<PAGE>

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

                                    FORM 10-Q

(Mark One)

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

For the quarterly period ended    March 31, 2002
                               -------------------------------------------------
                                       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:
                       ---------------------------------------------------------

                               ACTIVE POWER, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

           Delaware                                   74-2961657
--------------------------------------------------------------------------------
(State or other jurisdiction of                    (I.R.S. Employer
 incorporation or organization)                     Identification No.)

11525 Stonehollow Dr.,  Suite 110,  Austin, Texas        78758
--------------------------------------------------------------------------------
(Address of principal executive offices)               (Zip Code)


                                 (512) 836-6464
--------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)

--------------------------------------------------------------------------------
   (Former name, former address and former fiscal year, if changed since last
                                     report)

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.                         [X] Yes [_] No

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

     The number of shares of common stock as of March 31, 2002 was 40,990,798
with a par value of $.001 per share.
--------------------------------------------------------------------------------

<PAGE>

                               ACTIVE POWER, INC.
                                      INDEX


PART I - FINANCIAL INFORMATION.............................................  1

Item 1. Financial Statements...............................................  1

     BALANCE SHEETS........................................................  1

     STATEMENT OF OPERATIONS...............................................  2

     STATEMENT OF CASH FLOWS...............................................  3

     Notes to Financial Statements.........................................  4

Item 2. Management's Discussion and Analysis of Financial Condition and
        Results of Operations..............................................  6

     Liquidity and Capital Resources....................................... 10

     Quantitative and Qualitative Disclosures About Market Risk............ 10

     Risk Factors That May Affect Future Results........................... 12

Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 19

PART II - OTHER INFORMATION................................................ 20

Item 1. Legal Proceedings.................................................. 20

Item 2. Changes in Securities and Use of Proceeds.......................... 20

Item 3. Defaults Upon Senior Securities.................................... 20

Item 4. Submission of Matters to a Vote of Security Holders................ 20

Item 5. Other Information.................................................. 20

Item 6. Exhibits and Reports on Form 8-K................................... 20

                                       i

<PAGE>

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

                               ACTIVE POWER, INC.
                                 BALANCE SHEETS
                                 (in thousands)

<TABLE>
<CAPTION>

                                                                             March 31,       December 31,
                                                                               2002              2001
                                                                            -----------      ------------
                                                                            (unaudited)
<S>                                                                         <C>              <C>
           ASSETS

           Current assets:
                Cash and cash equivalents                                   $    74,567      $     80,401
                Accounts receivable, net                                          2,741             1,723
                Inventories, net                                                  7,763             7,869
                Prepaid expenses and other                                        1,002               714
                                                                            -----------      ------------
                     Total current assets                                        86,073            90,707
           Property and equipment, net                                           16,149            16,965
           Long-term investments                                                 29,344            31,704
                                                                            -----------      ------------
                     Total assets                                           $   131,566      $    139,376
                                                                            ===========      ============

           LIABILITIES AND STOCKHOLDERS' EQUITY

           Current liabilities:
                Accounts payable                                            $     2,228      $      4,530
                Accrued expenses                                                  2,925             3,116
                                                                            -----------      ------------
           Total liabilities                                                      5,153             7,646
           Stockholders' equity:
                Common Stock                                                         41                41
                Treasury stock                                                       (2)               (2)
                Deferred stock compensation                                      (1,788)           (2,575)
                Additional paid-in capital                                      214,967           214,637
                Accumulated deficit                                             (87,231)          (80,692)
                Other accumulated comprehensive income                              426               321
                                                                            -----------      ------------
                     Total stockholders' equity                                 126,413           131,730
                                                                            -----------      ------------
                     Total liabilities and stockholders' equity             $   131,566      $    139,376
                                                                            ===========      ============
</TABLE>

         See accompanying notes

                                       1

<PAGE>

                               ACTIVE POWER, INC.
                             STATEMENT OF OPERATIONS
               (in thousands, except share and per share amounts)

<TABLE>
<CAPTION>

                                                                          Three Months Ended March 31,
                                                                             2002              2001
                                                                           --------          --------
                                                                          (unaudited)       (unaudited)
<S>                                                                     <C>               <C>
     Revenues:
          Product revenue                                               $     3,131       $     5,107
          Development contract                                                1,000                 -
                                                                        -----------       -----------
               Total revenue                                            $     4,131       $     5,107
     Operating expenses:
          Cost of product revenue                                             4,471             6,513
          Cost of development contract                                          741                 -
          Research and development                                            2,611             3,543
          Selling, general & administrative                                   3,143             2,741
          Amortization of deferred stock compensation                           628             1,287
                                                                        -----------       -----------
               Total operating expenses                                      11,594            14,084

     Operating loss                                                          (7,463)           (8,977)
     Interest income                                                            905             2,238
     Other income (expense)                                                      19                24
                                                                        -----------       -----------
     Net loss to common stockholders                                    $    (6,539)      $    (6,715)
                                                                        ===========       ===========
     Net loss per share, basic & diluted                                $     (0.16)      $     (0.17)
     Shares used in computing net loss per share, basic & diluted        40,846,577        38,906,882

     Comprehensive income (loss):
         Net loss                                                       $    (6,539)      $    (6,715)
         Unrealized gain/loss - investments                                     105                 -
                                                                        -----------       -----------
         Comprehensive income (loss)                                    $    (6,434)      $    (6,715)
                                                                        ===========       ===========
</TABLE>


         See accompanying notes

                                       2

<PAGE>

                               ACTIVE POWER, INC.
                             STATEMENT OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>

                                                                                           Three Months Ended March 31,
                                                                                           ----------------------------
                                                                                               2002           2001
                                                                                             ---------      --------
                                                                                           (unaudited)     (unaudited)
<S>                                                                                          <C>             <C>
     Operating activities
     Net loss                                                                                $  (6,539)     $ (6,715)
         Adjustment to reconcile net loss to cash used in operating activities:
         Depreciation expense                                                                      937           500
         Amortization of deferred stock compensation                                               628         1,287
         Unrealized gain on available-for-sale investments                                         105             -
         Changes in operating assets and liabilities:
              Accounts receivable, net                                                          (1,018)       (1,714)
              Inventories, net                                                                     108        (1,689)
              Prepaid expenses and other assets                                                   (288)         (653)
              Accounts payable                                                                  (2,302)          704
              Accrued expenses                                                                    (191)          (71)
                                                                                             ---------      --------
     Net cash used in operating activities                                                      (8,560)       (8,351)

     Investing activities
     Net maturity (purchase) of short-term investments                                           2,361        16,603
     Purchases of property and equipment                                                          (122)       (1,549)
                                                                                             ---------      --------
     Net cash provided by investing activities                                                   2,239        15,054

     Financing activities
     Net proceeds from issuance of common stock                                                    487           700
                                                                                             ---------    ----------
     Net cash provided by financing activities                                                     487           700
                                                                                             ---------    ----------
     Increase (decrease) in cash and cash equivalents                                           (5,834)        7,403
     Cash and cash equivalents, beginning of period                                             80,401        92,720
                                                                                             ---------    ----------
     Cash and cash equivalents, end of period                                                $  74,567    $  100,123
                                                                                             =========    ==========
</TABLE>


         See accompanying notes.

                                       3

<PAGE>

                               Active Power, Inc.
                          Notes to Financial Statements
                                 March 31, 2002
                                   (unaudited)


1.   Organization

     Active Power, Inc. was founded in 1992 for the purpose of developing and
commercializing advances in the field of electromechanics. Prior to 2000, we
devoted our efforts principally to research and development, pursuing patent
protection for intellectual property, successful production of our initial
prototypes, raising capital and pursuing markets for our flywheel-based power
quality and energy storage products. In 2000 and 2001, we expanded the size and
scope of our operations considerably. We raised our level of new product
development expenditures, increased our manufacturing capabilities and capacity,
and added resources in sales and service to strengthen our distribution
channels.

2.   Basis of Presentation

     The accompanying unaudited interim financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
Accordingly, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These financial statements should be
read in conjunction with the audited financial statements and accompanying notes
thereto included in our Form 10-K for the year ending December 31, 2001. In the
opinion of management the financial statements include all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the results for the periods presented. Results of operations for any interim
period are not necessarily indicative of results for any other interim period or
for the full year.

3.   Inventory

     Active Power states inventories at the lower of cost or replacement cost,
with cost being determined on a standard cost basis, which does not differ
materially from actual cost.

     Inventories consist of the following:
<TABLE>
<CAPTION>

                                             March 31,         December 31,
                                                2002                2001
                                            ------------        ------------
<S>                                         <C>                 <C>
         Raw materials.................     $  4,579,495        $  4,326,357
         Work in process...............        3,657,318           3,923,040
         Finished goods................          596,593             190,718
         Less Reserves.................       (1,070,756)           (570,756)
                                            ------------        ------------
                                            $  7,762,650        $  7,869,359
                                            ============        ============
</TABLE>

During the quarter ended March 31, 2002 we increased our inventory reserve to
recognize the potential obsolescence of component parts that are at risk of
becoming obsolete when various

                                       4

<PAGE>

engineering product enhancements and cost reduction design changes are
implemented over the next 12 months.

4.   Capital Structure

     The following table sets forth the computation of basic and diluted net
loss per share:

<TABLE>
<CAPTION>
                                                                  Three Months Ended March 31,
                                                                  ----------------------------
                                                                       2002             2001
                                                                       ----             ----
<S>                                                              <C>               <C>
Net loss to common stockholders (thousands) ...................    $   (6,539)       $   (6,715)
Basic and diluted:
    Weighted-average shares of common stock
       outstanding ............................................    40,920,118        39,262,431
    Weighted-average shares of common stock
       subject to repurchase ..................................       (73,541)         (355,549)
                                                                   ----------        ----------
Shares used in computing basic and diluted net
    loss per share ............................................    40,846,577        38,906,882
                                                                   ==========        ==========
Basic and diluted net loss per share ..........................    $    (0.16)       $    (0.17)
                                                                   ==========        ==========
</TABLE>

                                       5

<PAGE>

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

     The following discussion should be read in conjunction with the financial
statements appearing elsewhere in this Form 10-Q and within our Form 10-K for
the year ending December 31, 2001. This report contains forward-looking
statements, within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, that involve risks and
uncertainties. Our expectations with respect to future results of operations
that may be embodied in oral and written forward-looking statements, including
any forward looking statements that may be included in this report, are subject
to risks and uncertainties that must be considered when evaluating the
likelihood of our realization of such expectations. Our actual results could
differ materially. The words "believe," "expect," "intend," "plan," "project,"
"will" and similar phrases as they relate to us are intended to identify such
forward-looking statements. Among the important factors which could cause actual
results to differ materially include: the potential for significant losses to
continue; inability to accurately predict revenue and budget for expenses for
future periods; fluctuations in revenue and operating results; overall market
performance; a slowing global economy; limited product lines; inability to
manufacture products of the quality necessary to be accepted in the power
quality market; inability to expand our distribution channels; our dependence on
our relationship with Caterpillar; inability to successfully integrate new OEM
channel partners; competition; delays in research and development; inability to
increase sales volumes to fully utilize our increased manufacturing capacity;
inventory risks; risks of delay or poor execution from a variety of sources;
limited resources; dependence upon key personnel; inability to protect our
intellectual property rights; potential future acquisitions; and the volatility
of our stock price. The discussion below addresses some of these factors.
Additional risks and uncertainties that we are unaware of or that we currently
deem immaterial also may become important factors that affect us.

Overview

     We design, manufacture and market power quality products that provide the
consistent, reliable electric power required by today's digital economy. We
believe that we are the first company to commercialize a flywheel energy storage
system that provides a highly reliable, low-cost and non-toxic replacement for
lead-acid batteries used in conventional power quality installations. Leveraging
our expertise in this technology and in conjunction with Caterpillar Inc., the
leading maker of engine generators for the power reliability market, we have
developed a battery-free uninterruptible power supply (UPS), which is marketed
under the Caterpillar brand name as the Cat(R) UPS. We have also developed a
battery-free DC system that is compatible with all major UPS brands,
CleanSource2 DC. We sell our CleanSource2 DC products through Powerware, an
original equipment manufacturer, or OEM. Our products are sold for use in the
facilities of companies in many different industries that all share a critical
need for reliable, high-quality power, such as plastic manufacturers,
semiconductor manufacturers, hospitals, credit card processing centers,
broadcasters, advanced data centers, and electric utilities.

     Since 1996, we have focused our efforts and financial resources primarily
on the design and development of our CleanSource(R) line of power quality
products and on establishing effective OEM channels to market our products
(CleanSource2 DC and CleanSource UPS). As of March 31, 2002, we had generated an
accumulated deficit of $87.2 million and expect to continue to sustain operating
losses for the next several quarters. We initially funded our operations
primarily through sales of shares of preferred stock, which resulted in gross
proceeds of approximately $42.6 million. We believe the proceeds from our August
2000 initial public

                                       6

<PAGE>

offering, approximately $138.4 million net of commissions and issuance costs,
together with cash balances on hand prior to August 2000 will be sufficient to
meet our capital requirements through at least the next 24 months. Our cash and
investments position at March 31, 2002 was $103.9 million.

     Since our inception, a small number of customers have accounted for the
majority of our annual sales. During 1999, our four largest customers accounted
for 89% of our sales, with our largest customer, Caterpillar and its dealer
network, accounting for 39%. In 2000 and 2001, our business level with
Caterpillar and its dealer network grew substantially, accounting for 96% and
87%, respectively, of our revenue due to the commercial introduction of the
CleanSource(R) UPS product line. We expect to continue to be dependent on a few
OEM customers, primarily Caterpillar, for the majority of our sales for the
foreseeable future.

     Since the commercial release of the CleanSource UPS in May 2000 under the
Caterpillar brand name, the demand for our products has increased significantly.
To address this growth in demand and to position us for anticipated future
growth, we increased the scale of our operations in the following ways:

     o    Expanded our manufacturing facilities and added manufacturing
          personnel to address increases in product demand;

     o    Increased our personnel levels in product development and engineering
          to accelerate time to market on new products and enhance existing
          product lines; and

     o    Added sales, service and marketing personnel to support our OEM
          customers and accelerate our other sales efforts.

     Although these efforts have increased our operating expenses, we believe
they are necessary to enable us to realize significant revenue growth.

Critical Accounting Policies

We believe the following list represents our critical accounting policies:

     Revenue recognition. We recognize product revenue when title transfers and
our obligations are complete, usually when a unit is shipped. We recognize
product revenue related to units shipped for evaluation by the customer at the
time the customer accepts the unit. We recognize development funding revenue as
we achieve development milestones specified in the respective agreements.

     Bad debt. We estimate an allowance for doubtful accounts based on factors
related to the credit risk of each customer. Credit losses have not been
significant to date. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.

     Inventories. We state inventories at the lower of cost or replacement cost,
with cost being determined on a standard cost basis, which does not differ
materially from actual cost. If actual future demand or market conditions are
less favorable than those projected by management, additional inventory
write-downs may be required.

     Warranty costs. We provide for the estimated cost of product warranties at
the time revenue is recognized. While we engage in product quality programs and
processes, our warranty obligation is affected by product failure rates,
material usage and service delivery costs incurred

                                       7

<PAGE>

in correcting a product failure. Should actual product failure rates, material
usage or service delivery costs differ from our estimates, revisions to the
estimated warranty liability may be required.

Results of Operations

     Product revenue. Product revenue primarily consists of sales of our
CleanSource line of power quality products. Sales decreased $2.0 million, or
39%, to $3.1 million for the three months ended March 31, 2002, from $5.1
million for the three months ended March 31, 2001. We believe this decrease was
primarily attributable to a significant reduction in the market for capital
equipment due, in large part, to the overall economic slowdown that has taken
place in the United States and globally. In the three months ended March 31,
2002, we sold 54 quarter-megawatt flywheel units, while we sold 101
quarter-megawatt flywheel units for the same period of 2001. The majority of the
units shipped in both periods were sold to our CleanSource UPS OEM, Caterpillar.

     Development contract revenue. Development contract revenue primarily
consists of funding paid to us by Caterpillar. In 1999 we entered into an
agreement with Caterpillar to develop the Cat UPS. As part of that agreement
Caterpillar provided us with $5.0 million in funding for the successful
completion of several development milestones. In September 2001 we signed an
extension to our development agreement with Caterpillar to expand the Cat UPS
product line. The extension calls for an additional $5.0 million in funding upon
successful completion of certain development milestones. In December 2001 we
completed the first milestone and collected $1.0 million, and in January 2002 we
completed a second milestone and collected another $1.0 million. There was no
development contract revenue recorded in the first quarter of 2001.

     Cost of product revenue. Cost of product revenue includes the cost of
component parts of our product that are sourced from suppliers, personnel,
equipment and other costs associated with our assembly and test operations,
shipping costs, and the costs of manufacturing support functions such as
logistics and quality assurance. Cost of product revenue decreased $2.0 million,
or 31%, to $4.5 million for the three months ended March 31, 2002, from $6.5
million for the three months ended March 31, 2001. This decrease was primarily
due to the lower sales activity in 2002 compared to the same period of 2001,
which we believe was due to the overall economic slowdown. In anticipation of
future demand for our products, we have significantly expanded our manufacturing
capacity by increasing our manufacturing facilities, which has increased our
fixed manufacturing expense base. This increase will adversely impact our gross
margins until production volumes increase enough to cover these added costs.
While our variable product margin (sales less materials and direct labor) was
positive in 2001 and the first quarter of 2002, our overall product margin was
negative due, in large part, to the underutilization of our indirect
manufacturing costs. Over time we believe gross margins will improve as we
increase product volumes, achieve greater economies of scale in production and
in purchasing component parts, and introduce additional engineering design
savings.

     Cost of development contract. Cost of development contract primarily
consists of engineering expenses incurred related to the joint development
process with Caterpillar, through which we receive development funding. For the
three months ended March 31, 2002, we incurred $741,000 in development contract
expenses. We had no development contract expenses for the same period in 2001.
The margins we achieve in our development funding activities can

                                       8

<PAGE>

vary considerably depending on the difficulty of each development milestone, the
level of contract development we purchase from third parties, and level of
materials purchased.

     Research and development. Research and development expense primarily
consists of compensation and related costs of employees engaged in research,
development and engineering activities, third party consulting and development
activities, as well as an allocated portion of our occupancy costs. Research and
development expense decreased $0.9 million, or 26%, to $2.6 million for the
three months ended March 31, 2002, from $3.5 million for the three months ended
March 31, 2001. The decrease in research and development expense was driven by
two principal factors. The first factor was a phase down of spending on our low
power telecom development project. Although many of the internal resources
committed to this project have been redirected to other new product initiatives,
such as our high power UPS product line extension, the external funding
associated with this project has been eliminated, thereby reducing our overall
spending levels. The second factor was the separation of costs associated with
the development of our high power UPS product line extension. These costs have
been separated from R&D and recorded as a separate line on the income statement,
called "cost of development contracts" (see above). The impact this separate
accounting for the cost of development contracts has on what is reported as R&D
spending will vary according to the level of activity and assignment of
personnel on development contract projects. We believe that research and
development expenses will remain flat for the foreseeable future, but will
decrease as a percentage of sales over time as revenue increases.

     Selling, general and administrative. Selling, general and administrative
expense is primarily comprised of compensation and related costs for sales,
service, marketing and administrative personnel, selling and marketing expenses,
professional fees, and for product warranty and bad debt costs and reserves.
Selling, general and administrative expense increased approximately $0.4
million, or 15%, to $3.1 million for the three months ended March 31, 2002, from
$2.7 million for the three months ended March 31, 2001. The increase in selling,
general and administrative expense was principally due to increased personnel in
our sales, service and marketing organizations to support our OEM channel
partners' sales and service ramp up. We believe that selling, general and
administrative expense will increase in future periods as we add sales, and
service personnel and costs to position us for anticipated future sales growth.

     Amortization of deferred stock compensation. Deferred stock compensation is
a non-cash expense that reflects the difference between the exercise price of
option grants to employees and the estimated fair value determined subsequently
by us of our common stock at the date of grant. We are amortizing deferred stock
compensation as an operating expense over the vesting periods of the applicable
options, which resulted in amortization expense of $628,000 for the three months
ended March 31, 2002 and $1.3 million for the three months ended March 31, 2001.
We expect this amortization expense to decrease in the future, as the options
for which we are amortizing this expense become fully vested and, to a lesser
extent, as some employees to whom these options were granted leave the company
and any unvested options are canceled.

     Interest income. Interest income decreased $1.3 million to $0.9 million for
the three months ended March 31, 2002, from $2.2 million for the three months
ended March 31, 2001. This decrease is attributable to two factors. First, there
was a decrease in our average cash and investments balance for the three-month
period of 2002 of $105.1 million compared to an average cash and investments
balance of $140.6 million for the first quarter of 2001. Second, the average
rate of return on our investments dropped significantly from the first quarter
of 2001 to

                                       9

<PAGE>

the same period in 2002, as interest rates in the financial markets have
declined over the past year.

Liquidity and Capital Resources

     Our principal source of liquidity as of March 31, 2002 consisted of $103.9
million of cash, cash equivalents and investments.

     In August 2000, we completed a successful initial public offering, raising
approximately $138.4 million, net of commissions and issuance expenses. This is
in addition to our private financing efforts, including the sale of shares of
our preferred stock, which have resulted in gross proceeds of approximately
$42.6 million, and $7.0 million in development funding received from Caterpillar
since 1999. During the three months ended March 31, 2002, cash used by operating
activities remained relatively flat at $8.6 million, compared to $8.4 million of
cash used by operating activities for the three months ended March 31, 2001.

     Capital expenditures were $122,000 for the three months ended March 31,
2002 and $1.5 million for the three months ended March 31, 2001. Our
expenditures in 2001 were primarily attributable to the increase in our
manufacturing capacity, including several new product test lines and leasehold
improvements for our new manufacturing facility. In 2002 our expenditures were
limited to leasehold improvements to our engineering testing facilities and
other general computer equipment and software for administrative purposes. We
expect to incur approximately $2.0 to $3.0 million in additional capital
expenditures in 2002 primarily on additional engineering lab equipment and
improvements, demonstration units, and general computer equipment and software
for manufacturing, engineering and administrative purposes.

     We believe our existing cash balance at March 31, 2002 will be sufficient
to meet our capital requirements through at least the next 24 months, although
we might elect to seek additional funding prior to that time. Beyond the next 24
months, our capital requirements will depend on many factors, including the rate
of sales growth, the market acceptance of our products, the timing and level of
development funding, the rate of expansion of our sales and marketing
activities, the rate of expansion of our manufacturing facilities, and the
timing and extent of research and development projects. Although we are not a
party to any agreement or letter of intent with respect to a potential
acquisition, we may enter into acquisitions or strategic arrangements in the
future, which could also require us to seek additional equity or debt financing.

Quantitative and Qualitative Disclosures About Market Risk

     Our interest income is sensitive to changes in the general level of U.S.
interest rates, particularly since the majority of our investments are in
short-term instruments. We believe that our investment policy is conservative,
both in terms of the average maturity of investments that we allow and in terms
of the credit quality of the investments we hold. We estimate that a 1% decrease
in market interest rates would decrease our interest income by $1.0 million.
Because of the short-term nature of the majority of our investments, we do not
believe a 1% decline in interest rates would have a material effect on their
fair value.

                                       10

<PAGE>

     We invest our cash in a variety of financial instruments, including bank
time deposits, and taxable variable rate and fixed rate obligations of
corporations, municipalities, and local, state and national government entities
and agencies. These investments are denominated in U.S. dollars.

                                       11

<PAGE>

Risk Factors That May Affect Future Results

     In addition to the other information in this Form 10-Q, the following
factors should be considered in evaluating Active Power and our business. These
factors include, but are not limited to the potential for significant losses to
continue; inability to accurately predict revenue and budget for expenses for
future periods; fluctuations in revenue and operating results; overall market
performance; a slowing global economy; limited product lines; inability to
manufacture products of the quality necessary to be accepted in the power
quality market; inability to expand our distribution channels; our dependence on
our relationship with Caterpillar; inability to successfully integrate new OEM
channel partners; competition; delays in research and development; inability to
increase sales volumes to fully utilize our increased manufacturing capacity;
inventory risks; risks of delay or poor execution from a variety of sources;
limited resources; dependence upon key personnel; inability to protect our
intellectual property rights; potential future acquisitions; and the volatility
of our stock price. The discussion below addresses some of these factors.
Additional risks and uncertainties that we are unaware of or that we currently
deem immaterial also may become important factors that affect us.

We have incurred significant losses and anticipate losses for the next several
quarters.

     We have incurred operating losses since our inception and expect to
continue to incur losses for the next several quarters. As of March 31, 2002, we
had an accumulated deficit of $87.2 million. To date, we have funded our
operations principally through the sale of our stock, our product revenue and
$7.0 million in development funding payments from Caterpillar. We will need to
generate significant additional revenue to achieve profitability, and we cannot
assure you that we will ever realize additional revenue at such levels. We also
expect to incur significant product development, sales and marketing and
administrative expenses and, as a result, we expect to continue to incur losses.

Due to our limited operating history and the uncertain market acceptance of our
products, we may never achieve significant revenue and may have difficulty
accurately predicting revenue for future periods and appropriately budgeting for
expenses.

     We have generated a total of $31.5 million in product revenue since January
1, 1998, and we have sold approximately 600 CleanSource DC and UPS products. We
are uncertain whether our products will achieve market acceptance such that our
revenue will increase or whether we will be able to achieve significant revenue.
Therefore, we have a very limited ability to predict future revenue. Our limited
operating experience, the uncertain market acceptance for our products, and
other factors that are beyond our control make it difficult for us to accurately
forecast our quarterly and annual revenue. However, we use our forecasted
revenue to establish our expense budget. Most of our expenses are fixed in the
short term or incurred in advance of anticipated revenue. As a result, we may
not be able to decrease our expenses in a timely manner to offset any revenue
shortfall. Further, we have expanded our staff and facilities and increased our
expense levels in anticipation of future revenue growth. If our revenue does not
increase as anticipated, we will continue to incur significant losses.

Our business is subject to fluctuations in operating results, which could
negatively impact the price of our stock.

                                       12

<PAGE>

     Our product revenue, expense and operating results have varied in the past
and may fluctuate significantly in the future due to a variety of factors, many
of which are outside of our control. These factors include, among others:

     o    the timing of orders from our customers and the possibility that these
          customers may change their order requirements with little or no
          advance notice to us;

     o    the rate of adoption of our flywheel-based energy storage system as an
          alternative to lead-acid batteries;

     o    the deferral of customer orders in anticipation of new products from
          us or other providers of power quality systems;

     o    the ongoing need for short-term power outage protection in traditional
          UPS systems;

     o    the uncertainty regarding the adoption of our current and future
          products, including our recently introduced CleanSource UPS and
          CleanSource2 DC products, as well as our other products, which are
          currently under development; and

     o    the rate of growth of the markets for our products.

Our business is dependent on the market for power quality products and the
health of the overall economy, and if this market does not expand as we
anticipate, if alternatives to our products are successful, or if the downturn
in the economy continues to limit capital spending, our business will suffer.

     The market for power quality products is rapidly evolving and it is
difficult to predict its potential size or future growth rate. Most of the
organizations that may purchase our products have invested substantial resources
in their existing power systems and, as a result, may be reluctant or slow to
adopt a new approach. Moreover, our products are alternatives to existing UPS
and battery-based systems and may never be accepted by our customers or may be
made obsolete by other advances in power quality technologies. Improvements may
also be made to the existing alternatives to our products that could render them
less desirable or obsolete. Furthermore, our business depends on capital
expenditures by organizations, which tend to decrease when the U.S. or global
economy slows. Our business has suffered during the recent economic slowdown,
and will continue to suffer if the slowdown continues.

We have limited product offerings, and our success depends on our ability to
develop in a timely manner new and enhanced products that achieve market
acceptance.

     While our products are achieving a more significant operating history at
customer sites, our CleanSource2 DC and CleanSource UPS products are relatively
new to the marketplace. To grow our revenue, we must rely on Powerware and
Caterpillar to successfully market our DC and UPS products, respectively, and we
must develop and introduce to the market new products and product enhancements
in a timely manner. Even if we are able to develop and commercially introduce
new products and enhancements, they may not achieve market acceptance. This
would substantially impair our revenue, profitability and overall financial
prospects.

Failure to expand our distribution channels and manage our distribution
relationships could impede our future growth.

     The future growth of our business will depend in part on our ability to
expand our existing relationships with OEMs, to identify and develop additional
channels for the distribution and sale of our products and to manage these
relationships. As part of our growth strategy, we intend to expand our
relationships with OEMs and to develop relationships with new OEMs. We

                                       13

<PAGE>

will also look to identify and develop relationships with additional partners
that could serve as distributors for our products. Our inability to successfully
execute this strategy and to reduce our reliance on Caterpillar could impede our
future growth.

We are heavily dependent on our relationship with Caterpillar. If our
relationship is unsuccessful, for whatever reason, our business and financial
prospects will suffer.

     If our relationship with Caterpillar is not successful, or if Caterpillar's
distribution of the Cat UPS product is not successful, our business and
financial prospects will suffer. Pursuant to a development agreement,
Caterpillar has provided us with $7.0 million in funding through March 31, 2002,
to support the development of the Cat UPS product and other development efforts.
In exchange for this payment, Caterpillar received co-ownership of the
proprietary rights in this product. Either Caterpillar or we may license to
other entities the intellectual property that we jointly own without seeking the
consent of the other and the licensing party will solely retain all licensing
revenue generated by licensing this intellectual property. However, we may not
license the joint intellectual property to specifically identified competitors
of Caterpillar until January 1, 2007. Caterpillar may terminate this agreement
at any time by giving us 90 days' advance written notice. We also have a
distribution agreement with Caterpillar. During 2000 and 2001, our business
level with Caterpillar and its dealer network accounted for 96% and 87% of our
product revenue, respectively. Pursuant to the distribution agreement with
Caterpillar, they are the exclusive distributor, subject to limited exceptions,
of our CleanSource UPS product. Caterpillar is not obligated to purchase any
CleanSource UPS units.

We depend on a limited number of OEM customers for the vast majority of our
revenue and service and support functions. The loss or significant reduction in
orders, or the failure to provide adequate service and support to the end users
of our products, from any key OEM customer, particularly Caterpillar or
Powerware, would significantly reduce our revenue.

     We rely on OEMs as a primary distribution channel because they are able to
sell our products to a large number of end user organizations. We further rely
on our OEMs to provide service and support to the end users of our products
because they have the experience and personnel to perform such activities. We
believe that the use of OEM channels will enable our products to achieve broad
market penetration, while we devote a limited amount of our resources to sales,
marketing and customer service and support. Our operating results in the
foreseeable future will continue to depend on sales to a relatively small number
of OEM customers, primarily Caterpillar. For example, in 2000 and 2001, our
volume of business with Caterpillar and its dealers accounted for 96% and 87% of
our product revenue, respectively. Therefore, the loss of our key OEM customer,
Caterpillar, or a significant reduction in sales to Caterpillar and its dealers,
would significantly reduce our revenue. We have granted Caterpillar
semi-exclusive worldwide rights to distribute our UPS product, provided that
they meet minimum annual sales requirements. We have also granted Powerware
semi-exclusive distribution rights to our CleanSource2 DC product in North
America. Because we have entered into exclusive or semi-exclusive agreements for
the distribution of our products with a very limited number of OEM customers,
the failure of any one of these relationships, particularly Caterpillar or
Powerware, could negatively impact our revenue.

                                       14

<PAGE>

We have no experience manufacturing our products in the quantities we expect to
sell in the future.

     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 more limited quantities. This
presents a number of technological and engineering challenges for us. We have
not previously manufactured our products in high volume. We do not know whether
or when we will be able to develop efficient, low-cost manufacturing capability
and processes that will enable us to meet the quality, price, engineering,
design and product standards or production volumes required to successfully
manufacture large quantities of our products. Even if we are successful in
developing our manufacturing capability and processes, we do not know whether we
will do so in time to meet our product commercialization schedule or to satisfy
the requirements of our customers.

We expanded our manufacturing facility based on our forecasted sales volumes in
the future. If we do not achieve these forecasted sales volumes, we will
underutilize our manufacturing capacity and our business will suffer.

     We recently completed a 127,000 square foot facility used for manufacturing
and testing our three-phase product line, including our DC and UPS products. In
order for us to fully utilize the capacity of the facility and spread out its
associated overhead, we must achieve significantly higher sales volumes. If we
do not reach our forecasted sales volumes, our revenue will suffer and our
ability to reach profitability will be materially limited.

Quality problems relating to one or more of our new or existing products could
negatively impact the market's acceptance of our products and cause us to miss
our revenue goals and/or to incur significant liability.

     Because of the nature of the power quality and reliability market, quality
problems attributable to the CleanSource DC or UPS product lines could
significantly affect the market's perception of our technology and slow or limit
their acceptance. This would substantially impair our revenue prospects.
Moreover, quality problems for our product lines could cause us to delay or
cease shipments of products, or recall products, thus impairing our revenue or
cost targets. In addition, while we seek to limit our liability as a result of
product failures or defects through warranty and other limitations, if one of
our products fails then a customer could suffer a significant loss and seek to
hold us responsible for that loss.

We are subject to increased inventory risks and costs because we outsource the
manufacturing of components of our products in advance of binding commitments
from our customers to purchase our products.

     To assure the availability of our products to our OEM customers, we
outsource the manufacturing of components prior to the receipt of purchase
orders from OEM customers based on their forecasts of their product needs.
However, these forecasts do not represent binding purchase commitments, and we
do not recognize revenue for such products until the product is shipped to the
OEM. As a result, we incur inventory and manufacturing costs in advance of
anticipated revenue. As demand for our products may not materialize, this
product delivery method subjects us to increased risks of high inventory
carrying costs, obsolescence and excess, and may increase our operating costs.
In addition, we may from time to time make design changes to our products, which
could lead to obsolescence of inventory.

                                       15

<PAGE>

We depend on sole source and limited source suppliers for certain key
components, and if we are unable to buy these components on a timely basis, our
delayed ability to deliver our products to our customers may result in reduced
revenue and lost sales.

     We purchase a power module and a microprocessor for our products from sole
source suppliers. As a result, if our suppliers receive excess demand for their
products, we may receive a low priority for order fulfillment as large volume
customers will receive priority. If we are delayed in acquiring components for
our products, the manufacture and shipment of our products also will be delayed.
We are, however, trying to enter into long-term agreements with our sole
suppliers and other key suppliers, using a rolling sales volume forecast to
stabilize component availability. Our power module supplier currently maintains
a buffer stock and, our microprocessor demand is covered by purchase orders for
the next two quarters. Lead times for ordering materials and components vary
significantly and depend on factors such as specific supplier requirements,
contract terms, the extensive production time required and current market demand
for such components. Some of these delays may be substantial. As a result, we
purchase these components in large quantities to protect our ability to deliver
finished products. If we overestimate our component requirements, we may have
excess inventory, which will increase our costs. If we underestimate our
component requirements, we will have inadequate inventory, which will delay our
manufacturing and render us unable to deliver products to customers on scheduled
delivery dates. If we are unable to obtain a component from a supplier or if the
price of a component has increased substantially, we may be required to
manufacture the component internally, which will result in delays. Manufacturing
delays could negatively impact our ability to sell our products and could damage
our customer relationships.

We depend on key personnel to manage our business and develop new products in a
rapidly changing market, and if we are unable to retain our current personnel
and hire additional personnel, our ability to develop and sell our products
could be impaired.

     We believe our future success will depend in large part upon our ability to
attract and retain highly skilled managerial, engineering and sales and
marketing personnel. There is a limited supply of skilled employees in the power
quality marketplace. If we are unable to retain the personnel we currently
employ, or if we are unable to quickly replace departing employees, our
operations and new product development may suffer.

We are a relatively small company with limited resources compared to some of our
current and potential competitors, and competition within our markets may limit
our sales growth.

     The markets for power quality and power reliability are intensely
competitive. There are many companies engaged in all areas of traditional and
alternative UPS and backup systems in the United States and abroad, including,
among others, major electric and specialized electronics firms, as well as
universities, research institutions and foreign government-sponsored companies.
There are many companies that are developing flywheel-based energy storage
systems and flywheel-based power quality systems. We also compete indirectly
with companies that are developing other types of power technologies, such as
superconducting magnetic energy storage, ultra-capacitors and dynamic voltage
restorers.

     Many of our current and potential competitors have longer operating
histories, significantly greater resources, broader name recognition and a
larger customer base than we have. As a result, these competitors may have
greater credibility with our existing and potential customers. They also may be
able to adopt more aggressive pricing policies and devote greater resources to
the development, promotion and sale of their products than we can to ours, which

                                       16

<PAGE>

would allow them to respond more quickly than us to new or emerging technologies
or changes in customer requirements. In addition, some of our current and
potential competitors have established supplier or joint development
relationships with our current or potential customers. These competitors may be
able to leverage their existing relationships to discourage these customers from
purchasing products from us or to persuade them to replace our products with
their products. Increased competition could decrease our prices, reduce our
sales, lower our margins, or decrease our market share. These and other
competitive pressures could prevent us from competing successfully against
current or future competitors and could materially harm our business.

If we are unable to protect our intellectual property, we may be unable to
compete.

     Our products rely on our proprietary technology, and we expect that future
technological advancements made by us will be critical to sustain market
acceptance of our products. Therefore, we believe that the protection of our
intellectual property rights is, and will continue to be, important to the
success of our business. We rely on a combination of patent, copyright,
trademark and trade secret laws and restrictions on disclosure to protect our
intellectual property rights. We also enter into confidentiality or license
agreements with our employees, consultants and business partners and control
access to and distribution of our software, documentation and other proprietary
information. Despite these efforts, unauthorized parties may attempt to copy or
otherwise obtain and use our products or technology. Monitoring unauthorized use
of our products is difficult, and we cannot be certain that the steps we have
taken will prevent unauthorized use of our technology, particularly in foreign
countries where applicable laws may not protect our proprietary rights as fully
as in the United States. In addition, the measures we undertake may not be
sufficient to adequately protect our proprietary technology and may not preclude
competitors from independently developing products with functionality or
features similar to those of our products.

Our efforts to protect our intellectual property may cause us to become involved
in costly and lengthy litigation, which could seriously harm our business.

     In recent years, there has been significant litigation in the United States
involving patents, trademarks and other intellectual property rights. We have
recently been named in a lawsuit that we describe in further detail in "Legal
Proceedings" below. We may become involved in additional litigation in the
future to protect our intellectual property or defend allegations of
infringement asserted by others. Legal proceedings, including the lawsuit in
which we were recently named as a defendant, could subject us to significant
liability for damages or invalidate our intellectual property rights. Any
litigation, regardless of its outcome, would likely be time consuming and
expensive to resolve and would divert management's time and attention. Any
potential intellectual property litigation also could force us to take specific
actions, including:

     o    cease selling our products that use the challenged intellectual
          property;

     o    obtain from the owner of the infringed intellectual property right a
          license to sell or use the relevant technology or trademark, which
          license may not be available on reasonable terms, or at all; or

     o    redesign those products that use infringing intellectual property or
          cease to use an infringing trademark.

                                       17




<PAGE>

Any acquisitions we make could disrupt our business and harm our financial
condition.

     Although we are not currently negotiating any material business or
technology acquisitions, as part of our growth strategy, we intend to review
opportunities to acquire other businesses or technologies that would complement
our current products, expand the breadth of our markets or enhance our technical
capabilities. We have no experience in making acquisitions. Acquisitions entail
a number of risks that could materially and adversely affect our business and
operating results, including:

     o    problems integrating the acquired operations, technologies or products
          with our existing business and products;

     o    potential disruption of our ongoing business and distraction of our
          management;

     o    difficulties in retaining business relationships with suppliers and
          customers of the acquired companies;

     o    difficulties in coordinating and integrating overall business
          strategies, sales and marketing, and research and development efforts;

     o    the maintenance of corporate cultures, controls, procedures and
          policies;

     o    risks associated with entering markets in which we lack prior
          experience; and

     o    potential loss of key employees.

We may require substantial additional funds in the future to finance our product
development and commercialization plans.

     Our product development and commercialization schedule could be delayed if
we are unable to fund our research and development activities or the development
of our manufacturing capabilities with our revenue, cash on hand and proceeds
from our initial public offering. We expect that our current cash and
investments, together with our other available sources of working capital, will
be sufficient to fund development activities for at least 24 months. However,
unforeseen delays or difficulties in these activities could increase costs and
exhaust our resources prior to the full commercialization of our products under
development. We do not know whether we will be able to secure additional
funding, or funding on terms acceptable to us, to continue our operations as
planned. If financing is not available, we may be required to reduce, delay or
eliminate certain activities or to license or sell to others some of our
proprietary technology.

Provisions in our charter documents and of Delaware law, and provisions in our
agreements with Caterpillar, could prevent, delay or impede a change in control
of our company and may depress the market price of our common stock.

     Provisions of our certificate of incorporation and bylaws could have the
effect of discouraging, delaying or preventing a merger or acquisition that a
stockholder may consider favorable. We also are subject to the anti-takeover
laws of the State of Delaware, which may further discourage, delay or prevent
someone from acquiring or merging with us. In addition, our agreement with
Caterpillar for the distribution of CleanSource UPS provides that Caterpillar
may terminate the agreement in the event we are acquired or undergo a change in
control. The possible loss of our most significant customer could be a
significant deterrent to possible acquirors and may substantially limit the
number of possible acquirors. All of these factors may decrease the likelihood
that we would be acquired, which may depress the market price of our common
stock.

                                       18

<PAGE>

Our stock price may be volatile.

     Since January 1, 2001, the market price of our common stock has fluctuated
between $3.13 and $31.50 per share. The market price of our common stock can be
expected to fluctuate significantly in response to numerous factors, some of
which are beyond our control, including the following:

     o    actual or anticipated fluctuations in our operating results;

     o    changes in financial estimates by securities analysts or our failure
          to perform in line with such estimates;

     o    changes in market valuations of other technology companies,
          particularly those that sell products used in power quality systems;

     o    announcements by us or our competitors of significant technical
          innovations, acquisitions, strategic partnerships, joint ventures or
          capital commitments;

     o    introduction of technologies or product enhancements that reduce the
          need for flywheel energy storage systems;

     o    the loss of one or more key OEM customers; and o departures of key
          personnel.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     This information is included in the section captioned "Quantitative and
Qualitative Disclosures About Market Risk" in Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations.

                                       19

<PAGE>

                               ACTIVE POWER, INC.

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings.

          On March 25, 2002, we, along with Joseph F. Pinkerton, III, our
     chairman and chief executive officer, Pinkerton Generator, Inc. (a
     corporation in which Mr. Pinkerton was an officer, director and the primary
     shareholder), and Caterpillar Inc. were named as defendants in a complaint
     filed in Michigan state court in the Circuit Court for the County of Wayne.
     The plaintiffs, Magnex Corporation, Enigma Corporation and Bergeron
     Corporation, and their individual principals, are seeking damages for: the
     alleged breach of a joint venture agreement dated June 23, 1989, which was
     entered into by and among Pinkerton Generator, Inc., Magnex Corp. and
     Enigma Corp.; the breach of fiduciary duties; the misappropriation of trade
     secrets; and the commission of other torts relating to this joint venture.
     Neither Active Power nor any of its predecessors in interest was a party to
     the joint venture agreement. A First Amended Complaint was filed on April
     16, 2002. We were not served with the Original Complaint and Amended
     Complaint until April 19, 2002. This proceeding is at a very early stage
     and while we are still investigating this matter and have yet to respond,
     both we and Mr. Pinkerton believe the claims have no merit, deny the
     allegations in the complaint and intend to defend ourselves vigorously.

Item 2.  Changes in Securities and Use of Proceeds.

          During the first quarter of 2002, we issued an aggregate of 246,050
     shares of our common stock pursuant to exercises of stock options that were
     granted prior to August 7, 2000 with exercise prices ranging from $0.16 to
     $1.85 per share. These issuances were deemed exempt from registration under
     Section 5 of the Securities Act of 1933 in reliance upon Rule 701
     thereunder and appropriate legends were affixed to the share certificates
     issued in each such transaction.

Item 3.  Defaults Upon Senior Securities.

          Not applicable.

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

          Not applicable.

Item 5.  Other Information.

          On March 26, 2002 Benjamin Scott was elected to our board of directors
     as a Class I director. He shall serve until the company's 2004 annual
     meeting of stockholders, or until his successor has been duly elected and
     qualified. This appointment increases our total number of directors to
     seven.

Item 6.  Exhibits and Reports on Form 8-K.

          Not applicable.

                                       20


<PAGE>

                                   SIGNATURES*

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

                                           ACTIVE POWER, INC.
                                              (Registrant)

May 13, 2002                          /s/ Joseph F. Pinkerton, III
                         -----------------------------------------------------
(Date)                                  Joseph F. Pinkerton, III
                           Chairman of the Board and Chief Executive Officer
                                     (Principal Executive Officer)


May 13, 2002                               /s/ David S. Gino
                         -----------------------------------------------------
(Date)                                       David S. Gino
                          Chief Operating Officer and Chief Financial Officer
                                     (Principal Accounting Officer)