<PAGE>

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

                                   FORM 10-Q

(Mark One)

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

For the quarterly period ended       March 31, 2001
                                -----------------------------------------------

                                      or

[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the transition period from  __________________________ to __________________

Commission file number:  _______________________________________________________


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

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

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


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

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

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

                     APPLICABLE ONLY TO CORPORATE ISSUERS:

     Indicate the number of shares outstanding of each of the issuer's classes
     of common stock, as of the latest practicable date. The number of shares of
     common stock as of March 31, 2001 was 39,545,535 with a par value of $.001
     per share.
--------------------------------------------------------------------------------
<PAGE>

                               ACTIVE POWER, INC.
                                     INDEX

<TABLE>
<S>                                                               <C>
  Item 1. Financial Statements..................................   1
 BALANCE SHEETS.................................................   1
 STATEMENT OF OPERATIONS........................................   2
 STATEMENT OF CASH FLOWS........................................   3
 Notes to Financial Statements..................................   4
 Liquidity and Capital Resources................................   8
 Quantitative and Qualitative Disclosures About Market Risk.....   9
 Risk Factors That May Affect Future Results....................  10
  Item 1.  Legal Proceedings....................................  17
  Item 2. Changes in Securities and Use of Proceeds.............  17
  Item 3. Defaults Upon Senior Securities.......................  17
  Item 4. Submission of Matters to a Vote of Security Holders...  17
  Item 5. Other Information.....................................  17
  Item 6. Exhibits and Reports on Form 8-K......................  17
</TABLE>


                                       i
<PAGE>

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

                              ACTIVE POWER, INC.
                                BALANCE SHEETS

                                 (in thousands)

                                                        March 31,   December 31,
                                                          2001         2000
                                                          ----         ----
                                                      (unaudited)
 ASSETS

 Current assets:
      Cash and cash equivalents                         $100,123       $ 92,720
      Short-term investments                              18,542         42,541
      Accounts receivable, net                             3,648          1,934
      Inventories, net                                     4,032          2,343
      Prepaid expenses and other                           1,220          1,177
                                                        --------       --------
              Total current assets                       127,565        140,715
 Property and equipment, net                               5,518          4,469
 Long-term investments                                    18,344         10,948
                                                        --------       --------
                   Total assets                         $151,427       $156,132
                                                        ========       ========

 LIABILITIES AND STOCKHOLDERS' EQUITY

 Current liabilities:
      Accounts payable                                  $  2,836       $  2,133
      Accrued expenses                                     1,540          1,610
                                                        --------       --------
              Total current liabilities                    4,376          3,743

 Stockholders' equity:
      1992 preferred stock                                     -              -
      Common stock                                            39             39
      Treasury stock                                          (2)            (2)
      Deferred stock compensation                         (5,553)        (7,519)
      Additional paid-in capital                         212,012        212,601
      Accumulated deficit                                (59,445)       (52,730)
                                                        --------       --------
         Total stockholders' equity                      147,051        152,389
                                                        --------       --------
         Total liabilities and stockholders' equity      151,427       $156,132
                                                        ========       ========

     See accompanying notes

                                       1
<PAGE>

                              ACTIVE POWER, INC.
                            STATEMENT OF OPERATIONS

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

                                                                     Three Months Ended March 31,
                                                                  ----------------------------------
                                                                     2001                   2000
                                                                  -----------            -----------
                                                                  (unaudited)            (unaudited)
<S>                                                               <C>                    <C>
Product revenue                                                   $     5,107            $       182
Cost of goods sold                                                      6,513                    521
                                                                  -----------            -----------
Product margin (loss)                                                  (1,406)                  (339)

Operating expenses:
Research and development                                                3,543                  1,463
Selling, general and administrative                                     2,741                  1,098
Amortization of deferred stock compensation                             1,287                  1,281
                                                                  -----------            -----------
Total operating expenses                                                7,571                  3,842
                                                                  -----------            -----------
Operating loss                                                         (8,977)                (4,181)

Interest income                                                         2,238                    370
Change in fair value of warrants with redemption rights                     -                 (1,042)
Other income (expense)                                                     24                     (4)
                                                                  -----------            -----------

Net loss                                                          $    (6,715)           $    (4,857)
Preferred stock dividends and accretion                                     -                 (7,231)
                                                                  -----------            -----------
Net loss to common shareholders                                   $    (6,715)           $   (12,088)
                                                                  ===========            ===========

Net loss per share - basic and diluted                            $     (0.17)           $     (1.15)
Shares used in computing net loss per share, basic and diluted     38,906,882             10,555,748
</TABLE>

See accompanying notes

                                       2
<PAGE>

                               ACTIVE POWER, INC.
                            STATEMENT OF CASH FLOWS

                                 (in thousands)

<TABLE>
<CAPTION>
                                                                             Three Months Ended March 31,
                                                                            ----------------------------
                                                                             2001                  2000
                                                                             ----                  ----
                                                                          (unaudited)           (unaudited)
<S>                                                                       <C>                   <C>
Operating  activities
Net loss                                                                   $ (6,715)             $(4,857)
         Adjustment to reconcile net loss to cash used in
         operating activities:
         Depreciation expense                                                   500                  154
         Amortization of deferred stock compensation                          1,287                1,281
         Change in fair value of warrants with redemption rights                  -                1,042
         Changes in operating assets and liabilities:
           Accounts receivable, net                                          (1,714)                (158)
           Inventories, net                                                  (1,689)                (298)
           Prepaid expenses and other assets                                   (653)                 (26)
           Accounts payable                                                     704                  464
           Accrued expenses                                                     (71)                 (99)
           Other non-current liabilities                                          -                   (7)
                                                                           --------              -------
Net cash used in operating activities                                        (8,351)              (2,504)

Investing activities
Purchases of property and equipment                                          (1,549)                (589)
Net maturity (purchase) of investments                                       16,603               (3,345)
                                                                           --------              -------
Net cash provided by (used in) investing activities                          15,054               (3,934)

Financing activities
Proceeds from issuance of common stock, net of issuance costs                   700                  243
Payments on notes payable                                                         -                  (55)
                                                                           --------              -------
Net cash provided by financing activities                                       700                  188
                                                                           --------              -------
Increase in cash and cash equivalents                                         7,403               (6,250)
Cash and cash equivalents, beginning of period                               92,720               24,856
                                                                           --------              -------
Cash and cash equivalents, end of period                                   $100,123              $18,606
                                                                           ========              =======
</TABLE>

     See accompanying notes.

                                       3
<PAGE>

                               Active Power, Inc.
                         Notes to Financial Statements

                                  (unaudited)

1.  Organization

    Active Power, Inc. was founded in 1992 for the purpose of developing and
commercializing advances in the field of electromechanics. Since inception,
Active Power has devoted its efforts principally to research and development,
production and marketing of flywheel-based power quality and storage products
that provide consistent, reliable electric power required by today's digital
economy. These efforts have included pursuing patent protection for intellectual
property, successful production of initial prototypes and limited production
volumes, development of manufacturing processes, raising capital and pursuing
markets for Active Power's products.

2.  Basis of Presentation

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

3.  Inventory

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

    Inventories consist of the following:

                                        March 31,    December 31,
                                          2001           2000
                                       -----------   ------------
     Raw Materials                     $ 4,629,200     $2,902,224
     Work in Progress                      622,635        310,330
     Finished Goods                         40,469          4,981
     Less Reserves                      (1,260,246)      (874,867)
                                       -----------     ----------
                                       $ 4,032,058     $2,342,668
                                       ===========     ==========

                                       4
<PAGE>

4.  Capital Structure

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

<TABLE>
<CAPTION>

                                                                        Three Months Ended March 31,
                                                                        ----------------------------
                                                                            2001           2000
                                                                            ----           ----
<S>                                                                     <C>           <C>
Net loss to common stockholders (thousands)                             $    (6,715)    $   (12,088)
Basic and diluted:
         Weighted-average shares of common stock outstanding             39,262,431      10,878,251
         Weighted-average shares of common stock subject to
          repurchase                                                       (355,549)       (322,503)
                                                                        -----------     -----------
Shares used in computing basic and diluted net loss per share            38,906,882      10,555,748
                                                                        ===========     ===========
Basic and diluted net loss per share                                    $     (0.17)    $     (1.15)
                                                                        ===========     ===========
</TABLE>

                                       5
<PAGE>

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

     The following discussion should be read in conjunction with the financial
statements appearing elsewhere in this Form 10-Q and within our Form 10-K for
the year ending December 31, 2000. This report contains forward-looking
statements, within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of various factors, including
those discussed below under the heading "Risk Factors," and other factors
detailed in the Company's filings with the Securities and Exchange Commission,
specifically our Form 10-K for the year ending December 31, 2000.

Overview

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

     Since 1996, we have focused our efforts and financial resources primarily
on the design and development of our CleanSource(R) line of power quality
products and on establishing effective OEM channels to market our products. As
of March 31, 2001, we had generated an accumulated deficit of $59.4 million and
expect to continue to sustain operating losses for the next several quarters. We
initially funded our operations through sales of shares of our preferred stock,
which have resulted in gross proceeds of approximately $42.6 million. We believe
the proceeds from our August 2000 initial public offering, approximately $138.4
million net of commissions and issuance costs, together with cash balances on
hand prior to August 2000 will be sufficient to meet our capital requirements
through at least the next 24 months. Our cash and investments position at March
31, 2001 was $137.0 million.

     Since our inception, a small number of customers have accounted for the
majority of our annual sales. During 1999, our four largest customers accounted
for 89% of our sales, with our largest customer, Caterpillar and its dealer
network, accounting for 39%. In 2000 and the first quarter of 2001, our business
level with Caterpillar and its dealer network grew substantially, accounting for
96% and 78% respectively of our revenue due to the commercial introduction of
the CleanSource UPS product line. We expect to continue to be dependent on a few
OEM customers, primarily Caterpillar, for the majority of our sales for the
foreseeable future.

                                       6
<PAGE>

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

     .     expand our manufacturing facilities and add manufacturing personnel
           to address anticipated increases in product demand;

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

     .     add sales and marketing personnel to support our OEM customers.

     We believe that although these efforts will increase our operating
expenses, they will also enable us to realize significant revenue growth.


Results of Operations

     Product Revenue. Product revenue primarily consists of sales of our
CleanSource power quality products. Sales increased $4.9 million to $5.1 million
for the three months ended March 31, 2001 from $182,000 for the three months
ended March 31, 2000. This increase was primarily attributable to a ramp up in
the sales of our recently launched CleanSource UPS product line. In the three
months ended March 31, 2001, we sold 101 quarter-megawatt flywheel units. The
majority of these units were sold to our CleanSource UPS distribution partner,
Caterpillar.

     Cost of goods sold. Cost of goods sold includes the cost of component parts
of our product that are sourced from suppliers, personnel, equipment and other
costs associated with our assembly and test operations, shipping costs, and the
costs of manufacturing support functions such as logistics and quality
assurance. Cost of goods sold increased $6.0 million to $6.5 million for the
three months ended March 31, 2001 from $521,000 for the three months ended March
31, 2000. This increase was primarily due to product costs that grew
commensurate with the increase in sales and a scale up in our manufacturing
operations. In anticipation of future demand for our products, we plan to
significantly expand our manufacturing capacity by increasing both our
manufacturing facilities and production personnel, which will increase our
manufacturing cost base. We believe gross margins will improve over time as our
product volumes increase, and we achieve greater economies of scale in
production and in purchasing component parts, and introduce engineering design
savings.

     Research and development. Research and development expense primarily
consists of compensation and related costs of employees engaged in research,
development and engineering activities, third party consulting and development
activities, as well as an allocated portion of our occupancy costs. Research and
development expense increased $2.0 million, or 142%, to $3.5 million for the
three months ended March 31, 2001 from $1.5 million for the three months ended
March 31, 2000. The increase in research and development expense was primarily
due to an increase in product development activities on our next generation 6
kilowatt continuous power system. We believe that research and development
expense will continue to increase during 2001 and thereafter as we continue to
develop new products and enhance existing product lines.

                                       7
<PAGE>

     Selling, general and administrative. Selling, general and
administrative expense is primarily comprised of compensation and related costs
for sales, marketing and administrative personnel, selling and marketing
expenses, professional fees and reserves for bad debt. Selling, general and
administrative expense increased approximately $1.6 million, or 150%, to $2.7
million for the three months ended March 31, 2001 from $1.1 million for the
three months ended March 31, 2000. The increase in selling, general and
administrative expense was principally due to increased personnel in our sales
and marketing organizations in order to support our main OEM channel partner's
sales and service ramp up of the CleanSource UPS product line. We also incurred
higher administrative costs associated with the added responsibilities and
reporting requirements of a pubic company. We believe that selling, general and
administrative expense will increase in future periods as we add sales,
marketing and administrative personnel and costs to position us for future sales
growth and to assist in the administration of an expanding work force.

     Amortization of deferred stock compensation. Deferred stock
compensation reflects the difference between the exercise price of option grants
to employees and the estimated fair value determined subsequently by us of our
common stock at the date of grant. We are amortizing deferred stock compensation
as an operating expense over the vesting periods of the applicable options,
which resulted in amortization expense of $1.3 million for the three months
ended March 31, 2001 and $1.3 million for the three months ended March 31, 2000.
We expect the amortization expense to decrease during and after 2001, as the
options that were granted at exercise prices less than the estimated fair value
determined subsequently by us become fully vested.

     Interest income. Interest income increased $1.9 million to $2.2 million for
the three months ended March 31, 2001 from $370,000 for the three months ended
March 31, 2000. This is primarily due to the increase in our average cash
balance for the three month period of 2001 of $140.6 million compared to an
average cash and investments balance of $24.1 million for the first quarter of
2000. The increase in our cash and investments balance is primarily associated
with the approximately $138.4 million raised as part of our August 2000 initial
public offering.

     Change in fair value of warrants. Due to the redemption feature of warrants
we had outstanding in 1999 and 2000, we recorded a liability associated with the
fair value of the warrants on the balance sheet and recorded changes in fair
value of the warrants in expense. We calculated the fair value of the warrants
using a Black-Scholes pricing model. In 2000, the fair value of the underlying
common stock increased substantially, resulting in an increase in the warrant
value and corresponding expense. Expense recorded for the three months ended
March 31, 2001 was $0 and $1.0 million for the same period in 2000 as a result
of the conversion of the warrants to common stock as part of our initial public
offering.

Liquidity and Capital Resources


     Our principal source of liquidity as of March 31, 2001 consisted of
$137.0 million of cash, cash equivalents and investments.

     In August 2000, we completed a successful initial public offering, raising
approximately $138.4 million, net of commissions and issuance expenses. This is
in addition to our private financing efforts, including the sale of shares of
our preferred stock, which have resulted in gross

                                       8
<PAGE>

proceeds of approximately $42.6 million, and $5.0 million in development funding
received from Caterpillar in 1999. During the three months ended March 31, 2001,
cash used by operating activities was $8.4 million, which compares to $2.5
million of cash used by operating activities for the three months ended March
31, 2000. The cash usage in each of these periods was primarily attributable to
our focus on the development of products and the expansion of our manufacturing
operations and sales activities.

     Capital expenditures were $1.5 million for the three months ended March 31,
2001 and $589,000 for the three months ended March 31, 2000. We made these
expenditures to acquire engineering test equipment, and to purchase
manufacturing equipment to facilitate production testing, as well as for general
computer equipment and software for administrative purposes. We expect to incur
approximately $6.0 to $10.0 million in additional costs in 2001 primarily on the
build out of our new manufacturing facility.

     We believe our existing cash balance at March 31, 2001 will be sufficient
to meet our capital requirements through at least the next 24 months, although
we might elect to seek additional funding prior to that time. Beyond the next 24
months, our capital requirements will depend on many factors, including the rate
of sales growth, the market acceptance of our products, the rate of expansion of
our sales and marketing activities, the rate of expansion of our manufacturing
facilities, and the timing and extent of research and development projects.
Although we are not a party to any agreement or letter of intent with respect to
a potential acquisition, we may enter into acquisitions or strategic
arrangements in the future which could also require us to seek additional equity
or debt financing.

Quantitative and Qualitative Disclosures About Market Risk


     Our interest income is sensitive to changes in the general level of
U.S. interest rates, particularly because the majority of our investments are in
short-term instruments. We believe that our investment policy is conservative,
both in terms of the average maturity of investments that we allow and in terms
of the credit quality of the investments we hold. We estimate that a 1% decrease
in market interest rates would decrease our interest income by approximately
$1.3 million. Because of the short-term nature of the majority of our
investments, we do not believe a 1% decline in interest rates would have a
material effect on their fair value.

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

                                       9
<PAGE>

Risk Factors That May Affect Future Results

     You should carefully consider the following risks and all other information
contained in this filing before deciding to invest in our common stock.
Additional risks and uncertainties that we are unaware of or that we currently
deem immaterial also may become important factors that affect us.

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

We have incurred operating losses since our inception and expect to continue to
incur losses for the next several quarters. As of March 31, 2001, we had an
accumulated deficit of $59.4 million. To date, our product revenue has been
insignificant, and we have funded our operations principally through the sale of
our stock. We will need to generate significant revenue to achieve
profitability, and we cannot assure you that we will ever realize sufficient
revenue to achieve profitability. We also expect to incur significant product
development, sales and marketing and administrative expenses and, as a result,
we expect to continue to incur losses.

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

We have generated a total of $11.9 million in product revenue since January 1,
1998, and we have sold fewer than 275 CleanSource DC and CleanSource UPS
products. We are uncertain whether our products will achieve market acceptance
such that our revenues will increase or whether we will be able to achieve
significant revenue. Therefore, we have a very limited ability to predict future
revenue. Our limited operating experience, the uncertain market acceptance for
our products, and other factors that are beyond our control make it difficult
for us to accurately forecast our quarterly and annual revenue. However, we use
our forecasted revenue to establish our expense budget. Most of our expenses are
fixed in the short term or incurred in advance of anticipated revenue. As a
result, we may not be able to decrease our expenses in a timely manner to offset
any revenue shortfall. Further, we are expanding our staff and facilities and
increasing our expense levels in anticipation of future revenue growth. If our
revenue does not increase as anticipated, we will incur significant losses.

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

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

     .  the timing of orders from our customers and the possibility that these
        customers may change their order requirements with little or no advance
        notice to us;
     .  the rate of adoption of our fly-wheel-based energy storage system as an
        alternative to lead-acid batteries;

                                       10
<PAGE>

     .  the deferral of customer orders in anticipation of new products from us
        or other providers of power quality systems;
     .  the ongoing need for short-term power outage protection in traditional
        UPS systems;
     .  the uncertainty regarding the adoption of our current and future
        products, including our recently introduced CleanSource UPS product and
        our fully integrated CPS, which we expect to commercially introduce by
        the end of 2001; and
     .  the rate of growth of the markets for our products.


Our business is dependent on the market for power quality products, and if this
market does not expand as we anticipate, or if alternatives to our products are
successful, our business will suffer.

The market for power quality products is rapidly evolving and it is difficult to
predict its potential size or future growth rate. Most of the organizations that
may purchase our products have invested substantial resources in their existing
power systems and, as a result, may be reluctant or slow to adopt a new
approach. Moreover, our products are alternatives to existing UPS and CPS
systems and may never be accepted by our customers or may be made obsolete by
other advances in power quality technologies. Improvements may also be made to
the existing alternatives to our products that could render them less desirable
or obsolete.


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

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


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

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

                                       11
<PAGE>

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

If our relationship with Caterpillar is not successful, or if Caterpillar's
distribution of our CleanSource UPS product is not successful, our business and
revenue will suffer. Pursuant to a development agreement, Caterpillar provided
us with $5.0 million in funding to support the development of our CleanSource
UPS product. In exchange for this payment, Caterpillar received co-ownership of
the proprietary rights in this product. Either we or Caterpillar may license to
other entities the intellectual property that we jointly own without seeking the
consent of the other and all licensing revenue generated by licensing this
intellectual property will be solely retained by the licensing party. However,
we may not license the joint intellectual property to specifically identified
competitors of Caterpillar until January 1, 2005. Caterpillar may terminate this
agreement at any time by giving us 90 days' advance written notice. We also have
a distribution agreement with Caterpillar. In 2000 and the first quarter of
2001, our business level with Caterpillar and its dealer network accounted for
96% and 78% of our product revenue, respectively. Pursuant to the distribution
agreement with Caterpillar, they are the exclusive distributor, subject to
limited exceptions, of our CleanSource UPS product. Caterpillar is not obligated
to purchase any CleanSource UPS units.

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

We rely on OEMs as a primary distribution channel because they are able to sell
our products to a large number of end user organizations. We further rely on our
OEMs to provide service and support to the end users of our products because
they have the experience and personnel to perform such activities. We believe
that the use of OEM channels will enable our products to achieve broad market
penetration, while we devote a limited amount of our resources to sales,
marketing and customer service and support. Our operating results in the
foreseeable future will continue to depend on sales to a relatively small number
of OEM customers, primarily Caterpillar. For example, in 2000 and the first
quarter of 2001, our business level with Caterpillar and its dealer accounted
for 96% and 78% of our revenue, respectively. Therefore, the loss of our key OEM
customer, Caterpillar, or a significant reduction in sales to Caterpillar and
its dealers, would significantly reduce our revenue. We also have granted
Caterpillar semi-exclusive worldwide rights to distribute our CleanSource UPS
product, provided that they meet minimum annual sales requirements. These
restrictions will further increase our dependence upon Caterpillar. However,
Caterpillar is not obligated to purchase any CleanSource UPS units under this
agreement.

We may have difficulty managing the expansion of our operations.

We are undergoing rapid growth in the number of our employees, the size of our
physical facilities and the scope of our operations. For example, we had 38
employees on January 1, 1998, 126 employees on June 30, 2000 and 202 employees
on March 31, 2001. Such rapid expansion is likely to place a significant strain
on our senior management team and other resources. Our business, prospects,
results of operations or financial condition could be harmed if we encounter

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difficulties in effectively managing the budgeting, forecasting and other
process control issues presented by such a rapid expansion.

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

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

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

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

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

We purchase a power module and a microprocessor for our products from sole
sources. We do not have long-term contracts with most of our suppliers, and to
date most of our component purchases have been made in relatively small volumes.
As a result, if our suppliers receive excess demand for their products, we may
receive a low priority for order fulfillment as large volume customers will
receive priority. If we are delayed in acquiring components for our products,
the manufacture and shipment of our products also will be delayed. We generally
use a twelve-month forecast of our future product sales to determine our
component requirements. Lead times for ordering materials and components vary
significantly and depend on factors such as specific supplier requirements,
contract terms, the extensive production time required and current market demand
for such components. Some of these delays may be substantial. As a

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<PAGE>

result, we purchase these components in large quantities to protect our ability
to deliver finished products. If we overestimate our component requirements, we
may have excess inventory, which will increase our costs. If we underestimate
our component requirements, we will have inadequate inventory, which will delay
our manufacturing and render us unable to deliver products to customers on
scheduled delivery dates. If we are unable to obtain a component from a supplier
or if the price of a component has increased substantially, we will be required
to manufacture the component internally, which will result in delays.
Manufacturing delays could negatively impact our ability to sell our products
and could damage our customer relationships.

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

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

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

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

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

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<PAGE>

or decrease our market share. These and other competitive pressures could
prevent us from competing successfully against current or future competitors and
could materially harm our business.

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

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

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

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

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

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

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

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

Although we are not currently negotiating any material business or technology
acquisitions, as part of our growth strategy, we intend to review opportunities
to acquire other businesses or technologies that would complement our current
products, expand the breadth of our markets or

                                       15
<PAGE>

enhance our technical capabilities. We have no experience in making
acquisitions. Acquisitions entail a number of risks that could materially and
adversely affect our business and operating results, including:

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

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

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


Our stock price may be volatile.

Since our IPO in August 2000, we have experienced significant volatility in our
stock price. The market price of our common stock may fluctuate significantly in
response to numerous factors, some of which are beyond our control, including
the following:
     .  actual or anticipated fluctuations in our operating results;
     .  changes in financial estimates by securities analysts or our failure to
        perform in line with such estimates;
     .  changes in market valuations of other technology companies, particularly
        those that sell products used in power quality systems;
     .  announcements by us or our competitors of significant technical
        innovations, acquisitions, strategic partnerships, joint ventures or
        capital commitments;
     .  introduction of technologies or product enhancements that reduce the
        need for flywheel energy storage systems;
     .  the loss of one or more key OEM customers; and
     .  departures of key personnel.


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<PAGE>

                              ACTIVE POWER, INC.

                                    PART II


Item 1.   Legal Proceedings.

          Not applicable.

Item 2.   Changes in Securities and Use of Proceeds.

     Our registration statement (Registration No. 333-36946) under the
     Securities Act of 1933, as amended, relating to our initial public offering
     of our common stock became effective on August 7, 2000.  A total of
     9,200,000 shares of common stock were registered.  We sold a total of
     8,900,000 shares of our common stock and a selling shareholder sold 300,000
     shares to an underwriting syndicate.  The managing underwriters were
     Goldman, Sachs & Co., Merrill Lynch, Pierce Fenner & Smith Incorporated,
     Morgan Stanley & Co. Incorporated and CIBC World Markets Corp.  The
     offering commenced and was completed on August 8, 2000, at a price to the
     public of $17.00 per share.  The initial public offering resulted in net
     proceeds to us of $138.4 million after deducting underwriting commissions
     of $10.6 million and offering expenses of $2.2 million.  The Company has
     used approximately $3.7 million of the net offering proceeds for capital
     expenditures and $17.0 million for operating activities. The remaining
     proceeds from the IPO were invested in government securities and other
     short-term, investment-grade, interest bearing instruments.

Item 3.   Defaults Upon Senior Securities.

          Not applicable.

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

          Not applicable.

Item 5.   Other Information.

          Not applicable.

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

          Not applicable.

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<PAGE>

                                  SIGNATURES*

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


                                                 ACTIVE POWER, INC.
                                       _____________________________________
                                                    (REGISTRANT)


                                           /s/ Joseph Pinkerton, III
_______________________________        _____________________________________
         May 11, 2000                          Joseph Pinkerton, III
                                       President and Chief Executive Officer


                                                /s/ David S. Gino
_______________________________        _____________________________________
         May 11, 2000                               David S. Gino
                                               Chief Financial Officer




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