.

   As the markets for PEM fuel-cell related products, on-site hydrogen
generation and backup power develop, other large industrial companies may enter
these fields and compete with us. These large industrial companies may have the
research and development, manufacturing, marketing and sales resources
necessary to commercialize hydrogen generators and regenerative fuel cell
systems more quickly and effectively than we do.

 We depend on our intellectual property and our failure to protect it could
 enable competitors to market products with similar features that may reduce
 demand for our products.

   If we are unable to protect our intellectual property, our competitors could
use our intellectual property to market products similar to our products, which
could reduce demand for our products. Our success depends substantially upon
the internally developed technology that is incorporated in our products. We
may be unable to prevent unauthorized parties from attempting to copy or
otherwise obtain and use our products or technology. Policing unauthorized use
of our technology is difficult, and we may not be able to prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our intellectual property as fully as those in the United
States. Others may circumvent the trade secrets, trademarks and copyrights that
we own and any of the U.S. patents or foreign patents owned by us or
subsequently issued to us may be invalidated, circumvented, challenged or
rendered unenforceable. In addition, we may not be issued any patents as a
result of our pending and future patent applications, and any patents we are
issued may not have the breadth of claim coverage sought by us.

   Most of our intellectual property is not covered by any patent or patent
application. We seek to protect this proprietary intellectual property, which
includes intellectual property that may not be patented or patentable, in part
by confidentiality agreements with our distributors and employees. These
agreements afford only limited protection and may not provide us with adequate
remedies for any breach or prevent other persons or institutions from asserting
rights to intellectual property arising out of these relationships.

 We could incur substantial costs defending our intellectual property from
 infringement by others.

   Unauthorized parties may attempt to copy aspects of our products or to
obtain and use our proprietary information. Litigation may be necessary to
enforce our intellectual property rights, to protect our trade secrets and to
determine the validity and scope of the proprietary rights of others. Any
litigation could result in substantial costs and diversion of resources with no
assurance of success.

 We could incur substantial costs defending against claims that our products
 infringe on the proprietary rights of others.

   The patent situation in the field of PEM fuel cell technology is complex. A
large number of patents, including overlapping patents, relating to this
technology have been granted worldwide. We are aware of patents in the fuel
cell architecture field held by potential competitors and other third parties,
including Ballard Power Systems, General Motors, Giner, H-Power, Oronzio deNora
Impianti Electrochemical, Packard

                                       23
<PAGE>

Instrument, Plug Power, Shinko Pantec, Siemens, Toyota, United Technologies and
Whatman. Third parties could claim infringement by us with respect to these
patents or other patents or proprietary rights, and we cannot assure you that
we would prevail in any such proceeding.

   In addition, some of our employees are parties to assignment of invention
and nondisclosure agreements with their former employers. These agreements
generally grant the former employer rights to technology developed by the
employee while employed by the former employer and prohibit disclosure of that
technology or other employer information to third parties. We cannot assure you
that such employers will not assert claims against us or our employees alleging
a breach of those agreements or other violations of their proprietary rights or
alleging rights to inventions by our employees, or that we would prevail in any
such proceeding.

   Any infringement claim against us, whether meritorious or not, could:

  . be time-consuming;

  . result in costly litigation or arbitration and diversion of technical and
    management personnel; or

  . require us to develop non-infringing technology or to enter into royalty
    or licensing agreements.

   We might not be successful in developing non-infringing technologies.
Royalty or licensing agreements, if required, may not be available on terms
acceptable to us, or at all, and could significantly harm our business and
operating results. A successful claim of infringement against us or our failure
or inability to license the infringed or similar technology could require us to
pay substantial damages and could harm our business because we would not be
able to sell the affected product without redeveloping it or incurring
significant additional expense. In addition, to the extent we agree to
indemnify customers or other third parties against infringement of the
intellectual property rights of others, a claim of infringement could require
us to incur substantial time, effort and expense to indemnify these customers
and third parties and could disrupt or terminate their ability to use, market
or sell our products.

 We may not be able to control our warranty exposure, which could increase our
 expenses.

   Any significant incurrence of warranty expense could increase our costs. To
date, we have not had adequate information to estimate warranty obligations and
therefore we may be unable to reasonably predict our warranty expenses. In
addition, any warranty disclaimers we use may not effectively limit our
liability.

 We may be exposed to lawsuits and other claims if our products malfunction,
 which could increase our expenses, harm our reputation and prevent us from
 growing our business.

   Any liability for damages resulting from malfunctions of our products could
be substantial and could increase our expenses and prevent us from growing our
business. In particular, hydrogen is a flammable gas and can pose safety risks
if not handled properly. In addition, our products may require modifications to
operate properly under extreme temperatures. Potential customers will also rely
upon our products for critical needs, such as backup power. A malfunction of
our products could result in tort or warranty claims. In addition, a well-
publicized actual or perceived problem could adversely affect the market's
perception of our products. This could result in a decline in demand for our
products, which would reduce our revenue and harm our business.

 Future government regulation may impair our ability to market and sell our
 products.

   Our products are potentially subject to federal, local and foreign laws and
regulations governing, among other things, emissions to air as well as laws
relating to occupational health and safety. We may incur substantial costs or
liabilities in complying with governmental regulations. Our potential customers
must also comply with numerous laws and regulations, which could affect their
interest in our products. We could incur potentially significant expenditures
in complying with environmental and health and safety laws, regulations and
requirements that may be adopted or imposed in the future.

                                       24
<PAGE>

 We anticipate undergoing a period of rapid growth and our failure to manage
 this growth could harm our business.

   We anticipate undergoing a period of rapid growth in the number of our
employees and the scope of our operations. We intend to introduce new products,
increase our production capacity and develop additional distributor
relationships. Rapid expansion would likely place a significant strain on our
senior management team and other resources. In addition, we may be required to
hire additional senior management personnel. Our ability to manage growth will
depend in part on our ability to continue to enhance our operating, financial
and management information systems. Our personnel, systems and controls may be
unable to support our growth.

 We may not be able to obtain sufficient funds to grow our business.

   We have regularly needed to raise funds in order to operate our business and
believe we may need to raise additional funds to achieve full commercialization
of some or all of our products. If we are unable to raise additional funds when
needed, our ability to operate and grow our business could be impaired. We do
not currently have a line of credit. We do not know whether we will be able to
secure additional funding or funding on terms acceptable to us. Our ability to
obtain additional funding will be subject to a number of factors, including
market conditions, our operating performance and investor sentiment. These
factors may make the timing, amount, terms and conditions of additional funding
unattractive to us. If we issue additional equity securities, existing
stockholders may experience dilution or be subordinated to any rights,
preferences or privileges granted to the new equity holders.

 Our revenue and operating results may fluctuate significantly as a result of
 factors outside of our control, which could cause the market price of our
 common stock to decline.

   We expect our revenue and operating results to vary significantly from
quarter to quarter. As a result, quarterly comparisons of our financial results
are not necessarily meaningful and you should not rely on them as an indication
of our future performance. In addition, due to our stage of development, we
cannot predict our future revenue or results of operations accurately. As a
consequence, our operating results may fall below the expectations of
securities analysts and investors, which could cause the price of our common
stock to decline. Factors that may affect our operating results include:

  . the status of development of our technology, products and manufacturing
    capabilities;

  . the cost of our raw materials and key components;

  . the introduction, timing and market acceptance of new products introduced
    by us or our competitors;

  . the development of our strategic relationships and distribution channels;

  . general economic conditions, which can affect our customers' capital
    investments and the length of our sales cycle;

  . the development of vehicular PEM fuel cells and renewable energy markets;
    and

  . government regulation.

   We expect to make significant investments in all areas of our business,
particularly in research and product development and in expanding our
manufacturing capability. Because the investments associated with these
activities are relatively fixed in the short-term, we may be unable to adjust
our spending quickly enough to offset any unexpected shortfall in our revenue
growth. In addition, because we are in the very early stages of selling our
products and have a limited number of customers, we expect our order flow to be
uneven from period to period.

                                       25
<PAGE>

 Our stock price is likely to be highly volatile and may result in substantial
 losses for investors purchasing shares.

   The market price of our common stock is likely to be highly volatile. The
stock market in general, and the market for technology-related stocks in
particular, has been highly volatile. As a result, investors in our common
stock may experience a decrease in the value of their common stock regardless
of our operating performance or prospects. Our common stock may not trade at
the same levels as other technology-related stocks and technology-related
stocks in general may not sustain their current market prices. In addition, an
active public market for our securities may not be sustained.

   The trading price of our common stock could be subject to wide fluctuations
in response to:

  . our perceived prospects;

  . variations in our operating results and achievement of key business
    targets;

  . changes in securities analysts' recommendations or earnings estimates;

  . differences between our reported results and those expected by investors
    and securities analysts;

  . announcements of new products by us or our competitors;

  . market reaction to any acquisition, joint venture or strategic
    investments announced by us or our competitors; and

  . general economic or stock market conditions unrelated to our operating
    performance.

   In the past, securities class action litigation has often been instituted
against companies following periods of volatility in their stock price. This
type of litigation could result in substantial costs and divert our
management's attention and resources.

 Our executive officers, directors and their affiliates hold a large percentage
 of our stock and their interests may differ from other stockholders.

   Our directors, executive officers and individuals or entities affiliated
with our directors as a group beneficially own approximately thirty percent of
our outstanding common stock. If these stockholders choose to act or vote
together, they will have the power to significantly influence the election of
our directors, and the approval of any other action requiring the approval of
our stockholders, including any amendments to our certificate of incorporation
and mergers or sales of substantially all of our assets. In addition, without
the consent of these stockholders, we could be prevented from entering into
transactions that could be beneficial to us or our other stockholders. Also,
third parties could be discouraged from making a tender offer or bid to acquire
us at a price per share that is above the then-current market price.

 The provisions of our charter documents and Delaware law could inhibit a
 takeover that stockholders may consider favorable and diminish the voting
 rights of the holders of our common stock.

   There are provisions in our certificate of incorporation and by-laws that
make it more difficult for a third party to acquire, or attempt to acquire,
control of Proton, even if a change in control was considered favorable by our
stockholders. For example, our board of directors has the authority to issue up
to 5,000,000 shares of preferred stock. The board of directors can fix the
price, rights, preferences, privileges and restrictions of the preferred stock
without any further vote or action by our stockholders. The issuance of shares
of preferred stock may delay or prevent a change in control transaction. As a
result, the market price of our common stock and the voting and other rights of
our stockholders may be adversely affected. The issuance of shares of preferred
stock may result in the loss of voting control to other stockholders.

                                       26
<PAGE>

   Our charter documents contain other provisions that could have an anti-
takeover effect, including:

  . only one of the three classes of directors is elected each year;

  . stockholders have limited ability to remove directors;

  . stockholders cannot take actions by written consent;

  . stockholders cannot call a special meeting of stockholders; and

  . stockholders must give advance notice to nominate directors or submit
    proposals for consideration at stockholder meetings.

   In addition, we are subject to the anti-takeover provisions of Section 203
of the Delaware General Corporation Law, which regulates corporate
acquisitions. These provisions could discourage potential acquisition proposals
and could delay or prevent a change in control transaction. They could also
have the effect of discouraging others from making tender offers for our common
stock. These provisions may also prevent changes in our management.

 The substantial number of shares that will be eligible for sale in the near
 future could cause our common stock price to decline.

   Sales by our stockholders of a substantial number of shares of our common
stock in the public market, or the perception that these sales could occur,
could cause the market price of our common stock to decline. These sales also
might make it more difficult for us to sell equity or equity-related securities
in the future at a time and price that we deem appropriate. As of December 31,
2000, we have outstanding 33.1 million shares of common stock, assuming no
exercise of outstanding options. Of these shares, the 8.1 million shares sold
in our initial public offering and subsequent exercise of the underwriters over
allotment are freely tradable, 10.1 million additional shares of common stock
became available for sale in the public market on March 28, 2001 following the
expiration of lock-up agreements between our stockholders and the underwriters,
and 14.9 million more shares will become available for sale in the public
market on subsequent dates. Morgan Stanley & Co. Incorporated, on behalf of the
underwriters, may release stockholders from their lock-up agreements with the
underwriters at any time and without notice, which would allow for the earlier
sale of shares in the public market.

ITEM 7A. 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.

   The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates:

<TABLE>
<CAPTION>
                                                 Fair Value of Investments
                                                 At Expected Maturity Date
                                            ------------------------------------
                                                2001        2002       Total
                                            ------------ ---------- ------------
<S>                                         <C>          <C>        <C>
Investments
Fixed Rate................................. $165,102,600 $8,286,402 $173,389,002
Average Interest rate......................        5.87%      6.25%        5.59%
</TABLE>

                                       27
<PAGE>

ITEM 8. Financial Statements and Supplementary Data

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Report of Independent Accountants.........................................   29

Balance Sheets--December 31, 2000 and 1999................................   30

Statements of Operations for the Years ended December 31, 2000, 1999 and
 1998 and for the period from inception (August 16, 1996) through December
 31, 2000.................................................................   31

Statements of Changes in Stockholders' Equity (Deficit) for the period
 from inception (August 16, 1996) through December 31, 2000...............   32

Statements of Cash Flows for the Years ended December 31, 2000, 1999 and
 1998 and for the period from inception (August 16, 1996) through December
 31, 2000.................................................................   33
</TABLE>

                                       28
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
 Stockholders of Proton Energy Systems, Inc.:

   In our opinion, the accompanying balance sheets and the related statements
of operations, of stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of Proton Energy Systems, Inc. at
December 31, 2000 and 1999 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2000, and for the
period from inception (August 16, 1996) through December 31, 2000, in
conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which 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 financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/

PricewaterhouseCoopers LLP

Hartford, Connecticut
February 28, 2001


                                       29
<PAGE>

                         Part II--FINANCIAL INFORMATION

ITEM 1. Financial Statements

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

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                      December 31,   December
                                                          2000       31, 1999
                                                      ------------  -----------
<S>                                                   <C>           <C>
                       ASSETS
Current assets:
  Cash and cash equivalents.........................  $  1,360,127  $   580,709
  Marketable securities.............................   173,389,002    2,550,000
  Inventories and deferred costs (Note 4)...........     1,649,674      942,227
  Other current assets..............................     2,902,426       73,665
                                                      ------------  -----------
    Total current assets............................   179,301,229    4,146,601
                                                      ------------  -----------
Fixed assets, net (Note 5)..........................     1,204,353      847,374
Other assets........................................       246,889        6,299
                                                      ------------  -----------
    Total assets....................................  $180,752,471  $ 5,000,274
                                                      ============  ===========
  LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE
 PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
  Accounts payable..................................  $    185,733  $   113,072
  Accrued expenses..................................       435,598      319,687
  Accrued compensation..............................       507,250          --
  Deferred revenue..................................     1,035,302      488,482
  Customer advances.................................       156,549          --
  Taxes payable.....................................       125,000          --
                                                      ------------  -----------
    Total current liabilities.......................     2,445,432      921,241
                                                      ------------  -----------
Commitments and contingencies (Note 8)
Mandatorily redeemable convertible preferred stock
  (Note 6) $.01 par value; 0 and 9,108,511 shares
   authorized, respectively; 0 and 8,249,029 shares
   issued and outstanding, respectively; stated at
   redemption value.................................           --    13,135,917
                                                      ------------  -----------
Stockholders' equity (deficit) (Note 6):
  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; 33,088,043 and 1,900,000 shares
   issued and outstanding, respectively.............       330,880       19,000
  Additional paid-in capital........................   242,092,743      200,281
  Unearned compensation.............................    (2,374,361)    (808,821)
  Accumulated other comprehensive income............       289,000          --
  Deficit accumulated during the development stage..   (62,031,223)  (8,467,344)
                                                      ------------  -----------
    Total stockholders' equity (deficit)............   178,307,039   (9,056,884)
                                                      ------------  -----------
    Total liabilities, mandatorily redeemable
     convertible preferred stock and stockholders'
     equity (deficit)...............................  $180,752,471  $ 5,000,274
                                                      ============  ===========
</TABLE>

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

                                       30
<PAGE>

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

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                     For the
                                                                   period from
                                                                    inception
                                                                   (August 16,
                                                                      1996)
                                 Year Ended December 31,             through
                           --------------------------------------  December 31,
                               2000         1999         1998          2000
                           ------------  -----------  -----------  ------------
<S>                        <C>           <C>          <C>          <C>
Contract revenue.........  $    644,253  $   933,512  $       --   $  1,577,765
Product revenue..........        55,950          --           --         55,950
                           ------------  -----------  -----------  ------------
    Total revenues.......       700,203      933,512          --      1,633,715
Costs and expenses:
  Costs of contract
   revenue...............       396,169      354,532      377,705     1,128,406
  Costs of production....       247,692      154,000          --        401,692
  Research and
   development...........     3,227,421    2,181,548    1,322,945     7,746,856
  General and
   administrative........     4,392,011    1,705,369      949,824     7,945,813
                           ------------  -----------  -----------  ------------
    Total costs and
     expenses............     8,263,293    4,395,449    2,650,474    17,222,767
                           ------------  -----------  -----------  ------------
Loss from operations.....    (7,563,090)  (3,461,937)  (2,650,474)  (15,589,052)
Interest income
 (expense)...............     4,198,865      172,227      (30,931)    4,358,483
                           ------------  -----------  -----------  ------------
Loss before provision for
 taxes...................    (3,364,225)  (3,289,710)  (2,681,405)  (11,230,569)
Provision for taxes......       125,500          --           --        125,500
                           ------------  -----------  -----------  ------------
Net loss.................    (3,489,725)  (3,289,710)  (2,681,405)  (11,356,069)
Deemed preferred
 dividends and
 accretion...............   (52,691,154)    (899,000)    (441,000)  (54,191,154)
                           ------------  -----------  -----------  ------------
Net loss attributable to
 common stockholders.....  $(56,180,879) $(4,188,710) $(3,122,405) $(65,547,223)
                           ============  ===========  ===========  ============
Basic and diluted net
 loss per share
 attributable to common
 stockholders............  $      (5.92) $     (2.20) $     (1.64) $     (29.63)
                           ============  ===========  ===========  ============
Shares used in computing
 basic and diluted net
 loss per share
 attributable to common
 stockholders............     9,483,738    1,900,000    1,900,000     2,212,268
                           ============  ===========  ===========  ============
</TABLE>



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


                                       31
<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>
Inititial
 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 exercise 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
                          ========== ======== ============  ===========     ========    ============  ============
</TABLE>

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

                                       32
<PAGE>

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

                            STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                     For the
                                                                   period from
                                                                    inception
                                                                   (August 16,
                                Year ended December 31,           1996) through
                         ---------------------------------------  December 31,
                             2000          1999         1998          2000
                         -------------  -----------  -----------  -------------
<S>                      <C>            <C>          <C>          <C>
Cash flows from
 operating activities:
 Net loss............... $  (3,489,725) $(3,289,710) $(2,681,405) $ (11,356,069)
 Adjustments to
  reconcile net loss to
  net cash used in
  operations:
  Depreciation and
   amortization.........       296,292      164,588      231,261        743,233
  Accretion of discounts
   on securities........      (251,000)         --           --        (251,000)
  Non-cash stock-based
   expense..............       791,924      395,460       59,000      1,256,384
  Changes in operating
   assets and
   liabilities:
   Inventories and
    deferred costs......      (707,447)    (189,508)    (699,351)    (1,649,674)
   Other current
    assets..............    (2,828,761)      10,988      (74,587)    (2,902,426)
   Other assets.........      (240,590)         --         1,638       (246,889)
   Accounts payable and
    accrued expenses....       845,822      172,503       43,187      1,180,283
   Income taxes
    payable.............       125,000          --           --         125,000
   Deferred revenue and
    contract advances...       703,369     (147,488)     635,970      1,191,851
                         -------------  -----------  -----------  -------------
    Net cash used in
     operating
     activities.........    (4,755,116)  (2,883,167)  (2,484,287)   (11,909,307)
                         -------------  -----------  -----------  -------------
Cash flows from
 investing activities:
 Purchases of fixed
  assets................      (653,271)    (214,446)    (315,942)    (1,837,386)
 Purchases of marketable
  securities............  (179,210,023)  (2,550,000)  (2,750,000)  (186,610,023)
 Proceeds from
  maturities of
  marketable
  securities............     8,911,021    2,750,000    2,100,000     13,761,021
                         -------------  -----------  -----------  -------------
    Net cash used in
     investing
     activities.........  (170,952,273)     (14,446)    (965,942)  (174,686,388)
                         -------------  -----------  -----------  -------------
Cash flows from
 financing activities:
 Proceeds from sale of
  common stock, net.....   125,849,284          --           --     125,868,284
 Proceeds from exercise
  of stock options......         9,006          --           --           9,006
 Proceeds from exercise
  of warrants...........       590,358          --           --         590,358
 Proceeds from issuance
  of notes payable and
  warrants..............           --           --     2,000,000      2,000,000
 Proceeds from issuance
  of mandatorily
  redeemable convertible
  preferred stock and
  warrants..............    50,038,159    3,000,000    1,038,600     59,488,174
                         -------------  -----------  -----------  -------------
    Net cash provided by
     financing
     activities.........   176,486,807    3,000,000    3,038,600    187,955,822
                         -------------  -----------  -----------  -------------
Net increase
 (decrease).............       779,418      102,387     (411,629)     1,360,127
Cash and cash
 equivalents at
 beginning of period....       580,709      478,322      889,951            --
                         -------------  -----------  -----------  -------------
Cash and cash
 equivalents at end of
 period................. $   1,360,127  $   580,709  $   478,322  $   1,360,127
                         =============  ===========  ===========  =============
Supplemental disclosure
 of cash flow
 information:
 Cash paid during the
  period for:
   Interest.............           --           --   $     1,680  $      32,873
</TABLE>

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

                                       33
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. FORMATION AND OPERATIONS OF THE COMPANY

   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 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. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

   Significant accounting policies followed in the preparation of these
financial statements are as follows:

 Use of Estimates

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

 Revenue Recognition

   Beginning in 1999, the Company began delivering equipment units under
commercial agreements. As of December 31, 2000 and 1999, the Company had
deferred product revenue of $1,035,302 and $488,482, respectively, on
delivered units. Currently, product revenue is recognized upon the expiration
of the product warranty period. In the future, product revenue will be
recognized at the earlier of warranty expiration or when such estimates of
warranty obligations can be made.

   The Company receives payments under customer-sponsored research and
development contracts. For those research and development contracts that
require the Company to meet specific obligations as defined in the agreements
(including delivery and acceptance of units), amounts advanced pursuant to the
contracts are recognized as liabilities until such obligations are met. Once
the obligations are met, the amounts are recognized as contract revenue. For
those research and development contracts which do not require the Company to
meet specific obligations, the Company recognizes customer funding as contract
revenue utilizing the percentage of completion method by the relationship of
costs incurred to total estimated contract costs. As of December 31, 2000 and
1999, the Company had two research and development contracts in place. The
research and development contracts in place were for partial funding for
regenerative fuel cell systems development and general development research
within the area of PEM technology. Both contracts are scheduled to be
completed by the fourth quarter of 2002.

 Cash and Cash Equivalents

   The Company considers all highly liquid investments purchased with original
maturity dates of three months or less as of the purchase date to be cash
equivalents. The Company invests excess cash primarily in a money market
account at a major banking institution, which is subject to credit and market
risk.

 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." At December 31, 2000 and 1999, the

                                      34
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)

Company's investment portfolio consisted of U.S. government securities that are
held by two major banking institutions.

   Securities are carried at fair value with the unrealized gains and losses
reported as a separate component of stockholders' equity. The specific
identification method was used to determine cost in computing unrealized gain
or loss.

 Comprehensive Income (Loss)

   Comprehensive income (loss) is defined as changes in equity other than
transactions resulting from investments by owners and distributions to owners.
The Company's comprehensive loss for the year ended December 31, 2000,
consisted of reported net loss attributable to common stockholders and
unrealized gains on marketable securities and totaled $55,891,879. The
Company's comprehensive loss for the years ended December 31, 1999 and 1998 was
the same as its net loss attributable to common stockholders.

 Inventory

   Inventory is recorded at the lower of cost or market value. Cost is
determined by the first-in, first-out method.

 Fixed Assets

   Fixed assets are stated at cost and are depreciated using the straight-line
method over the following estimated useful lives by asset category:

<TABLE>
<CAPTION>
      Asset Category              Estimated Useful Life
      --------------              ---------------------
      <S>                         <C>
      Machinery and equipment     7 years
      Leasehold improvements      Shorter of remaining life of lease or 7 years
      Office furniture, fixtures  3-5 years
       and equipment
</TABLE>

   When assets are sold or retired, the related cost and accumulated
depreciation are removed from their respective accounts and any resulting gain
or loss is included in income. The Company periodically reviews the carrying
value of its fixed assets to assess recoverability based upon the expectation
of non-discounted future cash flows.

 Research and Development

   Research and development costs are expensed as incurred.

 Warranty Costs

   The Company's warranty policy is limited to replacement parts and services
and generally expires one year from date of shipment. Estimated future warranty
obligations will be provided for as costs of production in the period in which
the related revenue is recognized.

                                       35
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


 Income Taxes

   The Company uses the liability method of accounting for income taxes. Under
this method, deferred tax assets and liabilities are recognized for the
expected future tax consequences of temporary differences between the carrying
amounts and the tax basis of assets and liabilities. A valuation allowance is
established against net deferred tax assets if, based on the weight of
available evidence, it is more likely than not that some or all of the net
deferred tax assets will not be realized.

 Concentration of Risks

   Concentration of credit risk exists with respect to cash and cash
equivalents, investments and vendors. The Company maintains its cash and cash
equivalents and investments with high quality financial institutions. In
addition, certain critical product components are only available from one
source for which the source maintains proprietary rights.

   For the years ended December 31, 2000 and 1999, contract revenue from
government-sponsored agencies accounted for approximately 92% and 60% of total
revenue, respectively.

 Loss per Share

   Net loss per share has been computed by dividing the net loss attributable
to common stockholders by the number of 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.

 Stock-Based Compensation

   The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," (APB 25) and related interpretations in
accounting for its stock option plan and stock awards with the disclosure
provisions of SFAS No. 123 "Accounting for Stock-Based Compensation". Under APB
25, compensation expense is computed to the extent that the fair market value
of the underlying stock on the date of grant exceeds the exercise price of the
employee stock option or stock award. Compensation so computed is then
recognized over the vesting period. The Company accounts for equity instruments
issued to non-employees in accordance with SFAS 123 and Emerging Issues Task
Force ("EITF") 96-18. These pronouncements require the fair value of equity
instruments given as consideration for services rendered be recognized as a
non-cash charge to income over the shorter of the vesting or service period.
The equity instruments must be revalued on each subsequent reporting date until
performance is complete with a cumulative catch-up adjustment recognized for
any changes in their fair value.

 Recent Accounting Pronouncements

   The Financial Accounting Standards Board issued SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137
and SFAS No. 138. This statement establishes accounting and reporting standards
for derivative instruments and for hedging activities and requires recognition
of all derivatives at fair value in the financial statements. It is effective
for fiscal years beginning after June 15, 2000. The Company has reviewed SFAS
No. 133, as amended, and believes that upon implementation the standard will
not have a material impact on its financial statements.

                                       36
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


3. MARKETABLE SECURITIES

   The following tables summarize investments:

<TABLE>
<CAPTION>
                          Amortized   Gross Unrealized Gross Unrealized
                             cost          Gains            Losses       Fair Value
December 31, 2000        ------------ ---------------- ---------------- ------------
<S>                      <C>          <C>              <C>              <C>
U.S. government notes
 and bonds.............. $173,100,802     $294,000         $(5,000)     $173,389,002
                         ------------     --------         -------      ------------
  Total................. $173,100,802     $294,000         $(5,000)     $173,389,002
                         ============     ========         =======      ============
</TABLE>

<TABLE>
<CAPTION>
                         Amortized  Gross Unrealized Gross Unrealized
                            cost         Gains            Losses      Fair Value
December 31, 1999        ---------- ---------------- ---------------- ----------
<S>                      <C>        <C>              <C>              <C>
U.S. government notes
 and bonds.............. $2,550,000       $ 0              $ 0        $2,550,000
                         ----------       ---              ---        ----------
  Total................. $2,550,000       $ 0              $ 0        $2,550,000
                         ==========       ===              ===        ==========
</TABLE>

   As of December 31, 2000 and 1999, the approximate fair values of marketable
securities by maturity date are as follows:
<TABLE>
<CAPTION>
                                                             2000        1999
                                                         ------------ ----------
      <S>                                                <C>          <C>
      Less than one year................................ $165,102,600 $2,550,000
      One to five years.................................    8,286,402        --
                                                         ------------ ----------
        Total........................................... $173,389,002 $2,550,000
                                                         ============ ==========
</TABLE>

4. INVENTORIES AND DEFERRED COSTS

   Inventories and deferred costs are as follows:

<TABLE>
<CAPTION>
                                                                December 31,
                                                             -------------------
                                                                2000      1999
                                                             ---------- --------
   <S>                                                       <C>        <C>
   Raw materials............................................ $  545,583 $345,071
   Work in process..........................................    133,315   98,852
   Finished goods...........................................    970,776  498,304
                                                             ---------- --------
                                                             $1,649,674 $942,227
                                                             ========== ========
</TABLE>

5. FIXED ASSETS

<TABLE>
<CAPTION>
                                                              December 31,
                                                          ---------------------
                                                             2000       1999
                                                          ----------  ---------
   <S>                                                    <C>         <C>
   Machinery and equipment............................... $  805,229  $ 657,619
   Leasehold improvements................................    280,705    267,443
   Office furniture, fixtures and equipment..............    738,090    258,277
   Construction in process...............................     12,585        --
                                                          ----------  ---------
                                                           1,836,609  1,183,339
   Less accumulated depreciation.........................   (632,256) (335,965)
                                                          ----------  ---------
                                                          $1,204,353  $ 847,374
                                                          ==========  =========
</TABLE>

   Depreciation expense was $296,292, $164,588, and $121,061 for the years
ended December 31 2000, 1999, and 1998, respectively.

                                       37
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


6. CAPITAL STRUCTURE

 Mandatorily Redeemable Preferred Stock

   Since inception, the Company has issued Series A, A-1, B, B-1 and C
Convertible Preferred Stock ("Preferred Stock"). All of the series of Preferred
Stock had similar conversion rights, voting rights, dividend rights,
liquidation preferences and redemption rights.

   In May and July 1997, the Company issued an aggregate of 2,908,511 shares of
Series A Preferred Stock at $1.00 per share for $2,908,511. In December 1997,
the Company issued 2,275,367 shares of Series A-1 Preferred Stock at $1.10 per
share for $2,502,904. In July 1998, the Company issued 20,000 shares of Series
A-1 Preferred Stock, valued at $24,000, to service providers.

   In August 1998, the Company issued notes payable, accruing interest at 8%,
to existing preferred stockholders of the Company totaling $2,000,000. The
notes and any accrued but unpaid interest were convertible into Series B
Preferred Stock shares at a price of $2.00 per share upon a subsequent closing
of Series B Preferred Stock financing by the Company. The maturity date of the
notes was August 31, 1999. The notes payable were issued with detachable
warrants to acquire 341,959 shares of Series B Preferred Stock at $2.00 per
share with an expiration date of August 2003 or earlier upon occurrence of
certain liquidity events, including a public offering. In connection with a
liquidity event, and in lieu of cash payment, a warrant holder may convert all
but not less than all warrants into a number of shares of preferred stock
calculated pursuant to a formula defined in the agreement. The warrants were
valued at $331,058 and netted against the carrying value of the notes payable.

   In December 1998, the Company issued 1,545,151 shares of Series B Preferred
Stock. Of these shares, 1,025,851 shares were issued upon conversion of the
notes payable and accrued interest of $1,830,844. Of the remaining 519,300
shares, which were issued at $2.00 per share, 500,000 shares were issued with
100,000 warrants to acquire Series B Preferred Stock with the same
characteristics and expiration date as the warrants issued in August 1998.

   In May 1999, the Company issued 1,500,000 shares of Series B-1 Preferred
Stock at $2.00 per share for $3,000,000.

   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 $50.1 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 the consensus in EITF 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios," and represents 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 $50.1 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.

   In May 2000, the Company issued 103,163 shares of Series A-1 Preferred Stock
to a service provider for services rendered during 1998, 1999 and 2000. Total
shares reserved under this obligation as of December 31, 2000 and 1999, were 0
and 71,322, respectively. The Company had accrued expenses related to this
obligation based on the fair value of the Preferred Stock at the time the
obligation was incurred. For the years ended December 31, 2000, 1999, and 1998,
the Company incurred approximately $148,000, $105,000 and $45,000,
respectively, in expense for services rendered.

                                       38
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


   All outstanding shares of Series A, Series A-1, Series B, Series B-1 and
Series C Preferred Stock automatically converted into 22,659,093 shares of
common stock on a one for one basis, upon the closing of the Company's initial
public offering of common stock in October 2000.

   Also in October 2000, 424,689 shares of Series B Preferred Stock were issued
as a result of the exercise and conversion of warrants to acquire Series B
Preferred Stock. Of the 441,959 then outstanding warrants, 295,179 warrants
were exercised for cash and 146,780 were converted to 129,510 shares of Series
B Preferred Stock.

   Holders of the Series A, Series A-1, Series B, Series B-1 and Series C
mandatorily redeemable preferred stock had redemption rights equal to the
original purchase price plus dividends at 8% per annum (compounded annually)
for each year in which dividends were not declared and paid. Until the date of
conversion, as noted above, such dividends had not been declared or paid and
were being accreted annually to the carrying value of the Preferred Stock from
additional paid-in capital or accumulated deficit if additional paid-in capital
were not available. The Company recognized $2,616,999, $899,000 and $441,000 in
accretion for the years ended December 31, 2000, 1999, and 1998, respectively.

 Common Stock

   The Company has authorized 100,000,000 shares of common stock, par value
$.01 per share. The Company issued 1,900,000 shares of common stock upon
incorporation. Of the 1,900,000 issued shares, 1,400,000 shares were issued to
the Company's founders, subject to a vesting schedule. At December 31, 2000,
the shares were fully vested.

   In connection with a February 1998 customer-sponsored research and
development contract, the Company issued a warrant to purchase 50,000 shares of
the Company's common stock at a purchase price of $1.10 per share. At December
31, 2000, the warrant was fully exercisable and expires in February 2008.

   In October 2000, the Company completed an initial public offering of
8,050,000 shares of common stock at an offering price of $17.00 per share,
including 1,050,000 shares pursuant to the underwriters' exercise of their
over-allotment option (the "Offering"). The Company received proceeds of $125.8
million, which was net of $11.0 million of expenses and underwriting discounts
relating to the issuance and distribution of the securities. Upon the closing
of the Offering, all of the Company's then outstanding Preferred Stock
automatically converted into common stock on a one-for-one basis.

 Preferred Stock

   In June 2000, the Company created a class of 5,000,000 authorized but
undesignated shares of preferred stock, par value $.01.

7. EMPLOYEE BENEFIT PLANS

 Stock Option Plan

   The Company has two stock option plans: the 1996 Stock Option Plan (the
"1996 Plan") and the 2000 Stock Option Plan (the "2000 Plan"). The Company has
reserved a total of 7,700,000 shares of common stock for issuance under the
1996 and 2000 Plans. Together, the Plans provide for the grants of non-
qualified and incentive stock options, restricted stock awards and other stock-
based awards to its employees, officers, directors, consultants and advisors.
Options are generally granted at the fair market value of the common stock at
the time of grant, as determined by the Board of Directors. However, the
exercise price for each incentive stock option shall not be less than the fair
market value of the Common Stock, as determined by the Board, at the time the
incentive stock option is granted. Options generally vest ratably over four
years and expire ten years from the date of grant.

                                       39
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


   A summary of stock option activity for the years ended December 31, 2000,
1999 and 1998 under the Plans is as follows:
<TABLE>
<CAPTION>
                                                                      Weighted
                                                                      Average
                                                                      Exercise
                                                            Shares     Price
                                                           ---------  --------
   <S>                                                     <C>        <C>
   Outstanding at January 1, 1998 (18,000 shares
    exercisable)..........................................   328,000   $ 0.13
     Granted..............................................    46,201     0.15
                                                           ---------
   Outstanding at December 31, 1998 (107,050 shares
    exercisable)..........................................   374,201     0.13
     Granted..............................................   667,040     0.28
     Cancelled or forfeited...............................    (5,000)    0.35
                                                           ---------
   Outstanding at December 31, 1999 (246,225 shares
    exercisable).......................................... 1,036,241     0.23
     Granted.............................................. 1,811,871    11.86
     Exercised............................................   (52,311)    0.17
     Cancelled or forfeited...............................   (32,791)    0.17
                                                           ---------
   Outstanding at December 31, 2000 (424,508 shares
    exercisable).......................................... 2,763,010   $ 7.85
                                                           =========
</TABLE>

   In connection with the grant of certain stock options to employees during
the years ended December 31, 2000 and 1999, the Company recorded unearned stock
compensation of $2,018,107 and $1,099,281 respectively, representing the
difference between the deemed fair market value of the common stock on the date
of grant and the exercise price. Compensation related to options that vest over
time was recorded as unearned compensation, a component of stockholders' equity
(deficit), and is being amortized over the vesting periods of the related
options. During the years ended December 31, 2000 and 1999, the Company
recorded non-cash compensation expense relating to these options totaling
$577,226 and $290,460, respectively.

   During the year ended December 31, 2000, the Company granted non-qualified
stock options to non-employees to purchase an aggregate of 20,500 shares of
common stock. Of these options, options to purchase 5,500 shares were fully
vested at the date of grant, for which the Company recognized compensation
expense of $47,925. The options to purchase the remaining 15,000 shares vest
over four years and expire at the end of ten years. At December 31, 2000, these
options had an estimated fair value of $143,320, or $9.55 per share. Accounting
for these options requires that they be revalued on each subsequent reporting
date until performance is complete or vesting occurs with a cumulative catch-up
adjustment recognized for any changes in fair value. Compensation related to
these options that vest over time was recorded as unearned compensation, a
component of stockholders' equity (deficit), and is being amortized over the
vesting periods of the related options. Accordingly, the Company's results of
operations for the year ended December 31, 2000 include a non-cash charge of
$18,661 for amortization of the fair value of these options. The Company's
future results of operations could be materially impacted by a change in
valuation of the stock options issued as a result of future increases or
decreases in the price of the Company's common stock. The fair value of the
stock options were estimated using the Black-Scholes option-pricing model with
the following assumptions for the year ended December 31, 2000: risk free
interest rates of ranging from 5.12%-6.21%, an expected option life of 5 to 10
years, no dividend yield and 100% volatility.

                                       40
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


   The following table summarizes additional information about stock options
outstanding at December 31, 2000:

<TABLE>
<CAPTION>
                                       Options Outstanding                 Options Exercisable
                          ---------------------------------------------- -----------------------
                              Number     Weighted Average                    Number     Weighted
                          Outstanding at    Remaining        Weighted    Exercisable at Average
                           December 31,  Contractual Life    Average      December 31,  Exercise
Range of Exercise Prices       2000          (years)      Exercise Price      2000       Price
------------------------  -------------- ---------------- -------------- -------------- --------
<S>                       <C>            <C>              <C>            <C>            <C>
       $  .10 --
         $  .15               537,828          7.22           $0.14         328,010      $0.14
          .35 --
            .50               522,279          8.35            0.38          93,398        .35
         2.00 --
           6.00               434,950          9.49            5.87           3,100       5.23
        10.00 --
          15.25               434,453          9.93           10.82             --         --
        16.88 --
          17.00               833,000          9.67           17.00             --         --
        24.13 --
          24.13                   500          9.79           24.13             --         --
                            ---------                                       -------
                            2,763,010          8.96           $7.85         424,508      $0.22
                            =========                                       =======
</TABLE>

   The fair value of each option grant is estimated on the date of grant using
the minimum value option-pricing model for 1998, 1999, and the Black Scholes
option-pricing model for 2000, with the following assumptions:

<TABLE>
<CAPTION>
                                                2000        1999        1998
                                             ----------- ----------- -----------
   <S>                                       <C>         <C>         <C>
   Risk free interest rate.................. 5.17%-6.68% 4.82%-6.48% 5.38%-5.55%
   Expected dividend yield..................    None        None        None
   Expected life of option..................   5 years       6 years   7 years
   Expected volatility......................     100%         0%          0%
</TABLE>

   The weighted average fair value of options granted during 2000, 1999 and
1998 was $9.17, $1.81 and $0.15, respectively.

   If compensation expense had been recognized based on the fair value of
options at their grant date, in accordance with SFAS No. 123, "Accounting for
Stock-Based Compensation," the net loss for the years ended December 31, 2000,
1999 and 1998 would have been as follows:

<TABLE>
<CAPTION>
                                           2000         1999         1998
                                       ------------  -----------  -----------
   <S>                                 <C>           <C>          <C>
   Net loss attributable to common
    stockholders:
     As reported...................... $(56,180,879) $(4,188,710) $(3,122,405)
     Pro forma under SFAS 123.........  (57,588,581)  (4,439,118)  (3,126,505)
   Basic and diluted net loss per
    share attributable to common
    stockholders
     As reported...................... $      (5.92) $     (2.20) $     (1.64)
     Pro forma under SFAS 123.........        (6.07)       (2.34)       (1.65)
</TABLE>

   The above pro forma results are not necessarily indicative of future
results.

 2000 Employee Stock Purchase Plan

   In June 2000, the Company adopted the 2000 Employee Stock Purchase Plan. A
total of 250,000 shares of common stock have been reserved for issuance under
this plan. Eligible employees may purchase common stock pursuant to payroll
deductions at a price equal to 85% of the lower of the fair market value of the
common stock at the beginning or end of each three-month offering period.
Employee contributions are limited to 10% of an employee's eligible
compensation not to exceed amounts allowed by the Internal Revenue Code.

                                       41
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)

As of December 31, 2000, 1,950 shares of common stock have been issued for
proceeds of $17,404 and 248,050 shares are available for future issuance.

 401(k) Plan

   In 1997, the Company established a 401(k) plan covering substantially all of
its employees, subject to certain eligibility requirements. Participants have
the option of contributing up to 15% of their annual compensation.

8. COMMITMENTS AND CONTINGENCIES

 Development, Marketing and Distribution Agreement

   In November 1999, the Company entered into an agreement with a Matheson Tri-
Gas, Inc. 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. The Company recorded
a loss of approximately $121,667 for orders received and product delivered
under this contract for the year ended December 31, 2000. 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.

 Operating Leases

   At December 31, 2000, the Company was committed under operating leases for
its facilities extending through June 2004. The Company also rents certain
office equipment under operating leases.

   Rent expense under the non-cancelable operating leases was approximately
$197,000, $118,000 and $114,000 for the years ended December 31, 2000, 1999 and
1998, respectively.

   Minimum lease payments under the noncancelable leases at December 31, 2000
are as follows:

<TABLE>
        <S>                                                            <C>
        2001.......................................................... $306,905
        2002..........................................................  253,852
        2003..........................................................  179,089
        2004..........................................................   89,545
                                                                       --------
        Total minimum obligations..................................... $829,391
                                                                       ========
</TABLE>

                                       42
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


9. INCOME TAXES

   The Company's gross deferred tax assets and liabilities were as follows:

<TABLE>
<CAPTION>
                                                            December 31,
                                                       ------------------------
                                                          2000         1999
                                                       -----------  -----------
   <S>                                                 <C>          <C>
   Gross deferred tax assets:
       Net operating loss carryforwards............... $ 3,873,000  $ 2,885,000
       Deferred revenue...............................     495,000          --
       Inventory reserves.............................      41,000          --
       Accrued expenses...............................     229,000      136,000
       Research and development tax credits...........     385,000       15,000
                                                       -----------  -----------
                                                         5,023,000    3,036,000
   Gross deferred tax liabilities:
       Depreciation...................................      97,000       86,000
       Deferred costs.................................     403,000          --
                                                       -----------  -----------
                                                           500,000       86,000
                                                       -----------  -----------
   Net deferred tax asset.............................   4,523,000    2,950,000
   Less: valuation allowance..........................  (4,523,000)  (2,950,000)
                                                       -----------  -----------
                                                       $       --   $       --
                                                       ===========  ===========
</TABLE>

   Income tax expense for the year ended December 31, 2000 totaled $125,000 and
related to minimum state capital-based taxes.

   At December 31, 2000, the Company had approximately $9.4 million of federal
net operating loss carryforwards that expire beginning in the year 2011 through
2020, approximately $9.2 million of state net operating loss carryforwards that
expire beginning in the year 2001 through 2020 and federal research and
development tax credit carryforwards of approximately $385,000 that expire
beginning in the year 2001 through 2020.

   The amount of the net operating loss and research and development tax credit
carryforwards that may be utilized annually to offset future taxable income and
tax liability is limited as a result of certain ownership changes pursuant to
Section 382 of the Internal Revenue Code.

                                       43
<PAGE>

                          PROTON ENERGY SYSTEMS, INC.

              NOTES TO CONDENSED FINANCIAL STATEMENTS--(Continued)


10. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

   The following tables set forth certain unaudited quarterly statement of
operations data for the eight quarters ended December 31, 2000. This data has
been derived from unaudited financial statements. In managements' opinion,
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of such information in accordance with
generally accepted accounting principles. The operating results for any quarter
are not necessarily indicative of results for any future period.

<TABLE>
<CAPTION>
                                                   2000 Quarters
                                          -----------------------------------
                                           First    Second    Third   Fourth
                                          -------  --------  -------  -------
                                           Amounts in 000s except for per
                                                   share amounts
<S>                                       <C>      <C>       <C>      <C>
Revenues................................. $    56  $    131  $   350  $   163
Costs of contract revenue and
 production..............................     143        61      251      188
Gross margin.............................     (87)       70       99      (25)
Loss from operations.....................  (1,244)   (1,392)  (1,742)  (3,185)
Net loss.................................  (1,210)     (744)  (1,014)    (522)
Net loss attributable to common
 stockholders............................  (1,470)  (51,914)  (2,275)    (522)
Basic and diluted net loss per share
 attributable to common stockholders.....   (0.77)   (27.30)   (1.18)   (0.02)


<CAPTION>
                                                   1999 Quarters
                                          -----------------------------------
                                           First    Second    Third   Fourth
                                          -------  --------  -------  -------
<S>                                       <C>      <C>       <C>      <C>
Revenues................................. $    23  $     23  $    33  $   854
Costs of contract revenue and
 production..............................     160       102       56      190
Gross margin.............................    (137)      (79)     (23)     664
Loss from operations.....................    (665)     (809)    (900)  (1,088)
Net loss.................................    (633)     (764)    (849)  (1,044)
Net loss attributable to common
 stockholders............................    (820)     (981)  (1,096)  (1,292)
Basic and diluted net loss per share
 attributable to common stockholders.....   (0.43)    (0.51)   (0.58)   (0.68)
</TABLE>

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

   Not applicable.

                                       44
<PAGE>

                                    Part III

   Certain information required by Part III is omitted from this Annual Report
as we intend to file our definitive Proxy Statement for our Annual Meeting of
Stockholders to be held on June 12, 2001, pursuant to Regulation 14A of the
Securities Exchange Act of 1934, as amended, not later than 120 days after the
end of the fiscal year covered by this report, and certain information included
in the Proxy Statement is incorporated herein by reference.

ITEM 10. Directors and Executive Officers of the Registrant

   (a) Executive Officers and Directors--The information in the section
entitled "Executive Officers and Directors of the Registrant" in Part I hereof
is incorporated herein by reference.

   (b) Directors--The information in the section entitled "Directors and
Nominees for Director" in the Proxy Statement is incorporated herein by
reference.

   The disclosure required by Item 405 of Regulation S-K is incorporated by
reference to the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement.

ITEM 11. Executive Compensation

   The information in the sections entitled "Compensation of Executive
Officers," "Compensation of Directors" and "Compensation Committee Interlocks
and Insider Participation" in the Proxy Statement is incorporated herein by
reference.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

   The information in the section entitled "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement is incorporated herein
by reference.

ITEM 13. Certain Relationships and Related Transactions

   The information in the section entitled "Certain Transactions" in the Proxy
Statement is incorporated herein by reference.


                                       45
<PAGE>

                                    Part IV

ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

   (a) Documents filed as part of Form 10-K

1. Financial Statements

   The financial statements of the Company have been included in Item 8 of this
report:

  . Balance Sheets as of December 31, 2000 and 1999.

  . Statements of Operations for each of the three years ended December 31,
    2000, 1999 and 1998, and for the period from inception (August 16, 1996)
    through December 31, 2000.

  . Statements of Changes in Stockholders' Equity (Deficit) for the period
    from inception (August 16, 1996) through December 31, 2000.

  . Statements of Cash Flows for each of the three years ended December 31,
    2000, 1999 and 1998, and for the period from inception (August 16, 1996)
    through December 31, 2000

  . Notes to Financial Statements

2. Financial Statement Schedules

   All financial statement schedules have been omitted since they are either
not required or the information required is included in the financial
statements or the notes thereto.

                                       46
<PAGE>

3. Exhibit Listing

<TABLE>
<CAPTION>
 Exhibit                              Description
 -------                              -----------
 <C>     <S>
  1.1    Third Amended and Restated Certificate of Incorporation of the
         Registrant

  1.2    Amended and Restated By-Laws of the Registrant

  4.1*   Specimen common stock certificate

  4.2*   See Exhibits 3.1 and 3.2 for provisions of the Certificate of
         Incorporation and By-Laws of the Registrant defining the rights of
         holders of common stock of the Registrant

 10.1*   1996 Stock Option Plan

 10.2*   2000 Stock Incentive Plan

 10.3*   2000 Employee Stock Purchase Plan

 10.4*   Development, Marketing and Distribution Agreement, dated November 10,
         1999, between the Registrant and Matheson Tri-Gas, Inc.

 10.5*   Distribution Agreement, dated November 24, 1999, between the
         Registrant and Diamond Lite Limited

 10.6*   Lease, dated as of May 27, 1997, between the Registrant and 50 Inwood
         Road Limited Partnership, as amended on January 29, 1998, March 1,
         1999, and April 9, 1999.

 10.7*   Series C Preferred Stock Purchase Agreement, dated April 12, 2000,
         among the Registrant and certain stockholders

 10.8*   Form of Series B Preferred Stock Purchase Warrant

 10.9*   Common Stock Purchase Warrant, dated February 1998, issued to the
         Electric Power Research Institute

 10.10*  NASA SBIR Contract, dated October 25, 1999

 10.11*  Contract with the U.S. Department of Energy, dated May 21, 1998

 10.12*  Form of Indemnification Agreement with directors and executive
         officers

 10.13   Lease, dated as of January 1, 2001, between the Registrant and the
         Connecticut Student Loan Foundation

 10.14   Purchase and Sale Agreement, dated as of March 8, 2001, between the
         Registrant and
         WE Wallingford Land, L.L.C.

 10.15   Agreement, dated as of March 8, 2001, between the Registrant, Medway
         Associates Limited Partnership and Wallingford Land, L.L.C.

 10.16   Amendment dated December 4, 2000 to Lease, dated as of May 27, 1997,
         between Registrant and 50 Inwood Road Limited Partnership.

 23.1    Consent of PricewaterhouseCoopers LLP
</TABLE>
--------
*Incorporated herein by reference to the identically numbered exhibit of the
   Company's registration statement on Form S-1, SEC File No. 333-39748.

   (b) Reports on Form 8-K

   No reports on Form 8-K have been filed by the Registrant during the quarter
ended December 31, 2000.

                                       47
<PAGE>

                                   SIGNATURES

   In accordance with Section 13 or 15 (d) of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

                                          PROTON ENERGY SYTEMS , INC.

                                               /s/  Walter W. Schroeder
                                          By: _________________________________
                                                    Walter W. Schroeder
                                                         President

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

<TABLE>
<CAPTION>
              Signature                         Capacity                 Date
              ---------                         --------                 ----

<S>                                    <C>                        <C>
     /s/ Walter W. Schroeder           Chief Executive Officer,     March 30, 2001
______________________________________  President and Director
         Walter W. Schroeder            (Principal executive
                                        officer)

        /s/ Robert W. Shaw             Chairman of the Board        March 30, 2001
______________________________________
         Robert W. Shaw, Jr.

         /s/ Richard Aube              Director                     March 30, 2001
______________________________________
             Richard Aube

       /s/ Trent M. Molter             Vice President of            March 30, 2001
______________________________________  Engineering and
           Trent M. Molter              Technology and Director

      /s/ Gerald B. Ostroski           Director                     March 30, 2001
______________________________________
          Gerald B. Ostroski

       /s/ Philip R. Sharp             Director                     March 30, 2001
______________________________________
           Philip R. Sharp

       /s/ John A. Glidden             Vice President of Finance    March 30, 2001
______________________________________  (Principal financial and
           John A. Glidden              accounting officer)
</TABLE>

                                       48