<PAGE>

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

                                    FORM 10-Q

(Mark One)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
For the quarterly period ended       September 30, 2001
                               -------------------------------------------------

                                       or

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 For the transition period from           to
                                                        ----------   -----------

Commission file number:
                       ---------------------------------------------------------

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

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


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

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

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

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

                      APPLICABLE ONLY TO CORPORATE ISSUERS:

         Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. The number of shares
of common stock as of September 30, 2001 was 40,531,070 with a par value of
$0.001 per share.

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

                               ACTIVE POWER, INC.
                                      INDEX



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

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

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

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

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

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

     Item 2. Management's Discussion and Analysis of Financial
         Condition and Results of Operations...................................5

         Liquidity and Capital Resources.......................................8

         Quantitative and Qualitative Disclosures About Market Risk............9

         Risk Factors That May Affect Future Results..........................10

PART II- OTHER INFORMATION....................................................18

     Item 1. Legal Proceedings................................................18

     Item 2. Changes in Securities and Use of Proceeds........................18

     Item 3. Defaults Upon Senior Securities..................................18

     Item 4. Submission of Matters to a Vote of Security Holders..............18

     Item 5. Other Information................................................18

     Item 6. Exhibits and Reports on Form 8-K.................................18

                                       i
<PAGE>

PART I - FINANCIAL INFORMATION

     Item 1.  Financial Statements


                               ACTIVE POWER, INC.
                                 BALANCE SHEETS

                                 (in thousands)
<TABLE>
<CAPTION>


                                                                               September 30,  December 31,
                                                                                   2001           2000
                                                                                   ----           ----
                                                                                (unaudited)
<S>                                                                            <C>             <C>
     ASSETS
     Current assets:
              Cash and cash equivalents                                         $   80,005     $   92,720
              Short-term investments                                                10,013         42,541
              Accounts receivable, net                                               3,415          1,934
              Inventories, net                                                       6,153          2,343
              Prepaid expenses and other                                             1,344          1,177
                                                                                ----------     ----------
                       Total current assets                                        100,930        140,715
     Property and equipment, net                                                    16,489          4,469
     Long-term investments                                                          29,493         10,948
                                                                                ----------     ----------
                       Total assets                                             $  146,912     $  156,132
                                                                                ==========     ==========

     LIABILITIES AND STOCKHOLDERS' EQUITY

     Current liabilities:
              Accounts payable                                                  $    6,045     $    2,133
              Accrued expenses                                                       3,057          1,610
                                                                                ----------     ----------
                       Total current liabilities                                     9,102          3,743

     Stockholders' equity:
              1992 preferred stock                                                       -              -
              Common stock                                                              41             39
              Treasury stock                                                            (2)            (2)
              Deferred stock compensation                                           (3,604)        (7,519)
              Additional paid-in capital                                           215,029        212,601
              Accumulated deficit                                                  (73,654)       (52,730)
                                                                                ----------     ----------
                       Total stockholders' equity                                  137,810        152,389
                                                                                ----------     ----------
                       Total liabilities and stockholders' equity               $  146,912     $  156,132
                                                                                ==========     ==========

</TABLE>

     See accompanying notes

                                       1

<PAGE>

                               ACTIVE POWER, INC.
                             STATEMENT OF OPERATIONS

               (in thousands, except share and per share amounts)
                                   (unaudited)
<TABLE>
<CAPTION>



                                                            Three Months                   Nine Months
                                                          Ended September 30,          Ended September 30,
                                                      --------------------------    --------------------------
                                                          2001            2000          2001            2000
                                                      ------------   ------------   ------------   ------------
<S>                                                   <C>            <C>            <C>            <C>
Product revenue                                       $      6,219   $      1,343   $     18,058   $      2,204
Cost of goods sold                                           6,885          2,085         20,670          3,782
                                                      ------------   ------------   ------------   ------------
Product margin (loss)                                         (666)          (742)        (2,612)        (1,578)

Operating expenses:
Research and development                                     4,003          3,060         11,562          6,718
Selling, general and administrative                          2,908          1,578          8,571          4,138
Amortization of deferred stock compensation                    926          1,881          3,197          5,021
                                                      ------------   ------------   ------------   ------------
Total operating expenses                                     7,837          6,519         23,330         15,877
                                                      ------------   ------------   ------------   ------------
Operating loss                                              (8,503)        (7,261)       (25,942)       (17,455)

Interest income (expense)                                    1,266          1,548          5,167          2,243
Change in fair value of warrants with
       redemption rights                                         -              -              -         (1,562)
Other income (expense)                                        (123)           (76)          (148)           (80)
                                                      ------------   ------------   ------------   ------------
Net loss                                              $     (7,360)  $     (5,789)  $    (20,923)  $    (16,854)
Preferred stock dividends and accretion                          -         (3,669)             -        (19,079)
Net loss to common shareholders                       $     (7,360)  $     (9,458)  $    (20,923)  $    (35,933)
                                                      ============   ============   ============   ============

Net loss per share - basic and diluted                $      (0.18)  $      (0.35)  $      (0.53)  $      (2.18)

Shares used in computing net loss per share,
       basic and diluted                                40,153,164     27,322,877     39,532,822     16,467,498

</TABLE>


See accompanying notes


                                       2

<PAGE>

                               ACTIVE POWER, INC.
                             STATEMENT OF CASH FLOWS

                                 (in thousands)

<TABLE>
<CAPTION>
                                                                              Nine Months Ended
                                                                                September 30,
                                                                          -------------------------
                                                                             2001            2000
                                                                          ----------     ----------
                                                                          (unaudited)    (unaudited)
<S>                                                                       <C>            <C>
Operating activities
Net loss                                                                  $  (20,923)    $  (16,854)
         Adjustment to reconcile net loss to cash used in
         operating activities:
         Depreciation expense                                                  1,704            708
         Amortization of deferred stock compensation                           3,197          5,021
         Change in fair value of warrants with redemption rights                   -          1,562
         Changes in operating assets and liabilities:
              Accounts receivable, net                                        (1,481)          (880)
              Inventories, net                                                (3,811)        (1,082)
              Prepaid expenses and other assets                                 (777)        (1,026)
              Accounts payable                                                 3,913          1,448
              Accrued expenses                                                 1,447            230
              Other non-current liabilities                                        -             (7)
                                                                          ----------     ----------
Net cash used in operating activities                                        (16,731)       (10,880)

Investing activities
Purchases of property and equipment                                          (13,724)        (3,518)
Net maturity (purchase) of investments                                        13,983        (15,612)
                                                                          ----------     ----------
Net cash provided by (used in) investing activities                              259        (19,130)

Financing activities
Proceeds from issuance of common stock, net of issuance costs                  1,489        139,911
Proceeds from exercise of warrants                                             2,268             30
Payments on notes payable .                                                        -            (55)
                                                                          ----------     ----------
Net cash provided by financing activities                                      3,757        139,886
                                                                          ----------     ----------
Increase in cash and cash equivalents                                        (12,715)       109,876
Cash and cash equivalents, beginning of period                                92,720         24,856
                                                                          ----------     ----------
Cash and cash equivalents, end of period                                  $   80,005     $  134,732
                                                                          ==========     ==========

</TABLE>


See accompanying notes.


                                       3

<PAGE>

                               Active Power, Inc.
                          Notes to Financial Statements

                                   (unaudited)

1.       Organization

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

2.       Basis of Presentation

         The accompanying unaudited interim financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. These financial statements
should be read in conjunction with the audited financial statements and
accompanying notes thereto included in our Annual Report on Form 10-K for the
year ended December 31, 2000. In the opinion of management the financial
statements include all adjustments (consisting of normal recurring adjustments)
necessary for a fair presentation of the results for the periods presented.
Results of operations for any interim period are not necessarily indicative of
results for any other interim period or for the full year.

3.       Inventory

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

              Inventories consist of the following:

                                       September 30,     December 31,
                                            2001            2000
                                       ------------     ------------
         Raw Materials                 $  5,170,147     $  2,902,224
         Work in Progress                 2,540,858          310,330
         Finished Goods                      50,285            4,981
         Less Reserves                   (1,608,029)        (874,867)
                                       ------------     ------------
                                       $  6,153,261     $  2,342,668
                                       ============     ============




                                       4

<PAGE>

4.       Capital Structure

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

                                                             Three Months                   Nine Months
                                                          Ended September 30,            Ended September 30,
                                                      ---------------------------   ---------------------------
                                                          2001           2000            2001           2000
                                                      ------------   ------------   ------------   ------------
<S>                                                   <C>            <C>            <C>            <C>
Net loss to common stockholders (thousands)           $     (7,360)  $     (9,458)  $    (20,923)  $    (35,933)
Basic and diluted:
         Weighted-average shares of common
              stock outstanding                         40,318,355     27,820,583     39,769,876     16,894,343
         Weighted-average shares of common
              stock subject to repurchase                 (165,191)      (497,706)      (237,054)      (426,845)
                                                      ------------   ------------   ------------   ------------
Shares used in computing basic and diluted
     net loss per share                                 40,153,164     27,322,877     39,532,822     16,467,498
                                                      ============   ============   ============   ============

Basic and diluted net loss per share                  $      (0.18)  $      (0.35)  $      (0.53)  $      (2.18)
                                                      ============   ============   ============   ============

</TABLE>

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

         The following discussion should be read in conjunction with the
financial statements appearing elsewhere in this Quarterly Report on Form 10-Q
and within our Annual Report on Form 10-K for the year ended December 31, 2000.
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 actual results could differ
materially from those anticipated in these forward-looking statements as a
result of various factors, including those discussed below under the heading
"Risk Factors," and other factors detailed in the Company's filings with the
Securities and Exchange Commission, specifically our Form 10-K for the year
ended December 31, 2000.

Overview

         We design, manufacture and market power quality products that provide
the consistent, reliable electric power required by today's digital economy. We
believe that we are the first company to commercialize a flywheel energy storage
system that provides a highly reliable, low-cost and non-toxic replacement for
lead-acid batteries used in conventional power quality installations. Leveraging
our expertise in this technology and in conjunction with Caterpillar Inc., the
leading maker of engine generators for the power reliability market, we have
developed a battery-free power quality system, which is marketed under the
Caterpillar brand name (Cat(R) UPS). Our products are sold for use in the
facilities of companies in many different industries that all share a critical
need for reliable, high-quality power, such as semiconductor manufacturers,
hospitals, credit card processing centers, telecommunications providers,
Internet service providers, electric utilities and broadcasters. As an extension
of these existing product lines, we are developing additional products to more
broadly serve the various market segments within the power quality and
reliability market.

         Since 1996, we have focused our efforts and financial resources
primarily on the design and development of our CleanSource(R) line of power
quality products (CleanSource DC and Cat(R) UPS) and on establishing effective

                                       5
<PAGE>

OEM channels to market our products. As of September 30, 2001, we have generated
an accumulated deficit of $73.7 million and expect to continue to sustain
operating losses for the next several quarters. We initially funded our
operations through sales of shares of our preferred stock, which resulted in
gross proceeds of approximately $42.6 million. We believe the proceeds from our
August 2000 initial public offering, approximately $138.4 million net of
commissions and issuance costs, together with cash balances on hand prior to
August 2000 will be sufficient to meet our capital requirements through at least
the next 24 months. Our cash and investments position at September 30, 2001 was
$119.5 million.

         Since our inception, a small number of customers have accounted for the
majority of our annual sales. During 1999, our four largest customers accounted
for 89% of our sales, with our largest customer, Caterpillar and its dealer
network, accounting for 39%. In 2000 and the first nine months of 2001, our
volume of business with Caterpillar and its dealer network grew substantially,
accounting for 96% and 90%, respectively, of our revenue due to the commercial
introduction of the Cat UPS product line. We expect to continue to be dependent
on a few OEM customers, primarily Caterpillar, for the majority of our sales for
the foreseeable future.

         With the commercial release of our second-generation product line, Cat
UPS, in May 2000 under the Caterpillar brand name, and a growing market demand
for power quality equipment, the demand for our products has increased
significantly. To prepare for this growth in demand and to position us for
future growth, we have increased the scale of our operations in the following
ways:

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

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

         o        added sales and marketing personnel to support our OEM
                  customers.

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


Results of Operations

         Product Revenue. Product revenue primarily consists of sales of our
CleanSource power quality products. We recognize revenue upon the transfer of
title, which generally occurs upon shipment to our customers. Sales increased
$4.9 million, or 363%, to $6.2 million for the three months ended September 30,
2001 from $1.3 million for the three months ended September 30, 2000. For the
nine months ended September 30, sales increased $15.9 million, or 719%, to $18.1
million in 2001 from $2.2 million in the same period of 2000. Both of these
increases were primarily attributable to a continued ramp up in the sales of our
Cat UPS product line and sales of our new CleanSource2 product to General
Electric Company's Digital Energy business unit. In the nine months ended
September 30, 2001, we sold 306 quarter-megawatt flywheel units, in comparison
to the 44 quarter-megawatt flywheel units sold in the same period of 2000. The
majority of these units were sold to our Cat UPS distribution partner,
Caterpillar.

                                       6

<PAGE>

         Cost of goods sold. Cost of goods sold includes the cost of component
parts of our product that are sourced from suppliers, personnel, equipment and
other costs associated with our assembly and test operations, shipping costs,
and the costs of manufacturing support functions such as logistics and quality
assurance. Cost of goods sold increased $4.8 million to $6.9 million for the
three months ended September 30, 2001 from $2.1 million for the three months
ended September 30, 2000. For the nine months ended September 30, cost of goods
sold increased $16.9 million, or 447%, to $20.7 million in 2001 from $3.8
million in the same period of 2000. In both periods product costs grew
commensurate with the increase in sales and a scale up in our manufacturing
operations. Although the absolute dollar amounts increased year over year, we
achieved significant improvements in our gross margin as a percent of revenue in
each period. These improvements are a result of supplier cost reductions
associated with higher volume, changes in our supplier base, engineering design
savings, and leverage gained from higher production volumes. In anticipation of
future demand for our products, we have significantly expanded our manufacturing
capacity by increasing both our manufacturing facilities and production
personnel, which has increased our fixed manufacturing expense base. This
increase will adversely impact our gross margins until production volumes
increase enough to cover these added costs. Over time we believe gross margins
will improve as our product volumes increase, and we achieve greater economies
of scale in production and in purchasing component parts, and introduce
engineering design savings.

         Research and development. Research and development expense primarily
consists of compensation and related costs of employees engaged in research,
development and engineering activities, third party consulting and development
activities, as well as an allocated portion of our occupancy costs. Research and
development expense increased approximately $942,000, or 31%, to $4.0 million
for the three months ended September 30, 2001 from $3.1 million for the three
months ended September 30, 2000. For the nine months ended September 30,
research and development expense increased $4.9 million, or 72%, to $11.6
million in 2001 from $6.7 million in the same period of 2000. The increase in
research and development expense was primarily due to an increase in project
development costs on our HIT 6 continuous power system, high power Cat product
line extension and CleanSource2 DC products. After the recent completion of a
joint development agreement with Caterpillar to extend the Cat UPS product line
and a review of our new product opportunities we have adjusted our development
priorities. Our near term development efforts will focus on the Cat UPS product
line extension, and the development of a 30 to 150 kilowatt continuous power
system. As part of this reprioritization we plan to significantly reduce the
level of activity and spending on our HIT 6 product development. One of the
benefits expected from this change is a decrease in research and development
expense over the next few quarters as we phase down spending on our HIT 6
development. Although many of the internal resources committed to this project
will be redirected to other new product initiatives, the external funding
associated with the HIT 6 development will be eliminated, thereby reducing our
overall spending levels.

         Selling, general and administrative. Selling, general and
administrative expense is primarily comprised of compensation and other
personnel costs for marketing, sales, service, and administrative personnel,
selling and marketing expenses, professional fees and reserves for bad debt and
warranty. Selling, general and administrative expense increased approximately
$1.3 million, or 84%, to $2.9 million for the three months ended September 30,
2001 from $1.6 million for the three months ended September 30, 2000. For the
nine months ended September 30, selling, general and administrative expense
increased $4.5 million, or 107%, to $8.6 million in 2001 from $4.1 million

                                       7
<PAGE>

in the same period of 2000. The increase in selling, general and administrative
expense was principally due to increased personnel in our sales and marketing
organizations in order to support our main OEM channel partner's sales and
service ramp up of the Cat UPS product line. We also incurred higher
administrative costs associated with the added responsibilities and reporting
requirements of a public company. We believe our selling, general and
administrative expense will continue to increase as we add sales and service
personnel and costs to position us for future sales growth and to assist in the
administration of an expanding work force.

         Amortization of deferred stock compensation. Deferred stock
compensation reflects the difference between the exercise price of option grants
to employees and the estimated fair value determined subsequently by us of our
common stock at the date of grant. We are amortizing deferred stock compensation
as an operating expense over the vesting periods of the applicable options,
which resulted in amortization expense of approximately $926,000 for the three
months ended September 30, 2001 and $1.9 million for the three months ended
September 30, 2000. For the nine months ended September 30, amortization expense
was $3.2 million in 2001 and $5.0 million in the same period of 2000. We expect
amortization expense to decrease during the remainder of 2001 and beyond, as the
options for which we are amortizing this expense become fully vested, and to a
smaller extent as some employees to whom these options were granted leave the
company and any unvested options are canceled.

         Interest income. Interest income decreased $282,000 to approximately
$1.3 million for the three months ended September 30, 2001 from approximately
$1.5 million for the three months ended September 30, 2000. This is primarily
due to the decrease in our ending cash and investments balance for the third
quarter of 2001 of $119.5 million compared to an ending cash and investments
balance of $151.8 million for the third quarter of 2000. For the nine months
ended September 30, interest income increased $3.0 million, or 130%, to $5.2
million in 2001 from approximately $2.2 million in the same period of 2000. Our
interest income in the third quarter of 2001 declined compared to the second
quarter of 2001 due to lower interest rates and a lower average cash and
investments balance. We believe interest income will continue to decline as cash
consumed from operating and investing activities results in lower average cash
balances.

         Change in fair value of warrants. Due to the redemption feature of
warrants we had outstanding in 1999 and 2000, we recorded a liability associated
with the fair value of the warrants on the balance sheet and recorded changes in
fair value of the warrants in expense. We calculated the fair value of the
warrants using a Black-Scholes pricing model. In 2000, the fair value of the
underlying common stock increased substantially, resulting in an increase in the
warrant value and corresponding expense. For the nine months ended September 30,
there was no warrant expense recorded in 2001 and $1.6 million recorded in 2000.
We do not anticipate further warrant-related charges in the future.

Liquidity and Capital Resources

         Our principal source of liquidity as of September 30, 2001 consisted of
$119.5 million of cash, cash equivalents and investments.

         In August 2000, we completed a successful initial public offering,
raising approximately $138.4 million, net of commissions and issuance expenses.
This is in addition to our private

                                       8

<PAGE>

financing efforts, including the sale of shares of our preferred stock, which
resulted in gross proceeds of approximately $42.6 million, and $5.0 million in
development funding received from Caterpillar in 1999. During the nine months
ended September 30, 2001, cash used by operating activities was $16.7 million,
which compares to $10.9 million of cash used by operating activities for the
nine months ended September 30, 2000. The cash usage in each of these periods
was primarily attributable to our focus on the development of products and the
expansion of our manufacturing operations and sales activities.

         Capital expenditures were $13.7 million for the nine months ended
September 30, 2001 and $3.5 million for the nine months ended September 30,
2000. The 2001 increase in capital expenditures was primarily due to the build
out of our new manufacturing facility, which became fully operational during the
third quarter. We expect to incur approximately $1.0 to $2.0 million in
additional costs in 2001 primarily on additional manufacturing equipment,
engineering test equipment, and general computer equipment and software.

         During the quarter ended September 30, 2001 we raised $1.7 million from
the exercise of outstanding warrants issued as part of our November 1999 Series
E private financings. As of September 30, 2001 no additional warrants were
outstanding.

         We believe our existing cash balance at September 30, 2001 will be
sufficient to meet our capital requirements through at least the next 24 months,
although we might elect to seek additional funding prior to that time. Beyond
the next 24 months, our capital requirements will depend on many factors,
including the rate of sales growth, the market acceptance of our products, the
rate of expansion of our sales and marketing activities, the rate of expansion
of our manufacturing facilities, and the timing and extent of research and
development projects. Although we are not a party to any agreement or letter of
intent with respect to a potential acquisition, we may enter into acquisitions
or strategic arrangements in the future, which could also require us to seek
additional equity or debt financing.

Quantitative and Qualitative Disclosures About Market Risk

         Our interest income is sensitive to changes in the general level of
U.S. interest rates, particularly because the majority of our investments are in
short-term instruments. We believe that our investment policy is conservative,
both in terms of the average maturity of investments that we allow and in terms
of the credit quality of the investments we hold. We estimate that a 1% decrease
in market interest rates would decrease our interest income by approximately
$1.2 million. Because of the short-term nature of the majority of our
investments, we do not believe a 1% decline in interest rates would have a
material effect on their fair value.

         We invest our cash in a variety of financial investments, including
bank time deposits, taxable and tax-advantaged 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.

                                       9

<PAGE>

Risk Factors That May Affect Future Results

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


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

We have incurred operating losses since our inception and expect to continue to
incur losses for the next several quarters. As of September 30, 2001, we had an
accumulated deficit of $73.7 million. To date, we have funded our operations
principally through the sale of our stock and our product revenue. We will need
to generate significant additional revenue to achieve profitability, and we
cannot assure you that we will ever realize additional revenue at such levels.
We also expect to incur significant product development, sales and marketing and
administrative expenses and, as a result, we expect to continue to incur losses.


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

We have generated a total of $24.8 million in product revenue since January 1,
1998, and we have sold fewer than 480 CleanSource DC and Cat UPS products. We
are uncertain whether our products will achieve market acceptance such that our
revenues will increase or whether we will be able to achieve significant
revenue. Therefore, we have a very limited ability to predict future revenue.
Our limited operating experience, the uncertain market acceptance for our
products, and other factors that are beyond our control make it difficult for us
to accurately forecast our quarterly and annual revenue. However, we use our
forecasted revenue to establish our expense budget. Most of our expenses are
fixed in the short term or incurred in advance of anticipated revenue. As a
result, we may not be able to decrease our expenses in a timely manner to offset
any revenue shortfall. Further, we have expanded our staff and facilities and
increased our expense levels in anticipation of future revenue growth. If our
revenue does not increase as anticipated, we will incur significant losses.

                                       10

<PAGE>

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

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

         o        the timing of orders from our customers and the possibility
                  that these customers may change their order requirements with
                  little or no advance notice to us;
         o        the rate of adoption of our flywheel-based energy storage
                  system as an alternative to lead-acid batteries;
         o        the deferral of customer orders in anticipation of new
                  products from us or other providers of power quality systems;
         o        the ongoing need for short-term power outage protection in
                  traditional UPS systems;
         o        the uncertainty regarding the adoption of our current and
                  future products, including our recently introduced Cat UPS
                  product, CleanSource2 DC, and other products currently in
                  early development; and
         o        the rate of growth of the markets for our products.

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

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


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

We have only one principal product that has any significant operating history at
customer sites, CleanSource DC, and we have only recently introduced our
CleanSource2 DC and Cat UPS product. To grow our revenue, we must rely on
Caterpillar to successfully market our Cat UPS product, and we must develop and
introduce to market new products and product enhancements in a timely manner.
Even if we are able to develop and commercially introduce new products and
enhancements, they may not achieve market acceptance. This would substantially
impair our revenue prospects.

                                       11

<PAGE>

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

The future growth of our business will depend in part on our ability to expand
our existing relationships with OEMs, to identify and develop additional
channels for the distribution and sale of our products and to manage these
relationships. As part of our growth strategy, we intend to expand our
relationships with OEMs and to develop relationships with new OEMs. We will also
look to identify and develop relationships with additional partners that could
serve as distributors for our products. Our inability to successfully execute
this strategy and to reduce our reliance on Caterpillar could impede our future
growth.


We are heavily dependent on our relationship with Caterpillar. If our
relationship is unsuccessful, our business and revenue will suffer.

If our relationship with Caterpillar is not successful, or if Caterpillar's
distribution of our Cat UPS product is not successful, our business and revenue
will suffer. Pursuant to a development agreement, Caterpillar provided us with
$5.0 million in funding to support the development of our Cat UPS product. In
exchange for this payment, Caterpillar received co-ownership of the proprietary
rights in this product. Either we or Caterpillar may license to other entities
the intellectual property that we jointly own without seeking the consent of the
other and all licensing revenue generated by licensing this intellectual
property will be solely retained by the licensing party. However, we may not
license the joint intellectual property to specifically identified competitors
of Caterpillar until January 1, 2005. Caterpillar may terminate this agreement
at any time by giving us 90 days' advance written notice. We also have a
distribution agreement with Caterpillar. In 2000 and the first nine months of
2001, our business level with Caterpillar and its dealer network accounted for
96% and 90% of our product revenue, respectively. Pursuant to the distribution
agreement with Caterpillar, they are the exclusive distributor, subject to
limited exceptions, of our Cat UPS product. Caterpillar is not obligated to
purchase any Cat UPS units.


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

We rely on OEMs as a primary distribution channel because they are able to sell
our products to a large number of end user organizations. We further rely on our
OEMs to provide service and support to the end users of our products because
they have the experience and personnel to perform such activities. We believe
that the use of OEM channels will enable our products to achieve broad market
penetration, while we devote a limited amount of our resources to sales,
marketing and customer service and support. Our operating results in the
foreseeable future will continue to depend on sales to a relatively small number
of OEM customers, primarily Caterpillar. For example, in 2000 and the first nine
months of 2001, our volume of business with Caterpillar and its dealer accounted
for 96% and 90% of our product revenue, respectively. Therefore, the loss of our
key OEM customer, Caterpillar, or a significant reduction in sales to
Caterpillar and its dealers, would significantly reduce our revenue. We also
have granted Caterpillar semi-exclusive worldwide rights to distribute our Cat
UPS product, provided that they meet minimum annual sales requirements.

                                       12
<PAGE>

These restrictions will further increase our dependence upon Caterpillar.
However, Caterpillar is not obligated to purchase any Cat UPS units under this
agreement.


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

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


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

Because of the nature of the power quality and reliability market, quality
problems attributable to the CleanSource DC or Cat UPS product lines could
significantly affect the market's perception of our technology and slow their
acceptance. This would substantially impair our revenue prospects. Moreover,
quality problems for our product lines could cause us to delay or cease
shipments of products, or recall products, thus impairing our revenue or cost
targets.


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

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


                                       13

<PAGE>

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

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


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

We believe our future success will depend in large part upon our ability to
attract and retain highly skilled managerial, engineering and sales and
marketing personnel. In particular, due to the relatively early stage of our
business, we believe that our future success is highly dependent on Joseph F.
Pinkerton, III, our founder, chief executive officer and president, to provide
continuity in the execution of our growth plans. While we have severance
arrangements in place with Mr. Pinkerton and with David S. Gino, our chief
financial officer, we do not have long-term employment agreements in place with
any of our employees. The loss of the services of any of our key employees, the
inability to attract or retain qualified personnel in the future or delays in
hiring required personnel, particularly engineers and sales personnel, could
delay the development and introduction of, and negatively impact our ability to
sell, our products.


We have hired some of our employees from our current customers and from some of
our competitors, which could damage our customer relationships and expose us to
potential litigation.

There is a limited supply of skilled employees in the power quality industry. We
have hired some of our current employees from our customers and our competitors.
As a result, some of our current customers might begin to view us as competitors
in the future, and one or more of our competitors could file lawsuits against us
alleging the infringement of their trade secrets and other intellectual

                                       14
<PAGE>

property. Although we do not believe we have infringed upon the intellectual
property of our competitors, such lawsuits could divert our attention and
resources from our business operations.


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

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

Many of our current and potential competitors have longer operating histories,
significantly greater resources, broader name recognition and a larger customer
base than we have. As a result, these competitors may have greater credibility
with our existing and potential customers. They also may be able to adopt more
aggressive pricing policies and devote greater resources to the development,
promotion and sale of their products than we can to ours, which would allow them
to respond more quickly than us to new or emerging technologies or changes in
customer requirements. In addition, some of our current and potential
competitors have established supplier or joint development relationships with
our current or potential customers. These competitors may be able to leverage
their existing relationships to discourage these customers from purchasing
products from us or to persuade them to replace our products with their
products. Increased competition could decrease our prices, reduce our sales,
lower our margins, or decrease our market share. These and other competitive
pressures could prevent us from competing successfully against current or future
competitors and could materially harm our business.


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

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

                                       15

<PAGE>

preclude competitors from independently developing products with functionality
or features similar to those of our products.


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

In recent years, there has been significant litigation in the United States
involving patents, trademarks and other intellectual property rights. Although
we have not been involved in intellectual property litigation, we may become
involved in litigation in the future to protect our intellectual property or
defend allegations of infringement asserted by others. Legal proceedings could
subject us to significant liability for damages or invalidate our intellectual
property rights. Any litigation, regardless of its outcome, would likely be time
consuming and expensive to resolve and would divert management's time and
attention. Any potential intellectual property litigation also could force us to
take specific actions, including:

         o        cease selling our products that use the challenged
                  intellectual property;
         o        obtain from the owner of the infringed intellectual property
                  right a license to sell or use the relevant technology or
                  trademark, which license may not be available on reasonable
                  terms, or at all; or
         o        redesign those products that use infringing intellectual
                  property or cease to use an infringing trademark.


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

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

         o        problems integrating the acquired operations, technologies or
                  products with our existing business and products;
         o        potential disruption of our ongoing business and distraction
                  of our management;
         o        difficulties in retaining business relationships with
                  suppliers and customers of the acquired companies;
         o        difficulties in coordinating and integrating overall business
                  strategies, sales and marketing, and research and development
                  efforts;
         o        the maintenance of corporate cultures, controls, procedures
                  and policies;
         o        risks associated with entering markets in which we lack prior
                  experience; and
         o        potential loss of key employees.

                                       16

<PAGE>

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

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


Our stock price may be volatile.

Since our IPO in August 2000, we have experienced significant volatility in our
stock price. The market price of our common stock may fluctuate significantly in
response to numerous factors, some of which are beyond our control, including
the following:

         o        actual or anticipated fluctuations in our operating results;
         o        changes in financial estimates by securities analysts or our
                  failure to perform in line with such estimates;
         o        changes in market valuations of other technology companies,
                  particularly those that sell products used in power quality
                  systems;
         o        announcements by us or our competitors of significant
                  technical innovations, acquisitions, strategic partnerships,
                  joint ventures or capital commitments;
         o        introduction of technologies or product enhancements that
                  reduce the need for flywheel energy storage systems;
         o        the loss of one or more key OEM customers; and
         o        departures of key personnel.

                                       17

<PAGE>

PART II - OTHER INFORMATION

     Item 1.  Legal Proceedings.

         We are not currently a party to any material legal proceedings.

     Item 2.  Changes in Securities and Use of Proceeds.

         Our registration statement (Registration No. 333-36946) under the
     Securities Act of 1933, as amended, relating to our initial public offering
     of our common stock became effective on August 7, 2000. A total of
     9,200,000 shares of common stock were registered. We sold a total of
     8,900,000 shares of our common stock and a selling shareholder sold 300,000
     shares to an underwriting syndicate. The managing underwriters were
     Goldman, Sachs & Co., Merrill Lynch, Pierce Fenner & Smith Incorporated,
     Morgan Stanley & Co. Incorporated and CIBC World Markets Corp. The offering
     commenced and was completed on August 8, 2000, at a price to the public of
     $17.00 per share. The initial public offering resulted in net proceeds to
     us of $138.4 million after deducting underwriting commissions of $10.6
     million and offering expenses of $2.2 million. The Company has used
     approximately $15.8 million of the net offering proceeds for capital
     expenditures and $25.3 million for operating activities. The remaining
     proceeds from the IPO were invested in government securities and other
     short-term, investment-grade, interest bearing instruments.

     Item 3.  Defaults Upon Senior Securities.

         Not applicable.

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

         Not applicable.

     Item 5.  Other Information.

         Not applicable.

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

    (a)  Exhibit Index

    Exhibit
    Number     Description
    ------     -----------

      3.1*     Amended and Restated Certificate of Incorporation (filed as
               Exhibit 3.1 to Active Power's Registration Statement on Form S-1
               (SEC File No. 333-36496) (the "IPO Registration Statement)

      3.2*     Amended and Restated Bylaws (filed as Exhibit 3.2 to the IPO
               Registration Statement)

      4.1*     Specimen certificate for shares of Common Stock (filed as Exhibit
               4.1 to the IPO Registration Statement)

                                       18

<PAGE>

      10.20+   Distributor Agreement between Powerware Corporation and Active
               Power, Inc.

      10.21+   Master Sourcing Agreement between General Electric Company
               (through its Digital Energy business unit) and Active Power, Inc.


       -----------
       * Incorporated by reference to the indicated filing
       + Portions of this exhibit have been omitted pursuant to a request for
         confidential treatment.

       (b)  During the fiscal quarter ended September 30, 2001, Active
            Power did not file any current reports on Form 10-Q.

                                       19

<PAGE>

                                   SIGNATURES*

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

                                               ACTIVE POWER, INC.

                                       By:  /s/ JOSEPH F. PINKERTON, III
                                          --------------------------------------
                                          Joseph F. Pinkerton, III
                                          President and Chief Executive Officer


       November 9, 2001                    /s/ JOSEPH F. PINKERTON, III
                                          --------------------------------------
                                          Joseph F. Pinkerton, III
                                          President and Chief Executive Officer
                                          (Principal Executive Officer)

       November 9, 2001                    /s/ DAVID S. GINO
                                          --------------------------------------
                                           David S. Gino
                                           Vice President of Finance and
                                           Chief Financial Officer
                                           (Principal Accounting Officer)



                                       20

<PAGE>

                               Active Power, Inc.

                                 Exhibit Index


Exhibit
Number          Description
------          -----------


  3.1*          Amended and Restated Certificate of Incorporation (filed as
                Exhibit 3.1 to Active Power's Registration Statement on Form S-1
                (SEC File No. 333-36496) (the "IPO Registration Statement)

  3.2*          Amended and Restated Bylaws (filed as Exhibit 3.2 to the IPO
                Registration Statement)

  4.1*          Specimen certificate for shares of Common Stock (filed as
                Exhibit 4.1 to the IPO Registration Statement)

 10.20+         Distributor Agreement between Powerware Corporation and Active
                Power, Inc.

 10.21+         Master Sourcing Agreement between General Electric Company
                (through its Digital Energy business unit) and Active Power,
                Inc.


--------
*Incorporated by reference to the indicated filing
+Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.

(b)    During the fiscal quarter ended September 30, 2001, Active Power did not
       file any current reports on Form 10-Q.