##### Table of Contents





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 June 30, 2010

Or



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

For the transition period from  to

Commission file number: 000-30939





ACTIVE POWER, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 74-2961657                          
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer
Identification No.)
|                                                               | 
|2128 W. Braker Lane, BK12, Austin, Texas                       |  | 78758                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

(512)
836-6464

(Registrants telephone number, including area code)



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





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

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

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



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

Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange
Act).     ̈  Yes    x  No

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

The number of shares of common stock, par value of $0.001 per share, outstanding at July 26, 2010 was 79,710,373.









---

##### Table of Contents

ACTIVE POWER, INC.

FORM 10-Q

INDEX



|                                                                                               |  |   
|---------------------------------------------------------------------------------------------- |  | --
|PART I  FINANCIAL INFORMATION                                                                 |  | 3 
|                                                                                               | 
|Item 1. Condensed Consolidated Financial Statements.                                           |  | 3 
|                                                                                               | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. |  | 11
|                                                                                               | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk.                            |  | 19
|                                                                                               | 
|Item 4. Controls and Procedures.                                                               |  | 19
|                                                                                               | 
|PART II  OTHER INFORMATION                                                                    |  | 20
|                                                                                               | 
|Item 1. Legal Proceedings.                                                                     |  | 20
|                                                                                               | 
|Item 1A. Risk Factors.                                                                         |  | 20
|                                                                                               | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.                           |  | 20
|                                                                                               | 
|Item 3. Defaults Upon Senior Securities.                                                       |  | 20
|                                                                                               | 
|Item 4. Reserved.                                                                              |  | 20
|                                                                                               | 
|Item 5. Other Information.                                                                     |  | 20
|                                                                                               | 
|Item 6. Exhibits.                                                                              |  | 21



2



---

##### Table of Contents

PART I  FINANCIAL INFORMATION



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

Active Power, Inc.

Condensed Consolidated Balance Sheets

(in thousands)



|                                                                                                                                  |  |              |          |   |                  |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                  |  | June 30,2010 |          |   | December 31,2009 |  
|                                                                                                                                  |  | (unaudited)  |          |   |                  |  
|ASSETS                                                                                                                            |  |              |          |   |                  |   |          |  
|                                                                                                                                  |  |             
|Current assets:                                                                                                                   |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                         |  | $            | 15,714   |   |                  | $ | 7,489    |  
|Accounts receivable, net of allowance for doubtful accounts of $298 and $353 at June 30, 2010 and December 31, 2009,
respectively |  |              | 10,643   |   |                  |   | 11,529   |  
|Inventories                                                                                                                       |  |              | 7,081    |   |                  |   | 6,629    |  
|Prepaid expenses and other                                                                                                        |  |              | 358      |   |                  |   | 418      |  
|                                                                                                                                  |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                              |  |              | 33,796   |   |                  |   | 26,065   |  
|Property and equipment, net                                                                                                       |  |              | 2,208    |   |                  |   | 2,903    |  
|Deposits and other                                                                                                                |  |              | 392      |   |                  |   | 376      |  
|                                                                                                                                  |  |              |          |   |                  |   |          |  
|Total assets                                                                                                                      |  | $            | 36,396   |   |                  | $ | 29,344   |  
|                                                                                                                                  |  |              |          |   |                  |   |          |  
|                                                                                                                                  |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                              |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                              |  |              |          |   |                  |   |          |  
|Accounts payable                                                                                                                  |  | $            | 6,026    |   |                  | $ | 5,155    |  
|Accrued expenses                                                                                                                  |  |              | 5,460    |   |                  |   | 4,957    |  
|Deferred revenue                                                                                                                  |  |              | 2,189    |   |                  |   | 1,713    |  
|Revolving line of credit                                                                                                          |  |              | 2,559    |   |                  |   | 2,559    |  
|                                                                                                                                  |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                         |  |              | 16,234   |   |                  |   | 14,384   |  
|Long-term liabilities                                                                                                             |  |              | 629      |   |                  |   | 468      |  
|Stockholders equity:                                                                                                             |  |              |          |   |                  |   |          |  
|Common stock                                                                                                                      |  |              | 80       |   |                  |   | 66       |  
|Treasury stock                                                                                                                    |  |              | (103     | ) |                  |   | (73      | )
|Additional paid-in capital                                                                                                        |  |              | 273,995  |   |                  |   | 264,554  |  
|Accumulated deficit                                                                                                               |  |              | (254,001 | ) |                  |   | (249,876 | )
|Other accumulated comprehensive loss                                                                                              |  |              | (438     | ) |                  |   | (179     | )
|                                                                                                                                  |  |              |          |   |                  |   |          |  
|Total stockholders equity                                                                                                        |  |              | 19,533   |   |                  |   | 14,492   |  
|                                                                                                                                  |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                        |  | $            | 36,396   |   |                  | $ | 29,344   |  
|                                                                                                                                  |  |              |          |   |                  |   |          |  

See accompanying notes.



3



---

##### Table of Contents

Active Power, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except per share amounts)

(Unaudited)



|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                          |  | Three Months EndedJune 30, |        |   | Six Months
EndedJune 30, |  
|                                                                          |  | 2010                       |        |   | 2009                     |   |        | 2010 |  |   | 2009   |  
|Revenues:                                                                 |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Product revenue                                                           |  | $                          | 13,307 |   |                          | $ | 5,207  |      |  | $ | 22,693 |   |  | $ | 14,916 |  
|Service and other revenue                                                 |  |                            | 2,740  |   |                          |   | 1,423  |      |  |   | 4,471  |   |  |   | 2,857  |  
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                                                             |  |                            | 16,047 |   |                          |   | 6,630  |      |  |   | 27,164 |   |  |   | 17,773 |  
|                                                                          |  |                            |        |  
|Cost of goods sold:                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Cost of product revenue                                                   |  |                            | 10,171 |   |                          |   | 4,222  |      |  |   | 17,036 |   |  |   | 11,123 |  
|Cost of service and other revenue                                         |  |                            | 1,514  |   |                          |   | 933    |      |  |   | 2,915  |   |  |   | 1,913  |  
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total cost of goods sold                                                  |  |                            | 11,685 |   |                          |   | 5,155  |      |  |   | 19,951 |   |  |   | 13,036 |  
|                                                                          |  |                            |        |  
|Gross profit                                                              |  |                            | 4,362  |   |                          |   | 1,475  |      |  |   | 7,213  |   |  |   | 4,737  |  
|                                                                          |  |                            |        |  
|Operating expenses:                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Research and development                                                  |  |                            | 849    |   |                          |   | 1,058  |      |  |   | 1,684  |   |  |   | 2,159  |  
|Selling and marketing                                                     |  |                            | 3,526  |   |                          |   | 2,660  |      |  |   | 6,784  |   |  |   | 5,990  |  
|General and administrative                                                |  |                            | 1,433  |   |                          |   | 1,177  |      |  |   | 2,750  |   |  |   | 2,316  |  
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                                  |  |                            | 5,808  |   |                          |   | 4,895  |      |  |   | 11,218 |   |  |   | 10,465 |  
|                                                                          |  |                            |        |  
|Operating loss                                                            |  |                            | (1,446 | ) |                          |   | (3,420 | )    |  |   | (4,005 | ) |  |   | (5,728 | )
|                                                                          |  |                            |        |  
|Interest expense, net                                                     |  |                            | (26    | ) |                          |   | (18    | )    |  |   | (52    | ) |  |   | (28    | )
|Other expense, net                                                        |  |                            | (64    | ) |                          |   | (28    | )    |  |   | (68    | ) |  |   | (77    | )
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                                  |  | $                          | (1,536 | ) |                          | $ | (3,466 | )    |  | $ | (4,125 | ) |  | $ | (5,833 | )
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share, basic & diluted                                       |  | $                          | (0.02  | ) |                          | $ | (0.06  | )    |  | $ | (0.05  | ) |  | $ | (0.10  | )
|                                                                          |  |                            |        |  
|Shares used in computing net loss per share, basic & diluted              |  |                            | 79,656 |   |                          |   | 62,424 |      |  |   | 75,540 |   |  |   | 61,349 |  
|                                                                          |  |                            |        |  
|Comprehensive loss:                                                       |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                                  |  | $                          | (1,536 | ) |                          | $ | (3,466 | )    |  | $ | (4,125 | ) |  | $ | (5,833 | )
|Translation gain (loss) on subsidiaries denominated in foreign currencies |  |                            | (98    | ) |                          |   | 253    |      |  |   | (259   | ) |  |   | 235    |  
|Change in unrealized gain on investments in marketable securities         |  |                            |       |   |                          |   |       |      |  |   |       |   |  |   | 2      |  
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Comprehensive loss                                                        |  | $                          | (1,634 | ) |                          | $ | (3,213 | )    |  | $ | (4,384 | ) |  | $ | (5,596 | )
|                                                                          |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  

See accompanying notes.



4



---

##### Table of Contents

Active Power, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)



|                                                                          |  |                          |        |   |      |   |        |  
|------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                          |  | Six Months EndedJune 30, |       
|                                                                          |  | 2010                     |        |   | 2009 |  
|Operating activities                                                      |  |                          |        |   |      |   |        |  
|Net loss                                                                  |  | $                        | (4,125 | ) |      | $ | (5,833 | )
|Adjustments to reconcile net loss to cash used in operating activities:   |  |                          |        |   |      |   |        |  
|Depreciation expense                                                      |  |                          | 1,012  |   |      |   | 954    |  
|Change in allowance for doubtful accounts                                 |  |                          | (55    | ) |      |   | (34    | )
|Accretion of premium/discount on investments                              |  |                          |       |   |      |   | 2      |  
|Loss on disposal of fixed assets                                          |  |                          | 26     |   |      |   | 410    |  
|Stock-based compensation                                                  |  |                          | 418    |   |      |   | 671    |  
|Changes in operating assets and liabilities:                              |  |                          |        |   |      |   |        |  
|Accounts receivable                                                       |  |                          | 941    |   |      |   | 2,400  |  
|Inventories                                                               |  |                          | (452   | ) |      |   | (514   | )
|Prepaid expenses and other assets                                         |  |                          | 44     |   |      |   | 90     |  
|Accounts payable                                                          |  |                          | 871    |   |      |   | (241   | )
|Accrued expenses                                                          |  |                          | 503    |   |      |   | (1,193 | )
|Deferred revenue                                                          |  |                          | 476    |   |      |   | 772    |  
|Long-term liabilities                                                     |  |                          | 161    |   |      |   | 57     |  
|                                                                          |  |                          |        |   |      |   |        |  
|Net cash used in operating activities                                     |  |                          | (180   | ) |      |   | (2,459 | )
|                                                                          |  |                         
|Investing activities                                                      |  |                          |        |   |      |   |        |  
|Sales/maturities of marketable securities                                 |  |                          |       |   |      |   | 300    |  
|Purchases of property and equipment                                       |  |                          | (343   | ) |      |   | (213   | )
|                                                                          |  |                          |        |   |      |   |        |  
|Net cash (used in) provided by investing activities                       |  |                          | (343   | ) |      |   | 87     |  
|                                                                          |  |                         
|Financing activities                                                      |  |                          |        |   |      |   |        |  
|Proceeds from private placement of common stock                           |  |                          | 9,922  |   |      |   | 3,000  |  
|Issuance costs of private placement                                       |  |                          | (886   | ) |      |   |       |  
|Proceeds from employee stock purchases                                    |  |                          | 1      |   |      |   |       |  
|Purchases of treasury stock                                               |  |                          | (30    | ) |      |   |       |  
|                                                                          |  |                          |        |   |      |   |        |  
|Net cash provided by financing activities                                 |  |                          | 9,007  |   |      |   | 3,000  |  
|                                                                          |  |                         
|Translation gain (loss) on subsidiaries denominated in foreign currencies |  |                          | (259   | ) |      |   | 204    |  
|                                                                          |  |                         
|Change in cash and cash equivalents                                       |  |                          | 8,225  |   |      |   | 832    |  
|Cash and cash equivalents, beginning of period                            |  |                          | 7,489  |   |      |   | 10,468 |  
|                                                                          |  |                          |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                  |  | $                        | 15,714 |   |      | $ | 11,300 |  
|                                                                          |  |                          |        |   |      |   |        |  

See accompanying notes.



5



---

##### Table of Contents

Active Power, Inc.

Notes to Condensed Consolidated Financial Statements

June 30, 2010

(Unaudited)



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

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

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



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

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



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

Receivables

Accounts receivable consist of the following (in thousands):



|                                |  |              |        |   |                  |   |        |  
|------------------------------- |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                                |  | June 30,2010 |        |   | December 31,2009 |  
|Trade receivables               |  | $            | 10,941 |   |                  | $ | 11,882 |  
|Allowance for doubtful accounts |  |              | (298   | ) |                  |   | (353   | )
|                                |  |              |        |   |                  |   |        |  
|                                |  | $            | 10,643 |   |                  | $ | 11,529 |  
|                                |  |              |        |   |                  |   |        |  



6



---

##### Table of Contents

Inventory

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



|                            |  |              |        |   |                  |   |        |  
|--------------------------- |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                            |  | June 30,2010 |        |   | December 31,2009 |  
|Raw materials               |  | $            | 5,838  |   |                  | $ | 5,238  |  
|Work in process             |  |              | 2,687  |   |                  |   | 1,253  |  
|Finished goods              |  |              | 836    |   |                  |   | 2,448  |  
|Allowances for obsolescence |  |              | (2,280 | ) |                  |   | (2,310 | )
|                            |  |              |        |   |                  |   |        |  
|                            |  | $            | 7,081  |   |                  | $ | 6,629  |  
|                            |  |              |        |   |                  |   |        |  

Property and Equipment

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



|                                 |  |              |         |   |                  |   |         |  
|-------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                 |  | June 30,2010 |         |   | December 31,2009 |  
|Equipment                        |  | $            | 9,401   |   |                  | $ | 9,321   |  
|Demonstration units              |  |              | 1,535   |   |                  |   | 1,436   |  
|Computers and purchased software |  |              | 3,201   |   |                  |   | 3,076   |  
|Furniture and fixtures           |  |              | 355     |   |                  |   | 355     |  
|Leasehold improvements           |  |              | 7,308   |   |                  |   | 7,305   |  
|Construction in progress         |  |              | 44      |   |                  |   | 44      |  
|                                 |  |              |         |   |                  |   |         |  
|                                 |  |              | 21,844  |   |                  |   | 21,537  |  
|                                 |  |              |         |   |                  |   |         |  
|Accumulated depreciation         |  |              | (19,636 | ) |                  |   | (18,634 | )
|                                 |  |              |         |   |                  |   |         |  
|                                 |  | $            | 2,208   |   |                  | $ | 2,903   |  
|                                 |  |              |         |   |                  |   |         |  

Accrued Expenses

Accrued expenses consist of the following (in thousands):



|                                                 |  |              |       |                   |   |      
|------------------------------------------------ |  | ------------ | ----- | ----------------- | - | -----
|                                                 |  | June 30,2010 |       | December 
31,2009
|Compensation and benefits                        |  | $            | 2,737 |                   | $ | 1,549
|Warranty liability                               |  |              | 571   |                   |   | 620  
|Property, income, state, sales and franchise tax |  |              | 846   |                   |   | 1,427
|Professional fees                                |  |              | 362   |                   |   | 495  
|Other                                            |  |              | 944   |                   |   | 866  
|                                                 |  |              |       |                   |   |      
|                                                 |  | $            | 5,460 |                   | $ | 4,957
|                                                 |  |              |       |                   |   |      

Warranty Liability

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



7



---

##### Table of Contents

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



|                                                |  |   |      |  
|----------------------------------------------- |  | - | ---- | -
|Balance at December 31, 2009                    |  | $ | 663  |  
|Warranty expense                                |  |   | 338  |  
|Warranty charges incurred                       |  |   | (385 | )
|                                                |  |   |      |  
|Balance at June 30, 2010                        |  | $ | 616  |  
|                                                |  |   |      |  
|Warranty liability included in accrued expenses |  | $ | 571  |  
|Long term warranty liability                    |  |   | 45   |  
|                                                |  |   |      |  
|Balance at June 30, 2010                        |  | $ | 616  |  
|                                                |  |   |      |  

Revenue Recognition

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



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



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



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



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



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

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

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

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



8



---

##### Table of Contents

|4. | 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 EndedJune 30, |        |   | Six Months
EndedJune 30, |  
|                                                               |  | 2010                       |        |   | 2009                     |   |        | 2010 |  |   | 2009   |  
|Net loss                                                       |  | $                          | (1,536 | ) |                          | $ | (3,466 | )    |  | $ | (4,125 | ) |  | $ | (5,833 | )
|                                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted:                                             |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average shares of common stock outstanding            |  |                            | 79,656 |   |                          |   | 62,424 |      |  |   | 75,540 |   |  |   | 61,349 |  
|                                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing net loss per share, basic and diluted |  |                            | 79,656 |   |                          |   | 62,424 |      |  |   | 75,540 |   |  |   | 61,349 |  
|                                                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share, basic and diluted                          |  | $                          | (0.02  | ) |                          | $ | (0.06  | )    |  | $ | (0.05  | ) |  | $ | (0.10  | )

The calculation of diluted
loss per share excludes 9,159,754 and 6,921,558 shares of common stock issuable upon exercise of employee stock options as of June 30, 2010 and 2009, respectively, and 19,001 and 123,013 non-vested shares of common stock issuable upon exercise
of restricted stock awards as of June 30, 2010 and 2009, respectively, because their inclusion in the calculation would be anti-dilutive. As of June 30, 2010 and 2009, there was no common stock subject to repurchase.



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

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

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

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

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

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

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

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

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



9



---

##### Table of Contents

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



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

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



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

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



10



---

##### Table of Contents

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

The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, the financial statements
and notes thereto included in Item 1 of this Form 10-Q and the financial statements and notes thereto and our Managements Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2009
included in our 2009 Annual Report on Form 10-K. This report contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that involve risks
and uncertainties. Our expectations with respect to future results of operations that may be embodied in oral and written forward-looking statements, including any forward- looking statements that may be included in this report, are subject to risks
and uncertainties that must be considered when evaluating the likelihood of our realization of such expectations. Our actual results could differ materially. The words believe, expect, intend, plan,
project, will and similar phrases as they relate to us are intended to identify such forward-looking statements. In addition, please see the Risk Factors in Part 1, Item 1A of our 2009 Annual Report on
Form 10-K and in Part II, Item 1A of this Form 10-Q for a discussion of items that may affect our future results.

Overview

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

As of June 30, 2010, we have shipped more than 2,600 flywheels in UPS system installations, delivering more than 650 megawatts of
power to customers in 44 countries around the world. We are headquartered in Austin, Texas, with international offices in the United Kingdom, Germany and Japan.

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

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

Leveraging our manufacturing, containerization and product packaging capabilities, we also work with our IT channel partners to produce
portable data center infrastructure solutions. These solutions enable our IT channel partners to sell their IT products in a portable or modular package.



11



---

##### Table of Contents

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



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



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



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



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



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



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

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



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



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



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



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

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

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

Results of Operations



|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|--------------------------------- |  | --------------------------- | ------ | - | --------------------- | --- | -- | ---- | - | ------ | ----------------- |  | --- | -- |  | - | ----- | - |  | --- | --
|($ in thousands)                  |  | Three months ended June 30, |        |   | Variance2010 vs. 2009 |    
|                                  |  | 2010                        |        |   | % 
oftotalrevenue     |     |    | 2009 |   |        | % 
oftotalrevenue |  |     | $  |  |   | %     |  
|Product revenue                   |  | $                           | 13,307 |   |                       | 83  | %  |      | $ | 5,207  |                   |  | 79  | %  |  | $ | 8,100 |   |  | 156 | % 
|Service and other revenue         |  |                             | 2,740  |   |                       | 17  | %  |      |   | 1,423  |                   |  | 21  | %  |  |   | 1,317 |   |  | 93  | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Total revenue                     |  |                             | 16,047 |   |                       | 100 | %  |      |   | 6,630  |                   |  | 100 | %  |  |   | 9,417 |   |  | 142 | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Cost of product revenue           |  |                             | 10,171 |   |                       | 63  | %  |      |   | 4,222  |                   |  | 64  | %  |  |   | 5,949 |   |  | 141 | % 
|Cost of service and other revenue |  |                             | 1,514  |   |                       | 9   | %  |      |   | 933    |                   |  | 14  | %  |  |   | 581   |   |  | 62  | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Total cost of goods sold          |  |                             | 11,685 |   |                       | 73  | %  |      |   | 5,155  |                   |  | 78  | %  |  |   | 6,530 |   |  | 127 | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Gross profit                      |  |                             | 4,362  |   |                       | 27  | %  |      |   | 1,475  |                   |  | 22  | %  |  |   | 2,887 |   |  | 196 | % 
|Operating expenses:               |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Research and development          |  |                             | 849    |   |                       | 5   | %  |      |   | 1,058  |                   |  | 16  | %  |  |   | (209  | ) |  | (20 | )%
|Selling and marketing             |  |                             | 3,526  |   |                       | 22  | %  |      |   | 2,660  |                   |  | 40  | %  |  |   | 866   |   |  | 33  | % 
|General and administrative        |  |                             | 1,433  |   |                       | 9   | %  |      |   | 1,177  |                   |  | 18  | %  |  |   | 256   |   |  | 22  | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Total operating expenses          |  |                             | 5,808  |   |                       | 36  | %  |      |   | 4,895  |                   |  | 74  | %  |  |   | 913   |   |  | 19  | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Operating loss                    |  |                             | (1,446 | ) |                       | (9  | )% |      |   | (3,420 | )                 |  | (52 | )% |  |   | 1,974 |   |  | 58  | % 
|Interest expense, net             |  |                             | (26    | ) |                       |    |    |      |   | (18    | )                 |  |    |    |  |   | 8     |   |  | 44  | % 
|Other expense, net                |  |                             | (64    | ) |                       |    |    |      |   | (28    | )                 |  |    |    |  |   | 36    |   |  | 129 | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   
|Net loss                          |  | $                           | (1,536 | ) |                       | (10 | )% |      | $ | (3,466 | )                 |  | (52 | )% |  | $ | 1,930 |   |  | 56  | % 
|                                  |  |                             |        |   |                       |     |    |      |   |        |                   |  |     |    |  |   |       |   |  |     |   



12



---

##### Table of Contents



|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|--------------------------------- |  | ------------------------- | ------ | - | --------------------- | --- | -- | ---- | - | ------ | ---------------- |  | --- | -- |  | - | ----- | - |  | --- | --
|($ in thousands)                  |  | Six months ended June 30, |        |   | Variance2010 vs. 2009 |    
|                                  |  | 2010                      |        |   | %
oftotalrevenue      |     |    | 2009 |   |        | %
oftotalrevenue |  |     | $  |  |   | %     |  
|Product revenue                   |  | $                         | 22,693 |   |                       | 84  | %  |      | $ | 14,916 |                  |  | 84  | %  |  | $ | 7,777 |   |  | 52  | % 
|Service and other revenue         |  |                           | 4,471  |   |                       | 16  | %  |      |   | 2,857  |                  |  | 16  | %  |  |   | 1,614 |   |  | 56  | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Total revenue                     |  |                           | 27,164 |   |                       | 100 | %  |      |   | 17,773 |                  |  | 100 | %  |  |   | 9,391 |   |  | 53  | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Cost of product revenue           |  |                           | 17,036 |   |                       | 63  | %  |      |   | 11,123 |                  |  | 63  | %  |  |   | 5,913 |   |  | 53  | % 
|Cost of service and other revenue |  |                           | 2,915  |   |                       | 11  | %  |      |   | 1,913  |                  |  | 11  | %  |  |   | 1,002 |   |  | 52  | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Total cost of goods sold          |  |                           | 19,951 |   |                       | 73  | %  |      |   | 13,036 |                  |  | 73  | %  |  |   | 6,915 |   |  | 53  | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Gross profit                      |  |                           | 7,213  |   |                       | 27  | %  |      |   | 4,737  |                  |  | 27  | %  |  |   | 2,476 |   |  | 52  | % 
|Operating expenses:               |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Research and development          |  |                           | 1,684  |   |                       | 6   | %  |      |   | 2,159  |                  |  | 12  | %  |  |   | (475  | ) |  | (22 | )%
|Selling and marketing             |  |                           | 6,784  |   |                       | 25  | %  |      |   | 5,990  |                  |  | 34  | %  |  |   | 794   |   |  | 13  | % 
|General and administrative        |  |                           | 2,750  |   |                       | 10  | %  |      |   | 2,316  |                  |  | 13  | %  |  |   | 434   |   |  | 19  | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Total operating expenses          |  |                           | 11,218 |   |                       | 41  | %  |      |   | 10,465 |                  |  | 59  | %  |  |   | 753   |   |  | 7   | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Operating loss                    |  |                           | (4,005 | ) |                       | (15 | )% |      |   | (5,728 | )                |  | (32 | )% |  |   | 1,723 |   |  | 30  | % 
|Interest expense, net             |  |                           | (52    | ) |                       |    |    |      |   | (28    | )                |  |    |    |  |   | 24    |   |  | 86  | % 
|Other expense, net                |  |                           | (68    | ) |                       |    |    |      |   | (77    | )                |  |    |    |  |   | (9    | ) |  | (12 | )%
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   
|Net loss                          |  | $                         | (4,125 | ) |                       | (15 | )% |      | $ | (5,833 | )                |  | (33 | )% |  | $ | 1,708 |   |  | 29  | % 
|                                  |  |                           |        |   |                       |     |    |      |   |        |                  |  |     |    |  |   |       |   |  |     |   

Product revenue. Product revenue primarily consists of sales of our CleanSource power quality
products, comprised of both UPS and DC product lines, and sales of Continuous Power Systems (CPS) which are comprised of our UPS systems and some combination of third party ancillary equipment, such as engine generators and switchgear.
The CPS products may be sold in a containerized solution that we call PowerHouse, or as separate equipment. Product revenue also includes sales of our CoolAir DC product and other portable data center infrastructure solutions that we have recently
begun to produce for our IT channel partners leveraging our manufacturing, containerization and product packaging capabilities.

Product revenue for the three-month period ended June 30, 2010 increased 156%, or $8.1 million, compared to the second quarter of
2009, which is primarily attributable to a higher volume of UPS sales, higher sales of our continuous power systems including higher PowerHouse revenues and portable data center infrastructure solutions revenues. We saw an increase in virtually all
product lines, as evidenced by the $1.6 million increase in our 250-900 kVA CleanSource product line, an increase of approximately $684,000 in our megawatt class UPS products, and an increase of approximately $65,000 in sales of our smaller
130-150kVA products, compared to the second quarter of 2009. Powerhouse revenues were $4.9 million higher for the three-month period ended June 30, 2010 compared to the same quarter in 2009, reflecting stronger performance from Europe for
this product offering. We also recognized $2.2 million in revenue related to production of our data center infrastructure products for the three-month period ended June 30, 2010, compared to $0 during the same period of 2009.

For the six-month period ended June 30, 2010, our product revenue was $7.8 million, or 52%, higher than the comparable period of
2009. We saw an increase of $3.6 million in our 250-900 kVA CleanSource product line, offset by a decrease in our megawatt class UPS products of $2.2 million. The PowerHouse revenue and revenues related to data center infrastructure products were a
new revenue source for us in 2009 and so we did not have any such revenues in the first two quarters of 2009. For the three-month and six-month periods ended June 30, 2010, our PowerHouse revenues were $4.9 million and $5.9 million,
respectively and our revenues related to data center infrastructure products were $2.2 million and $2.8 million, respectively. Our product mix is driven by the particular customer orders at any point in time and can vary based upon customer load and
space requirements.



13



---

##### Table of Contents

Product revenue increased sequentially by 42% compared to the first quarter of 2010. This
compares to a 46% decrease in product revenue in the second quarter of 2009, as compared to the first quarter of 2009. The decrease in product revenue in 2009 was due to lower sales volume of our UPS products in 2009 that were primarily attributable
to external economic factors, as customers delayed product purchase decisions due to uncertainty or lack of liquidity. We have seen improvement in general economic conditions, particularly in North America in 2010, which has resulted in higher
product demand and orders across all of our products and from all of our different sales channels. Our PowerHouse contracts tend to be large in value from a small number of customers, and in the first half of 2010 comprised 22% of total revenue.

Product sales from our OEM channels for the three-month period ended June 30, 2010 increased by 67%, or $1.5 million,
compared to the second quarter of 2009 and decreased 7%, or $498,000 for the six-month period ended June 30, 2010 as compared to the same period in 2009. A portion of this increase is attributable to the timing of larger orders from our OEM
partners for their customers and an increase in sales in EMEA. Sales of our UPS products are also a much smaller part of our OEM partners total business and subject to more volatility in quarterly sales, particularly during difficult economic
periods as the OEM focuses on its core business. We do believe that sales from this channel will continue to increase in 2010, as general conditions improve and due to the marketing commitment of the OEM partners to promote our UPS products over the
last year. Revenues this quarter from our OEM channels increased by 48% over the first quarter of 2010. Sales to Caterpillar represented 28% of our product revenue for the three-month period ended June 30, 2010, as compared to 44% of our
product revenue in the comparable period of 2009, and were 28% of our product revenue for the six-month period ended June 30, 2010 as compared to 46% for the same period in 2009. Caterpillar remains our largest single customer as well as our
largest OEM customer.

During the three-month period ended June 30, 2010, we sold 99 flywheel product units, a 4%
increase over the 95 units that we sold in the first quarter of 2010, and an 80% increase from the 55 units we sold in the second quarter of 2009. The average selling price per flywheel for the second quarter of 2010 was approximately $79,000 per
flywheel, which compared to an average selling price of approximately $72,000 in the second quarter of 2009 and approximately $85,000 in the first quarter of 2010.

During the six-month period ended June 30, 2010, we sold 194 flywheel product units, an 11% increase over the 174 units that we sold
in the same period of 2009. The average sales price per flywheel for the six-month period ended June 30, 2010 was approximately $82,000, which compared to an average selling price of approximately $77,000 for the same period of 2009.

Our continuous power system, PowerHouse, and portable data center infrastructure solutions contracts tend to be larger in
value and this will contribute to more volatility on a quarterly basis based on the number and timing of such orders on hand. For the three months ended June 30, 2010, we completed construction of multiple PowerHouse orders that were received
in 2009, especially in Europe. Large contracts also significantly affect our cash flows as we have significantly larger receivables per customer order. While this concentration does increase liquidity risk for us, we continue to improve and refine
the payment terms of these sales opportunities as part of our working capital management. As our solutions business grows, the composition of our sales will likely change and fluctuate on a quarterly basis. We have experienced an increase in third
party systems and components and portable data center infrastructure solutions that are being packaged and resold to our customers, that we believe will continue to help increase our revenue. Margins on sales of third party equipment and portable
data center infrastructure solutions are less than what we generate on our own manufactured goods. Therefore, a significant increase in product revenues that was caused by higher sales of ancillary products may not result in a commensurate
percentage increase in our gross or operating profit levels. Further, the frequency and timing of our larger sales, including megawatt-class UPS products and our CPS, including PowerHouse, is more volatile and can result in material changes in
period-to-period revenue. Such revenues also can occur in periods other than when originally anticipated, which can add to the potential volatility and affect our ability to meet forecasted targets.

North America sales were 69% of our total revenue for the three-month period ended June 30, 2010, compared to 77% for the same
period in 2009 and 61% in the three-month period ended March 31, 2010. For the six-month period ended June 30, 2010, our North America sales were 66% of total revenue, which compared to 77% of total revenue in the same period of 2009. In
total, our North America sales increased by 31% for the six-month period ended June 30, 2010 compared to the same period of 2009, reflecting the overall growth in the market for our products and the improvement in overall market conditions.

We also sell products directly to customers in Asia and Western Europe. We have also added a network of international
distributors in other territories to sell products for us. In these markets, customers are more likely to purchase a total power solution from us rather than a stand alone UPS system. This usually results in a longer selling cycle and makes
quarterly results more volatile and dependent upon a smaller number of transactions. Thus the amount of revenue from our international markets can fluctuate significantly on a quarterly basis. Sales of Active Power branded products through our
direct and manufacturers representative channels were 60% of our total revenue for the three-month period ended June 30, 2010, compared to 61% for the same period of 2009, and 63% of our total revenue for the three-month period ended
March 31, 2010. Sales of Active Power branded products through our direct and manufacturers representative channels were 61% of our total revenue for the six-month period ended June 30, 2010, compared to 58% for the same period of
2009. As direct sales typically have higher profit margins than sales through our OEM channels, we will continue to focus on our direct sales channel to increase revenue and improve profit margins and to decrease our dependency upon our OEM channel.
We believe sales of our Active Power branded products in



14



---

##### Table of Contents

markets that were not covered by our OEMs will continue to increase over time and will continue to become a larger percentage of our total revenue. We believe that our direct sales volumes have
not been impacted as much by external factors compared to our OEM channels. This is highlighted by the fact that our direct sales increased by 138% in total for the three-month period ended June 30, 2010 compared to the second quarter of 2009,
which compared to a 59% increase in our OEM channel revenue over the same periods. We continue to expand the sales territories where we sell our Active Power branded products as we increase our sales distribution capabilities, particularly in Europe
and Asia. In 2009 we also increased the size of our sales and service organization in the U.K. and Germany. We anticipate higher revenues from both Europe and Asia in 2010 as a result of this expansion of our sales, service and marketing
capabilities.

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

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

Service and other
revenue increased by 93% for the three-month period ended June 30, 2010, compared to the same quarter of 2009 and increased by 56% for the six-month period ended June 30, 2010 as compared to the same period in 2009. This increase is
primarily due to higher levels of service and contract work from direct product sales made in prior quarters and from professional fees associated with PowerHouse and other continuous power system sales. For these customers we provide a full power
solution, including site preparation, installation of an entire power solution and provision of all products required to provide a turnkey product to the end user often including maintenance services. Where we make sales through our OEM channel, it
is typical for the OEM to provide these types of services to their end-user customers. We anticipate that service and other revenue will continue to grow with product revenue, particularly as our PowerHouse system revenue grows, and as our installed
base of UPS product expands, because as more units are sold to customers, more installation, startup and maintenance services will be required.

Cost of product revenue. Cost of product revenue includes the cost of component parts of our products, ancillary equipment
that is sourced from external suppliers, personnel, equipment and other costs associated with our assembly and test operations, including costs from having underutilized facilities, depreciation of our manufacturing property and equipment, shipping
costs, warranty costs, and the costs of manufacturing support functions such as logistics and quality assurance. The cost of product revenue as a percentage of total product revenue was 76% in the three-month periods ended June 30, 2010, as
compared to 81% for the comparable period of 2009, and was 75% in the six-month period ended June 30, 2010 and June 30, 2009. This decrease from 2009 is due primarily to increased sales, which resulted in more efficient utilization of our
manufacturing facility. We continue to operate a manufacturing facility that has a capacity significantly greater than our current product revenue levels. A large portion of the costs involved in operating this manufacturing facility are fixed in
nature and we incur approximately $300,000 to $700,000 in unabsorbed overhead each quarter. We continue to work on reducing our product costs through design enhancements and modifications, and vendor management programs.

Cost of service and other revenue. Cost of service and other revenue includes the cost of component parts that we use in
service or sell as spare parts, as well as labor and overhead costs of our service organization, including travel and related costs incurred in fulfilling our service obligations to our customers. The cost of service and other revenue decreased to
55% of service and other revenue in the three-month period ended June 30, 2010, compared to 66% in the same period of 2009 and 65% in the six-month period ended June 30, 2010, as compared to 67% in the same period of 2009. This decrease
reflects higher utilization of our service department due to higher sales and installation activity. A large portion of the costs involved in operating our service organization are fixed in nature and we incur approximately $300,000 to $500,000 in
unabsorbed overhead each quarter. We continue to work on reducing our service overhead through better utilization of our service employees and cost control measures.

Gross profit. Gross profit was 27% as a percentage of revenue for the three-month period ended June 30, 2010, compared
to 22% for the same quarter in 2009, and was 27% for each of the six-month periods ended June 30, 2010 and June 30, 2009. Factors that may impact our gross-profit levels include our sales channel mix, the effectiveness of our product
pricing to our customers, product discounts and customer incentives, product volume and mix, currency fluctuations, variations in our product cost and productivity and utilization of our manufacturing and service operations. Our ability to improve
our gross profit will depend, in part, on our ability to reduce material costs, improve our sales channel mix in favor of direct sales versus OEM, increase sales of higher margin products such as our flywheels, increase product prices and increase
our total revenues to a level that will allow us to improve the utilization of our manufacturing and service operations.



15



---

##### Table of Contents

Research and development. Research and development expense primarily consists
of compensation and related costs for employees engaged in research, development and engineering activities, third party consulting and development activities, as well as an allocated portion of our occupancy costs. Overall our research and
development expenses were approximately $209,000, or 20%, lower in the second quarter of 2010 compared to the second quarter of 2009 and remained steady with the first quarter of 2010. Our research and development efforts in 2009 were largely
focused on new configurations of our existing flywheel technology under development, as well as enhancements to our megawatt-class UPS products and refinement and standardization of our containerized product solutions. The decrease in spending
compared to 2009 reflects lower project related development costs this year. The prior year expenses included higher prototype and development costs for paralleling our megawatt-class UPS products. We believe research and development expenses in the
third quarter will remain at similar levels to those recorded in the second quarter.

Selling and marketing.Selling and marketing expense primarily consists of compensation, including variable sales compensation, and related costs, for sales and marketing personnel, and related travel, selling and marketing expenses, as well as an allocated
portion of our occupancy costs and the cost of our foreign sales operations. Selling and marketing costs were approximately $866,000, or 33%, higher in the second quarter of 2010 compared to the amount recorded in the second quarter of 2009 and
increased approximately $268,000, or 8%, from the first quarter of 2010. The increase from 2009 reflects increased headcount as we concentrate on developing and improving the Active Power brand, and expanding our sales organization, particularly in
Europe and Asia, to support our direct selling and channel sales activities. We have also added specific sales resources to support each of our OEM and IT sales channels during 2010, which we believe is contributing to the improved performance from
each of these channels in 2010. The increase from the first quarter of 2010 primarily reflects higher variable sales compensation and performance-based compensation as a result of higher revenue and improving results. We believe that fixed sales and
marketing expenses will decline slightly in the third quarter of 2010 compared to those recorded in the second quarter of 2010.

General and administrative. General and administrative expense is primarily comprised of compensation and related costs for
executive and administrative personnel, professional fees, and taxes, including sales, property and franchise taxes. General and administrative expenses for the second quarter of 2010 increased approximately $256,000, or 22%, compared to the same
period in 2009 and increased approximately $116,000, or 9%, as compared to the immediately preceding quarter. The increase primarily reflects higher professional and consulting services fees and higher performance-based compensation costs.

Interest expense, net. Net interest expense has increased from approximately $18,000 in the three-month period
ended June 30, 2009 to approximately $26,000 in the three-month period ended June 30, 2010. This increase is due to the decline in interest rates during 2009 that lowered our investment returns, and interest expense paid on balances
outstanding under our revolving credit arrangement. Our average cash and investments balance over the three-month period ending June 30, 2010 has increased by $5.5 million, or 50%, compared to the average balance over the comparable period
ending June 30, 2009 and for the six-month period ended June 30, 2010, has decreased by approximately $165,000, or less than 1%, as compared to the average balance over the comparable period.

Other expense, net. Net other expense in the second quarter of 2010 and 2009 reflects foreign exchange gains (losses) on a
bank account held in foreign currency.

Liquidity and Capital Resources

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

In February 2010, we sold approximately 13.25 million shares of common stock at a purchase price
of $0.75 per share, for proceeds, net of fees and expenses, of approximately $9 million, in a firm-commitment underwritten offering made under a shelf registration statement that we had filed with the Securities and Exchange Commission and that had
been declared effective in December 2009. The proceeds from this offering were designed to strengthen our balance sheet and will be used by us to help fund our working capital requirements during 2010 and for general corporate purposes.



16



---

##### Table of Contents

In October 2008, we entered into a modified Loan and Security Agreement (the Loan
Agreement) with Silicon Valley Bank (SVB). The Loan Agreement provides for a secured revolving line of credit in an amount of up to $6 million subject to a borrowing base formula. Three million dollars of this credit facility is
secured under a U.S. government guaranteed export-import credit facility that would add a U.S. government guarantee to the payments for these foreign shipments and make more of our foreign shipments eligible as security for the credit facility. This
guarantee applies to export-import sales of the parent company and does not apply to sales made by our foreign subsidiaries. The remaining $3 million of this credit facility does not have this guarantee and is secured by a first priority lien on
substantially all of our assets. Prior to this modification to add the export-import facility, export revenues were not eligible to be included as part of the borrowing base, which limited our ability to utilize the revolving credit facility. All
amounts borrowed under this credit facility are subject to a borrowing base formula based on eligible receivables and inventory. During the years ended December 31, 2009 and 2008 we borrowed $0.6 million and $2.0 million, respectively, under
this credit facility and these borrowings remained outstanding at June 30, 2010. There were no borrowings or repayments under this credit facility in the six-month period ended June 30, 2010. Based on the borrowing base formula, we had an
additional $0.6 million available for use at June 30, 2010 under this credit facility.

The Loan Agreement requires us to
maintain a minimum liquidity ratio of unrestricted cash to the outstanding amounts under the Loan Agreement of at least 1.35 to 1. In addition, the Loan Agreement contains customary affirmative covenants, including covenants that require, among
other things, the delivery of financial statements, compliance with laws, the maintenance of insurance and the protection and registration of intellectual property rights. Further, the Loan Agreement contains customary negative covenants, including
covenants that limit or restrict our ability to, among other things, dispose of assets, change our business, change our CEO or CFO, make acquisitions, be acquired, incur indebtedness, grant liens, make investments, make distributions, repurchase
stock, and enter into certain transactions with our affiliates, in each case subject to customary exceptions for a credit facility of this size and type. We were in compliance with all of these covenants at June 30, 2010.

Revolving loans under this credit facility may be borrowed, repaid and re-borrowed until October 5, 2010, at which time all amounts
borrowed must be repaid and all outstanding letters of credit must be cash collateralized. Revolving loans bear interest at a floating per annum rate equal to the greater of (i) SVBs prime rate plus 0.25% or (ii) 5.25%. A default
interest rate shall apply during an event of default at a rate per annum equal to 5.0% above the otherwise applicable interest rate. The revolving loans are secured by a first priority lien on substantially all of our assets, provided that such
security interest is limited to no more than 65% of the outstanding capital stock held by us of each of our subsidiaries.

The
Loan Agreement includes customary events of default that include, among other things, non-payment of principal, interest or fees, violation of covenants, the occurrence of a material adverse change, bankruptcy and insolvency events, defaults under
material agreements, material judgments against us and inaccuracy of representations and warranties. The occurrence of an event of default could result in the acceleration of any outstanding obligations under the Loan Agreement.

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

We are
currently negotiating a new bank facility to increase the total amount of credit available and to expand the borrowing base. Our current bank facility expires in October 2010, and we anticipate entering into a new bank facility prior to this
expiration date to provide us with additional sources of capital to address our working capital needs.

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



17



---

##### Table of Contents

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



|                                  |  |                           |      |   |                       |   |        |   |  |   |        |   |  |     |   
|--------------------------------- |  | ------------------------- | ---- | - | --------------------- | - | ------ | - |  | - | ------ | - |  | --- | --
|($ in thousands)                  |  | Six months endedJune 
30, |      |   | Variance2010 vs. 2009 |  
|                                  |  | 2010                      |      |   | 2009                  |   |        | $ |  |   | %      |  
|Cash used in operating activities |  | $                         | (180 | ) |                       | $ | (2,459 | ) |  | $ | (2,279 | ) |  | (93 | )%

Cash used in
operating activities decreased by 93% in the six-month period ended June 30, 2010 compared to the same period of 2009. This was primarily due to changes in our working capital and through a reduction in operating losses. Increased sales at the
latter end of the second quarter resulted in an increase in our receivables by approximately $941,000 compared to year end. While we were able to reduce our finished goods inventory by $1.6 million during the six-month period ended June 30,
2010, this was offset by an increase of $1.4 million in work-in-process inventory. We were able to largely fund this with increases in our accounts payable. We anticipate that the level of cash used in operating activities will be similar in the
third quarter as the current period. However, the size and timing of orders may require us to invest in inventory or receivables to support revenue growth.

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



|                                                |  |                           |      |                       |      |   |    |  |   |      |   |  |      |   
|----------------------------------------------- |  | ------------------------- | ---- | --------------------- | ---- | - | -- |  | - | ---- | - |  | ---- | --
|($ in thousands)                                |  | Six months endedJune 
30, |      | Variance2010 vs. 2009 |     
|                                                |  | 2010                      |      |                       | 2009 |   | $  |  |   | %    |  
|Cash (used in) provided by investing activities |  | $                         | (343 | )                     |      | $ | 87 |  | $ | (430 | ) |  | (494 | )%

Investing
activities primarily consist of sales and purchases of investments and purchases of property and equipment. Fluctuations in the sale and purchase of investments generally reflect our use of these funds to finance our ongoing operations. Capital
expenditures were approximately $343,000 in the six-month period ending June 30, 2010, compared to approximately $213,000 in the same period of 2009. Cash provided by sales and purchases of investments were $0 in the six-month period ending
June 30, 2010, compared to approximately $300,000 in the same period of 2009.

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



|                                      |  |                           |       |                       |   |       |  |       |  |     |  
|------------------------------------- |  | ------------------------- | ----- | --------------------- | - | ----- |  | ----- |  | --- | -
|($ in thousands)                      |  | Six months endedJune 
30, |       | Variance2010 vs. 2009 |  
|                                      |  | 2010                      |       | 2009                  |   | $     |  | %     | 
|Cash provided by financing activities |  | $                         | 9,007 |                       | $ | 3,000 |  | 6,007 |  | 200 | %

The increases
in funds provided by financing activities during the six-month period ended June 30, 2010 primarily reflect the sale of common stock in a firm-commitment underwritten offering pursuant to which we sold approximately 13.25 million shares of
common stock at a purchase price of $0.75 per share, for proceeds, net of fees and expenses, of $9.0 million. These proceeds are designed to strengthen our balance sheet and will be used to help fund our working capital requirements during 2010 and
for general corporate purposes. Funds provided by financing activities during the six-month period ended June 30, 2009 reflect the sale of common stock through a private placement to an institutional investor pursuant to which we sold
6.0 million shares of common stock at $0.50 per share.

We believe that our cash and investments will be sufficient to
fund our operations for at least the next 12 months. Our sales cycle is such that we generally have visibility 2-3 quarters in advance for future orders that allows us to predict revenues over this period of time with some degree of confidence.
However a sudden change in business volume, positive or negative, from any of our business or channel partners or in our direct business could significantly impact our expected revenues. The recent global economic slump has reduced our confidence at
predicting future revenues, and even with improving economic conditions, there is still uncertainty and risk in our forecasting. This 2-3 quarter window of sales visibility does provide us with some opportunity to adjust expenditures or take other
measures to reduce our cash consumption if we can see and anticipate a shortfall in revenue or give us time to identify additional sources of funding if we anticipate an increase in our working capital requirements due to increased revenues or
changes in our revenue mix. If there is a significant increase especially in our PowerHouse business, this could potentially impact the amount of working capital that we may require, due to the longer production time and cash cycle of sales of this
product.

We expect the level of capital investments to remain similar in 2010 to those in 2009. We currently intend to invest
in several PowerHouse systems to use for demonstration purposes in the U.S. and in the U.K. to help our sales efforts, but are not planning any other major capital investments during 2010. Outstanding accrued liabilities for tax obligations from the
stock option investigation expensed in 2007 have been paid in the second quarter of 2010. Payments were materially consistent with the amount accrued.



18



---

##### Table of Contents

Recent Accounting Pronouncements

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



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

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

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

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

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



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

Evaluation of
disclosure controls and procedures.

Our Chief Executive Officer and our Chief Financial Officer, based on the evaluation
of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded
that, as of June 30, 2010, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the Exchange Act, (i) is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting.

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



19



---

##### Table of Contents

PART II  OTHER INFORMATION



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

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



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

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

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

Our common
stock could be delisted from the NASDAQ Global Market if our stock price continues to trade below $1.00 per share.

On
March 24, 2010, we received a Staff Deficiency Letter from The Nasdaq Global Market LLC, or Nasdaq, notifying us that we were not in compliance with Nasdaqs Marketplace Rule 5450(a)(1), or the Rule, because the closing bid price for our
common stock had, for the preceding 30 consecutive business days, closed below the minimum $1.00 per share requirement for continued listing. In accordance with Marketplace Rule 5810(c)(3)(A) we were provided a period of 180 calendar days, or
until September 20, 2010, to regain compliance. If at any time before September 20, 2010, the bid price of our common stock closes at or above $1.00 per share for a minimum of 10 consecutive business days, Nasdaq will provide written
confirmation that we have achieved compliance with the Rule. If compliance with the Rule cannot be demonstrated by September 20, 2010, our common stock will be subject to delisting from The Nasdaq Global Market.

In the event that we receive notice that our common stock is being delisted from The Nasdaq Global Market, Nasdaq rules permit us to
appeal any delisting determination by the Nasdaq staff to a Nasdaq Hearings Panel. Alternatively, Nasdaq may permit us to transfer the listing of our common stock to The Nasdaq Capital Market if we satisfy the requirements for initial inclusion set
forth in Marketplace Rule 5505(a), except for the bid price requirement. Currently, we believe we satisfy these requirements. If our application for transfer is approved, we would have an additional 180 calendar days to comply with the Rule in order
to remain on The Nasdaq Capital Market.

We will continue to monitor the bid price for our common stock and consider various
options available to us if our common stock does not trade at a level that is likely to regain compliance.

Delisting from The
Nasdaq Global Market could have an adverse effect on our business and on the trading of our common stock. If a delisting of our common stock from The Nasdaq Stock Market were to occur, our common stock would trade on the OTC Bulletin Board or on the
pink sheets maintained by the National Quotation Bureau, Inc. Such alternatives are generally considered to be less efficient markets, and our stock price, as well as the liquidity of our common stock, may be adversely impacted as a
result.



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

None.



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

None.



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



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

None.



20



---

##### Table of Contents

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

The following
documents are filed as exhibits to this report:



|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*  |  | Restated Certificate of Incorporation (filed as Exhibit 3.1 to Active Powers Quarterly Report on Form 10-Q filed on July 28, 2006)                                                                                                                                                                                                                                                                                                             
|      | 
|3.2.* |  | Second Amended and Restated Bylaws (filed as Exhibit 3.2 to Active Powers Current Report on Form 8-K filed on February 2, 2007)                                                                                                                                                                                                                                                                                                                
|      | 
|3.3*  |  | Amendment to Second Amended and Restated Bylaws (filed as Exhibit 3.01 to Active Powers Current Report on Form 8-K filed on December 7, 2007)                                                                                                                                                                                                                                                                                                  
|      | 
|4.1*  |  | Specimen certificate for shares of Common Stock (filed as Exhibit 4.1 to Active Powers IPO Registration Statement on Form S-l (SEC File
No. 333-36946))                                                                                                                                                                                                                                                                                        
|      | 
|4.2*  |  | Rights Agreement, dated as of December 13, 2001, between Active Power and Equiserve Trust N.A., which includes the form of Certificate of Designation for the Series A Junior
Participating Preferred Stock as Exhibit A, the form of Rights Certificate as Exhibit B and the Summary of Rights to Purchase Series A Preferred Stock as Exhibit C (filed as Exhibit 4.1 to Active Powers Current Report on Form 8-K filed on
December 14, 2001)
|      | 
|4.3*  |  | See Exhibits 3.1, 3.2 and 3.3 for provisions of the Certificate of Incorporation and Bylaws of the registrant defining the rights of holders of common stock.                                                                                                                                                                                                                                                                                   
|      | 
|10.1* |  | Active Power, Inc. 2010 Equity Incentive Plan (filed as Exhibit 10.1 to Active Powers Current Report on Form 8-K filed on May 18, 2010)                                                                                                                                                                                                                                                                                                       
|      | 
|10.2* |  | Form of standard Stock Option Agreement under the Active Power, Inc. 2010 Equity Incentive Plan (filed as Exhibit 10.2 to Active Powers Current Report on Form 8-K filed on
May 18, 2010)                                                                                                                                                                                                                                                     
|      | 
|10.3* |  | Form of standard Restricted Stock Agreement under the Active Power, Inc. 2010 Equity Incentive Plan (filed as Exhibit 10.3 to Active Powers Current Report on Form 8-K filed
on May 18, 2010)                                                                                                                                                                                                                                                 
|      | 
|10.4* |  | Form of standard Restricted Stock Unit Agreement under the Active Power, Inc. 2010 Equity Incentive Plan (filed as Exhibit 10.4 to Active Powers Current Report on Form 8-K
filed on May 18, 2010)                                                                                                                                                                                                                                            
|      | 
|31.1  |  | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2003                                                                                                                                                                                                                                                                           
|      | 
|31.2  |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2003                                                                                                                                                                                                                                                                         
|      | 
|32.1  |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003                                                                                                                                                                                                                                                                                               
|      | 
|32.2  |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003                                                                                                                                                                                                                                                                                               



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

| | Management contract or compensatory plan or arrangement.
|- | --------------------------------------------------------



21



---

##### Table of Contents

SIGNATURES

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



|              |  |  |  |                                                                                                              
|------------- |  |  |  | -------------------------------------------------------------------------------------------------------------
|              |  |  |  | ACTIVE POWER, INC.                                                                                           
|              |  |  |  | (Registrant)                                                                                                 
|              |  | 
|July 27, 2010 |  |  |  | /s/    JAMES A.
CLISHEM                                                                                      
|(Date)        |  |  |  | James A. Clishem                                                                                             
|              |  |  |  | President and Chief Executive Officer
(Principal Executive Officer)                                          
|              |  | 
|July 27, 2010 |  |  |  | /s/    JOHN K.
PENVER                                                                                        
|(Date)        |  |  |  | John K. Penver                                                                                               
|              |  |  |  | Vice President of Finance, Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)



22