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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 September 30, 2010

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: 000-30939





ACTIVE POWER, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 74-2961657                          
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|2128 W. Braker Lane, BK12, 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 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.    x  Yes     ̈  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such
files).     ̈  Yes     ̈  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one)



|                        |  |                                                 |  |                           |  |  
|----------------------- |  | ----------------------------------------------- |  | ------------------------- |  | -
|Large Accelerated Filer |  |  ̈                                               |  | Accelerated Filer         |  | x
|                        |  |                                                 | 
|Non-Accelerated Filer   |  |  ̈ (Do not check if a smaller reporting company) |  | Smaller Reporting Company |  |  ̈

Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange
Act).     ̈  Yes    x  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, par value of $0.001 per share, outstanding at October 25, 2010 was 79,750,031.









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ACTIVE POWER, INC.

FORM 10-Q

INDEX



|                                                                                               |  |  |    | 
|---------------------------------------------------------------------------------------------- |  |  | -- | 
|PART I  FINANCIAL INFORMATION                                                                 |  |  | 3  | 
|                                                                                               | 
|Item 1. Condensed Consolidated Financial Statements.                                           |  |  | 3  | 
|                                                                                               | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations. |  |  | 12 | 
|                                                                                               | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk.                            |  |  | 21 | 
|                                                                                               | 
|Item 4. Controls and Procedures.                                                               |  |  | 21 | 
|                                                                                               | 
|PART II  OTHER INFORMATION                                                                    |  |  | 22 | 
|                                                                                               | 
|Item 1. Legal Proceedings.                                                                     |  |  | 22 | 
|                                                                                               | 
|Item 1A. Risk Factors.                                                                         |  |  | 22 | 
|                                                                                               | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.                           |  |  | 22 | 
|                                                                                               | 
|Item 3. Defaults Upon Senior Securities.                                                       |  |  | 22 | 
|                                                                                               | 
|Item 4. Reserved.                                                                              |  |  | 22 | 
|                                                                                               | 
|Item 5. Other Information.                                                                     |  |  | 22 | 
|                                                                                               | 
|Item 6. Exhibits.                                                                              |  |  | 22 | 



2



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PART I
 FINANCIAL INFORMATION



|Item 1. | Consolidated Financial Statements.
|------- | ----------------------------------

Active Power, Inc.

Condensed Consolidated Balance Sheets

(in thousands)



|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                       |  | September 30,2010 |          |   | December 31,2009 |  
|                                                                                                                                       |  | (unaudited)       |          |   |                  |  
|ASSETS                                                                                                                                 |  |                   |          |   |                  |   |          |  
|                                                                                                                                       |  |                  
|Current assets:                                                                                                                        |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                              |  | $                 | 14,439   |   |                  | $ | 7,489    |  
|Accounts receivable, net of allowance for doubtful accounts of $311 and $353 at September 30, 2010 and December 31,
2009, respectively |  |                   | 12,657   |   |                  |   | 11,529   |  
|Inventories                                                                                                                            |  |                   | 6,329    |   |                  |   | 6,629    |  
|Prepaid expenses and other                                                                                                             |  |                   | 625      |   |                  |   | 418      |  
|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Total current assets                                                                                                                   |  |                   | 34,050   |   |                  |   | 26,065   |  
|Property and equipment, net                                                                                                            |  |                   | 1,917    |   |                  |   | 2,903    |  
|Deposits and other                                                                                                                     |  |                   | 422      |   |                  |   | 376      |  
|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Total assets                                                                                                                           |  | $                 | 36,389   |   |                  | $ | 29,344   |  
|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|                                                                                                                                       |  |                  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                   |  |                   |          |   |                  |   |          |  
|Current liabilities:                                                                                                                   |  |                   |          |   |                  |   |          |  
|Accounts payable                                                                                                                       |  | $                 | 4,622    |   |                  | $ | 5,155    |  
|Accrued expenses                                                                                                                       |  |                   | 5,766    |   |                  |   | 4,957    |  
|Deferred revenue                                                                                                                       |  |                   | 1,703    |   |                  |   | 1,713    |  
|Revolving line of credit                                                                                                               |  |                   | 3,535    |   |                  |   | 2,559    |  
|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Total current liabilities                                                                                                              |  |                   | 15,626   |   |                  |   | 14,384   |  
|Long-term liabilities                                                                                                                  |  |                   | 606      |   |                  |   | 468      |  
|Stockholders equity:                                                                                                                  |  |                   |          |   |                  |   |          |  
|Common stock                                                                                                                           |  |                   | 80       |   |                  |   | 66       |  
|Treasury stock                                                                                                                         |  |                   | (103     | ) |                  |   | (73      | )
|Additional paid-in capital                                                                                                             |  |                   | 274,317  |   |                  |   | 264,554  |  
|Accumulated deficit                                                                                                                    |  |                   | (253,946 | ) |                  |   | (249,876 | )
|Other accumulated comprehensive loss                                                                                                   |  |                   | (191     | ) |                  |   | (179     | )
|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Total stockholders equity                                                                                                             |  |                   | 20,157   |   |                  |   | 14,492   |  
|                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                             |  | $                 | 36,389   |   |                  | $ | 29,344   |  
|                                                                                                                                       |  |                   |          |   |                  |   |          |  

See accompanying notes.



3



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Active Power, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except per share amounts)

(Unaudited )



|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                          |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                          |  | 2010                            |        |   | 2009                           |   |        | 2010 |  |   | 2009   |  
|Revenues:                                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |  
|Product revenue                                                           |  | $                               | 16,663 |   |                                | $ | 6,947  |      |  | $ | 39,356 |   |  | $ | 21,863 |  
|Service and other revenue                                                 |  |                                 | 1,793  |   |                                |   | 1,587  |      |  |   | 6,264  |   |  |   | 4,444  |  
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                                             |  |                                 | 18,456 |   |                                |   | 8,534  |      |  |   | 45,620 |   |  |   | 26,307 |  
|                                                                          |  |                                 |        |  
|Cost of goods sold:                                                       |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Cost of product revenue                                                   |  |                                 | 11,287 |   |                                |   | 5,751  |      |  |   | 28,323 |   |  |   | 16,874 |  
|Cost of service and other revenue                                         |  |                                 | 1,691  |   |                                |   | 901    |      |  |   | 4,606  |   |  |   | 2,814  |  
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total cost of goods sold                                                  |  |                                 | 12,978 |   |                                |   | 6,652  |      |  |   | 32,929 |   |  |   | 19,688 |  
|                                                                          |  |                                 |        |  
|Gross profit                                                              |  |                                 | 5,478  |   |                                |   | 1,882  |      |  |   | 12,691 |   |  |   | 6,619  |  
|                                                                          |  |                                 |        |  
|Operating expenses:                                                       |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Research and development                                                  |  |                                 | 833    |   |                                |   | 1,095  |      |  |   | 2,517  |   |  |   | 3,254  |  
|Selling and marketing                                                     |  |                                 | 3,539  |   |                                |   | 2,572  |      |  |   | 10,323 |   |  |   | 8,562  |  
|General and administrative                                                |  |                                 | 1,075  |   |                                |   | 1,201  |      |  |   | 3,825  |   |  |   | 3,517  |  
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                                  |  |                                 | 5,447  |   |                                |   | 4,868  |      |  |   | 16,665 |   |  |   | 15,333 |  
|                                                                          |  |                                 |        |  
|Operating profit (loss)                                                   |  |                                 | 31     |   |                                |   | (2,986 | )    |  |   | (3,974 | ) |  |   | (8,714 | )
|                                                                          |  |                                 |        |  
|Interest expense, net                                                     |  |                                 | (30    | ) |                                |   | (20    | )    |  |   | (82    | ) |  |   | (48    | )
|Other income (expense), net                                               |  |                                 | 13     |   |                                |   | 46     |      |  |   | (55    | ) |  |   | (31    | )
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) before income taxes                                         |  |                                 | 14     |   |                                |   | (2,960 | )    |  |   | (4,111 | ) |  |   | (8,793 | )
|Income tax benefit                                                        |  |                                 | 41     |   |                                |   |       |      |  |   | 41     |   |  |   |       |  
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                         |  | $                               | 55     |   |                                | $ | (2,960 | )    |  | $ | (4,070 | ) |  | $ | (8,793 | )
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss) per share, basic                                        |  | $                               | 0.00   |   |                                | $ | (0.04  | )    |  | $ | (0.05  | ) |  | $ | (0.14  | )
|Net income (loss) per share, diluted                                      |  | $                               | 0.00   |   |                                | $ | (0.04  | )    |  | $ | (0.05  | ) |  | $ | (0.14  | )
|                                                                          |  |                                 |        |  
|Shares used in computing net loss per share, basic                        |  |                                 | 79,674 |   |                                |   | 66,316 |      |  |   | 76,982 |   |  |   | 63,020 |  
|Shares used in computing net loss per share, diluted                      |  |                                 | 80,366 |   |                                |   | 66,316 |      |  |   | 76,982 |   |  |   | 63,020 |  
|                                                                          |  |                                 |        |  
|Comprehensive income (loss):                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                         |  | $                               | 55     |   |                                | $ | (2,960 | )    |  | $ | (4,070 | ) |  | $ | (8,793 | )
|Translation gain (loss) on subsidiaries denominated in foreign currencies |  |                                 | 247    |   |                                |   | (359   | )    |  |   | (12    | ) |  |   | (124   | )
|Change in unrealized gain on investments in marketable securities         |  |                                 |       |   |                                |   | (2     | )    |  |   |       |   |  |   |       |  
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Comprehensive income (loss)                                               |  | $                               | 302    |   |                                | $ | (3,321 | )    |  | $ | (4,082 | ) |  | $ | (8,917 | )
|                                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  

See accompanying notes.



4



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Active Power, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)



|                                                                          |  |                                |        |   |      |   |        |  
|------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                          |  | Nine Months EndedSeptember 30, |       
|                                                                          |  | 2010                           |        |   | 2009 |  
|Operating activities                                                      |  |                                |        |   |      |   |        |  
|Net loss                                                                  |  | $                              | (4,070 | ) |      | $ | (8,793 | )
|Adjustments to reconcile net loss to cash used in operating activities:   |  |                                |        |   |      |   |        |  
|Depreciation expense                                                      |  |                                | 1,510  |   |      |   | 1,441  |  
|Bad debt expense                                                          |  |                                | (42    | ) |      |   | (60    | )
|Accretion of premium/discount on investments                              |  |                                |       |   |      |   | 2      |  
|Loss on disposal of fixed assets                                          |  |                                | 8      |   |      |   | 384    |  
|Stock-based compensation                                                  |  |                                | 716    |   |      |   | 1,041  |  
|Changes in operating assets and liabilities:                              |  |                                |        |   |      |   |        |  
|Accounts receivable                                                       |  |                                | (1,086 | ) |      |   | 2,459  |  
|Inventories                                                               |  |                                | 300    |   |      |   | (1,878 | )
|Prepaid expenses and other assets                                         |  |                                | (253   | ) |      |   | 32     |  
|Accounts payable                                                          |  |                                | (533   | ) |      |   | 825    |  
|Accrued expenses                                                          |  |                                | 809    |   |      |   | (937   | )
|Deferred revenue                                                          |  |                                | (10    | ) |      |   | (81    | )
|Long-term liabilities                                                     |  |                                | 138    |   |      |   | 46     |  
|                                                                          |  |                                |        |   |      |   |        |  
|Net cash used in operating activities                                     |  |                                | (2,513 | ) |      |   | (5,519 | )
|                                                                          |  |                               
|Investing activities                                                      |  |                                |        |   |      |   |        |  
|Sales/maturities of marketable securities                                 |  |                                |       |   |      |   | 700    |  
|Purchases of property and equipment                                       |  |                                | (532   | ) |      |   | (498   | )
|                                                                          |  |                                |        |   |      |   |        |  
|Net cash (used in) provided by investing activities                       |  |                                | (532   | ) |      |   | 202    |  
|                                                                          |  |                               
|Financing activities                                                      |  |                                |        |   |      |   |        |  
|Proceeds from private placement of common stock                           |  |                                | 9,923  |   |      |   | 2,945  |  
|Issuance costs of private placement                                       |  |                                | (886   | ) |      |   |       |  
|Proceeds from draw on revolving line of credit                            |  |                                | 1,008  |   |      |   | 60     |  
|Payments on revolving line of credit                                      |  |                                | (32    | ) |      |   |       |  
|Proceeds from employee stock purchases                                    |  |                                | 24     |   |      |   |       |  
|Purchases of treasury stock                                               |  |                                | (30    | ) |      |   |       |  
|                                                                          |  |                                |        |   |      |   |        |  
|Net cash provided by financing activities                                 |  |                                | 10,007 |   |      |   | 3,005  |  
|                                                                          |  |                               
|Translation gain (loss) on subsidiaries denominated in foreign currencies |  |                                | (12    | ) |      |   | (123   | )
|                                                                          |  |                                |        |   |      |   |        |  
|                                                                          |  |                               
|Change in cash and cash equivalents                                       |  |                                | 6,950  |   |      |   | (2,435 | )
|Cash and cash equivalents, beginning of period                            |  |                                | 7,489  |   |      |   | 10,468 |  
|                                                                          |  |                                |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                  |  | $                              | 14,439 |   |      | $ | 8,033  |  
|                                                                          |  |                                |        |   |      |   |        |  

See accompanying notes.



5



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Active Power, Inc.

Notes to Condensed Consolidated Financial Statements

September 30, 2010

(Unaudited)



|1. | Organization and Basis of Presentation
|-- | --------------------------------------

Active Power, Inc. and its subsidiaries (hereinafter referred to as we, us, Active Power or the Company) manufacture and provide critical power quality
solutions that provide business continuity and protect customers in the event of an electrical power disturbance. Our products are designed to deliver continuous clean power, protecting customers from voltage fluctuations, such as surges and sags,
and frequency fluctuations, and also to provide ride-through, or temporary, power to bridge the gap between a power outage and the restoration of utility power. Our target customers are those global enterprises requiring power insurance
because they have zero tolerance for downtime in their mission critical operations. The Uninterruptible Power Supply (UPS) products we manufacture use kinetic energy to provide short-term power as a cleaner alternative to
electro-chemical battery-based energy. We sell stand alone UPS products as well as complete continuous power solutions, including a containerized version that we brand as PowerHouse. We also sell other containerized power infrastructure solutions
that can be used on a stand- alone basis or with our continuous power solutions. We sell our products globally through direct sales, manufacturers representatives, Original Equipment Manufacturer (OEM) and IT partner channels. Our
current principal markets are Europe, Middle East and Africa (EMEA), Asia and North America.

The accompanying
condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accounts of the Company and its consolidated subsidiaries. In the opinion of management, the accompanying
unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring items) necessary to present fairly the consolidated financial position of the Company and its consolidated results of operations and
cash flows. These interim financial statements should be read in conjunction with the financial statements and accompanying notes included in the Companys Annual Report on Form 10-K for the year ended December 31, 2009.



|2. | Recently Issued Accounting Standards
|-- | ------------------------------------

On January 1, 2010, we adopted amendments to authoritative literature that modifies the revenue recognition guidance for establishing separate units of accounting in a multiple element
arrangement and requires the allocation of arrangement consideration to each deliverable in the arrangement based on relative selling price of the elements. The selling price for each deliverable is based on vendor-specific objective evidence
(VSOE) if available, third-party evidence (TPE) if VSOE is not available, or best estimate of selling price (BESP) if neither VSOE nor TPE is available. BESP must be determined in a manner that is consistent with
that used to determine the price to sell the specific elements on a standalone basis. The authoritative literature permits prospective or retrospective adoption, and we elected prospective adoption. Other than the increased disclosure requirements
of adoption of this policy, the adoption of these amendments did not change our units of accounting, allocation of arrangement consideration, or pattern or timing of revenue recognition. It also did not have a significant impact on our financial
position, results of operations, or cash flows for the nine months ended September 30, 2010, nor do we anticipate a significant impact for the year ended December 31, 2010. See Note 3 for additional discussion of the Companys revenue
recognition policy.



|3. | Supplemental Balance Sheet Information
|-- | --------------------------------------

Receivables

Accounts receivable consist of the following
(in thousands):



|                                |  |                   |        |   |                  |   |        |  
|------------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                                |  | September 30,2010 |        |   | December 31,2009 |  
|Trade receivables               |  | $                 | 12,968 |   |                  | $ | 11,882 |  
|Allowance for doubtful accounts |  |                   | (311   | ) |                  |   | (353   | )
|                                |  |                   |        |   |                  |   |        |  
|                                |  | $                 | 12,657 |   |                  | $ | 11,529 |  
|                                |  |                   |        |   |                  |   |        |  



6



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Inventory

We state inventories at the lower of cost or market, using the first-in-first-out-method (in thousands):



|                            |  |                   |        |   |                  |   |        |  
|--------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                            |  | September 30,2010 |        |   | December 31,2009 |  
|Raw materials               |  | $                 | 5,147  |   |                  | $ | 5,238  |  
|Work in process             |  |                   | 2,293  |   |                  |   | 1,253  |  
|Finished goods              |  |                   | 1,195  |   |                  |   | 2,448  |  
|Allowances for obsolescence |  |                   | (2,306 | ) |                  |   | (2,310 | )
|                            |  |                   |        |   |                  |   |        |  
|                            |  | $                 | 6,329  |   |                  | $ | 6,629  |  
|                            |  |                   |        |   |                  |   |        |  

Property and Equipment

Property and equipment consist of the following (in thousands):



|                                 |  |                   |         |   |                  |   |         |  
|-------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                 |  | September 30,2010 |         |   | December 31,2009 |  
|Equipment                        |  | $                 | 9,476   |   |                  | $ | 9,321   |  
|Demonstration units              |  |                   | 1,310   |   |                  |   | 1,436   |  
|Computers and purchased software |  |                   | 3,296   |   |                  |   | 3,076   |  
|Furniture and fixtures           |  |                   | 362     |   |                  |   | 355     |  
|Leasehold improvements           |  |                   | 7,328   |   |                  |   | 7,305   |  
|Construction in progress         |  |                   | 44      |   |                  |   | 44      |  
|                                 |  |                   |         |   |                  |   |         |  
|                                 |  |                   | 21,816  |   |                  |   | 21,537  |  
|                                 |  |                   |         |   |                  |   |         |  
|Accumulated depreciation         |  |                   | (19,899 | ) |                  |   | (18,634 | )
|                                 |  |                   |         |   |                  |   |         |  
|                                 |  | $                 | 1,917   |   |                  | $ | 2,903   |  
|                                 |  |                   |         |   |                  |   |         |  

Accrued Expenses

Accrued expenses consist of the following (in thousands):



|                                                 |  |                   |       |  |                  |   |       | 
|------------------------------------------------ |  | ----------------- | ----- |  | ---------------- | - | ----- | 
|                                                 |  | September 30,2010 |       |  | December 31,2009 |  
|Compensation and benefits                        |  | $                 | 3,215 |  |                  | $ | 1,549 | 
|Warranty liability                               |  |                   | 628   |  |                  |   | 620   | 
|Property, income, state, sales and franchise tax |  |                   | 684   |  |                  |   | 1,427 | 
|Professional fees                                |  |                   | 435   |  |                  |   | 495   | 
|Other                                            |  |                   | 804   |  |                  |   | 866   | 
|                                                 |  |                   |       |  |                  |   |       | 
|                                                 |  | $                 | 5,766 |  |                  | $ | 4,957 | 
|                                                 |  |                   |       |  |                  |   |       | 

Warranty Liability

Generally, the warranty period for our power quality products is 12 months from the date of commissioning or 18 months
from the date of shipment from Active Power, whichever period is shorter. Occasionally we offer longer warranty periods to certain customers. The warranty period for products sold to our OEM customer, Caterpillar, is 12 months from the date of
shipment to the end-user, or up to 36 months from shipment to Caterpillar, whichever period is shorter. This is dependent upon Caterpillar complying with our storage requirements for our products in order to preserve this warranty period beyond the
standard 18-month limit. We provide for the estimated cost of product warranties at the time revenue is recognized and this accrual is included in accrued expenses and long term liabilities on the accompanying consolidated balance sheet.



7



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Changes in our warranty liability are presented in the following table (in thousands):



|                                                |  |   |      |  
|----------------------------------------------- |  | - | ---- | -
|Balance at December 31, 2009                    |  | $ | 663  |  
|Warranty expense                                |  |   | 512  |  
|Warranty charges incurred                       |  |   | (496 | )
|                                                |  |   |      |  
|Balance at September 30, 2010                   |  | $ | 679  |  
|                                                |  |   |      |  
|Warranty liability included in accrued expenses |  | $ | 628  |  
|Long term warranty liability                    |  |   | 51   |  
|                                                |  |   |      |  
|Balance at September 30, 2010                   |  | $ | 679  |  
|                                                |  |   |      |  

Revenue Recognition

We recognize revenue when four criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the sales price is
fixed or determinable; and (iv) collectability is reasonably assured. Revenue-generating transactions generally fall into one of the following categories of revenue recognition:



| |  |  | We recognize product revenue at the time of shipment for substantially all products sold directly to customers and through distributors because title
and risk of loss pass on delivery to the common carrier. Our customers and distributors do not have the right to return products. If title and risk of loss pass at some other point in time, we recognize such revenue for our customers when the
product is delivered to the customer and title and risk of loss has passed.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We recognize installation and service and maintenance revenue at the time the service is performed.
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | We recognize revenue associated with extended maintenance agreements (EMAs) over the life of the contracts using the straight-line method,
which approximates the expected timing in which applicable services are performed. Amounts collected in advance of revenue recognition are recorded as a current or long-term liability based on the time from the balance sheet date to the future date
of revenue recognition.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We recognize revenue on certain rental programs over the life of the rental agreement using the straight-line method. Amounts collected in advance of
revenue recognition are recorded as a current or long-term liability based on the time from the balance sheet date to the future date of revenue recognition.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Shipping costs reimbursed by the customer are included in revenue.
| | - |  | ------------------------------------------------------------------

Multiple element arrangements (MEAs). Arrangements to sell products to customers frequently include multiple
deliverables. Our most significant MEAs include the sale of one or more of our CleanSource UPS, PowerHouse or data center infrastructure products, combined with one or more of the following products: design services, project management,
commissioning and installation services, spare parts or consumables, and EMAs. Delivery of the various products or performance of services within the arrangement may or may not coincide. Certain services related to design and consulting may occur
prior to delivery of product and commissioning and installation typically take place within 6 months of product delivery, depending upon customer requirements. EMAs, consumables, and repair, maintenance or consulting services generally are
delivered over a period of one to five years. In certain arrangements revenue recognized is limited to the amount invoiced or received that is not contingent on the delivery of future products and services.

We allocate revenue to each element based on the relative selling price and recognize revenue when the elements have stand-alone value
and the four criteria for revenue recognition have been met for each element. We establish the selling price of each element based on VSOE if available, TPE if VSOE is not available, or BESP if neither VSOE nor TPE is available. We generally
determine selling price based on amounts charged separately for the delivered and undelivered elements to similar customers in stand-alone sales of the specific elements. When arrangements include an EMA, we recognize revenue related to the EMA at
the stated contractual price on a straight-line basis over the life of the agreement.

Any taxes imposed by governmental
authorities on our revenue-producing transactions with customers are shown in our consolidated statement of operations on a net-basis; that is excluded from our reported revenues.



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|4. | Net Income (Loss) Per Share
|-- | ---------------------------

Basic net income (loss) per share is computed based on the weighted average number of common shares outstanding for each period presented. Diluted net income per share reflects the potential dilution that
would have occurred if securities or other contracts to issue common stock were exercised, converted, or resulted in the issuance of common stock. The following table reconciles the numerator and denominator used in the basic and diluted net income
(loss) per share (in thousands, except per share data):



|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ |  | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                                                                                                                      |  | Three Months EndedSeptember 30, |        |  | Nine Months EndedSeptember 30, |  
|                                                                                                                                                                                                                                      |  | 2010                            |        |  | 2009                           |   |        | 2010 |  |   | 2009   |  
|Numerator:                                                                                                                                                                                                                            |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                                                                                                                                                                                     |  | $                               | 55     |  |                                | $ | (2,960 | )    |  | $ | (4,070 | ) |  | $ | (8,793 | )
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|Denominator:                                                                                                                                                                                                                          |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                                                                                                                                                      |  |                                 |        | 
|Weighted-average shares of common stock outstanding                                                                                                                                                                                   |  |                                 | 79,674 |  |                                |   | 66,316 |      |  |   | 76,982 |   |  |   | 63,020 |  
|Dilutive effect of employee stock options and restricted stock awards                                                                                                                                                                 |  |                                 | 692    |  |                                |   |       |      |  |   |       |   |  |   |       |  
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|Weighted average shares for diluted net income per share                                                                                                                                                                              |  |                                 | 80,366 |  |                                |   | 66,316 |      |  |   | 76,982 |   |  |   | 63,020 |  
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|Basic net income (loss) per share                                                                                                                                                                                                     |  | $                               | 0.00   |  |                                | $ | (0.04  | )    |  | $ | (0.05  | ) |  | $ | (0.14  | )
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                                                                                                                                                      |  |                                 |        | 
|Diluted income (loss) per share:                                                                                                                                                                                                      |  | $                               | 0.00   |  |                                | $ | (0.04  | )    |  | $ | (0.05  | ) |  | $ | (0.14  | )
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                                                                                                                                                      |  |                                 |        | 
|Common stock equivalents that were not included in the calculation because the option price was greater than the average market
price of the common shares or the net loss would cause the effect of the options to be anti-dilutive: |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|Employee stock options                                                                                                                                                                                                                |  |                                 | 5,363  |  |                                |   | 5,766  |      |  |   | 7,160  |   |  |   | 5,766  |  
|Performance-based options                                                                                                                                                                                                             |  |                                 | 2,100  |  |                                |   |       |      |  |   | 2,100  |   |  |   |       |  
|Restricted stock awards                                                                                                                                                                                                               |  |                                 | 9      |  |                                |   | 123    |      |  |   | 19     |   |  |   | 123    |  
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                                                                                                                                                      |  |                                 | 7,472  |  |                                |   | 5,889  |      |  |   | 9,279  |   |  |   | 5,889  |  
|                                                                                                                                                                                                                                      |  |                                 |        |  |                                |   |        |      |  |   |        |   |  |   |        |  

As of September 30, 2010 and 2009, there was no common stock subject to repurchase.



|5. | Fair Value of Financial Instruments
|-- | -----------------------------------

Investments in marketable securities currently consist of money-market funds, although at times we do invest in commercial paper and debt securities with readily determinable fair values. Active Power
accounts for investments that are reasonably expected to be realized in cash, sold or consumed during the year as short-term investments. We classify investments in marketable securities as available-for-sale and all reclassifications made from
unrealized gains/losses to realized gains/losses are determined based on the specific identification method. We had no such short-term investments at September 30, 2010 or at December 31, 2009.

In accordance with our investment policy and guidelines, our short-term investments are diversified among and limited to high quality
securities with a minimum of investment grade ratings. We actively monitor our investment portfolio to ensure compliance with our investment objectives to preserve capital, meet liquidity requirements and maximize return on our investments. We do
not require collateral or enter into master netting arrangements to mitigate our credit risk.

We have established a framework
for measuring fair value as well as guidelines for required disclosures regarding fair value measurements.

Level 1uses
quoted prices in active markets for identical assets or liabilities we have the ability to access.



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Level 2uses
observable inputs other than quoted prices in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are
observable or can be corroborated by observable market data.

Level 3uses one or more significant inputs that are
unobservable and supported by little or no market activity, and that reflect the use of significant management judgment.

Inputs are referred to as assumptions that market participants would use in pricing the asset or liability. The uses of inputs in the
valuation process are categorized into a three-level fair value hierarchy.

Our Level 1 assets and liabilities consist of cash
equivalents, which are primarily invested in money market funds. These assets are classified as Level 1 because they are valued using quoted prices and other relevant information generated by market transactions involving identical assets and
liabilities.

The fair value of our cash equivalents was determined using the aforementioned inputs as of September 30,
2010 (in thousands):



|                          |  |                                                 |       |  |         |   |   |         |  |   |       |  |  |   |       | 
|------------------------- |  | ----------------------------------------------- | ----- |  | ------- | - | - | ------- |  | - | ----- |  |  | - | ----- | 
|                          |  | Fair Value Measurements at Reporting Date Using |      
|                          |  | Level 1                                         |       |  | Level 2 |   |   | Level 3 |  |   | Total | 
|Money Market funds        |  | $                                               | 3,093 |  |         | $ |  |         |  | $ |      |  |  | $ | 3,093 | 
|                          |  |                                                 |       |  |         |   |   |         |  |   |       |  |  |   |       | 
|Total                     |  | $                                               | 3,093 |  |         | $ |  |         |  | $ |      |  |  | $ | 3,093 | 
|                          |  |                                                 |       |  |         |   |   |         |  |   |       |  |  |   |       | 
|                          |  |                                                 |       | 
|Amounts included in:      |  |                                                 |       |  |         |   |   |         |  |   |       |  |  |   |       | 
|Cash and cash equivalents |  | $                                               | 3,093 |  |         | $ |  |         |  | $ |      |  |  | $ | 3,093 | 
|                          |  |                                                 |       |  |         |   |   |         |  |   |       |  |  |   |       | 
|Total                     |  | $                                               | 3,093 |  |         | $ |  |         |  | $ |      |  |  | $ | 3,093 | 
|                          |  |                                                 |       |  |         |   |   |         |  |   |       |  |  |   |       | 

For cash and cash equivalents, marketable securities, accounts receivable, and accounts payable, the
carrying amount approximates fair value because of the relative short maturity of those instruments.



|6. | Guarantees
|-- | ----------

In certain
geographical regions, particularly Europe and Africa, we are sometimes required to issue performance guarantees to our customers as a condition of sale. These guarantees usually provide financial protection to our customers in the event that we fail
to fulfill our warranty obligations. We secure these guarantees with standby letters of credit through our bank. At both September 30, 2010, and December 31, 2009, we had $754 and $48, respectively, of performance guarantees outstanding to
customers that were secured with letters of credit.



|7. | Revolving Credit Facility
|-- | -------------------------

On August 5, 2010, we entered into a Second Amended and Restated Loan and Security Agreement (the Loan Agreement) with
Silicon Valley Bank (SVB). This new two-year loan facility provides for a secured revolving line of credit in an aggregate amount of up to eighty percent (80%) of the facility amount of $15.625 million, or $12.5 million, subject to
certain borrowing bases. In the event we have maintained cash and cash equivalents of at least $6.25 million with SVB for at least 30 consecutive days, which is referred to as being in a Streamline Period, the borrowing base formula is
based on eligible accounts receivable, eligible purchase orders and eligible inventory, subject to a sublimit of $5 million for U.K. accounts receivable, $3.5 million for inventory and $1.5 million for purchase orders. When we are not in a
Streamline Period, our borrowings are limited based on accounts receivable and purchase orders that SVB has specifically agreed to finance and a borrowing base for eligible inventory. We may also request that SVB issue letters of credit on our
behalf, of up to $1.5 million, as a portion of our total loan facility.

On August 5, 2010 we borrowed approximately $2.5
million in revolving loans, all of which was used to refinance all indebtedness owing from the Company to SVB pursuant to our previous revolving credit facility. The new credit facility increases the total credit available from our previous loan
facility with SVB, which was $6.0 million, and enables us to borrow against eligible inventory, foreign receivables and customer purchase orders in addition to eligible accounts receivable. During the quarter ended September 30, 2010, we
borrowed an additional $1.0 million under this credit facility. Based on the borrowing base formula, we had an additional $3.1 million available for use at September 30, 2010 under this credit facility.



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The Company will pay a
finance charge on each account receivable financed by SVB at a per annum rate equal to SVBs prime rate, subject to a minimum prime rate of four percent (4.00%), plus one and one-half percent (1.50%). The Company will pay a finance charge on
each purchase order financed by SVB at a per annum rate equal to SVBs prime rate, subject to a minimum prime rate of four percent (4.00%), plus one and one-quarter percent (1.25%) when a Streamline Period is not in effect or two percent
(2.00%) when a Streamline Period is in effect. When we are not in a Streamline Period, these finance charges will be based on the face amount of the receivable or the purchase order, and otherwise, will be based on the amount financed by SVB.

Each advance based upon inventory accrues interest at a per annum rate equal to SVBs prime rate, subject to a minimum
prime rate of four percent (4.00%), plus (i) one and one-half percent (1.50%) when we are in a Streamline Period and (ii) three and five-eighths percent (3.625%) when we are not in a Streamline Period.

Finance charges and interest are payable monthly, and all principal and interest is due on the maturity date of August 5, 2012.
However, when we are not in a Streamline Period, we must repay advances based on receivables when we receive payment on the receivable that has been financed, and we must repay advances based on purchase orders within 120 days of the date of the
purchase order, together with all finance charges on such advances.

The revolving loans made to us under this loan facility
will be secured by a lien on substantially all of our assets. In addition, on August 5, 2010, Active Power Solutions Limited, a wholly-owned United Kingdom subsidiary of the Company, entered into a Guarantee and Debenture with SVB (the
Guarantee and Debenture), pursuant to which Active Power Solutions Limited guarantied all of the obligations of the Company under the Loan Agreement and secured its obligations under the Guarantee and Debenture with a security interest
on substantially all of its assets.

The Loan Agreement includes customary affirmative covenants for a credit facility of this
size and type, including delivery of financial statements, compliance with laws, maintenance of insurance and protection of intellectual property rights. Further, the Loan Agreement contains customary negative covenants for a credit facility of this
size and type, including covenants that limit or restrict the Companys ability to, among other things, dispose of assets, change its business, change its CEO or CFO without replacing such person within 120 days, have a change in control, make
acquisitions, be acquired, incur indebtedness, grant liens, make investments, make distributions, repurchase stock, and enter into certain transactions with affiliates. The Loan Agreement also requires the Company to maintain a minimum liquidity
ratio of 1.25:1. The Company is currently in compliance with all loan covenants under the Loan Agreement.

The Loan Agreement
contains customary events of default that include, among other things, non-payment defaults, covenant defaults, material adverse change defaults, insolvency defaults, material judgment defaults and inaccuracy of representations and warranty
defaults. The occurrence of an event of default could result in the acceleration of obligations under the Loan Agreement, in which case the Company must repay all loans and related charges, fees and amounts then due and payable, and our subsidiary
may be required to pay any such amounts under the Guarantee and Debenture. At the election of SVB, upon the occurrence and during the continuance of an event of default, finance charges or interest rates, as applicable, will increase an additional
five percentage points (5.00%) per annum above the rate that is otherwise applicable thereto upon the occurrence of such event of default, and the collateral handling fees will increase by one-half percent (0.50%).



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| | Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
| | ------- | --------------------------------------------------------------------------------------

The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, the financial statements
and notes thereto included in Item 1 of this Form 10-Q and the financial statements and notes thereto and our Managements Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2009
included in our 2009 Annual Report on Form 10-K. 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. In addition, please see the Risk Factors in Part 1, Item 1A of our 2009 Annual Report on
Form 10-K and in Part II, Item 1A of this Form 10-Q for a discussion of items that may affect our future results.

Overview

Active Power
is a manufacturer and provider of efficient, reliable and green continuous power solutions incorporating uninterruptible power supply (UPS) systems that ensure business continuity for enterprises in the event of power disturbances. Our
products and solutions are designed to deliver continuous clean power, protecting customers from voltage fluctuations, such as surges and sags, and frequency fluctuations and to provide ride-through, or temporary, power to bridge the gap between a
power outage and the restoration of utility power. Our target customers are global enterprises requiring power insurance because they have zero tolerance for downtime in their mission critical operations. The UPS products we manufacture
use kinetic energy to provide short-term power as a cleaner alternative to electro-chemical battery-based energy. These products are highly reliable, are energy and space efficient and significantly reduce client electricity expenses.

As of September 30, 2010, we have shipped more than 2,700 flywheels in UPS system installations, delivering more than 675 megawatts
of power to customers in 44 countries around the world. We are headquartered in Austin, Texas, with international offices in the United Kingdom, Germany, China and Japan.

Our patented flywheel-based UPS systems store kinetic energy by constantly spinning a compact steel wheel
(flywheel) driven from utility power in a low friction environment. When the utility power used to spin the flywheel fluctuates or is interrupted, the flywheels inertia causes it to continue spinning. The resulting kinetic energy
of the spinning flywheel generates electricity known as bridging power for short periods, until either utility power is restored or a backup electric generator starts and takes over generating longer-term power in the case of an extended
electrical outage. We believe our flywheel products provide many competitive advantages over conventional battery-based UPS systems, including substantial space savings, higher power densities, green energy storage, and higher power
efficiencies up to 98%. This high energy efficiency reduces operating costs and provides customers a lower total cost of ownership. We offer our flywheel products with load capabilities from 130kVA to 8,400kVA. We typically target higher power
applications of 200kVA and above, largely because the majority of customers in this market segment have backup generators. Our flywheel-based UPS systems are marketed under the brand name
CleanSource®.

Our containerized continuous power systems (CPS), which incorporate our UPS products with switchgear and a generator to provide complete short- and long-term protection in the event of a power
disturbance, are marketed under the brand name PowerHouseTM. PowerHouse can be deployed in either a 20-foot or 40-foot-long ISO container depending upon the customers power load requirements. These systems are specifically designed to
handle the demands of high-tech facilities requiring the highest power integrity available while maximizing up time, useable floor space and operational efficiency. Designed to offer a highly flexible architecture to a customers constantly
changing environment, our systems are offered in four standard modular power configurations, enabling sizing for infrastructure on demand. These systems are highly differentiated as they offer flexibility in placement, space savings, fast deployment
time after receipt of order, high energy efficiency, and prompt capital deployment to meet current demands. They also deliver significant value to customers as the entire system is integrated and tested prior to delivery for a repeatable simple
solution.

Leveraging our manufacturing, containerization and product packaging capabilities, we also work with our IT channel
partners to produce portable data center infrastructure solutions. These solutions provide power distribution, cooling capabilities, security systems, fire suppression and monitoring capabilities for our IT channel partners. Our IT channel partners
are then able to add their IT equipment and deliver a complete portable or modular data center package to their customers.



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We believe a number of
underlying macroeconomic trends place Active Power in a strong position to be one of the leading providers of critical power protection. These trends include:



| |  |  | Ever-increasing demands placed on the public utility infrastructure;
| | - |  | --------------------------------------------------------------------



| |  |  | An inadequate investment in global utility infrastructure;
| | - |  | ----------------------------------------------------------



| |  |  | Rising costs of energy worldwide;
| | - |  | ---------------------------------



| |  |  | Increasing business costs of downtime;
| | - |  | --------------------------------------



| |  |  | A rapidly expanding need for data centers that provide reliable, efficient power; and
| | - |  | -------------------------------------------------------------------------------------



| |  |  | An increasing demand for economically green solutions.
| | - |  | ------------------------------------------------------

We have evolved significantly since our founding in 1992 as an engineering business focused on research, development and invention. The technological foundation of Active Power has yielded more than 100
worldwide patents and a highly differentiated, cost-efficient product platform. Since 2005, our management team has implemented a commercialization strategy focused on:



| |  |  | building the Active Power brand in the marketplace;
| | - |  | ---------------------------------------------------



| |  |  | expanding our distribution channels;
| | - |  | ------------------------------------



| |  |  | creating innovative solutions; and
| | - |  | ----------------------------------



| |  |  | focusing on operating and product cost reduction.
| | - |  | -------------------------------------------------

As a result of this strategy, we have been successful in improving our operating and financial performance, broadening our global footprint, diversifying our customer base, broadening our sales channels
and partners and moving higher up the customer value chain with innovative developments of our core underlying product technology. This is most recently illustrated by our newest product offering, PowerHouse, a containerized, portable, complete
continuous power solution.

We sell our products to a wide array of commercial and industrial customers across a variety of
vertical markets, including data centers, manufacturing, technology, broadcast and communications, financial, utilities, healthcare, government and airports. We have expanded our global sales channels and direct sales force, selling in all major
geographic regions of the world, but particularly in North America, Europe and Asia.

Results of Operations



|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|--------------------------------- |  | -------------------------------- | ------ | - | --------------------- |  | --- | ---- |  | - | ---------------- | - |  | - | --- | -- | - | - | ----- | - |  |  | --- | --
|($ in thousands)                  |  | Three months ended September 30, |        |   | Variance2010 vs. 2009 | 
|                                  |  | 2010                             |        |   | % oftotalrevenue      |  |     | 2009 |  |   | % oftotalrevenue |   |  | $ |     |    | % |  
|Product revenue                   |  | $                                | 16,663 |   |                       |  | 90  | %    |  | $ | 6,947            |   |  |   | 81  | %  |   | $ | 9,716 |   |  |  | 140 | % 
|Service and other revenue         |  |                                  | 1,793  |   |                       |  | 10  | %    |  |   | 1,587            |   |  |   | 19  | %  |   |   | 206   |   |  |  | 13  | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Total revenue                     |  |                                  | 18,456 |   |                       |  | 100 | %    |  |   | 8,534            |   |  |   | 100 | %  |   |   | 9,922 |   |  |  | 116 | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Cost of product revenue           |  |                                  | 11,287 |   |                       |  | 61  | %    |  |   | 5,751            |   |  |   | 67  | %  |   |   | 5,536 |   |  |  | 96  | % 
|Cost of service and other revenue |  |                                  | 1,691  |   |                       |  | 9   | %    |  |   | 901              |   |  |   | 11  | %  |   |   | 790   |   |  |  | 88  | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Total cost of goods sold          |  |                                  | 12,978 |   |                       |  | 70  | %    |  |   | 6,652            |   |  |   | 78  | %  |   |   | 6,326 |   |  |  | 95  | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Gross profit                      |  |                                  | 5,478  |   |                       |  | 30  | %    |  |   | 1,882            |   |  |   | 22  | %  |   |   | 3,596 |   |  |  | 191 | % 
|Operating expenses:               |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Research and development          |  |                                  | 833    |   |                       |  | 5   | %    |  |   | 1,095            |   |  |   | 13  | %  |   |   | (262  | ) |  |  | (24 | )%
|Selling and marketing             |  |                                  | 3,539  |   |                       |  | 19  | %    |  |   | 2,572            |   |  |   | 30  | %  |   |   | 967   |   |  |  | 38  | % 
|General and administrative        |  |                                  | 1,075  |   |                       |  | 6   | %    |  |   | 1,201            |   |  |   | 14  | %  |   |   | (126  | ) |  |  | (10 | )%
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Total operating expenses          |  |                                  | 5,447  |   |                       |  | 30  | %    |  |   | 4,868            |   |  |   | 57  | %  |   |   | 579   |   |  |  | 12  | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Operating profit (loss)           |  |                                  | 31     |   |                       |  | 0   | %    |  |   | (2,986           | ) |  |   | (35 | )% |   |   | 3,017 |   |  |  | 101 | % 
|Interest expense, net             |  |                                  | (30    | ) |                       |  |    |      |  |   | (20              | ) |  |   |    |    |   |   | 10    |   |  |  | 50  | % 
|Other expense, net                |  |                                  | 13     |   |                       |  |    |      |  |   | 46               |   |  |   |    |    |   |   | (33   | ) |  |  | (72 | )%
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Income (loss) before income taxes |  |                                  | 14     |   |                       |  |    |      |  |   | (2,960           | ) |  |   |    |    |   |   | 2,974 |   |  |  | 100 | % 
|Income tax benefit                |  |                                  | 41     |   |                       |  |    |      |  |   |                 |   |  |   |    |    |   |   | 41    |   |  |  |    | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   
|Net income (loss)                 |  | $                                | 55     |   |                       |  | 0   | %    |  | $ | (2,960           | ) |  |   | (35 | )% |   | $ | 3,015 |   |  |  | 102 | % 
|                                  |  |                                  |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |       |   |  |  |     |   



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|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|--------------------------------- |  | ------------------------------- | ------ | - | --------------------- |  | --- | ---- |  | - | ---------------- | - |  | - | --- | -- | - | - | ------ | - |  |  | --- | --
|($ in thousands)                  |  | Nine months ended September 30, |        |   | Variance2010 vs. 2009 | 
|                                  |  | 2010                            |        |   | % oftotalrevenue      |  |     | 2009 |  |   | % oftotalrevenue |   |  | $ |     |    | % |  
|Product revenue                   |  | $                               | 39,356 |   |                       |  | 86  | %    |  | $ | 21,863           |   |  |   | 83  | %  |   | $ | 17,493 |   |  |  | 80  | % 
|Service and other revenue         |  |                                 | 6,264  |   |                       |  | 14  | %    |  |   | 4,444            |   |  |   | 17  | %  |   |   | 1,820  |   |  |  | 41  | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Total revenue                     |  |                                 | 45,620 |   |                       |  | 100 | %    |  |   | 26,307           |   |  |   | 100 | %  |   |   | 19,313 |   |  |  | 73  | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Cost of product revenue           |  |                                 | 28,323 |   |                       |  | 62  | %    |  |   | 16,874           |   |  |   | 64  | %  |   |   | 11,449 |   |  |  | 68  | % 
|Cost of service and other revenue |  |                                 | 4,606  |   |                       |  | 10  | %    |  |   | 2,814            |   |  |   | 11  | %  |   |   | 1,792  |   |  |  | 64  | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Total cost of goods sold          |  |                                 | 32,929 |   |                       |  | 72  | %    |  |   | 19,688           |   |  |   | 75  | %  |   |   | 13,241 |   |  |  | 67  | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Gross profit                      |  |                                 | 12,691 |   |                       |  | 28  | %    |  |   | 6,619            |   |  |   | 25  | %  |   |   | 6,072  |   |  |  | 92  | % 
|Operating expenses:               |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Research and development          |  |                                 | 2,517  |   |                       |  | 6   | %    |  |   | 3,254            |   |  |   | 12  | %  |   |   | (737   | ) |  |  | (23 | )%
|Selling and marketing             |  |                                 | 10,323 |   |                       |  | 23  | %    |  |   | 8,562            |   |  |   | 33  | %  |   |   | 1,761  |   |  |  | 21  | % 
|General and administrative        |  |                                 | 3,825  |   |                       |  | 8   | %    |  |   | 3,517            |   |  |   | 13  | %  |   |   | 308    |   |  |  | 9   | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Total operating expenses          |  |                                 | 16,665 |   |                       |  | 37  | %    |  |   | 15,333           |   |  |   | 58  | %  |   |   | 1,332  |   |  |  | 9   | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Operating loss                    |  |                                 | (3,974 | ) |                       |  | (9  | )%   |  |   | (8,714           | ) |  |   | (33 | )% |   |   | 4,740  |   |  |  | 54  | % 
|Interest expense, net             |  |                                 | (82    | ) |                       |  |    |      |  |   | (48              | ) |  |   |    |    |   |   | 34     |   |  |  | 71  | % 
|Other expense, net                |  |                                 | (55    | ) |                       |  |    |      |  |   | (31              | ) |  |   |    |    |   |   | 24     |   |  |  | 77  | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Loss before income taxes          |  |                                 | (4,111 | ) |                       |  |    |      |  |   | (8,793           | ) |  |   |    |    |   |   | 4,682  |   |  |  | 53  | % 
|Income tax benefit                |  |                                 | 41     |   |                       |  |    |      |  |   |                 |   |  |   |    |    |   |   | 41     |   |  |  |    | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   
|Net loss                          |  | $                               | (4,070 | ) |                       |  | (9  | )%   |  | $ | (8,793           | ) |  |   | (33 | )% |   | $ | 4,723  |   |  |  | 54  | % 
|                                  |  |                                 |        |   |                       |  |     |      |  |   |                  |   |  |   |     |    |   |   |        |   |  |  |     |   

Product revenue. Product revenue primarily consists of sales of our CleanSource power quality
products, our CPS and other data center infrastructure solutions. Our CleanSource power quality products are comprised of both UPS and DC product lines and our CPS are comprised of our UPS systems and some combination of third party ancillary
equipment, such as engine generators and switchgear. The CPS products may be sold in a containerized solution that we call PowerHouse, or as separate equipment. Our data center infrastructure solutions provide power distribution, cooling
capabilities, security systems, fire suppression and monitoring capabilities for our IT channel partners. We have recently begun to produce our data center infrastructure solutions for our IT channel partners, leveraging our manufacturing,
containerization and product packaging capabilities.



|                                     |  |                                  |        |  |          |   |       |                                |  |   |          |   |  |      |      |    |      |   |        |   |  |   |        |  |  |   |        |  |  |  |      |  
|------------------------------------ |  | -------------------------------- | ------ |  | -------- | - | ----- | ------------------------------ |  | - | -------- | - |  | ---- | ---- | -- | ---- | - | ------ | - |  | - | ------ |  |  | - | ------ |  |  |  | ---- | -
|($ in thousands)                     |  | Three Months 
EndedSeptember 30, |        |  | Variance |   |       | Nine Months
EndedSeptember 30, |  |   | Variance |  
|                                     |  | 2010                             |        |  | 2009     |   |       | $                              |  |   | %        |   |  | 2010 |      |    | 2009 |   |        | $ |  |   | %      | 
|Product revenue:                     |  |                                  |        |  |          |   |       |                                |  |   |          |   |  |      |      |    |      |   |        |   |  |   |        |  |  |   |        |  |  |  |      |  
|UPS product revenue                  |  | $                                | 8,358  |  |          | $ | 4,897 |                                |  | $ | 3,461    |   |  |      | 71   | %  |      | $ | 23,210 |   |  | $ | 19,813 |  |  | $ | 3,397  |  |  |  | 17   | %
|Continuous Power Systems             |  |                                  | 1,210  |  |          |   | 1,879 |                                |  |   | (669     | ) |  |      | (36  | )% |      |   | 6,298  |   |  |   | 1,879  |  |  |   | 4,419  |  |  |  | 235  | %
|Data center infrastructure solutions |  |                                  | 7,095  |  |          |   | 171   |                                |  |   | 6,924    |   |  |      | 4049 | %  |      |   | 9,848  |   |  |   | 171    |  |  |   | 9,677  |  |  |  | 5659 | %
|                                     |  |                                  |        |  |          |   |       |                                |  |   |          |   |  |      |      |    |      |   |        |   |  |   |        |  |  |   |        |  |  |  |      |  
|Total product revenue                |  | $                                | 16,663 |  |          | $ | 6,947 |                                |  | $ | 9,716    |   |  |      | 140  | %  |      | $ | 39,356 |   |  | $ | 21,863 |  |  | $ | 17,493 |  |  |  | 80   | %
|                                     |  |                                  |        |  |          |   |       |                                |  |   |          |   |  |      |      |    |      |   |        |   |  |   |        |  |  |   |        |  |  |  |      |  



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Product revenue for
the three-month period ended September 30, 2010 increased by 140%, or $9.7 million, compared to the third quarter of 2009. $6.9 million of this increase was from the sale of data center infrastructure solutions for one of our IT channel
partners, a new revenue source for the Company. Substantially all of the remaining increase was from a higher volume of sales of our CleanSource flywheel-based UPS products, which was offset partially by a decrease in sales of continuous power
systems. The number of flywheels contained in UPS systems sold increased to 97 in this quarter compared to 56 in the third quarter of 2009 which drove the increase in UPS product revenue. Continuous power systems product revenues were down by
$669,000 for the three-month period ended September 30, 2010 compared to the same quarter in 2009, due to a lower number of PowerHouse related projects.

For the nine-month period ended September 30, 2010, our product revenue was $39.4 million, which was $17.5 million, or 80%, higher than the comparable period of 2009. Of this increase $9.7 million
was from the sale of data center infrastructure solutions and $4.4 million was from increased sale of continuous power solution products. UPS product revenues also increased by $3.4 million due to higher unit sales of product compared to 2009.

Product revenue increased sequentially by 25% compared to the second quarter of 2010. The increase in data center
infrastructure solutions contributed the majority of this increase, but UPS product revenues were 26% higher than the second quarter of 2010 and continuous power systems revenues decreased by 73% from the previous quarter. Our revenue related to
production of our data center infrastructure products and our continuous power systems tend to be larger in value and from a small number of customers compared to sales of our UPS products. This smaller number of customers with greater transaction
value can contribute to large quarterly fluctuations in revenue from each product family, due to the timing of orders and shipments in any particular accounting period. This quarter, revenue from data center infrastructure solutions represented 43%
of total product revenue, up from 16% in the prior quarter.

Product sales from our OEM channels for the three-month period
ended September 30, 2010 increased by 111%, or $773,000, compared to the third quarter of 2009 and represented 9% of our total product revenue for the period compared to 10% of total product revenue in the third quarter of 2009. For the
nine-month period ended September 30, 2010 product sales from our OEM channels increased 4%, or $275,000 as compared to the same period in 2009 and represented 20% of our total product revenue for this period as compared to 34% of revenue in
2009. The growth in sales during 2010 from our OEM channel has been less than growth from our direct sales and our IT channel. Sales of our UPS products are a much smaller part of our OEM partners total business and subject to more volatility
in quarterly sales, particularly during difficult economic periods as the OEM focuses on its core business. We do believe that sales from this channel will continue to increase as general conditions improve and due to the marketing commitment of the
OEM partners to promote our UPS products over the last year. Caterpillar remains our largest OEM customer but is no longer the largest single customer of the Company.

During the three-month period ended September 30, 2010, we sold 97 flywheel units in UPS products, comparable to the 99 units that we sold in the second quarter of 2010. This was a 73% increase from
the 56 units we sold in the third quarter of 2009. The average selling price per flywheel for the third quarter of 2010 was approximately $87,500 per flywheel, which compared to an average selling price of approximately $79,000 in the second quarter
of 2010 and $78,000 in the third quarter of 2009. The higher average selling price is driven by higher non-OEM revenues, which historically generate higher average selling prices than our OEM channel sales.

During the nine-month period ended September 30, 2010, we sold 291 flywheel units in UPS products, a 27% increase over the 230 units
that we sold in the same period of 2009. The average sales price per flywheel for the nine-month period ended September 30, 2010 was approximately $84,000, which compared to an average selling price of approximately $77,500 for the same period
of 2009.

Our continuous power systems, including PowerHouse, and our data center infrastructure solutions contracts tend to
be larger in value than our sales of UPS products, and this will contribute to more volatility on a quarterly basis based on the number and timing of such orders on hand for the relatively low number of transactions that we currently have each
quarter. For the three months ended September 30, 2010, we completed one large order for data center infrastructure products that was over $7 million. Large contracts also can significantly affect our cash flows as we have significantly larger
receivables per customer order. While this order and customer concentration does increase liquidity risk for us, we continue to improve and refine the payment terms of these sales opportunities as part of our working capital management. As our
solutions business grows, the composition of our sales will likely change and fluctuate on a quarterly basis. We have experienced an increase in third party systems and components and data center infrastructure solutions that are being packaged and
resold to our customers, that we believe will continue to help increase our total revenue. Margins on sales of third party equipment and portable data center infrastructure solutions are lower than the margins that we generate on our own
manufactured goods.



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Therefore, a significant increase in product revenues that was caused by higher sales of non -UPS products may not result in a commensurate percentage increase in our gross or operating profit
levels. Further, the frequency and timing of our larger sales, including megawatt-class UPS products and our CPS, including PowerHouse, is more volatile and can result in material changes in period-to-period revenue. Such revenues also can occur in
periods other than when originally anticipated, which can add to the potential volatility and affect our ability to meet forecasted targets.

North America sales were 82% of our total revenue for the three-month period ended September 30, 2010, compared to 40% for the same period in 2009 and 69% in the three-month period ended
June 30, 2010. For the nine-month period ended September 30, 2010, our North America sales were 73% of total revenue, which compared to 65% of total revenue in the same period of 2009. In total, our North America sales increased by 94% for
the nine-month period ended September 30, 2010 compared to the same period of 2009, reflecting the overall growth in the market for our products in total and in particular for our data center infrastructure solutions, and the improvement in
overall market conditions within the U.S. data center market.

We also sell products directly to customers in Asia and Western
Europe and we have a network of international distributors in other territories to sell products for us. In these markets, customers are more likely to purchase a total power solution from us rather than a stand-alone UPS system. This usually
results in a longer selling cycle and makes quarterly results from these regions more volatile and dependent upon a smaller number of transactions. Thus the amount of revenue from our international markets can fluctuate significantly on a quarterly
basis. Sales of Active Power branded products through our direct and manufacturers representative channels were 50% of our total revenue for the three-month period ended September 30, 2010, compared to 88% for the same period of 2009, and
60% of our total revenue for the three-month period ended June 30, 2010. Sales of Active Power branded products through our direct and manufacturers representative channels were 57% of our total revenue for the nine-month period ended
September 30, 2010, compared to 68% for the same period of 2009. As direct sales typically have higher profit margins than sales through our OEM channels, we will continue to focus on our direct sales channel to increase revenue and improve
profit margins and to decrease our dependency upon our OEM channel. We believe sales of our Active Power branded products in markets that were not covered by our OEMs will continue to increase over time and will continue to become a larger
percentage of our total revenue.

We continue to expand the sales territories where we sell our Active Power branded products
as we increase our sales distribution capabilities, particularly in Europe and Asia. In August we opened our first sales office in China as part of our efforts to add sales and service capabilities to this market in anticipation of future revenues.
There is usually a gap between adding sales and service capability and generating meaningful revenue from a new territory. As a result, the investments that we have made during 2009 and 2010 in Europe and Asia will not generate higher revenues, if
at all, from these regions until at least the fourth quarter of 2010. We continue to invest in sales, service and marketing capabilities in each of these regions.

Our products perform well in harsh environments where power quality or reliability is particularly poor, which makes them a good fit for countries with a poor power infrastructure or in harsh
manufacturing or process environments, or situations where reliability is paramount, such as mission-critical business applications, particularly data center applications. Therefore we have traditionally focused our direct sales efforts on these
types of customer situations.

Service and other revenue. Service and other revenue primarily relates to revenue
generated from both traditional (after-market) service work and from customer-specific system engineering. This includes revenue from design, installation, startup, repairs or reconfigurations of our products and the sale of spare or replacement
parts to our OEM and end-user customers. It also includes revenue associated with the costs of travel of our service personnel and revenues or fees received upon contract deferment or cancellation. Revenue from extended maintenance contracts with
our customers is also included in this revenue category.

Service and other revenue increased by 13% for the three-month
period ended September 30, 2010, compared to the same quarter of 2009 and increased by 41% for the nine-month period ended September 30, 2010 as compared to the same period in 2009. This increase is primarily due to higher levels of
service and contract work from direct product sales made in prior quarters and from professional fees associated with PowerHouse and other continuous power system sales. For these customers we provide a full power solution, including site
preparation, installation of an entire power solution and provision of all products required to provide a turnkey product to the end user often including maintenance services. Where we make sales through our OEM channel, it is typical for the OEM to
provide these types of services to their end-user customers. We anticipate that service and other revenue will continue to grow with product revenue, particularly as our PowerHouse system revenue grows, and as our installed base of UPS product
expands, because as more units are sold to customers, more installation, startup and maintenance services will be required.

Cost of product revenue. Cost of product revenue includes the cost of component parts of our products, ancillary equipment
that is sourced from external suppliers, personnel, equipment and other costs associated with our assembly and test operations, including costs from having underutilized facilities, depreciation of our manufacturing property and



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equipment, shipping costs, warranty costs, and the costs of manufacturing support functions such as logistics and quality assurance. The cost of product revenue as a percentage of total product
revenue was 68% in the three-month periods ended September 30, 2010, as compared to 83% for the comparable period of 2009, and was 72% and 77 % in the nine-month periods ended September 30, 2010 and September 30, 2009,
respectively. This decrease in cost as a percentage of revenue compared to 2009 is due primarily to increased sales volumes, which resulted in more efficient utilization of our manufacturing facility and a lower level of unabsorbed overhead costs.
We continue to operate a manufacturing facility that has a manufacturing and testing capacity significantly greater than our current product revenue levels. A large portion of the costs involved in operating this manufacturing facility are fixed in
nature and we typically incur approximately $300,000 to $500,000 in unabsorbed overhead each quarter. We continue to work on reducing our product costs through design enhancements and modifications, and vendor management programs and increasing our
sales volume to absorb these expenses.

Cost of service and other revenue. Cost of service and other revenue
includes the cost of component parts that we use in service or sell as spare parts, as well as labor and overhead costs of our service organization, including travel and related costs incurred in fulfilling our service obligations to our customers.
The cost of service and other revenue increased to 94% of service and other revenue in the three-month period ended September 30, 2010, compared to 57% of service and other revenue in the same period of 2009. For the nine-month period ended
September 30, 2010, the cost of service and other revenue was 74% of revenue as compared to 63% in the same period of 2009. This increase reflects higher costs relative to the increase in service and other revenues as we continue to expand the
service team to broaden the geographic regions where we have service capability as our total business grows. Operationally we are challenged to manage the growth of our service organization congruent with the growth in total revenues so that we can
meet customer requirements without growing our service organization cost structure too rapidly. During the current quarter we also did not have as many implementation projects for our continuous power systems, which contributed to lower utilization
of our service personnel and decreased margins in our service business. A large portion of the costs involved in operating our service organization are fixed in nature and we incur approximately $300,000 to $600,000 in unabsorbed overhead each
quarter. We continue to work on reducing our service overhead through better utilization of our service employees and cost control measures.

Gross profit. For the three month period ended September 30, 2010, our gross profit margin was 30% of revenue, compared to a 22% gross margin for the third quarter in 2009. For the
nine-month period ended September 30, 2010 our gross margin was 28% of revenue, compared to 25% for the same period of 2009 The improvement in third quarter margin, combined with higher revenue levels resulted in a $3.6 million, or 191%,
increase in gross profit for the quarter compared to the same period of the previous year. For the nine months ended September 30, 2010 our gross profits increased by $6.1 million, or 92%, compared to the same period in 2009. Higher average
selling prices for our products, higher volumes of sales, new product introductions such as the data center infrastructure solutions, and the resulting greater utilization of our manufacturing facilities are the primary drivers behind this increase
in gross profit compared to 2009. Our ability to continue to improve our gross profit will depend, in part, on our ability to continue to reduce material costs, improve our sales channel mix in favor of direct sales versus OEM, increase sales of
higher margin products such as our UPS products, increase product prices and increasing our total revenues to a level that will allow us to improve the utilization of our manufacturing and service operations.

Research and development. Research and development expense primarily consists of compensation and related costs for
employees engaged in research, development and engineering activities, third party consulting and development activities, as well as an allocated portion of our occupancy costs. Overall our research and development expenses were approximately
$262,000, or 24%, lower in the third quarter of 2010 compared to the third quarter of 2009 and remained steady with the second quarter of 2010. Our research and development efforts in 2009 were largely focused on new configurations of our existing
flywheel technology under development, as well as enhancements to parallel our UPS products and refinement and standardization of our containerized product solutions. The decrease in spending compared to 2009 reflects lower project related
development costs this year as well as lower headcount costs. The prior year expenses also included higher prototype and development costs for paralleling our megawatt-class UPS products. We believe research and development expenses in the fourth
quarter will remain at similar levels to those recorded in the third quarter.

Selling and marketing.Selling
and marketing expense primarily consists of compensation, including variable sales compensation, and related costs, for sales and marketing personnel, and related travel, selling and marketing expenses, as well as an allocated portion of our
occupancy costs and the cost of our foreign sales operations. Selling and marketing costs were approximately $967,000, or 38%, higher in the third quarter of 2010 compared to the amount recorded in the third quarter of 2009 and remained steady with
the expense level of the second quarter of 2010. The increase from 2009 primarily reflects higher variable sales compensation and performance-based compensation as a result of higher revenue and improving results. Our increase in total revenues has
driven higher sales compensation expense, including payments we made to third party representatives, and is the most significant cause of the increase in selling and marketing expenses. The increase also reflects increased headcount as we
concentrate on building and improving the Active Power brand, and expanding our sales



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organization, particularly in Europe and Asia, to support our direct selling and channel sales activities. We have added specific sales resources to support each of our OEM and IT sales channels
during 2010, which we believe is contributing to the improved performance from each of these channels in 2010. We believe that fixed sales and marketing expenses will remain consistent in the fourth quarter of 2010 compared to those recorded in the
third quarter of 2010.

General and administrative. General and administrative expense is primarily comprised of
compensation and related costs for executive and administrative personnel, professional fees, and taxes, including sales, property and franchise taxes. General and administrative expenses for the third quarter of 2010 decreased approximately
$126,000, or 10%, compared to the same period in 2009 and decreased approximately $358,000, or 25%, as compared to the immediately preceding quarter. The decrease primarily reflects lower professional and consulting services fees and lower
performance-based compensation expenses.

Interest expense, net. Net interest expense has increased from
approximately $20,000 in the three-month period ended September 30, 2009 to approximately $30,000 in the three-month period ended September 30, 2010. This increase is due to the overall decline in interest rates since 2008 that lowered our
investment returns, and higher interest expense paid on balances outstanding under our revolving credit arrangement as we have increased the amount outstanding under our credit facilities compared to 2009. Our average cash and investments balance
over the three-month period ending September 30, 2010 has increased by $5.4 million, or 56%, compared to the average balance over the comparable period ending September 30, 2009 and has increased by approximately $1.7 million, or 19%, for
the nine-month period ended September 30, 2010, , compared to the average balance over the comparable period of 2009.

Other expense, net. Net other expense in the third quarter of 2010 and 2009 reflects foreign exchange gains (losses) on a
bank account held in foreign currencies by our subsidiary companies.

Liquidity and Capital Resources

Our primary sources of liquidity at September 30, 2010 are our cash and investments on hand, our bank credit facilities and projected
cash flows from operating activities. If we meet our cash flow projections in our current business plan, we expect that we have adequate capital resources in order to continue operating our business for at least the next 12 months. Our business plan
and our assumptions around the adequacy of our liquidity are based on estimates regarding expected revenues and future costs. However, there are scenarios in which our revenues may not meet our projections, our costs may exceed our estimates or our
working capital needs may be greater than anticipated. Further, our estimates may change and future events or developments may also affect our estimates. Any of these factors may change our expectation of cash usage in 2010 and beyond or
significantly affect our level of liquidity.

In February 2010, we sold approximately 13.25 million shares of common
stock at a purchase price of $0.75 per share, for proceeds, net of fees and expenses, of approximately $9.0 million, in a firm-commitment underwritten offering made under a shelf registration statement that we had filed with the Securities and
Exchange Commission and that had been declared effective in December 2009. The proceeds from this offering were designed to strengthen our balance sheet and to help fund our working capital requirements during 2010 and for general corporate
purposes.

In August 2010, we entered into a Second Amended and Restated Loan and Security Agreement (the Loan
Agreement with our existing bank, Silicon Valley Bank (SVB). This new facility increased the total liquidity available from $6.0 million to $12.5 million subject to certain borrowing bases. This new facility expanded our ability to
borrow funds from U.S. receivables to also include qualifying receivables from our U.K. operations, increased our ability to use inventory as collateral for borrowing against, and also added an ability to borrow against purchase orders. These
additional bases of borrowing were designed to allow us to use the credit facility to fund inventory purchases in the event we received large or multiple sales orders that would require a major investment in inventory and work in progress, to help
fund continued growth in our business.

This new two-year loan facility provides for a secured revolving line of credit in an
aggregate amount of up to eighty percent (80%) of the facility amount of $15.625 million, or $12.5 million, subject to certain borrowing bases. In the event we have maintained cash and cash equivalents of at least $6.25 million with SVB for at
least 30 consecutive days, which is referred to as being in a Streamline Period, the borrowing base formula is based on eligible accounts receivable, eligible purchase orders and eligible inventory, subject to a sublimit of $5 million
for U.K. accounts receivable, $3.5 million for inventory and $1.5 million for purchase orders. When we are not in a Streamline Period, our borrowings are limited based on accounts receivable and purchase orders that SVB has specifically agreed to
finance and a borrowing base for eligible inventory. We may also request that SVB issue letters of credit on our behalf, of up to $1.5 million, as a portion of our total loan facility.



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On August 5,
2010, the Company borrowed approximately $2.5 million in revolving loans, all of which was used to refinance all indebtedness owing from the Company to SVB under our previous credit facility. The new credit facility increases the total credit
available from our previous loan facility with SVB, which was $6.0 million, and enables us to borrow against eligible inventory, foreign receivables and customer purchase orders in addition to eligible accounts receivable.

During the quarter ended September 30, 2010, we borrowed an additional $1.0 million under this credit facility. Based on the
borrowing base formula, we had an additional $3.1 million available for use at September 30, 2010 under this credit facility.

The Company will pay a finance charge on each account receivable financed by SVB at a per annum rate equal to SVBs prime rate, subject to a minimum prime rate of four percent (4.00%), plus one and
one-half percent (1.50%). The Company will pay a finance charge on each purchase order financed by SVB at a per annum rate equal to SVBs prime rate, subject to a minimum prime rate of four percent (4.00%), plus one and one-quarter percent
(1.25%) when a Streamline Period is not in effect or two percent (2.00%) when a Streamline Period is in effect. When we are not in a Streamline Period, these finance charges will be based on the face amount of the receivable or the
purchase order, and otherwise, will be based on the amount financed by SVB.

Each advance based upon inventory accrues
interest at a per annum rate equal to SVBs prime rate, subject to a minimum prime rate of four percent (4.00%), plus (i) one and one-half percent (1.50%) when we are in a Streamline Period and (ii) three and five-eighths percent
(3.625%) when we are not in a Streamline Period.

Finance charges and interest are payable monthly, and all principal and
interest is due on the maturity date of August 5, 2012. However, when we are not in a Streamline Period, we must repay advances based on receivables when we receive payment on the receivable that has been financed, and we must repay advances
based on purchase orders within 120 days of the date of the purchase order, together with all finance charges on such advances.

The revolving loans made to us under this loan facility will be secured by a lien on substantially all of our assets. In addition, on
August 5, 2010, Active Power Solutions Limited, a wholly-owned United Kingdom subsidiary of the Company, entered into a Guarantee and Debenture with SVB (the Guarantee and Debenture), pursuant to which Active Power Solutions Limited
guarantied all of the obligations of the Company under the Loan Agreement and secured its obligations under the Guarantee and Debenture with a security interest on substantially all of its assets.

The Loan Agreement includes customary affirmative covenants for a credit facility of this size and type, including delivery of financial
statements, compliance with laws, maintenance of insurance and protection of intellectual property rights. Further, the Loan Agreement contains customary negative covenants for a credit facility of this size and type, including covenants that limit
or restrict the Companys ability to, among other things, dispose of assets, change its business, change its CEO or CFO without replacing such person within 120 days, have a change in control, make acquisitions, be acquired, incur indebtedness,
grant liens, make investments, make distributions, repurchase stock, and enter into certain transactions with affiliates. The Loan Agreement also requires the Company to maintain a minimum liquidity ratio of 1.25:1. The Company is currently in
compliance with all loan covenants under the Loan Agreement.

The Loan Agreement contains customary events of default that
include, among other things, non-payment defaults, covenant defaults, material adverse change defaults, insolvency defaults, material judgment defaults and inaccuracy of representations and warranty defaults. The occurrence of an event of default
could result in the acceleration of obligations under the Loan Agreement, in which case the Company must repay all loans and related charges, fees and amounts then due and payable, and our subsidiary may be required to pay any such amounts under the
Guarantee and Debenture. At the election of SVB, upon the occurrence and during the continuance of an event of default, finance charges or interest rates, as applicable, will increase an additional five percentage points (5.00%) per annum above
the rate that is otherwise applicable thereto upon the occurrence of such event of default, and the collateral handling fees will increase by one-half percent (0.50%).

A substantial increase in sales of our PowerHouse or our data center infrastructure solutions products or an increase in UPS sales may materially impact the amount of liquidity required to fund our
operations. The amount of time between the receipt of payment from our customers and our expenditures for raw materials, manufacturing and shipment of products (the cash cycle) for sales of our CleanSource UPS product can be as short as 45 days, and
is typically 60 days. However, the cash cycle on a PowerHouse sale can be as much as 210 days, depending upon customer payment terms. We intend to mitigate the financial impact of this longer cash cycle by requiring customer deposits and periodic
payments where possible from our customers. This is not always commercially feasible, and in order to increase our PowerHouse sales, we may be required to make larger investments in inventory and receivables. These larger investments may require us
to obtain additional sources of working capital, debt or equity financing in order to fund this business.



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As discussed, should
additional funding be required, we would expect to raise the required funds through borrowings or public or private sales of debt or equity securities. If we raise additional funds through the issuance of debt or equity securities, the ownership of
our stockholders could be significantly diluted. If we obtain additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt
securities issued could impose significant restrictions on our operations.

The following table summarizes the quarterly
changes in cash provided by (used in) operating activities:



|                                  |  |                                |        |   |                       |   |        |   |  |   |        |   |  |  |     |   
|--------------------------------- |  | ------------------------------ | ------ | - | --------------------- | - | ------ | - |  | - | ------ | - |  |  | --- | --
|($ in thousands)                  |  | Nine months endedSeptember 30, |        |   | Variance2010 vs. 2009 |  
|                                  |  | 2010                           |        |   | 2009                  |   |        | $ |  |   | %      |  
|Cash used in operating activities |  | $                              | (2,513 | ) |                       | $ | (5,519 | ) |  | $ | (3,006 | ) |  |  | (54 | )%

Cash used in operating
activities decreased by $3 million, or 54%, in the nine-month period ended September 30, 2010 compared to the same period of 2009. This was primarily due to a $4.8 million reduction in operating losses compared to 2009, offset by a $1.8 million
increase in our working capital requirements. Increased sales in the third quarter resulted in an increase in our receivables by approximately $1.1 million compared to year end and an increase of $2 million compared to June 30, 2010 levels.
While we were able to reduce our finished goods inventory by $1.3 million during the nine-month period ended September 30, 2010, this was offset by an increase of $1.0 million in work-in-process inventory due to in-process order fulfillment for
future PowerHouse orders. We also decreased our accounts payable by approximately $500,000 compared to year end due to normal vendor payment schedules and consistent with the decrease in inventory. We anticipate that the level of cash used in
operating activities will decrease in the fourth quarter of 2010 as we collect these outstanding receivables. However, the size and timing of orders and shipments during the fourth quarter may require us to invest in inventory or receivables to
support the anticipated revenue growth.

The following table summarizes the quarterly changes in cash (used in) provided by
investing activities:



|                                                |  |                                |      |   |                       |   |     |   |  |   |      |   |  |  |      |   
|----------------------------------------------- |  | ------------------------------ | ---- | - | --------------------- | - | --- | - |  | - | ---- | - |  |  | ---- | --
|($ in thousands)                                |  | Nine months endedSeptember 30, |      |   | Variance2010 vs. 2009 |  
|                                                |  | 2010                           |      |   | 2009                  |   |     | $ |  |   | %    |  
|Cash (used in) provided by investing activities |  | $                              | (532 | ) |                       | $ | 202 |   |  | $ | (734 | ) |  |  | (363 | )%

Investing activities
primarily consist of sales and purchases of investments and purchases of property and equipment. Fluctuations in the sale and purchase of investments generally reflect our use of these funds to finance our ongoing operations. Capital expenditures
were approximately $532,000 in the nine-month period ending September 30, 2010, compared to approximately $498,000 in the same period of 2009. Cash provided by sales and purchases of investments were $0 in the nine-month period ending
September 30, 2010, compared to approximately $700,000 in the same period of 2009.

The following table summarizes the
quarterly changes in cash provided by financing activities:



|                                      |  |                                |        |  |                       |   |       |   |  |  |       |  |  |  |     |  
|------------------------------------- |  | ------------------------------ | ------ |  | --------------------- | - | ----- | - |  |  | ----- |  |  |  | --- | -
|($ in thousands)                      |  | Nine months endedSeptember 30, |        |  | Variance2010 vs. 2009 |  
|                                      |  | 2010                           |        |  | 2009                  |   |       | $ |  |  | %     | 
|Cash provided by financing activities |  | $                              | 10,007 |  |                       | $ | 3,005 |   |  |  | 7,002 |  |  |  | 233 | %

The increases in funds
provided by financing activities during the nine-month period ended September 30, 2010 primarily reflect the sale of common stock in February 2010 in a firm-commitment underwritten offering pursuant to which we sold approximately
13.25 million shares of common stock at a purchase price of $0.75 per share, for proceeds, net of fees and expenses, of $9.0 million. These proceeds were designed to strengthen our balance sheet and used to help fund our working capital
requirements during 2010 and for general corporate purposes. We also drew $1.0 million on our revolving line of credit in the nine-month period ended September 30, 2010, as compared to $60,000 in the comparable period of 2009. Funds provided by
financing activities during the nine-month period ended September 30, 2009 reflect the sale of common stock through a private placement to an institutional investor pursuant to which we sold 6.0 million shares of common stock at $0.50 per
share.

We believe that our cash and investments will be sufficient to fund our operations for at least the next 12 months.
Our sales cycle is such that we generally have visibility 2-3 quarters in advance for future orders that allows us to predict revenues over this period of time with some degree of confidence. However, a sudden change in business volume, positive or
negative,



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from any of our business or channel partners or in our direct business could significantly impact our expected revenues. The recent global economic downturn has reduced our confidence at
predicting future revenues, and even with improving economic conditions, there is still uncertainty and risk in our forecasting. This 2-3 quarter window of sales visibility does provide us with some opportunity to adjust expenditures or take other
measures to reduce our cash consumption if we can see and anticipate a shortfall in revenue or give us time to identify additional sources of funding if we anticipate an increase in our working capital requirements due to increased revenues or
changes in our revenue mix. If there is a significant increase especially in our PowerHouse or our data center infrastructure solutions business, this could potentially impact the amount of working capital that we may require, due to the longer
production time and cash cycle of sales of these products.

We expect the level of capital investments to remain similar in
2010 to those in 2009. We currently intend to invest in several PowerHouse systems to use for demonstration purposes in the U.S., China and the U.K. to help our sales efforts, but we are not planning any other major capital investments during the
remainder of 2010.

Recent Accounting Pronouncements

In October 2009, the FASB updated FASB ASC 605, Revenue Recognition (FASB ASC 605) that amended the criteria for
separating consideration in multiple-deliverable arrangements. The amendments establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific
objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The amendments will change
the application of the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates
any discount in the arrangement proportionally to each deliverable on the basis of each deliverables selling price. This update will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010. Early adoption is permitted and so we adopted this policy with effect from the beginning of our financial year on January 1, 2010. Other than increased disclosure requirements, adoption of this policy did
not have any material impact on our consolidated financial statements.



|Item 3. | Quantitative and Qualitative Disclosures about Market Risk
|------- | ----------------------------------------------------------

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.

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. Because of the nature of the majority of our investments, we do not believe a 1% decline in interest rates would have a material effect on interest income or their fair value.

Our international sales have historically been made in U.S. dollars. As we have increased sales in foreign markets and opened
operations in multiple foreign countries, we have executed more transactions that are denominated in other currencies, primarily Euros and British pounds. Those sales and expenses in currencies other than U.S. dollars can result in translation gains
and losses which have not been significant to date. Currently, we do not engage in hedging activities for our international operations other than an increasing amount of sales and support expenses being incurred in foreign currencies as a natural
hedge. However, recent volatility in currencies, particularly with the British pound and Euro, is increasing the amount of potential translation gains and losses and we may engage in hedging activities in the future to mitigate the risks caused by
such currency volatility.

Our international business is subject to the typical risks of any international business,
including, but not limited to, the risks described in Item 1ARisk Factors in our 2009 Annual Report on Form 10-K. Accordingly, our future results could be materially harmed by the actual occurrence of any of these or other
risks.



|Item 4. | Controls and Procedures
|------- | -----------------------

Evaluation of
disclosure controls and procedures.

Our Chief Executive Officer and our Chief Financial Officer, based on the evaluation
of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded
that, as of September 30, 2010, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the Exchange Act, (i) is recorded, processed,
summarized and reported within the time periods



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specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting.

During the three months ended September 30, 2010, there were no changes in our internal control over financial
reporting identified in connection with the evaluation required by Rule 13a-15(d) and Rule 15d-15(d) under the Exchange Act that have materially affected, or that we believe are reasonably likely to materially affect, our internal control over
financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.

PART II  OTHER
INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

We
are, from time to time, subject to various legal proceedings, claims and litigation arising in the ordinary course of business. We do not believe we are party to any currently pending legal proceedings the outcome of which may have a material effect
on our operations or consolidated financial position. There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse affect on our financial position,
results of operations or cash flows.



|Item 1A. | Risk Factors
|-------- | ------------

You should carefully
consider the risks described in Item 1A of our 2009 Annual Report on Form 10-K before making a decision to invest in our common stock or in evaluating Active Power and our business. The risks and uncertainties described in our 2009 Annual
Report on Form 10-K are not the only ones we face. Additional risks and uncertainties that we do not presently know, or that we currently view as immaterial, may also impair our business operations. This report is qualified in its entirety by these
risk factors.

The actual occurrence of any of the risks described in our 2009 Annual Report on Form 10-K could materially harm our
business, financial condition and results of operations. In that case, the trading price of our common stock could decline.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds.
|------- | ------------------------------------------------------------

None.



|Item 3. | Defaults Upon Senior Securities.
|------- | --------------------------------

None.



|Item 4. | Reserved.
|------- | ---------



|Item 5. | Other Information.
|------- | ------------------

None.



|Item 6. | Exhibits.
|------- | ---------

The following
documents are filed as exhibits to this report:



|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*  |  | Restated Certificate of Incorporation (filed as Exhibit 3.1 to Active Powers Quarterly Report on Form 10-Q filed on July 28, 2006)                                                                                                                                                                                                                                                                                                             
|      | 
|3.2.* |  | Second Amended and Restated Bylaws (filed as Exhibit 3.2 to Active Powers Current Report on Form 8-K filed on February 2, 2007)                                                                                                                                                                                                                                                                                                                
|      | 
|3.3*  |  | Amendment to Second Amended and Restated Bylaws (filed as Exhibit 3.01 to Active Powers Current Report on Form 8-K filed on December 7, 2007)                                                                                                                                                                                                                                                                                                  
|      | 
|4.1*  |  | Specimen certificate for shares of Common Stock (filed as Exhibit 4.1 to Active Powers IPO Registration Statement on Form S-l (SEC File
No. 333-36946))                                                                                                                                                                                                                                                                                        
|      | 
|4.2*  |  | Rights Agreement, dated as of December 13, 2001, between Active Power and Equiserve Trust N.A., which includes the form of Certificate of Designation for the Series A Junior
Participating Preferred Stock as Exhibit A, the form of Rights Certificate as Exhibit B and the Summary of Rights to Purchase Series A Preferred Stock as Exhibit C (filed as Exhibit 4.1 to Active Powers Current Report on Form 8-K filed on
December 14, 2001)



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|     |  |                                                                                                                                                                        
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.3* |  | See Exhibits 3.1, 3.2 and 3.3 for provisions of the Certificate of Incorporation and Bylaws of the registrant defining the rights of holders of common stock.          
|     | 
|10.1 |  | Second Amended and Restated Loan and Security Agreement dated August 5, 2010                                                                                           
|     | 
|10.2 |  | Guarantee and Debenture dated August 5, 2010                                                                                                                           
|     | 
|31.1 |  | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2003  
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2003
|     | 
|32.1 |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003                      
|     | 
|32.2 |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003                      



|* | Incorporated by reference to the indicated filing.
|- | --------------------------------------------------



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SIGNATURES

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



|                 |  |                                                                                                              
|---------------- |  | -------------------------------------------------------------------------------------------------------------
|                 |  | ACTIVE POWER, INC.                                                                                           
|                 |  | (Registrant)                                                                                                 
|                 | 
|October 26, 2010 |  | /S/    JAMES A.
CLISHEM                                                                                      
|(Date)           |  | James A. Clishem                                                                                             
|                 |  | President and Chief Executive Officer
(Principal Executive Officer)                                          
|                 | 
|October 26, 2010 |  | /S/    JOHN K.
PENVER                                                                                        
|(Date)           |  | John K. Penver                                                                                               
|                 |  | Vice President of Finance, Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)



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