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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended March 31, 2007

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



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ACTIVE POWER, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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)



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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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one)

Large Accelerated
Filer ̈Accelerated Filer  x    Non-Accelerated Filer ̈

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 May 8, 2007 was 50,101,201.



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ACTIVE POWER, INC.

FORM 10-Q

INDEX



|                               |  |                                                                                        |  |   
|------------------------------ |  | -------------------------------------------------------------------------------------- |  | --
|PART I  FINANCIAL INFORMATION |  | 1                                                                                     
|                               |  |                                                                                       
|Item 1.                        |  | Consolidated Financial Statements.                                                     |  | 1 
|                               |  |                                                                                       
|Item 2.                        |  | Management's Discussion and Analysis of Financial Condition and Results of Operations. |  | 8 
|                               |  |                                                                                       
|Item 3.                        |  | Quantitative and Qualitative Disclosures about Market Risk                             |  | 15
|                               |  |                                                                                       
|Item 4.                        |  | Controls and Procedures                                                                |  | 15
|                               | 
|PART II  OTHER INFORMATION    |  | 17                                                                                    
|                               |  |                                                                                       
|Item 1.                        |  | Legal Proceedings                                                                      |  | 17
|                               |  |                                                                                       
|Item 1A.                       |  | Risk Factors                                                                           |  | 18
|                               |  |                                                                                       
|Item 2.                        |  | Unregistered Sales of Equity 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.                                                                              |  | 18



i



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PART I  FINANCIAL INFORMATION



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

Active Power, Inc.

Condensed Consolidated Balance Sheets

(in thousands)



|                                                |  |               |          |   |                  |   |          |  
|----------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                |  | March 31,2007 |          |   | December 31,2006 |  
|                                                |  | (unaudited)   |          |   |                  |  
|ASSETS                                          |  |               |          |   |                  |   |          |  
|                                                |  |              
|Current assets:                                 |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                       |  | $             | 7,804    |   |                  | $ | 7,652    |  
|Short-term investments in marketable securities |  |               | 9,191    |   |                  |   | 13,059   |  
|Accounts receivable, net                        |  |               | 5,291    |   |                  |   | 7,671    |  
|Inventories                                     |  |               | 11,789   |   |                  |   | 10,279   |  
|Prepaid expenses and other                      |  |               | 419      |   |                  |   | 492      |  
|                                                |  |               |          |   |                  |   |          |  
|Total current assets                            |  |               | 34,494   |   |                  |   | 39,153   |  
|Property and equipment, net                     |  |               | 6,979    |   |                  |   | 7,341    |  
|Other assets                                    |  |               | 212      |   |                  |   | 232      |  
|                                                |  |               |          |   |                  |   |          |  
|Total assets                                    |  | $             | 41,685   |   |                  | $ | 46,726   |  
|                                                |  |               |          |   |                  |   |          |  
|                                                |  |              
|LIABILITIES AND STOCKHOLDERS' EQUITY            |  |               |          |   |                  |   |          |  
|                                                |  |              
|Current liabilities:                            |  |               |          |   |                  |   |          |  
|Accounts payable                                |  | $             | 1,328    |   |                  | $ | 2,663    |  
|Accrued expenses                                |  |               | 6,747    |   |                  |   | 4,715    |  
|Deferred revenue                                |  |               | 839      |   |                  |   | 570      |  
|                                                |  |               |          |   |                  |   |          |  
|Total current liabilities                       |  |               | 8,914    |   |                  |   | 7,948    |  
|Stockholders' equity:                           |  |               |          |   |                  |   |          |  
|Common stock                                    |  |               | 50       |   |                  |   | 50       |  
|Treasury stock                                  |  |               | (5       | ) |                  |   | (5       | )
|Additional paid-in capital                      |  |               | 244,068  |   |                  |   | 243,519  |  
|Accumulated deficit                             |  |               | (211,189 | ) |                  |   | (204,765 | )
|Other accumulated comprehensive income          |  |               | (153     | ) |                  |   | (21      | )
|                                                |  |               |          |   |                  |   |          |  
|Total stockholders' equity                      |  |               | 32,771   |   |                  |   | 38,778   |  
|                                                |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders' equity      |  | $             | 41,685   |   |                  | $ | 46,726   |  
|                                                |  |               |          |   |                  |   |          |  

See accompanying notes.



- 1 -



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Active Power, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except per
share amounts)

(Unaudited)



|                                                                  |  |                             |        |   |      |   |        |  
|----------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                  |  | Three Months EndedMarch 31, |       
|                                                                  |  | 2007                        |        |   | 2006 |  
|Product revenue                                                   |  | $                           | 5,271  |   |      | $ | 5,044  |  
|Service and spares revenue                                        |  |                             | 702    |   |      |   | 525    |  
|                                                                  |  |                             |        |   |      |   |        |  
|Total revenue                                                     |  |                             | 5,973  |   |      |   | 5,569  |  
|                                                                  |  |                            
|Cost of product revenue                                           |  |                             | 4,911  |   |      |   | 5,140  |  
|Cost of service and spares revenue                                |  |                             | 725    |   |      |   | 576    |  
|                                                                  |  |                             |        |   |      |   |        |  
|Total cost of revenue                                             |  |                             | 5,636  |   |      |   | 5,716  |  
|                                                                  |  |                            
|Gross profit (loss)                                               |  |                             | 337    |   |      |   | (147   | )
|                                                                  |  |                            
|Operating expenses:                                               |  |                             |        |   |      |   |        |  
|Research and development                                          |  |                             | 1,584  |   |      |   | 2,238  |  
|Selling and marketing                                             |  |                             | 2,625  |   |      |   | 2,685  |  
|General and administrative                                        |  |                             | 2,751  |   |      |   | 1,653  |  
|                                                                  |  |                             |        |   |      |   |        |  
|Total operating expenses                                          |  |                             | 6,960  |   |      |   | 6,576  |  
|                                                                  |  |                            
|Operating loss                                                    |  |                             | (6,623 | ) |      |   | (6,723 | )
|                                                                  |  |                            
|Interest income                                                   |  |                             | 201    |   |      |   | 394    |  
|Other income (expense)                                            |  |                             | (2     | ) |      |   | 79     |  
|                                                                  |  |                             |        |   |      |   |        |  
|Net loss                                                          |  | $                           | (6,424 | ) |      | $ | (6,250 | )
|                                                                  |  |                             |        |   |      |   |        |  
|Net loss per share, basic & diluted                               |  | $                           | (0.13  | ) |      | $ | (0.13  | )
|Shares used in computing net loss per share, basic & diluted      |  |                             | 50,088 |   |      |   | 49,183 |  
|                                                                  |  |                            
|Comprehensive loss:                                               |  |                             |        |   |      |   |        |  
|Net loss                                                          |  | $                           | (6,424 | ) |      | $ | (6,250 | )
|Translation gain on subsidiaries in foreign currencies            |  |                             | 144    |   |      |   |       |  
|Change in unrealized loss on investments in marketable securities |  |                             | (12    | ) |      |   | (84    | )
|                                                                  |  |                             |        |   |      |   |        |  
|Comprehensive loss                                                |  | $                           | (6,292 | ) |      | $ | (6,334 | )
|                                                                  |  |                             |        |   |      |   |        |  

See accompanying notes.



- 2 -



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Active Power, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)



|                                                                        |  |                              |        |   |      |   |        |  
|----------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                                        |  | Three Months Ended March 31, |       
|                                                                        |  | 2007                         |        |   | 2006 |  
|Operating activities                                                    |  |                              |        |   |      |   |        |  
|Net loss                                                                |  | $                            | (6,424 | ) |      | $ | (6,250 | )
|Adjustments to reconcile net loss to cash used in operating activities: |  |                              |        |   |      |   |        |  
|Depreciation expense                                                    |  |                              | 518    |   |      |   | 516    |  
|Change in allowance for doubtful accounts                               |  |                              | (55    | ) |      |   | (233   | )
|Accretion of premium/discount on marketable securities                  |  |                              | (12    | ) |      |   | (30    | )
|Loss on disposal of fixed assets                                        |  |                              | 200    |   |      |   |       |  
|Stock-based compensation                                                |  |                              | 549    |   |      |   | 1,449  |  
|Changes in operating assets and liabilities:                            |  |                              |        |   |      |   |        |  
|Accounts receivable                                                     |  |                              | 2,435  |   |      |   | (205   | )
|Inventories                                                             |  |                              | (1,510 | ) |      |   | (723   | )
|Prepaid expenses and other assets                                       |  |                              | 93     |   |      |   | 102    |  
|Accounts payable                                                        |  |                              | (1,335 | ) |      |   | (357   | )
|Accrued expenses                                                        |  |                              | 2,032  |   |      |   | (663   | )
|Deferred revenue                                                        |  |                              | 269    |   |      |   | 190    |  
|                                                                        |  |                              |        |   |      |   |        |  
|Net cash used in operating activities                                   |  |                              | (3,240 | ) |      |   | (6,204 | )
|                                                                        |  |                             
|Investing activities                                                    |  |                              |        |   |      |   |        |  
|Purchases of marketable securities                                      |  |                              | (259   | ) |      |   | (2,132 | )
|Sales/maturities of marketable securities                               |  |                              | 4,150  |   |      |   | 8,795  |  
|Purchases of property and equipment                                     |  |                              | (355   | ) |      |   | (345   | )
|                                                                        |  |                              |        |   |      |   |        |  
|Net cash provided by investing activities                               |  |                              | 3,536  |   |      |   | 6,318  |  
|                                                                        |  |                             
|Financing activities                                                    |  |                              |        |   |      |   |        |  
|Net proceeds from issuance of common stock                              |  |                              |       |   |      |   | 1,539  |  
|                                                                        |  |                              |        |   |      |   |        |  
|Net cash provided by financing activities                               |  |                              |       |   |      |   | 1,539  |  
|                                                                        |  |                              |        |   |      |   |        |  
|Translation gain on subsidiaries in foreign currencies                  |  |                              | (144   | ) |      |   |       |  
|Change in cash and cash equivalents                                     |  |                              | 152    |   |      |   | 1,653  |  
|Cash and cash equivalents, beginning of period                          |  |                              | 7,652  |   |      |   | 7,590  |  
|                                                                        |  |                              |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                |  | $                            | 7,804  |   |      | $ | 9,243  |  
|                                                                        |  |                              |        |   |      |   |        |  

See accompanying notes.



- 3 -



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Active Power, Inc.

Notes to Condensed Consolidated Financial Statements

March 31, 2007

(Unaudited)



|1. | Significant Accounting Policies
|-- | -------------------------------

Basis of presentation:Active Power, Inc. and its subsidiaries (hereinafter referred to as we, Active Power or the Company) design manufacture and market power quality solutions and Uninterruptible
Power Supply (UPS) systems to enable business continuity in the event of power disturbances. Our solutions provide ride-through, or temporary, power for the majority of power disturbances such as voltage sags and surges, and bridge the gap between a
utility outage and restoration of power, or the time required to switch to generator power. We offer a range of patented flywheel energy storage systems that provide an alternative for lead-acid batteries used in conventional power quality
installations. We have recently broadened our product offerings with a battery-free extended runtime technology that utilizes thermal and compressed air storage to provide backup power for minutes to hours depending on the application. We sell our
products globally through direct and Original Equipment Manufacturer (OEM) channels. Our current principal markets are North America and Europe, Middle East and Africa (EMEA).

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 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, 2006.

Recently issued accounting
standards: In September 2006 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 provides enhanced guidance for using fair value to
measure assets and liabilities. The standard also responds to investors requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the
effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS
157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effect that the adoption of
SFAS 157 will have on its financial position and results of operations.

The Company adopted FASB Interpretation
No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) at the beginning of 2007. Adoption of FIN 48 did not have a material impact upon the Company. We have no unrecognized tax benefits and have not recognized any interest and
penalties relating to uncertain tax positions. The Company will recognize interest and penalties related to uncertain tax positions in the provision for income taxes. The tax years 2003 through 2006 remain open to examination by the major taxing
authorities to which we are subject.



- 4 -



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|2. | Supplemental Balance Sheet Information
|-- | --------------------------------------

Receivables

Accounts receivable consist of the following (in thousands):



|                                |  |               |        |   |                  |   |        |  
|------------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                |  | March 31,2007 |        |   | December 31,2006 |  
|Trade receivables               |  | $             | 6,592  |   |                  | $ | 9,027  |  
|Allowance for doubtful accounts |  |               | (1,301 | ) |                  |   | (1,356 | )
|                                |  |               |        |   |                  |   |        |  
|                                |  | $             | 5,291  |   |                  | $ | 7,671  |  
|                                |  |               |        |   |                  |   |        |  

Inventory

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



|                                   |  |               |        |   |                  |   |        |  
|---------------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                   |  | March 31,2007 |        |   | December 31,2006 |  
|Raw materials                      |  | $             | 7,060  |   |                  | $ | 6,650  |  
|Work in process and finished goods |  |               | 5,011  |   |                  |   | 3,999  |  
|Allowances for obsolescence        |  |               | (282   | ) |                  |   | (370   | )
|                                   |  |               |        |   |                  |   |        |  
|                                   |  | $             | 11,789 |   |                  | $ | 10,279 |  
|                                   |  |               |        |   |                  |   |        |  

Included in inventory at March 31, 2007 is $4.4 million of inventory relating exclusively to
our CoolAir family of products. If we are unable to sell sufficient quantities of our finished CoolAir products, we may need to record an impairment charge for some or all of that amount.

Property and Equipment

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



|                         |  |               |         |   |                  |   |         |  
|------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                         |  | March 31,2007 |         |   | December 31,2006 |  
|Equipment                |  | $             | 9,594   |   |                  | $ | 9,438   |  
|Computers and software   |  |               | 2,556   |   |                  |   | 2,534   |  
|Demonstration units      |  |               | 1,081   |   |                  |   | 1,081   |  
|Furniture and fixtures   |  |               | 331     |   |                  |   | 331     |  
|Leasehold improvements   |  |               | 7,066   |   |                  |   | 7,066   |  
|Construction in progress |  |               | 263     |   |                  |   | 261     |  
|                         |  |               |         |   |                  |   |         |  
|                         |  |               | 20,891  |   |                  |   | 20,711  |  
|                         |  |               |         |   |                  |   |         |  
|Accumulated depreciation |  |               | (13,912 | ) |                  |   | (13,370 | )
|                         |  |               |         |   |                  |   |         |  
|                         |  | $             | 6,979   |   |                  | $ | 7,341   |  
|                         |  |               |         |   |                  |   |         |  



- 5 -



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Accrued Expenses

Accrued expenses consist of the following (in thousands):



|                                         |  |               |       |                  |   |      
|---------------------------------------- |  | ------------- | ----- | ---------------- | - | -----
|                                         |  | March 31,2007 |       | December 31,2006
|Compensation and benefits                |  | $             | 1,342 |                  | $ | 1,418
|Warranty liability                       |  |               | 676   |                  |   | 734  
|Federal, state, property and sales taxes |  |               | 817   |                  |   | 845  
|Professional fees                        |  |               | 2,023 |                  |   | 495  
|Other                                    |  |               | 1,889 |                  |   | 1,223
|                                         |  |               |       |                  |   |      
|                                         |  | $             | 6,747 |                  | $ | 4,715
|                                         |  |               |       |                  |   |      

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. We provide for the estimated cost of product warranties at the time revenue is recognized and this accrual is contained in accrued expenses on the accompanying balance sheet.

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



|                             |  |   |     |  
|---------------------------- |  | - | --- | -
|Balance at December 31, 2006 |  | $ | 734 |  
|Warranty expense             |  |   | 22  |  
|Warranty charges incurred    |  |   | (80 | )
|                             |  |   |     |  
|Balance at March 31, 2007    |  | $ | 676 |  
|                             |  |   |     |  



|3. | Net Loss Per Share
|-- | ------------------

The following
table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):



|                                                               |  |                              |        |   |      |   |        |  
|-------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                               |  | Three Months Ended March 31, |       
|                                                               |  | 2007                         |        |   | 2006 |  
|Net loss                                                       |  | $                            | (6,424 | ) |      | $ | (6,250 | )
|                                                               |  |                              |        |   |      |   |        |  
|Basic and diluted:                                             |  |                              |        |   |      |   |        |  
|Weighted-average shares of common stock Outstanding            |  |                              | 50,088 |   |      |   | 49,183 |  
|                                                               |  |                              |        |   |      |   |        |  
|Shares used in computing net loss per share, basic and diluted |  |                              | 50,088 |   |      |   | 49,183 |  
|                                                               |  |                              |        |   |      |   |        |  
|Net loss per share, basic and diluted                          |  | $                            | (0.13  | ) |      | $ | (0.12  | )
|                                                               |  |                              |        |   |      |   |        |  

Our calculation of diluted loss per share excludes 5,861,427 and 6,703,408 shares
of common stock issuable upon exercise of employee stock options as of March 31, 2007 and 2006, respectively, because their inclusion in the calculation would be anti-dilutive. As of March 31, 2007 and 2006, there was no common stock
subject to repurchase.



- 6 -



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|4. | Subsequent Events
|-- | -----------------

In connection with a review of
our historical stock option granting procedures, our Board of Directors decided on April 19, 2007, that the Company would not honor any outstanding options held by persons that the Board determined were significantly responsible for the
problematic practices identified by the investigation and knew or should have known that the practices were contrary to the terms of our stock option plan, Delaware law, or proper accounting practices. On April 19, 2007, the Board directed the
Companys counsel to communicate the Companys demand that any such options still outstanding should be treated by any such optionee as cancelled. All 483,469 of such options that were still outstanding as of April 19, 2007 have now
expired according to their original terms without any attempted exercises.

On April 19, 2007, the Board also decided that the Company
should seek the return of profits realized upon the exercise of certain options by persons that the Board determined were significantly responsible for the problematic practices identified in the investigation and knew or should have known that the
practices were contrary to our stock option plan, Delaware law or proper accounting practices. On April 19, 2007, the Board directed the Companys counsel to communicate to such persons the Companys demand for the return of such
profits, totaling $323,000 in the aggregate. To date, we have collected $19,250 of such profits from one of the affected individuals. Demands with respect to several other such persons remain pending.

With respect to unexercised options, the Board has further determined in April that we will either implement a plan to assist certain affected optionees
not involved in the problematic stock option granting practices in meeting their liabilities for the amount of the incremental tax obligations caused by incorrect treatment of outstanding options by adjusting the terms of the original option grant
(in the case of out-of-the-money options) or adjusting the terms of the original option grant and paying the affected employees an amount to compensate such employees for the increase in exercise price (in the case of in-the-money options). We have
determined that certain persons who were significantly involved in the problematic practices identified in our internal stock option investigation will not be afforded any such assistance. Accordingly, we anticipate recording certain expenses
associated with such assistance in the second quarter of 2007 as this was the period in which such determinations were made. We currently anticipate such expenses to be approximately $285,000 although the exact amount will depend upon the
Companys stock price at the time these decisions are implemented. The Company intends to negotiate a settlement with the Internal Revenue Service for these items, and so the actual amount of expense will be determined at the time of such
settlement. In addition to liabilities for amounts we may be required to pay to the Internal Revenue Service, the adjustments to outstanding unexercised options that the Board plans to make to assist certain affected optionees, as described above,
may result in additional charges to future compensation expense relating to those adjusted options. The amount of such charges will depend on the fair value of the adjusted options at the time of the adjustments as compared to their fair value at
the time of their original issuance.

We anticipate that we will continue to incur significant legal, professional and other expenses as a
result of our investigation of historical stock granting procedures, including potentially significant expenses for tax obligations for innocent employees, and possible indemnification of costs to certain former directors and officers of the Company
in the event of further regulatory reviews emanating from the stock option review.



- 7 -



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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 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 Operation for the year ended December 31, 2006 included in our 2006 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 in our 2006 Annual Report on Form 10-K for a discussion of items that may affect our future results.

Overview

We design, manufacture and market
efficient, reliable and green power quality solutions and Uninterruptible Power Supply (UPS) systems to enable business continuity in the event of power disturbances. Our solutions provide ride-through, or temporary, power for the majority of power
disturbances such as voltage sags and surges, and bridge the gap between a utility outage and restoration of power, or the time required to switch to generator power. Our products are designed to be environmentally friendly compared to existing
solutions without compromising functionality, efficiency or cost. We have shipped over 1,500 flywheels or more than 375 megawatts of our products to businesses in over 40 countries since we were founded in 1992.

Our patented flywheel energy storage 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 utility power is fully restored or a backup electricity generator starts and takes over generating longer term power in the case of an extended electrical outage. We believe that our flywheel
products provide many advantages over traditional battery-based systems, including substantial space savings, higher power densities, green energy storage and power efficiencies as high as 98% that reduce total operating costs. We offer
our flywheel products with load capabilities from 130 kVA to 3,600 kVA, while typically targeting power density applications above 200 kVA since the majority of these customers already have back-up generators. We market our flywheel products under
the brand name CleanSource®. CleanSource DC is a
non-chemical replacement for lead-acid batteries used for bridging power. Utilizing our flywheel energy storage technology, the CleanSource DC is a stand-alone, direct current (DC) product that is compatible with all major brands of uninterruptible
power supplies (UPS). We built on the technological success of CleanSource DC by creating a battery-free UPS, CleanSource UPS, which integrates the UPS electronics and our flywheel energy storage system into one compact cabinet. CleanSource UPS
represents the majority of our current revenue. The CleanSource UPS is also marketed by Caterpillar Inc. under the brand name Cat® UPS. Combining our CleanSource UPS with a generator provides customers with complete short and long-term protection in the event of a power
disturbance. We sell our CleanSource flywheel products to commercial and industrial customers across a variety of vertical markets, including manufacturing, technology, communications, utilities, healthcare, banking and military and in all major
geographic regions of the world, but particularly in North America and Europe.



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To address the requirements of customers without
backup generators that require protection from utility disturbances, we have also developed a patented extended runtime product that we call CoolAirTMDC. We initially have targeted CoolAir DC at lower power levels than our flywheel products, and it is sold as a minute-for-minute replacement for lead-acid batteries. CoolAir DC can provide backup
power for several minutes to hours depending on the customer application. CoolAir DC utilizes mature thermal and compressed air storage (TACAS) technologies combined in a proprietary manner to produce backup power during an electrical disturbance.
This product discharges cool air as a by-product of its operation that also can be used by customers during an electrical disturbance as a source of backup cooling. In addition to offering a DC-only solution, when customers desire a complete backup
solution with an extended runtime, we have introduced the CoolAir UPS that couples our CoolAir DC product with a third-party double-conversion UPS. CoolAir initially is being targeted at small to medium-sized data center customers in North America
following its commercial introduction in the US in the second quarter of 2006, and an international version in the fourth quarter of 2006.

Our primary sales channels in North America have traditionally been through our OEM partners, Caterpillar, Inc. and Eaton Electrical (formerly known as PowerWare). Since 2005 we have developed additional sales channels in North America
including direct sales employees and a network of manufacturers representatives. Direct sales tend to improve our relationships with clients, improve our gross margins and add service and other revenue opportunities.

Our primary sales channels in Europe, Middle East and Asia (EMEA) include selling directly to end users and indirectly through select value added
resellers (VARs). We also provide services including engineering, installation, start-up, monitoring, and repair for our products under contracts with our customers.



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Results of Operations



|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|---------------------------------- |  | ---------------------------- | ------- | ----------------- | ---------------------- | - | ---- | - | ----------------- |  | ----- | - |  | - | ----- |  | ---- | -
|($ in thousands)                   |  | Three months ended March 31, |         |                   | Variance 2007 vs. 2006 |  
|                                   |  | 2007                         |         | % of totalrevenue |                        |   | 2006 |   | % of totalrevenue |  |       | $ |  | % |      
|Product revenue                    |  | $                            | 5,271   |                   | 88                     | % |      | $ | 5,044             |  | 91    | % |  | $ | 227   |  | 5    | %
|Service and spares revenue         |  |                              | 702     |                   | 12                     |   |      |   | 525               |  | 9     |   |  |   | 177   |  | 34   | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Total revenue                      |  |                              | 5,973   |                   | 100                    |   |      |   | 5,569             |  | 100   |   |  |   | 404   |  | 7    | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Cost of product revenue            |  |                              | 4,911   |                   | 82                     |   |      |   | 5,140             |  | 92    |   |  |   | (229) |  | (4)  | %
|Cost of service and spares revenue |  |                              | 725     |                   | 12                     |   |      |   | 576               |  | 10    |   |  |   | 149   |  | 26   | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Total cost of revenue              |  |                              | 5,636   |                   | 94                     |   |      |   | 5,716             |  | 103   |   |  |   | (80)  |  | (1)  | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Gross profit (loss)                |  |                              | 337     |                   | 6                      |   |      |   | (147)             |  | (3)   |   |  |   | 484   |  | 329  |  
|Operating expenses:                |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Research and development           |  |                              | 1,584   |                   | 27                     |   |      |   | 2,238             |  | 40    |   |  |   | (654) |  | -29  | %
|Selling and marketing              |  |                              | 2,625   |                   | 44                     |   |      |   | 2,685             |  | 48    |   |  |   | (60)  |  | (2)  | %
|General and administrative         |  |                              | 2,751   |                   | 46                     |   |      |   | 1,653             |  | 30    |   |  |   | 1,098 |  | 66   | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Total operating expenses           |  |                              | 6,960   |                   | 117                    |   |      |   | 6,576             |  | 118   |   |  |   | 384   |  | 6    | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Operating loss                     |  |                              | (6,623) |                   | (111)                  |   |      |   | (6,723)           |  | (121) |   |  |   | 100   |  | 1    | %
|Interest income                    |  |                              | 201     |                   | 3                      |   |      |   | 394               |  | 7     |   |  |   | (193) |  | (49) | %
|Other income (expense)             |  |                              | (2)     |                   |                       |   |      |   | 79                |  | (1)   |   |  |   | 81    |  | 103  | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  
|Net loss                           |  | $                            | (6,424) |                   | (108)                  | % |      | $ | (6,250)           |  | (112) | % |  | $ | (174) |  | -3   | %
|                                   |  |                              |         |                   |                        |   |      |   |                   |  |       |   |  |   |       |  |      |  

Product revenue. Product revenue consists of sales of our CleanSource power quality
products, comprising both UPS and DC product lines, and sales of third-party ancillary equipment, such as engine generators, electrical and switchgear products.

The increase in product revenue from the same period of 2006 was due to higher sales of our 250-900 kVA UPS product line and continued growth from our direct sales channel. When we sell product directly, as compared
to through our OEM channels, we typically generate higher prices and better contribution margins as we do not have to offer channel discounts. The average selling price over the first three months of 2007 was $82,000 per quarter-megawatt flywheel,
compared to $54,000 over the same period in 2006 due to higher direct sales and selling products with more options, which occurs more frequently with direct transactions compared to our OEM sales. A single product, depending on its power rating, may
be comprised of multiple flywheel units.

During the quarter ended March 31, 2007 we sold 48 flywheel units compared to 91 in the
comparable period of 2006. In the prior year period there was a large OEM transaction of 8 megawatt-class UPS machines (representing 32 flywheels) that sold at lower average selling prices than our direct UPS sales and which negatively influenced
the average selling price. Excluding this transaction, the average selling price of a flywheel in 2006 would have been $74,000. The frequency and timing of our larger system sales, including megawatt class UPS products, is more volatile and can
result in material changes in period-to-period revenue. Such revenues may also occur in periods other than when originally anticipated, which can add to the potential volatility and affect our ability to meet forecasted targets.



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North American sales were 60% of our total revenue for the three-month period ended March 31, 2006
compared to 74% for the same period of 2006, and 55% in the immediately preceding quarter.

Since 2005 we have been increasing the size of
our direct sales organization in an effort to expand the territories in which we sell our Active Power branded products. Most of this effort initially was focused in the EMEA market where we now have multiple sales offices. During the current
quarter we opened our first office in the Asia Pacific region, located in Tokyo. We also plan on expanding into Central America in 2007. Sales of Active Power branded products through our direct and manufacturers representative channels were
76% of our total revenues for the three-month period ended March 31, 2007 compared to 36% for the same period of 2006, reflecting the impact of this direct sales strategy. Direct sales typically have higher profit margins than sales through our
OEM channels; therefore, increasing our direct sales channel is expected to result in increased revenue and improved profit margins. We believe sales of our Active Power branded products to government facilities and industrial customers in regions
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.

Caterpillar remains our largest OEM partner and largest overall customer and represented 23% of our revenue for the three-month period ended March 31, 2007 compared to 46% of our revenue for the three-month period ended March 31,
2006. We have had recent success with Caterpillar selling our megawatt-class UPS products along with their large engine generators, and expect total revenue from this channel to increase in 2007.

Our products perform well in harsh environments where power quality is particularly poor, which makes them a good fit for industrial countries with a
poor power infrastructure and therefore we have focused our direct sales efforts to these customers. Due to the large size of some of our customer orders relative to our current total revenue levels, our quarterly total revenue trend and the
proportion of sales made directly by us can be expected to fluctuate quarterly from the amounts recorded so far in 2007. We have also seen and anticipate a further increase in capital spending in data centers where there is a requirement for
higher-density power solutions such as flywheels, and believe that this along with our expanding direct sales strategy will result in higher product revenue levels for us in 2007.

Service and spares revenue. Service and spares revenue primarily relates to revenue generated from installation, startup, repairs or
reconfigurations of our product, 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. Service and spares revenue increased by 34% for the
three-month period ended March 31, 2007 compared to the same prior year period. This increase is primarily due to higher levels of service and contract work from direct product sales made in the last two quarters. For some of 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. We anticipate that service and spares revenue will continue to
grow with product revenue and as our installed base of product expands, because as more units are sold to customers, more installation, startup and maintenance services will be required. Where we make sales through our OEM channel, it is typical for
the OEM to provide these type of services to their end-user customers.

Cost of product revenue. Cost of product revenue
includes the cost of component parts of our products that are sourced from suppliers, personnel, equipment and other costs associated with our assembly and test operations, including costs from having underutilized facilities, 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 in the three-month period ended March 31, 2007 decreased by 10%
compared to the comparable period in 2006 due to the effect of higher selling prices, improved efficiency in our manufacturing operations and material and overhead costs



- 11 -



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reductions. We have instituted programs to reduce product and component costs where feasible, and this has resulted in a decrease in materials costs as a
percentage of product revenue. We continue to operate a manufacturing facility that has a capacity level significantly greater than our current product revenue levels. In addition, a large portion of the costs involved in operating our manufacturing
facility are fixed in nature and we incur approximately $1.2 million to $1.5 million in unabsorbed overhead each quarter. We reduced our manufacturing staff levels in 2003 and have continued to reduce our overhead levels where feasible. We are still
seeking to lower our manufacturing overhead levels through reducing the physical space we lease as well as other cost reduction activities that we expect to implement in 2007. We also continue to work on reducing our product costs through design
enhancements and modifications, and vendor management programs. We have achieved gross-margin break-even in the last three quarters; however, our accomplishment of gross-margin break even is heavily dependent upon our sales channel mix and the
effectiveness of our product pricing to our customers. Our ability to maintain positive product gross margin will depend on multiple factors, including our ability to continue to reduce material costs, improve our sales channel mix in favor of
direct sales versus OEM, our ability to increase product prices, and to increase our total revenues to a level that will allow us to improve the utilization of our manufacturing operations.

Items that could impact our ability to further improve our gross margin include sales product volume and mix, pricing discounts and customer incentives,
currency fluctuations, and variations in our product cost and productivity.

Cost of service and spares revenue. Cost of
service and spares revenue includes the cost of component parts, as well as labor and overhead of our spare parts, costs associated with travel and labor used in servicing a unit and unabsorbed overhead from the service group. The cost of service
and spares revenue decreased to 103% of service and spares revenue in the three-month period ended of March 31, 2007 compared to 110% in the same period of 2006. This decrease reflects better utilization of our service personnel, improved
pricing for service, and higher margins on contract work compared to the prior period.

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 product development activities, as well as an allocated portion of our
occupancy costs. Overall our research and development expenses were $654,000 or 29% lower that the first quarter of 2006, and were $23,000 or 1% higher than the preceding quarter. The major reason for the decrease from 2006 was due to the effect of
headcount reductions that the Company made in the third quarter of 2006, and due to lower project related development costs this year. The prior year expenses included higher prototype and development costs for our CoolAir DC product and costs
incurred in paralleling our megawatt-class UPS product. We believe research and development expenses in the second quarter will stay at similar levels to those recorded in the first quarter.

Selling and marketing.Selling and marketing expenses primarily comprise 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. Sales and marketing costs were $60,000 or 2% lower than the amounts recorded in the first quarter of
2006, and were $202,000 or 8% higher than the immediately preceding quarter. The increase in our sales and marketing costs from the last quarter reflects higher marketing expenditures to support our direct sales force, re-branding of the
Companys collateral and other direct sales activities as part of our effort to facilitate more direct sales. We also wrote off $200,000 of expenses relating to fixed assets used for demonstration purposes. Our total headcount in sales and
marketing remains at similar levels to last quarter, although we have changed the composition of our sales team over the last year as we expand our direct sales force. We believe that sales and marketing expenses will increase slightly in the second
quarter as we expand into the Asia market with a new office, and as our revenue levels increase and our variable compensation increases.



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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 increased by $1,098,000 or 66% from the levels of the same
period in 2006 and increased by 42% or $816,000 from the immediately preceding quarter. This increase was primarily attributable to $1.5 million of professional fees incurred with a review of the Companys historical stock option granting
procedures that covered the period from 2000 through 2006. The first quarter of 2006 included legal fees connected to litigation as well as a recovery of $236,000 of previously-reserved doubtful accounts. We expect general and administrative
expenses to decrease from the current level in the next quarter as we believe most of the work associated with the option review has been completed; however, the amount of professional fees relating to the option review remains unknown and will be
influenced by the number and extent of regulatory reviews that occur as a result of this investigation. The Company is intending to settle outstanding tax matters emanating from the option review with the Internal Revenue Service, and will record
expenses of approximately $285,000 in the second quarter of 2007 for these items. The actual amount expensed will depend upon the actual settlement amount as well as the price of the Companys stock at that time. Absent the impact of such
expenses from the option review, the level of general and administrative expenses should stay at similar levels.

Interest income.Interest income has decreased from $394,000 in 2006 to $201,000 in the three-month periods ended March 31, 2007. This reflects the decrease in our average cash and investments balance compared to the prior year as the Company has used
its investments to fund operations. Our average cash and investments balance over the three month period ending March 31, 2007 has decreased by approximately $20.7 million or 52% compared to the average balance over the comparable period ending
March 31, 2006.

Other income (expense). Other income in the corresponding quarter of 2006 included cost recoveries from
annual audits of our real estate leases.

Liquidity and Capital Resources

Our principal sources of liquidity as of March 31, 2007 consisted of $17.0 million of cash and investments. We have primarily funded our operations
through public and private placements of our common stock as well as $10.0 million in development funding received from Caterpillar since 1999, and from our product, service and spares revenue. Although we believe that our cash and investments on
hand will be sufficient to fund our operations through at least the middle of 2008, based upon our historical and projected cash burn it is likely that the Company will raise additional funds before the end of 2007, either through future equity or
debt offerings, in order to continue to fund and grow its business beyond that date and to ensure that we have adequate cash reserves. In August of 2006 we filed a universal Shelf Registration Statement on Form S-3 with the Securities and Exchange
Commission that would have provided for the sale of up to $75 million of equity or debt instruments. Due to the failure to file our 2006 Annual Report on Form 10-K in a timely fashion, we are no longer eligible to use our Shelf Registration
Statement. This will influence the type and amount of any future capital raisings that the Company may complete but will not prevent the Company from raising additional funds. At this point, the Company has made no determination as to the amount,
timing or type of any future capital raising that it will undertake, but we have had ongoing discussions with a number of investment banking organizations. The Company is also evaluating a number of proposals to establish a bank revolving line of
credit to provide additional liquidity to assist in managing its short-term working capital.



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The following table summarizes the yearly changes in cash used in operating activities:



|                                  |  |                              |        |   |                        |   |        |   |  |   |        |   |  |     |   
|--------------------------------- |  | ---------------------------- | ------ | - | ---------------------- | - | ------ | - |  | - | ------ | - |  | --- | --
|($ in thousands)                  |  | Three months ended March 31, |        |   | Variance 2006 vs. 2005 |  
|                                  |  | 2007                         |        |   | 2006                   |   |        | $ |  |   | %      |  
|Cash used in operating activities |  | $                            | (3,241 | ) |                        | $ | (6,204 | ) |  | $ | (2,963 | ) |  | (48 | )%

Cash used in operating activities decreased by 48% compared to the same period of 2006. This is
primarily attributable to a decrease in our receivables balance following collections from the immediately preceding quarter where the Company had record revenue levels. Receivables decreased by $2.4 million from the prior quarter. The company also
had a $2 million increase in accrued expenses mostly connected with the costs associated with the option review. Offsetting these sources of funds were decreases in our accounts payable reflecting our lower business level in the quarter from the
prior quarter, and an increase in inventory as we prepared goods for second quarter shipment. We anticipate cash used in operating activities to increase in the second quarter as we discharge the liabilities from the stock option review, reach
settlement of the related income tax liabilities, and record an expected increase in receivables due to anticipated higher revenues.

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 $355,000 in the three-month period ending March 31, 2007 compared to $345,000 in the same period of 2006.

Funds provided by financing activities during the three-months ended March 31, 2006 reflect proceeds from employee share purchases. The significant decrease in funds from financing activities compared to the
comparable period of 2006 is due to the fact that during the first quarter of 2006 we had proceeds from an employee stock purchase plan, and significantly higher levels of stock option exercises because of a much higher stock price for the
Companys common stock that fueled more exercises.

As noted above, we believe our existing cash and investments balances at
March 31, 2007 will be sufficient to meet our cash requirements through at least the next 12 months, although we may elect to seek additional funding prior to that time. Beyond the next 12 months, our cash requirements will depend on many
factors, including the rate of sales growth, the success of our direct selling strategy, the market acceptance of our products, including the CoolAir DC product family, the timing and level of development funding, the rate of expansion of our sales
and marketing activities, the efficiency of our manufacturing processes, and the timing and extent of research and development projects.

Recent Accounting Pronouncements

In September 2006 the FASB issued Statement of Financial Accounting Standards
No. 157, Fair Value Measurements (SFAS 157). SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities. The standard also responds to investors requests for expanded information about the extent to
which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require (or permit) assets or liabilities
to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. Early adoption is permitted. The Company is currently evaluating the effect that the adoption of SFAS 157 will have on its financial position and results of operations.

The Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) at the beginning of 2007. Adoption of FIN 48
did not have a material impact upon the Company. We have no unrecognized tax benefits and have not recognized any interest and penalties relating to uncertain tax positions. The Company will recognize interest and penalties related to uncertain tax
positions in the provision for income taxes. The tax years 2003 through 2006 remain open to examination by the major taxing authorities to which we are subject.



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|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. We estimate that a 1%
decrease in market interest rates would decrease our annual interest income by $120,000.

Our international sales are made primarily in
U.S. dollars. Those sales in currencies other than U.S. dollars can result in translation gains and losses. As we increase sales in foreign markets, we anticipate making more sales denominated in foreign currencies, primarily euro and pounds
sterling. Currently, we do not engage in hedging activities for the collection of foreign currency receivables in our international operations. However, we may engage in hedging activities in the future.

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 2006 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
|------- | -----------------------



| | (a) | Evaluation of disclosure controls and procedures. We performed an evaluation under the supervision and with the participation of our management, including our Chief Executive
Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d -15(f) under the Securities Exchange Act of 1934. Based on their
evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were effective as of March 31, 2007 (the end of the period covered by this Quarterly Report on Form 10-Q) to ensure that information
required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) | Changes in internal control over financial reporting. During the three months ended March 31, 2007 there was no change in our internal control over financial reporting
that occurred that has materially affected, or that we believe is reasonably likely to materially affect, our internal control over financial reporting except the following new controls that were put in place following as a result of the
investigation into our historical stock option granting procedures:
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Designating one or more persons adequately trained in the legal and accounting implications of stock option grants to be responsible for administration and
monitoring. This person shall report to, and such persons work is to be reviewed directly by the Companys Chief Financial Officer. This person will review all proposed grants before they are submitted to the Board or Compensation
Committee, review all grants prior to submission to the third-party administrator of the Companys Stock Plans, and ensure that the exercise price established for all options is equal to or higher than the fair market value of the underlying
common stock on the date that the grant has occurred.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



- 15 -



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| |  |  | Except in unusual circumstances that require an unscheduled meeting, ensuring that all stock option grants will be approved in previously scheduled meetings of the
Board or Compensation Committee and that such approvals will be reflected in resolutions set forth in the minutes of those meetings. Such minutes will be prepared promptly following the action taken at the meeting and unnecessary ratifications or
subsequent approvals will not be requested. We will not award grants pursuant to a unanimous written consent unless unusual circumstances dictate a deviation from this policy and the reasons and circumstances are contemporaneously documented.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adopting a Stock-Based Award Policy that precludes the selection of any grant date with the benefit of hindsight or during any period designated as a quarterly
blackout period under the Companys Insider Trading Policy.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expressly advise persons implementing our processes for stock-based compensation awards that the Companys written Stock-Based Compensation Awards Policies and
Procedures preclude the selection of grant dates or exercise prices with the benefit of hindsight.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our stock option granting procedures will be in writing and will be reviewed annually by our Chief Executive Officer and Chief Financial Officer and, to the extent
deemed necessary, our Board (or its appropriate committees) to ensure compliance with all applicable laws and regulations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ACTIVE POWER, INC.

PART II  OTHER INFORMATION



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

We voluntarily contacted the United States Securities and Exchange Commission
(SEC) regarding the Special Committees investigation into our stock option granting practices and have agreed to share the results of the Special Committee with the SEC. We have received requests for voluntary production of documents from the
SEC and we are fully cooperating with the SEC.

While we believe that we have made appropriate judgments in concluding the correct
measurement dates for stock option grants and option modifications, the SEC may disagree with the manner in which we have accounted for and reported, or not reported, the financial impact of past stock option grant measurement date and option
modification errors, and there is a risk that any SEC inquiry could lead to circumstances in which we may have to further restate our prior financial statements, or otherwise take actions not currently contemplated. Any such circumstances could also
lead to future delays in filing our subsequent SEC reports and possible delisting of our stock from The Nasdaq Global Market. Furthermore, if we are subject to adverse findings in any of these other matters, we could be required to pay damages or
penalties or have other remedies imposed upon us which could harm our business, financial condition, results of operations and cash flows.

Additionally, we believe there is a possibility that the matters relating to the investigation by the Special Committee of our Board of Directors into our stock option granting practices and the restatement of our consolidated financial
statements for the years 2001 through September 2006 may result in future litigation or formal regulatory inquiries.



- 17 -



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

You should carefully consider the risks described in Item 1A of our 2006 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 2006 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 2006 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. | Submission of Matters to a Vote of Security Holders.
|------- | ----------------------------------------------------

None.



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

None.



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

The following documents are filed as exhibits to this report:



|     |  |                                                                                                                                                       
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  | Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to Active Powers IPO Registration Statement on Form S-1 (File No. 333-36946))
|     | 
|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)                      
|     | 
|31.1 |  | Rule 13a-15(e)/15d-15(e) Certification of Principal Executive Officer                                                                                 
|     | 
|31.2 |  | Rule 13a-15(e)/15d-15(e) Certification of Principal Financial Officer                                                                                 
|     | 
|32.1 |  | Section 1350 Certification of Principal Executive Officer                                                                                             
|     | 
|32.2 |  | Section 1350 Certification of Principal Financial Officer                                                                                             



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---

SIGNATURES

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



|             |  |                                                                 
|------------ |  | ----------------------------------------------------------------
|             |  | ACTIVE POWER, INC. (Registrant)                                 
|             | 
|May 15, 2007 |  | /s/ James A. Clishem                                            
|(Date)       |  | James A. Clishem                                                
|             |  | President and Chief Executive Officer                           
|             |  | (Principal Executive Officer)                                   
|             | 
|May 15, 2007 |  | /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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