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

                               ----------------

                                   Form 10-K

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

                  For the fiscal year ended December 31, 2000

                        Commission file number 000-30939

                               ----------------

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

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

            11525 Stonehollow Drive, Suite 110, Austin, Texas 78758
          (Address of principal executive offices, including Zip Code)

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

        Securities registered pursuant to Section 12(b) of the Act: None

          Securities registered pursuant to Section 12(g) of the Act:

                    Common Stock, par value $0.001 per share
                             (Title of each class)

   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

   Indicated by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

   The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 1, 2001, based upon the closing sale price of Common
Stock on such date, as reported on the Nasdaq National Market, was
approximately $581.3 million (affiliates being, for these purposes only,
directors, executive officers and holders of more than 5% of the Registrant's
Common Stock).

   As of March 1, 2001, the Registrant had 39,257,420 outstanding shares of
Common Stock.

                      Documents Incorporated by Reference:
  (Specific pages incorporated are indicated under the applicable Item herein)

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<CAPTION>
                                                                 Incorporated
                                                                  by Reference
                                                                  in Part No.
                                                                 -------------
<S>                                                              <C>
Our proxy statement filed in connection with our 2001 Annual
 Meeting of Stockholders........................................      III
</TABLE>

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                               Active Power, Inc.

   Unless otherwise indicated, "we," "us," "our," and "Active Power" mean
Active Power, Inc., including our predecessor Texas corporation. We own the
trademarks CLEANSOURCE(R) and MAKING ELECTRICITY BETTER(R). All other
trademarks, tradenames or service marks referred to in this document are the
property of their respective owners. References in this document to "$" or
"dollars" are to United States of America currency.

                               ----------------

                               Table of Contents

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<S>                                                                         <C>
Table of Contents..........................................................   i
Special Note Regarding Forward-Looking Statements..........................  ii


PART I.....................................................................   1


  ITEM 1. Business.........................................................   1
  ITEM 2. Properties.......................................................  19
  ITEM 3. Legal Proceedings................................................  19
  ITEM 4. Submission of Matters to a Vote of Security Holders..............  19


PART II....................................................................  20


  ITEM 5. Market for Registrant's Common Equity and Related Stockholder
   Matters.................................................................  20
  ITEM 6. Selected Financial Data..........................................  21
  ITEM 7. Management's Discussion and Analysis of Financial Condition and
         Results of Operations.............................................  22
  ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk......  25
  ITEM 8. Financial Statements and Supplementary Data......................  25
  ITEM 9. Changes in and Disagreements With Accountants on Accounting and
         Financial Disclosure..............................................  25


PART III...................................................................  26


  ITEM 10. Executive Officers of the Registrant............................  26
  ITEM 11. Executive Compensation..........................................  27
  ITEM 12. Security Ownership of Certain Beneficial Owners and Management..  27
  ITEM 13. Certain Relationships and Related Transactions..................  27


PART IV....................................................................  28


  ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-
   K.......................................................................  28
</TABLE>

                       Note on Incorporation by Reference

   Throughout this report, various information and data are incorporated by
reference to portions of our 2001 Proxy Statement. Any reference in this report
to disclosures in our 2001 Proxy Statement shall constitute incorporation by
reference of that specific material into this Form 10-K.

                                       i
<PAGE>

               Special Note Regarding Forward-Looking Statements

   This document contains forward-looking statements that involve substantial
risks and uncertainties, such as statements concerning:

  . industry trends;

  . customer demand for our products;

  . growth and future operating results;

  . developments in our markets and strategic focus;

  . expansion of and enhancements to our manufacturing and engineering
    facilities and product offerings;

  . customer benefits attributable to our products;

  . potential acquisitions and joint ventures and the integration of acquired
    businesses;

  . technologies and operations;

  . strategic relationships with third parties; and

  . future economic, business and regulatory conditions.

   You can identify these statements by forward-looking words such as "may,"
"will," "expect," "intend," "anticipate," "believe," "estimate," "continue" and
other similar words. You should read statements that contain these words
carefully because they discuss our future expectations, make projections of our
future results of operations or financial condition, or state other "forward-
looking" information. We believe that it is important to communicate our future
expectations to our investors. However, there may be events in the future that
we are not able to accurately predict or control. The factors listed in the
sections captioned "Additional Factors That May Affect Future Results" in Item
1 of this report and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Item 7 of this report, as well as any
cautionary language in this annual report, provide examples of risks,
uncertainties and events that may cause our actual results to differ materially
from the expectations we described in our forward-looking statements.

                                       ii
<PAGE>

                                     PART I

ITEM 1. Business.

Overview

   We design, manufacture and market battery-free 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 that
is marketed under the Caterpillar brand name. 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 rapidly growing
telecommunications industry.

Industry Background

 Power Requirements of the New Economy

   The worldwide demand for high quality electricity has been increasing
rapidly in recent years, driven in large part by growth in the use of
computers, the Internet, on-line transactions and the telecommunications
infrastructure. Industry sources have estimated that the share of all U.S.
electricity consumed by computer-based microprocessors is 13% and that within
the next two decades up to 50% of the nation's electricity supply may support
the direct and indirect needs of the Internet.

   As the proliferation of sophisticated digital electronics grows and the
dependence on high performance computing and networked systems increases, the
need for very high levels of quality power and reliable power becomes
paramount. However, despite this increasingly dramatic change in the mix of
electricity demand, the distribution system used to provide power has not
changed. The power delivered over the electric utility grid today is subject to
power disturbances, such as voltage sags and surges, and power outages. These
disturbances, while typically lasting less than two seconds, can have
significant financial and operational effects on companies doing business in
the digital economy.

                            [GRAPHIC APPEARS HERE]

   [Description of Graphic: This graphic depicts sine waves representing both
the types of problems with power supplied from the electric utility grid and the
desired sine wave for "Reliable, Quality Electric Power". The first graphic on
the far left is titled "Reliability Problem" and shows a steady sine wave that
turns into a straight line. Above the straight line is the word "Outage" with an
arrow pointing at the straight line. In the middle of the graphic under "Power
Quality Problems" are two sine waves. The top sine wave has smaller peaks and
valleys in the middle of the sine wave. Above the middle of the sine wave are
the words "Voltage Sag" with an arrow pointing at the center of the sine wave.
The bottom sine wave has larger peaks and valleys in the middle of the sine
wave. Above the middle of the sine wave are the words "Voltage Surges" with an
arrow pointing at the center of the sine wave. On the right side of the diagram
is a smooth, continuous sine wave which is labeled "Reliable, Quality Electric
Power".]

   The highly publicized recent power outages in California, as well as in a
number of major cities in the U.S., has highlighted the increasing likelihood
of costly interruptions and the need to seek continuous electric power
protection. Power disturbances are a significant concern for everything from
the computers used in modern commercial and industrial processes to
telecommunications equipment. Leaving these devices unprotected from
disturbances can have significant and negative impacts on the power user. A
1999 study by the Electric Power Research Institute estimated that electric
power problems annually cost U.S. industry more than $30 billion in lost data,
material and productivity. Even the loss of quality power for one second at a
semiconductor manufacturing plant can result in the loss of millions of
dollars. As the digital economy grows, avoiding network and equipment downtime
due to power-related problems will become even more important.

   Electric utilities are dependent on the existing utility grid for
transmission and distribution of electric power. The electric utility grid is
unable to provide high quality, uninterrupted power due in large part to being

                                       1
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exposed to severe weather, animals, accidents and other external events. While
substantial upgrades and other investment could improve overall utility grid
reliability, the absolute level of power quality required for these
sophisticated electronic applications remains difficult to achieve without
local uninterrupted power protection close to the point of use.

 Power Quality Systems: Uninterruptible Power Supplies and Continuous Power
 Systems

   Currently, there are a variety of approaches that attempt to address the
deficiencies of power delivered by the electric utility grid. Conventional
power quality systems have been constructed from an array of devices, including
batteries for short-term power disturbances, engine generators, commonly
referred to as "gensets," for longer-term outages, and control electronics to
bridge the two. A short-term (seconds to minutes) energy storage device with
control electronics is referred to as an uninterruptible power supply, or UPS.
A UPS coupled with a genset to protect against longer-term outages (minutes to
hours or days) is referred to as a continuous power system, or CPS.

   A UPS protects sensitive systems from sags, surges and other temporary
interruptions in utility-supplied power. A UPS consists of solid-state switches
and electronics that are connected to both the electric utility grid and a
back-up power source, typically lead-acid batteries. The UPS electronics
monitor the power from the electric utility grid. If the UPS determines that
the power being supplied from the grid is unacceptable or that insufficient
power is being supplied, it will draw power from the back-up power source to
ensure uninterrupted, quality power. These systems typically provide 5 to 15
minutes of back-up power before the batteries are depleted.

   A CPS provides back-up power indefinitely. As described above, if the UPS
determines that there is a power quality or power reliability problem, it
initially turns to the back-up power source. If, however, the disturbance lasts
for an extended period (typically, more than 5 to 10 seconds), the CPS genset
is activated and begins to provide back-up power. Internet service providers,
data processing centers, semiconductor plants, cellular phone sites and fiber
nodes all use CPS to keep critical business equipment operating when electric
utility grid power falters.

   The following diagrams depict a conventional UPS and CPS:

                            [GRAPHIC APPEARS HERE]

   [Description of graphic: The graphic on the left depicts a "Conventional UPS
System". From the left side of the graphic is an arrow pointed to the center of
the graphic with the caption "Electric Power from Utility" beneath the arrow.
The arrow points to a box in the center of the graphic with the caption
"Uninterruptible Power Supply Electronics" inside the box. Beneath the box and
connected to the box with a line is another box with the caption "Lead Acid
Battery for short term power (seconds to minutes)" inside the box. From the
center box is an arrow pointed to the right side of the graphic with the caption
"Uninterruptible Power to Customer" beneath the arrow. Beneath this graphic is
the following text "Electric power from the electric utility passes through the
UPS to the customer. If this power is interrupted or is disturbed, the UPS
immediately draws power from the battery to supply uninterrupted power to
customer".

   The graphic on the right depicts a "Conventional CPS System". From the left
side of the graphic is an arrow pointed to the center of the graphic with the
caption "Electric Power from Utility" beneath the arrow. The arrow points to a
box in the center of the graphic with the caption "Uninterruptible Power Supply
Electronics" inside the box. Above the box and connected to the center box with
a line is an oval with the caption "Generator" inside the oval and the caption
"long term power (minutes to days)" to the left of the oval. Beneath the center
box and connected to the center box with a line is another box with the caption
"Lead Acid Battery for short term power (seconds to minutes)" inside the box.
From the center box is an arrow pointed to the right side of the graphic with
the caption "Uninterruptible Power to customer" beneath the arrow. Beneath this
graphic is the following text: "In a CPS configuration, if the power disturbance
lasts longer than a few seconds, the standby generator is started to provide
electric power for as long as required."]

   Electric power from the                    In a CPS configuration, if the
   electric utility passes                    power disturbance lasts longer
   through the UPS to the                     than a few seconds, the standby
   customer. If this power is                 generator is started to provide
   interrupted or is                          electric power for as long as
   disturbed, the UPS                         required.
   immediately draws power
   from the battery to supply
   uninterrupted power to the
   customer.

                                       2
<PAGE>

 Limitations of Conventional UPS and CPS

   Conventional battery-based UPS and CPS devices have evolved out of a
makeshift combination of diesel engines, generators, automobile batteries and
UPS electronics. We believe that this patchwork approach to UPS and CPS has
resulted in systems that are less efficient, less reliable and more expensive
than they otherwise could be. The lead-acid batteries that provide ride-
through, or temporary, power for the UPS and CPS, are viewed as the most
unreliable and most costly element of conventional power quality and
reliability solutions. Lead-acid batteries have numerous problems, including:

 Reliability

  . Relatively high failure rate--Batteries are prone to heat buildup and
    acid leaks that lead to battery failure.

  . Limited life based on usage--When batteries are repeatedly used at close
    to their maximum power output, their power output capacity can rapidly
    decrease, reducing the batteries' effectiveness over time.

 Cost

  . High maintenance--Batteries must be regularly inspected, generally every
    three months, to detect problems. Batteries also require periodic testing
    to determine their power output capacity, which degrades over time.

  . Bulky--Generally, multiple batteries forming banks or strings must be
    used to support UPS functions. They also must be spaced apart to prevent
    uncontrolled heating. Batteries therefore consume valuable space which
    otherwise could be allocated to revenue generating equipment.

  . Frequent replacement required--Regardless of usage, batteries have a
    limited useful life and must be replaced every 2 to 6 years, depending
    upon the type of use, environment and other factors.

  . Temperature sensitivity--Unless cooled by costly air conditioning
    systems, battery life will rapidly degrade.

 Environmental

  . Toxicity--Batteries contain toxic materials such as lead and sulfuric
    acid.

  . Disposal--State and federal environmental regulations governing battery
    disposal are rigorous and costly.

   Beyond the specific problems associated with lead-acid batteries, existing
UPS and CPS contain inefficiencies inherent in any system that was not designed
as an integrated solution. Specifically, the major components of these systems
do not come from a single reliable source. This lack of a single-source
supplier makes installation, maintenance and failure analysis more difficult,
costly and complex. Typically, separate companies manufacture, market and
service the genset, UPS electronics and batteries. The end user must often
assume the responsibility to integrate and monitor the system.

Active Power's Products--Making Electricity Better

   Rather than adopt conventional approaches to power quality systems, we
design new solutions specifically for the power quality market. As a result, we
believe that we create products that are less expensive, more efficient and
more reliable than other systems presently available.

 CleanSource DC

   CleanSource DC is the first commercially viable, non-chemical replacement
for lead-acid batteries used for short-term power in power quality
installations. As opposed to the chemical energy stored by batteries, our

                                       3
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patented flywheel energy storage system stores kinetic energy by spinning
constantly in a patented low-friction environment. When the UPS electronics
detect a power disturbance, CleanSource DC draws upon the power stored as
kinetic energy to generate back-up power. Our CleanSource flywheel energy
storage system is compact, quiet and has demonstrated field proven reliability.

   CleanSource DC can run in conjunction with or can replace battery strings
used in UPS and CPS systems and can replace the batteries now used with fuel
cells and microturbines to meet peak power demands. This system is available in
a variety of delivered power ratings up to 480 kW per flywheel system. We also
can configure the units in parallel to achieve higher power. CleanSource DC has
been designed for much longer service intervals and more extreme environments
than typical lead-acid battery installations. Our first CleanSource DC unit was
placed in service in March 1997. Our installed CleanSource DC units have
accumulated over 400,000 hours of field operation.

 CleanSource UPS

   Building on the technological success of CleanSource DC, we created a
battery-free UPS, CleanSource UPS, which is the primary focus of our current
sales efforts. Historically, a UPS is created by coupling together two
components--a string or strings of batteries and control electronics.
CleanSource UPS integrates UPS electronics and our flywheel energy storage
system into a single power quality solution. CleanSource UPS is contrasted with
a conventional battery-based system in the illustration below.

                            [GRAPHIC APPEARS HERE]

   [Description of graphic: This graphic depicts a comparison of a "Conventional
Battery-Based UPS" and a "CleanSource UPS". The Traditional Battery-Based UPS is
pictured on the left side of the graphic. The left portion of the Traditional
Battery-Based UPS is labeled "battery cabinets" and the right side of the
Traditional Battery-Based UPS is labeled "UPS electronics". Beneath the picture
of the Traditional Battery-Based UPS is the following information: "240 KW UPS
with minimum battery cabinet; Footprint - 37.5 sq. ft., Weight - 13,000 lbs.,
Electrical Efficiency - 92%". The CleanSource UPS is pictured on the right side
of the graphic. Beneath the picture of the CleanSource UPS is the following
information: "250 KW UPS with energy storage; Footprint - 10 sq. ft., Weight -
3,250 lbs., Electrical Efficiency - 98%".]

   The CleanSource UPS design takes advantage of the many component
similarities between CleanSource DC and standard UPS electronics. Each system
requires power conversion electronics, fans for cooling, a frame for structural
support, a user display and data reporting capability, and other overlapping
functions. By combining these functions into a single system, as shown in the
figure below, we can provide a highly reliable power quality solution while
achieving significant cost savings.


                                       4
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                            [GRAPHIC APPEARS HERE]

   [Description of graphic: This graphic depicts "CleanSource UPS System
Efficiencies". The graphic is a ven diagram consisting of two circles which
partially overlap in the middle of the graphic. The circle on the left side of
the graphic is labeled "Energy Storage" at the bottom left. Inside the left
circle on the left side of the circle are the words "flywheel puck". In the
middle of the left circle is the caption "Flywheel Electronics". In the middle
of the graphic where the circles overlap from top to bottom are the words "heat
sinks & fans", "cabinet frame & skins" and "monitoring & display". Above the
overlapping portion of the circles is the caption "System Efficiencies" with an
arrow pointed toward the overlapping portion of the diagram. The circle on the
right side of the graphic is labeled "UPS" at the bottom right. Inside the right
circle on the right side of the circle are the words "bypass switch contactors".
In the middle of the right circle is the caption "UPS Electronics".]

   Due to its unique design, CleanSource UPS can typically match the installed
cost of a conventional battery-based UPS. Due to its high efficiency and long
service life, we believe that the total cost of ownership of CleanSource UPS,
which includes the purchase price, installation, maintenance and energy costs
accumulated over a ten year period, is less than half of that of conventional
battery-free systems. In conjunction with Caterpillar, we designed CleanSource
UPS to be compatible with new and installed standby generators, extending their
application to CPS. As of the end of 2000, we are currently delivering
CleanSource UPS units that span the power range from 250kVA up to 900kVA. We
have plans to further expand the power range of the CleanSource UPS product up
to 3000kVA. Availability of these higher power systems is targeted for the
third quarter of 2001.

 Future Products--Fully Integrated Continuous Power System

   We are developing an advanced continuous power system for the distributed
telecommunications market that combines short and long-term energy storage and
power electronics functionality into one fully integrated system. We believe
the benefits of this fully integrated CPS product will include increased
reliability, lower cost and less maintenance relative to the piecemeal systems
in use today. We anticipate commercial availability of our first CPS product by
the end of 2001.

Our Business Strategy

   Our goal is to become the leading supplier of battery-free power quality and
reliability equipment. Key elements of our strategy include:

 Design, Manufacture And Market Optimal Solutions For Targeted Markets

   We design products for specific markets. Our first products, CleanSource DC
and CleanSource UPS, put this principle into practice. With CleanSource DC, we
created a flywheel product to meet the specific needs of the UPS market. In so
doing, we overcame the design constraints that had hampered preceding flywheel
programs to produce the first commercially viable alternative to lead-acid
batteries. Building on that success, we developed our second product, the
CleanSource UPS, the world's most efficient and compact UPS to specifically
address the market's growing desire for compact and reliable power protection.
We intend to continue to identify market needs for the power industry and
design products to address those specific needs.

 Leverage Our Core Technologies to Develop Next Generation Products

   We intend to continue to use our expertise in advanced electromechanical
technologies, combined with an integrated solutions approach, to create
innovative products that lower the cost and increase the quality of

                                       5
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electric power. We are designing a fully integrated CPS with applications in
the distributed telecommunications power quality and reliability market.

 Distribute and Market our Products through Established OEM Channels

   We believe that working with leading original equipment manufacturers, or
OEMs, enables us to rapidly introduce our products into established customer
and dealer networks and promote the adoption of new technologies. To date, our
most important OEM relationship is with Caterpillar, a worldwide distributor of
the CleanSource UPS product line. Additionally, we have established distributor
relationships with leading UPS OEMs Liebert, Powerware and MGE UPS Systems for
our CleanSource DC product. We intend to continue to use development and
distribution relationships for our future products to achieve rapid market
penetration.

 Leverage Our Relationship with Caterpillar to Achieve Rapid Market Penetration

   We believe that our distribution agreement with Caterpillar allows us to
rapidly penetrate the power quality and reliability market through
Caterpillar's worldwide network of over 200 dealers and over 1,500 branch
outlets. A portion of Caterpillar's large installed base of over 300,000
gensets also provides a significant retrofit opportunity by converting
installed standby systems to CPS with the addition of our CleanSource UPS. Our
relationship with Caterpillar should enhance our credibility among the
generally conservative customers within the power quality and reliability
market. We will continue to examine additional ways to leverage our
relationship with Caterpillar.

 Outsource Components to Rapidly Scale Manufacturing

   We intend to continue to outsource all non-proprietary hardware and
electronics by maintaining and building on multiple supplier relationships so
that we can respond quickly to significant quantity increases. We intend to
focus on the final assembly and testing of our products, decreasing production
cycle times and increasing volume production capability.

 Aggressively Protect Our Intellectual Property

   We seek to aggressively identify and protect our key intellectual property,
primarily through the use of patents. We believe that a policy of actively
protecting intellectual property is an important component of our strategy to
serve as a leading innovator in power quality technology and will provide us
with a long-term competitive advantage.

Market Opportunities

   The Electric Power Research Institute estimates that power disturbances cost
U.S. businesses more than $30 billion each year. According to industry sources,
in 1999 businesses spent in excess of $11.0 billion globally on power quality
and reliability products in an attempt to reduce these losses. Our current
products, CleanSource DC and CleanSource UPS, are targeted at the $5.5 billion
market for UPS. We believe that our products are superior alternatives to
conventional UPS and CPS products and should be able to rapidly penetrate this
growing segment of the power quality industry. With future products, we
anticipate that we will be able to compete in most segments of this market.
   With our current and future products we intend to focus on the following
market opportunities:

 Internet Data Center Market

   A 1999 study conducted by the University of Texas and released by Cisco
Systems, Inc. found that the U.S. Internet economy grew at an estimated average
annual rate of 175% from 1995 to 1998. The June 2000 update to this study also
projected that the Internet economy would grow to $850 billion in 2000, up 62%
from 1999. To support this growth, businesses must construct new advanced data
centers to house the computers and

                                       6
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communications systems required to provide around-the-clock service to their
customers. To ensure continuous 24 x 7 service, power quality equipment
protection is essential.

 Telecommunications Market

   To ensure uninterrupted service, reliable backup power is critical for
wireless base stations, remote switching centers and broadband communications
such as fiber-to-cable and DSL distribution. This market for back-up
telecommunications power systems represented approximately $4.0 billion of the
$11.0 billion power quality market in 1999. Conventional CPS systems currently
satisfy market demand using a patchwork of gensets, lead-acid batteries and
power electronics. We are designing our next generation product, a fully
integrated CPS, to service the specific needs of this market, although we
expect broader market applications in the future. We believe that our fully
integrated CPS will be well positioned to serve this market and will achieve
rapid market penetration.

 Other Power Quality and Reliability Markets

   Industrial. An Electric Power Research Institute study on recurring U.S.
power problems estimated that the average U.S. manufacturing facility
experienced in excess of 20 power disturbances annually. Exacerbating this
problem, manufacturing organizations are employing increasing levels of
automation, especially process and machine control, communications and
computerized optimization of material flow. Even brief power disturbances,
which result in lost material, lost data and worker and plant down time, can be
very expensive. Industries with the potential to suffer significant loss from
power disturbances include semiconductor and pharmaceutical manufacturing,
textiles and precision machining.

   Commercial Facilities. Many commercial facilities such as office buildings,
hotels and university facilities now have a large number of computers or
servers. Historically, these businesses and their personal computer networks
have been unprotected from power disturbances or have only been spot-protected
with a small PC UPS under each person's desk. A single CleanSource UPS system
can protect as few as 200 PCs more cost effectively than many small PC UPS
products.

   Retrofit Market. Caterpillar has the largest installed base of standby
generators, or generators that are not coupled with a UPS, in the world. As
even a brief power outage can cause an extended shutdown of sensitive
electronic equipment, many of the customers that rely on standby generators for
long-term power outages can no longer afford the five to ten second outage
while the generator starts and therefore need to add a UPS for short-term
protection. While a lead-acid battery based UPS can be used to upgrade a
standby generator into a CPS, Caterpillar sells our CleanSource UPS and does
not offer a battery-based UPS. We believe that upgrading, or retrofitting, a
portion of Caterpillar's approximately 300,000 installed gensets worldwide by
adding our CleanSource UPS, thereby creating a CPS, represents a significant
market opportunity.

 Distributed Generation

   Fuel cells and microturbines, which allow users to bypass the electric
utility grid by generating power locally, represent potential markets for our
CleanSource products. These distributed generation technologies currently
cannot respond effectively to rapid changes in electric power demands, or
loads, due to their slow response capability. CleanSource DC can absorb sharp
peaks in electrical demand, allowing a relatively expensive microturbine or
fuel cell to be sized for the average power requirement of the customer. This
combination provides a cost competitive alternative to sizing the fuel cell or
microturbine to handle both peak and average electrical demands. In addition,
CleanSource UPS can seamlessly transfer a customer load from electric utility
grid power to fuel cell or microturbine standby power in the event of a utility
outage.


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Our Relationship with Caterpillar

   We have established a strategic relationship with Caterpillar, granting
Caterpillar the world wide right to distribute CleanSource UPS, which is
marketed as "Cat UPS." Caterpillar is a market leader in new genset sales and
has the largest installed base of existing standby generators in the world. By
offering the Cat UPS with a standby genset, Caterpillar can transform a standby
power system into a CPS. The combined solution reduces maintenance cost and
increases reliability relative to traditional CPS products. Moreover, because
Caterpillar's product line now includes both a UPS and a genset, Caterpillar is
now selling, installing and servicing a complete CPS under a single brand name.
We believe that this total solution gives both Caterpillar and us a significant
competitive advantage in the power quality market. Through Caterpillar's
worldwide dealership and sales force network and its market reputation, we
believe that we will be able to rapidly penetrate the market for our products.

   UPS Development Agreement. We entered into a development agreement with
Caterpillar in January 1999 for the creation and distribution of Cat UPS
marketed under the Caterpillar brand name. Under the development agreement,
Caterpillar provided $5.0 million in funding to support the development of Cat
UPS.

   While we retained sole ownership of the underlying flywheel energy storage
technology, we jointly own with Caterpillar intellectual property associated
with the integration of UPS electronics with CleanSource DC. 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 the joint 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.

   Distribution Agreement. We also have a distribution agreement with
Caterpillar. During 2000, we received approximately $4.7 million, or 96% of our
product revenue, from Caterpillar and its dealer network under this agreement.
The principal provisions of this agreement are summarized below:

  . Caterpillar has semi-exclusive worldwide rights to distribute Cat UPS
    under the Caterpillar brand name;

  . As long as Caterpillar meets minimum annual sales requirements, we will
    not sell Cat UPS to specifically identified competitors of Caterpillar
    until January 1, 2005 or the termination of the distribution agreement;
    and

  . We will provide Caterpillar the same warranty Caterpillar provides its
    customers procuring electric power generation products (one year from
    delivery).

   Caterpillar may continue to distribute Cat UPS until January 1, 2005. At
such time the agreement will continue for additional six-month periods unless
either party provides written notice to the other within ninety days of the end
of the current period of its decision not to renew the agreement. The agreement
may also be terminated by Caterpillar for any uncured material breach by us, if
Cat UPS consistently and materially fails to meet our published specifications,
or if we substantially and continuously fail to meet agreed shipment dates for
products ordered by Caterpillar. Finally, either party may terminate in the
event of a change in control of the other.

Sales, Marketing and Support

 Sales and Marketing

   In the power quality industry, we believe that partnering with established
companies with significant relationships and service capabilities enables us to
promote the adoption of new technology that otherwise would take significantly
longer for wide application. Our sales activity has focused principally on OEM
adoption of our products through extensive OEM testing, product qualification
and early product placement with select end users. We intend to continue to
sell through OEMs to gain acceptance of our proprietary and innovative power
technologies. We believe that focusing on product acceptance and support from
OEMs

                                       8
<PAGE>

provides the greatest opportunity for market penetration and sales growth with
minimal resources. We are also expanding our international sales activities
through our multinational OEM sales channels. We employ a small, geographically
dispersed sales force to develop leads and educate our OEM customers in their
sales efforts.

   Our marketing efforts are geared toward developing and sustaining key
relationships with OEMs, participating in tradeshows to promote and launch our
products, and training for the salespeople within the OEM channels. We also
work with OEM partners on promotional activities such as advertising
development, direct mail and telemarketing strategies. We use our marketing
resources to stimulate end user sales through trade press articles,
participation in industry conferences and limited direct mail to specific power
quality customers.

 Service and Support

   We continue to transition the primary service and maintenance of our
products from our own service personnel to the OEMs who sell our products. We
believe that this will reduce the need for a large end user support
organization by enabling our OEMs to provide installation, service and primary
support to their customers. Our service personnel will remain as a back-up for
difficult situations or where no trained personnel are immediately available
and will support initial applications of the products. Our customer service and
support organization also provides comprehensive training programs to our OEM
customers.

Our Customers

   Our primary customers are OEMs. To date, our most significant OEM is
Caterpillar, which distributes CleanSource UPS under its brand name. We intend
to continue to use selected development and distribution partnerships to
develop and distribute our future products into selected markets and achieve
rapid market penetration.

   End use industries for our products include advanced data centers,
semiconductor manufacturers, telecommunication providers, pharmaceutical
manufacturers, hospitals, electric utilities and broadcasters.

   During 2000, Caterpillar and its dealer network accounted for 96% of our
total revenue. No other customer accounted for more than 1% of our revenue
during 2000. Due to Caterpillar's semi-exclusive CleanSource UPS distribution
rights, we anticipate that revenue from Caterpillar will comprise a majority of
our revenue in 2001.

Technology

 Flywheel Energy Storage System

   Our patented flywheel energy storage system stores kinetic energy -- energy
produced by motion -- by spinning a compact rotor constantly in a low-friction
environment. When the user requires short-term back-up power -- i.e. when the
electric power used to spin the flywheel fluctuates or is lost -- the wheel's
inertia causes it to continue spinning. The resulting kinetic energy of the
spinning flywheel generates electricity for short periods. We believe that
relative to other energy storage alternatives, our system provides high
quality, reliable power at the lowest cost.

   Over the past 20 years, attempts at commercializing flywheel systems have
been based on technology used in aerospace applications, such as satellite
momentum control, that attempt to maximize the amount of stored energy with the
absolute minimum system weight. Cost has been a secondary concern for such
applications. As a result of these design goals, these flywheel designs require
extremely high rotational speeds in excess of 50,000 rotations per minute. In
order to achieve such high speeds, the flywheel must be made of expensive
materials, such as composite carbon fiber. As a result, high-speed flywheel
concepts require a number of

                                       9
<PAGE>

expensive safety systems, including extensive inertial containment and "active"
magnetic bearing systems that use sophisticated computer controls to
continuously monitor the position and balance of the flywheel.

   Rather than rely on the flywheel concepts developed for other applications,
we focused our development efforts on providing products that meet the specific
needs of the power quality and reliability market. Users requiring back-up
power products want products that can deliver high quality, reliable power at
the lowest cost. As a result of these needs, we developed a flywheel system
that operates at significantly lower speeds, under 8,000 rotations per minute.
These speeds are comparable to those of automobile engines and industrial
machinery. This lower flywheel speed has allowed us to develop a lower cost
design by using an inexpensive bearing system and conventional steel in place
of expensive composite materials.

   The design of our flywheel system, which is displayed below, integrates the
function of a motor (which utilizes electric current from the electric utility
grid to provide the energy to rotate the flywheel), flywheel rotor (which spins
constantly to maintain a ready source of kinetic energy) and generator (which
converts the kinetic energy of the flywheel into electricity) into a single
integrated system. This integration further reduces the cost of our product and
increases its efficiency.

                            [GRAPHIC APPEARS HERE]

[Description of graphic: This graphic depicts "The CleanSource Flywheel
Technology" and lists the patents we have obtained or filed on the specific
parts of the flywheel system. From the top of the left side of the flywheel to
the bottom, we have listed the following patents: "Magnetic bearing integrated
into field circuit, Patent# US5920138", "Constant voltage regulation, Patent#
US5932935", "Smooth air-gap armature, Patent Pending", High-Power
motor-generator, Patent# US5905321". From the top of the right side of the
flywheel to the bottom, we have listed the following patents: "Ball bearing
cartridge for easy replacement, Patent# US6029538", High inertia motor-generator
rotor, Patent# US5929548" and "Slotless motor-generator stator, Patent#
US5731654, Patent# 5969457".]

   The flywheel rotor is designed to spin in a near frictionless environment by
the use of a low-cost, combination magnetic and mechanical bearing system. The
friction in the spinning chamber is further reduced by the creation of a
partial vacuum, which reduces the amount of air in the chamber that otherwise
creates drag on the flywheel rotor. The flywheel rotor stores energy in the
form of kinetic energy by constantly rotating within the vacuum container. As
the flywheel rotor slows down when a user requires power, the rotor's magnetism
is increased as it rotates past copper coils contained in the armature to
generate constant output power. This enables the flywheel system to provide
between ten and sixty seconds of electricity during power disturbances. While a
lead-acid battery can typically provide back-up power for a much longer period,
this capability usually is not required. Our flywheel-based system can provide
ride-through, or temporary, power for the majority of power disturbances, such
as voltage sags and surges, and can bridge the gap between a power outage and
the time required to switch to generator power.

   We have verified our flywheel design with both internal and external three-
dimensional finite element analysis, as well as tests designed to determine the
flywheel's safety at varying speeds. We test each flywheel rotor with stringent
quality control methods. These tests have demonstrated a factor of safety
consistent with common industrial machines such as large motors and generators.

                                       10
<PAGE>

 The CleanSource Family of Products

   Our unique flywheel energy storage system device is being used in our two
currently offered products: CleanSource DC and CleanSource UPS. The CleanSource
UPS design takes advantage of the many component similarities between the
CleanSource DC and a traditional UPS system. Both products require power
conversion electronics, fans for cooling, a frame for structural support,
telemetry, data reporting, a user display and other overlapping functions. By
combining these functions into a single system, we achieved significant cost
efficiencies.

   The UPS electronics we use in the CleanSource UPS product line are the
latest in power semiconductor devices using highly reliable and efficient
insulated gate bipolar transistors. This results in an efficient, highly
responsive power conditioning system that can protect sensitive customer power
requirements from even the briefest of electric power anomalies. Tightly
integrating these power electronics with our flywheel energy storage system
results in an efficient, compact and cost effective UPS system.

 Generator Start Enhancement

   To enhance the overall system reliability of CleanSource UPS, we have
patented a method to draw power from the flywheel to supply 24 volts of
starting power to a genset to augment or replace the typical starter battery,
which is the cause of most generator start failures. When taking advantage of
this flywheel-sourced starting power, the reliability of the entire CPS
solution is significantly enhanced.

Research and Development

   We believe that our research and development efforts are essential to our
ability to successfully deliver innovative products that address the needs of
our customers as the market for power quality products evolves. Our research
and development team works closely with our marketing and sales team and OEMs
to define product requirements to address the specific needs of the power
quality market. Our research and development expenses were $4.0 million, $4.4
million and $9.9 million in 1998, 1999 and 2000, respectively. We anticipate
maintaining significant levels of research and development expenditures in the
future. At December 31, 2000, our research, development and engineering team
consisted of 54 engineers and technicians.

Manufacturing

   We source all of our components from contract manufacturers to enhance our
ability to scale our operations and minimize cost. This approach allows us to
respond quickly to customer orders while maintaining high quality standards.

   Our internal manufacturing process consists of assembly, functional testing
and quality control of our products. We also test components, parts and
subassemblies obtained from suppliers for quality control purposes.

   We are in the process of implementing long-term agreements with our
suppliers, but currently purchase most of our components on a purchase order
basis. Although we use standard parts and components for our products where
possible, we purchase a particular type of power module from Semikron
International and a microprocessor from Motorola, both of whom are single
source suppliers. If we were unable to obtain these components, we believe it
would take approximately six months to develop a substitute power module and
approximately four months to develop a substitute microprocessor. The power
module from Semikron International is now covered by a long-term agreement and
requires the supplier to maintain a safety stock of power modules in the United
States. We further maintain a two month inventory of such component. Our
requirements for the Motorola microprocessor are covered by purchase orders
into the third quarter of 2001. We further maintain approximately three months
of inventory of the Motorola microprocessor.


                                       11
<PAGE>

   We plan to substantially expand our manufacturing facilities and capacity in
order to support projected volume demand for our products.

Proprietary Rights

   We rely on a combination of patents and trademarks, as well as
confidentiality agreements and other contractual restrictions with employees
and third parties, to establish and protect our proprietary rights. We have
filed over 30 patent applications before the United States Patent and Trademark
Office, 26 of which have issued into patents. Additionally, we have made a
concerted effort to obtain patent protection abroad for Active Power's
technology by continuing to file patent applications in Europe and Asia. Our
patent strategy is critical for preserving our rights in and to the
intellectual property embodied in our CleanSource product line. As a
manufactured, tangible device that is sold rather than licensed, the
CleanSource product line does not qualify for copyright or trade secret
protection. To enforce our ownership of such technology, we principally rely on
the protection obtained through the patents we own, as well as state unfair
competition laws. We intend to aggressively protect our patents, including by
bringing legal actions if we deem it necessary.

   We own the registered trademarks CLEANSOURCE(R) and MAKING ELECTRICITY
BETTER(R) in the United States and have applied for a trademark on our logo.
All other trademarks, service marks or trade names referred to in this report
are the property of their respective owners.

Competition

   The power quality and power reliability markets are intensely competitive.
The principal bases of competition are system reliability, availability, cost,
including initial cost and total cost of ownership, and OEM endorsement and
brand recognition.

   Our CleanSource DC product competes with makers of lead-acid batteries and
groups that are developing their own battery-free technologies. Industry
sources estimate that the U.S. UPS lead-acid battery market was approximately
$400 million in 2000, substantially all of which will be comprised of sales of
lead-acid batteries rather than battery-free technologies designed to replace
lead-acid batteries, such as CleanSource DC. Of the makers of battery-free
products, Piller and International Computer Power are the only companies
currently offering flywheel energy storage systems that directly compete with
the CleanSource DC. The Piller flywheel is only available with Piller's
proprietary UPS system. In the 500 kW and under power range, we believe that we
have a substantial majority of the installed base of flywheel products. In the
overall flywheel market, we believe that we and Piller each have approximately
half of the installed flywheel units. The CleanSource DC is the only flywheel
system that is sold and serviced by the major UPS manufacturers--Powerware,
Liebert and MGE UPS Systems. Examples of other technologies potentially
competitive with CleanSource DC include high-speed composite flywheels, ultra
capacitors and superconducting magnetic energy storage. To date, however, we
believe that none of these technologies has achieved a sufficient presence in
our market to be considered a competitor.

   The CleanSource UPS as distributed by Caterpillar competes with UPS
manufacturers such as Powerware, Liebert and MGE UPS Systems, who also are
CleanSource DC distributors. When sold in conjunction with a standby generator,
the CleanSource UPS competes with battery-free systems from Piller, Hitec and
EuroDiesel. While CleanSource UPS is a new product and we therefore have not
sold a significant number of units, we believe that the high efficiency, broad
power range and compact footprint of the CleanSource UPS, coupled with
Caterpillar's brand recognition and support, will allow us to compete
successfully with these alternatives.

   We expect our future CPS product to compete with batteries, flywheels and
gensets that are used in the telecommunications market from such companies as
C&D Technologies, Beacon, Yuasa, Panasonic, the Hawker division of Invensys and
Generac. While we believe that our future CPS product will offer the
telecommunications market a superior technology to what currently exists, we
may have difficulty competing with the existing product offerings in this
market and may never develop a competitive product offering.

                                       12
<PAGE>

Employees

   At December 31, 2000, we had 167 employees, with 54 engaged in research,
development and engineering, 64 in manufacturing, 19 in sales, 4 in marketing
and customer support, and 26 in administration, information technology and
finance. None of our employees are represented by a labor union. We have not
experienced any work stoppages and consider our relations with our employees to
be good.

                                       13
<PAGE>

               Additional Factors That May Affect Future Results

   You should carefully consider the following risks and all other information
contained in this prospectus 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
years.

   We have incurred operating losses since our inception and expect to continue
to incur losses in the foreseeable future. As of December 31, 2000, we had an
accumulated deficit of $52.7 million. To date, our product revenue has been
insignificant, and we have funded our operations through sales of our stock and
a $5.0 million development funding payment from Caterpillar. 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 $6.8 million in product revenue over the past
three years, and we have sold fewer than 160 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 flywheel-based energy storage system as an
    alternative to lead-acid batteries;

  . 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.

                                       14
<PAGE>

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.

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. During 2000, we received
approximately $4.7 million, or 96% of our product revenue from Caterpillar.
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

                                       15
<PAGE>

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, sales to Caterpillar and its dealer network accounted for 96% of our
revenue. 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 167 employees
on December 31, 2000. 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 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

                                       16
<PAGE>

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
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, 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.

                                       17
<PAGE>

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 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.

                                       18
<PAGE>

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

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

Our stock price may be volatile.

   During 2000, we 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.

ITEM 2. Properties.

   As of December 31, 2000, our corporate headquarters facility, which houses
our administrative, advanced development, engineering, information systems,
marketing, sales and service and support groups, consists of approximately
27,550 square feet in Austin, Texas. We lease our corporate headquarters
facility pursuant to an agreement that expires in March 2003. Our current
manufacturing facility of approximately 42,300 square feet is also located in
Austin, Texas; however, the lease on this facility will expire in September
2001. The total monthly lease payments due for these facilities is
approximately $61,000. Additionally, we have recently signed a lease, which
will be effective in May 2001, for an additional 86,000 square feet of
manufacturing space to replace our existing manufacturing facility. The size of
this facility will increase to approximately 127,000 square feet by the end of
the lease term in May 2005. Our total monthly lease payments will increase by
$40,800 when the lease for this new facility becomes effective.

ITEM 3. Legal Proceedings.

   We are not party to any legal proceedings.

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

   None.

                                       19
<PAGE>

                                    PART II

ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.

   Our common stock has been quoted on the Nasdaq National Market under the
symbol "ACPW" since our initial public offering on August 7, 2000. Prior to the
initial public offering, there had been no public market for our common stock.
The following table lists the high and low per share sales price for our common
stock as reported by the Nasdaq National Market for the periods indicated:

<TABLE>
<CAPTION>
                                                                   High   Low
                                                                  ------ ------
   <S>                                                            <C>    <C>
   Year Ended December 31, 2000
     Third Quarter (from August 7, 2000.......................... $79.75 $17.00
     Fourth Quarter.............................................. $63.50 $12.75
</TABLE>

   As of March 1, 2001, there were 39,257,420 shares of our common stock
outstanding held by 771 stockholders of record.

   We have never declared or paid cash dividends on our capital stock. We
currently intend to retain any earnings for use in our business and do not
anticipate paying any cash dividends in the foreseeable future. Future
dividends, if any, will be determined by our board of directors.

   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 $139.0 million after deducting underwriting commissions of
$10.6 million and offering expenses of $1.6 million. As of January 31, 2001, we
have used $12 million of our available funds. The remaining proceeds from the
IPO were invested in government securities and other short-term, investment-
grade, interest bearing instruments.

                                       20
<PAGE>

ITEM 6. Selected Financial Data.

                            SELECTED FINANCIAL DATA

   The following tables set forth our selected financial data. The data for the
three years ended December 31, 2000, 1999 and 1998 has been derived from the
audited financial statements appearing elsewhere in this document. The data for
the years ended December 31, 1997 and 1996 has been derived from audited
financial statements not appearing in this document. You should read the
selected financial data set forth below in conjunction with our financial
statements and the notes thereto, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and other financial information
appearing elsewhere in this document.

Results of Operations:

<TABLE>
<CAPTION>
                                          Year ended December 31,
                          ------------------------------------------------------------
                             2000         1999         1998        1997        1996
                          -----------  -----------  ----------  ----------  ----------
                                   (In thousands, except per share data)
<S>                       <C>          <C>          <C>         <C>         <C>
Product revenue.........  $     4,872  $     1,047  $      915  $      138         --
Cost of goods sold......        7,966        3,006       1,238         158         --
                          -----------  -----------  ----------  ----------  ----------
Product margin..........  $    (3,094) $    (1,959) $     (323) $      (20)        --
Development funding.....          --         5,000         --          --          --
Operating expenses:
  Research and
   development..........        9,864        4,441       4,045       2,598  $      968
  Selling, general &
   administrative.......        6,205        3,972       1,925       1,264         483
  Amortization of
   deferred stock
   compensation.........        6,692        1,631         --          --          --
                          -----------  -----------  ----------  ----------  ----------
    Total operating
     expenses...........       22,761       10,044       5,970       3,862       1,451
                          -----------  -----------  ----------  ----------  ----------
Operating loss..........      (25,855)      (7,003)     (6,294)     (3,882)     (1,451)
Interest income/expense,
 net....................        4,363          421         305         144         109
Change in fair value of
 warrants with
 redemption rights......       (1,562)      (3,614)        --          --          --
Other income............          (50)           8          10         --          --
                          -----------  -----------  ----------  ----------  ----------
Net loss................  $   (23,104) $   (10,188) $   (5,979) $   (3,738) $   (1,342)
Preferred stock
 dividends, accretion, &
 conversion.............       19,079       29,660       2,789         826         293
Net loss to common
 stockholders...........  $   (42,183) $   (39,848) $   (8,767) $   (4,564) $   (1,635)
                          ===========  ===========  ==========  ==========  ==========
Net loss per share,
 basic and diluted......  $     (1.92) $     (3.98) $    (0.90) $    (0.48) $    (0.17)
Shares used in computing
 net loss per share,
 basic and diluted......   21,928,874   10,009,554   9,789,407   9,589,462   9,426,456
</TABLE>

Balance Sheet Data:

<TABLE>
<CAPTION>
                                            As of December 31,
                                ---------------------------------------------
                                  2000     1999      1998     1997     1996
                                -------- --------  --------  -------  -------
                                               (thousands)
<S>                             <C>      <C>       <C>       <C>      <C>
Cash, cash equivalents and
 investments................... $146,209 $ 26,265  $  7,536  $ 4,340  $ 2,434
Working capital................  136,972   26,394     8,008    4,565    2,470
Total assets...................  156,132   28,366     9,734    5,921    3,002
Long-term obligations, less
 current portion...............      --       --         55      170      --
Redeemable convertible
 preferred stock...............      --    54,235    24,575   11,786    4,960
Total stockholders' equity
 (deficit).....................  152,389  (30,338)  (15,524)  (6,742)  (2,167)
</TABLE>

                                       21
<PAGE>

ITEM 7. 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-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 actual results could differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including those discussed below and elsewhere in this report, particularly
under the heading "Risk Factors." Please also see "Special Note Regarding
Forward Looking Statements."

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). 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 rapidly growing
telecommunications industry.

   Since 1996, we have focused our efforts and financial resources primarily on
the design and development of our CleanSource line of power quality products
and on establishing effective OEM channels to market our products. As of
December 31, 2000, we had generated an accumulated deficit of $52.7 million and
expect to continue to sustain operating losses for the next several years. We
initially funded our operations primarily 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 $139.0 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 December 31, 2000 was $146.2 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, our business level with Caterpillar and
its dealer network grew substantially accounting for 96% 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.

   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.


                                       22
<PAGE>

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

Results of Operations

 Comparison of 2000, 1999 and 1998

   Product Revenue. Product revenue primarily consists of sales of our
CleanSource power quality products. Sales increased $3.9 million, or 365%, to
$4.9 million in 2000 from $1.0 million in 1999. Sales increased $131,000, or
14%, to $1.05 million in 1999 from $915,000 in 1998. Both the 2000 and 1999
increases are attributable to an increase in the sales of our recently launched
CleanSource UPS product line, with initial sales of this new product line
beginning in the fourth quarter of 1999. During 2000 we sold 118 of our
quarter-megawatt flywheel units, compared to 24 in 1999 and 23 in 1998.

   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 $5.0 million, or 165%, to $8.0 million
in 2000 from $3.0 million in 1999. Cost of goods sold increased $1.8 million,
or 143%, to $3.0 million in 1999 from $1.2 million in 1998. Both the 2000 and
1999 increases were primarily attributable to increases in manufacturing
capacity to support an increase in sales volume and an anticipated increase in
demand for our products. We expect that as our product volumes increase over
time, unit production costs will tend to decrease as we achieve greater
economies of scale in production and in purchasing component parts.

   Development funding. Development funding consists of funds received from
Caterpillar to support the development of the CleanSource UPS product. In 1999,
we received $5.0 million in development funding from Caterpillar. We did not
receive any development funding in 2000 or 1998. We do not currently have any
other development funding contracts.

   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 $5.5 million, or 122%, to $9.9 million in
2000 from $4.4 million in 1999. Research and development expense increased
$396,000, or 10%, to $4.4 million in 1999 from $4.0 million in 1998. The
increase in research and development expense was primarily due to the increased
product development of CleanSource UPS and other products including our 6
kilowatt continuous power system. We believe that research and development
expense will continue to increase significantly in 2001 and thereafter as we
continue to develop new products and enhance existing product lines.

   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 $2.2 million, or 56%, to $6.2
million in 2000 from $4.0 million in 1999. Selling, general and administrative
expense increased approximately $2.0 million, or 106%, to $4.0 million in 1999
from $1.9 million in 1998. The 1999 increase in selling, general and
administrative expense was principally due to a charge of $1.4 million related
to warrants we issued to stockholders in conjunction with strategic alliance
agreements we entered into with them relating to their use, evaluation and
feedback of products they agreed to purchase and other business assistance. In
2000, we increased personnel in our sales organization in order to support our
OEM channel partners and to address opportunities for sales of our CleanSource
UPS product line. We believe that selling, general and administrative expense
will increase in future periods as we add sales, marketing and administrative
personnel to position us for future sales growth and to assist in the
administration of an expanding work force and the additional activities
associated with becoming a public company.

                                       23
<PAGE>

   Amortization of deferred stock compensation. Deferred stock compensation is
a non-cash expense that 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 $1.6 million in
1999. No amortization of deferred stock compensation occurred in 1998 as, prior
to 1999, we believe that all options were granted at exercise prices equal to
the fair value of the underlying stock on the date of grant. This amortization
expense increased in 2000 to $6.7 million due to the vesting of options that
were granted in 1999 and 2000. However, we expect the amortization expense to
decrease after 2000, as the options on which we are amortizing deferred stock
compensation become fully vested.

   Interest income/expense. Interest income net of interest expense increased
$3.9 million, or 936%, to $4.4 million in 2000 from approximately $421,000 in
1999. Net interest income/expense increased $116,000, or 38%, to $421,000 in
1999 from $305,000 in 1998. The significant increase in 2000 is primarily due
to increases in our average cash, cash equivalent and investment balances
associated with the approximately $139.0 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 until the initial public offering, 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 earnings. We calculated the
fair value of the warrants using a Black-Scholes pricing model. In 1999 and
2000 the fair value of the underlying common stock increased substantially,
resulting in an increase in the warrant value and corresponding non-cash
expense.

   Preferred stock dividends, accretion and conversion. We recorded non-cash
charges of $19.1 million in 2000 and $7.7 million in 1999 associated with our
redeemable preferred stock to reflect dividend rights and accretion to
redemption value. In 1999, we issued Series E convertible preferred stock at a
lower price than the price which was subsequently determined by the board of
directors to be the fair market value totaling a $22.0 million discount. All of
our preferred stock was converted to common at the time of our initial public
offering.

   Income Tax Expense. As of December 31, 2000, our accumulated net operating
loss carryforward was $30 million. We anticipate that all of this loss
carryforward amount will remain available for offset against any future tax
liabilities that we may incur. However, because of uncertainty regarding our
ability to use these carryforwards, we have established a valuation allowance
for the full amount of our deferred tax assets.

 Liquidity and Capital Resources

   Our principal sources of liquidity as of December 31, 2000 consisted of $146
million of cash and investments. We have primarily funded our operations
through our initial public offering in August 2000, resulting in net proceeds
of $139 million, sales of shares of our preferred stock, which have resulted in
gross proceeds of approximately $43 million, as well as $5 million in
development funding received from Caterpillar in 1999. Cash used in operating
activities in 2000 was $15.3 million, a $12.7 million increase from the
$2.6 million used in 1999. The increased level of cash usage is primarily
attributable to a higher level of product development, and the expansion of our
manufacturing operations and sales activities.

   Capital expenditures were $4.4 million in 2000 and $598,000 and $793,000 in
1999 and 1998, respectively. We made these expenditures to acquire engineering
test equipment, to develop market demonstration units, and to purchase
manufacturing equipment to facilitate production testing, as well as for
general computer equipment and software for administrative purposes, and for
the buildout of additional office, engineering lab and manufacturing space. We
expect to incur $8.0 to $10.0 million in capital expenditures in 2001 primarily
on manufacturing facility improvements, including product test and assembly
equipment, to increase our manufacturing capacity.

                                       24
<PAGE>

   We believe our existing cash balances at December 31, 2000 will be
sufficient to meet our capital requirements through at least the next 24
months, although we may 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.

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.

   Our interest income is sensitive to changes in the general level of U.S.
interest rates, particularly since the majority of our investments are in
short-term instruments. We believe that our investment policy is conservative,
both in terms of the average maturity of investments that we allow and in terms
of the credit quality of the investments we hold. We estimate that a 1%
decrease in market interest rates would decrease our interest income by $1.5
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 instruments, including bank
time deposits, and 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.

ITEM 8. Financial Statements and Supplementary Data.

   The financial statements and supplementary data required by this item is
included in Part IV, Item 14(a) on this Form 10-K and are presented beginning
on page F-1.

ITEM 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.

   None.

                                       25
<PAGE>

                                    PART III

ITEM 10. Executive Officers of the Registrant.

   The following table sets forth, as of December 31, 2000, certain information
concerning our executive officers:

<TABLE>
<CAPTION>
          Name                   Age                 Position(s)
          ----                   ---                 -----------
   <C>                           <C> <S>
   Eric L. Jones...............   65 Chairman of the Board of Directors
   Joseph F. Pinkerton, III....   37 President and Chief Executive Officer
   David S. Gino...............   42 Vice President of Finance, Chief Financial
                                      Officer, Treasurer, and Secretary
   James A. Balthazar..........   47 Vice President of Marketing
   William E. Ott, II..........   45 Vice President of Sales and Service
</TABLE>

   Eric L. Jones has served as the Chairman of our Board of Directors since
March 1995. Since April 1994, he has been a partner with SSM Venture Partners,
L.P., an Austin, Texas-based venture capital firm. Mr. Jones is currently a
director/chairman of several private companies including Motive Communications,
360 Commerce, eTopware and NetBotz. He is also the past chairman of the board
of directors of VTEL Corporation and Tivoli Systems, both of whom became public
corporations during his tenure. During a 25-year career at Texas Instruments,
Mr. Jones managed a Fortune 500-sized business units as a corporate vice
president and Group president. Mr. Jones holds a Ph.D. in mechanical
engineering from the University of Texas at Austin.

   Joseph F. Pinkerton, III, our founder, has served as our Chief Executive
Officer, President and director since August 1992. Mr. Pinkerton formed Active
Power in 1992. Shortly after founding the company, Mr. Pinkerton patented the
world's first room temperature magnetic bearing capable of operating without
electronic controls. Since then, he has brought together a team of experienced
engineers, developed a revolutionary flywheel device and filed over 30 patent
applications covering magnetic bearings, flywheel systems and rotating
electric machinery. From June 1989 to June 1992, Mr. Pinkerton was a principal
with Fundamental Research Company,in Walled Lake, Michigan. While at FRC, Mr.
Pinkerton completed two joint research projects with the University of Texas at
Austin and was awarded a patent for a novel electrical generator. Mr. Pinkerton
received a Bachelor of Arts degree in Physics from Albion College, Albion, MI
in association with Columbia University, New York, N.Y.

   David S. Gino has served as Chief Financial Officer, Vice President of
Finance and Secretary since joining Active Power in December 1999. From August
1995 to November 1999, Mr. Gino was the Chief Financial Officer and Executive
Vice President of Finance of DuPont Photomasks, Inc. (DPI), a public
semiconductor component manufacturer. Mr. Gino led DPI through a period of
rapid growth, numerous acquisitions, its initial public offering and secondary
public financing. Prior to joining DPI, Mr. Gino held a number of financial and
business management positions with The DuPont Company's semiconductor
materials, imaging systems and printing and publishing businesses. Mr. Gino
holds a Bachelor of Arts degree in economics from the University of California
at Santa Barbara and an M.B.A. from the University of Phoenix.

   James A. Balthazar has served as our Vice President of Marketing since
October 1996. Mr. Balthazar is responsible for worldwide marketing activities
at Active Power, including market development, channel development and product
marketing activities. Prior to joining Active Power, Mr. Balthazar held various
management positions, including Vice President of Marketing, during his 12-year
tenure at Convex Computer Corporation, a public supercomputer manufacturer in
Richardson, Texas. He joined Convex as an early employee, prior to the company
becoming public, and assisted in its growth to an over $250 million company
before being purchased by Hewlett Packard in 1995. Before that, he worked as a
consulting engineer for Structural Dynamics Research Corp. (SDRC), Cincinnati,
Ohio, and for University Computing Co. (UCC),

                                       26
<PAGE>

Dallas, Texas. The Maryland native has a Bachelor of Science degree from the
University of Maryland, College Park and a Master's of Science degree in
theoretical and applied mechanics from Cornell University, Ithaca, New York.

   William E. Ott, II has served as our Vice President of Sales and Service
since September 1997. Before Active Power, Mr. Ott held several senior field
management positions in the high technology arena including over nine years
with Convex Computer Corporation, which was acquired in 1995 by Hewlett
Packard. Most recently, Mr. Ott served as General Manager for Eastern United
States, Canada and Latin America at US Data Corp., a public manufacturer of
automation software. From August 1995 to July 1996, he was the Southeastern
Sales Director for Pyramid Technology Corp., a public high performance UNIX
server manufacturer, and from July 1994 to June 1995, he was the Southeastern
United States Sales Manager for Sybase, Inc. Mr. Ott holds a Bachelor of
Science degree in electrical engineering and an M.B.A. from the University of
Missouri at Columbia.

   Further information required by this Item is incorporated by reference to
our Proxy Statement under the sections captioned "Matters to be Considered at
Annual Meeting--Proposal One: Election of Directors" and "Compliance with
Section 16(a) of the Securities Exchange Act of 1934."

ITEM 11. Executive Compensation.

   The information required by this Item is incorporated by reference to our
Proxy Statement under the sections captioned "Executive Compensation and Other
Information" and "Certain Transactions."

ITEM 12. Security Ownership of Certain Beneficial Owners and Management.

   The information required by this Item is incorporated by reference to our
Proxy Statement under the section captioned "Ownership of Securities."

ITEM 13. Certain Relationships and Related Transactions.

   The information required by this Item is incorporated by reference to our
Proxy Statement under the section captioned "Certain Transactions."

                                       27
<PAGE>

                                    PART IV

ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

   (a) The following documents are filed as part of this 10-K:

     1. Financial Statements. The following financial statements of Active
  Power, Inc. are filed as a part of this Form 10-K on the pages indicated:

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Report of Independent Auditors............................................. F-1

Financial Statements:

Balance Sheets............................................................. F-2

Statements of Operations................................................... F-3

Statements of Stockholders' Equity (Deficit)............................... F-4

Statements of Cash Flows................................................... F-5

Notes to Financial Statements.............................................. F-6
</TABLE>

     2. Schedules.

   All schedules have been omitted since the information required by the
schedule is not applicable, or is not present in amounts sufficient to require
submission of the schedule, or because the information required is included in
the Financial Statements and notes thereto.

     3. Exhibits.

<TABLE>
<CAPTION>
 Exhibit
 Number  Description
 ------- -----------
 <C>     <S>
 3.1*    Form of Amended and Restated Certificate of Incorporation (filed as
         Exhibit 3.1 to the Company's IPO Registration Statement on Form S-l
         (SEC File No. 333-36946) (the "IPO Registration Statement")

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

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

 4.2*    Warrant to Purchase Common Stock issued to Enron North America Corp.
         (filed as Exhibit 4.2 to the IPO Registration Statement)

 4.3*    Warrant to Purchase Common Stock issued to Stephens Group, Inc. (filed
         as Exhibit 4.3 to the IPO Registration Statement)

 10.1*   Form of Indemnity Agreement (filed as Exhibit 10.1 to the IPO
         Registration Statement)

 10.2*   Active Power, Inc. 2000 Stock Incentive Plan (filed as Exhibit 10.2 to
         the IPO Registration Statement)

 10.3*   Active Power, Inc. 2000 Employee Stock Purchase Plan (filed as Exhibit
         10.3 to the IPO Registration Statement)

 10.4*   Second Amended and Restated Investors' Rights Agreement by and between
         Active Power, Inc. and certain of its stockholders (filed as Exhibit
         10.4 to the IPO Registration Statement)

 10.5*   Consulting Services Agreement by and between Active Power and Eric L.
         Jones (filed as Exhibit 10.5 to the IPO Registration Statement)
</TABLE>

                                       28
<PAGE>

<TABLE>

<CAPTION>
 Exhibit
 Number  Description
 ------- -----------
 <C>     <S>
 10.6+*  Phase II Development and Phase III Feasibility Agreement by and
         between Active Power, Inc. and Caterpillar Inc. (filed as Exhibit 10.6
         to the IPO Registration Statement)

 10.7*   Credit Terms and Conditions by and between Active Power, Inc. and
         Imperial Bank (filed as Exhibit 10.7 to the IPO Registration
         Statement)

 10.8*   Security and Loan Agreement by and between Active Power, Inc. and
         Imperial Bank (filed as Exhibit 10.8 to the IPO Registration
         Statement)

 10.9*   Lease Agreement by and between Active Power, Inc. and Braker Phase
         III, Ltd. (filed as Exhibit 10.9 to the IPO Registration Statement)

 l0.l0*  First Amendment to Lease Agreement by and between Active Power, Inc.
         and Braker Phase III, Ltd. (filed as Exhibit 10.10 to the IPO
         Registration Statement)

 10.11*  Second Amendment to Lease Agreement by and between Active Power, Inc.
         and Braker Phase III, Ltd. (filed as Exhibit 10.11 to the IPO
         Registration Statement)

 10.12*  Third Amendment to Lease Agreement by and between Active Power, Inc.
         and Braker Phase III, Ltd. (filed as Exhibit 10.12 to the IPO
         Registration Statement)

 10.13*  Fourth Amendment to Lease Agreement by and between Active Power, Inc.
         and Metropolitan Life Insurance Company (filed as Exhibit 10.13 to the
         IPO Registration Statement)

 10.14*  Fifth Amendment to Lease Agreement by and between Active Power, Inc.
         and Metropolitan Life Insurance Company (filed as Exhibit 10.14 to the
         IPO Registration Statement)

 10.15*  Sublease Agreement by and between Active Power, Inc. and Video
         Associates Laboratories, Inc. (filed as Exhibit 10.15 to the IPO
         Registration Statement)

 10.16*  Employee offer letter (including severance arrangements) from Active
         Power, Inc. to David S. Gino (filed as Exhibit 10.16 to the IPO
         Registration Statement)

 10.17   Lease Agreement by and between Active Power, Inc. and BC12 99, Ltd.

 10.18   Sixth Amendment to Lease Agreement by and between Active Power, Inc.
         and Metropolitan Life Insurance Company

 10.19   Seventh Amendment to Lease Agreement by and between Active Power, Inc.
         and Metropolitan Life Insurance Company

 23.1    Consent of Ernst & Young LLP

 24.1    Power of Attorney, pursuant to which amendments to this Form 10-K may
         be filed, is included on the signature page contained in Part IV of
         this Form 10-K
</TABLE>
--------
*  Incorporated by reference to the indicated filing
+  Confidential treatment previously granted

                                       29
<PAGE>

                                   SIGNATURES

   Pursuant to the requirements of Section 13 or 15(d) 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.

                                               /s/ Joseph F. Pinkerton, III,
                                          By:__________________________________
                                                 Joseph F. Pinkerton, III,
                                               President and Chief Executive
                                                          Officer

                               POWER OF ATTORNEY

   KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby severally constitutes and appoints, Joseph F. Pinkerton, III and
David S. Gino, and each or any of them, his true and lawful attorney-in-fact
and agent, each with the power of substitution and resubstitution, for him in
any and all capacities, to sign any and all amendments to this Annual Report on
Form 10-K and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each said attorney-in-fact and agent, or his
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.

   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                 Name                            Title                   Date
                 ----                            -----                   ----

<S>                                    <C>                        <C>
   /s/ Joseph F. Pinkerton, III        President, Chief Executive   March 15, 2001
______________________________________  Officer and Director
       Joseph F. Pinkerton, III         (principal executive
                                        officer)

        /s/ David S. Gino              Vice President of Finance    March 15, 2001
______________________________________  and Chief Financial
            David S. Gino               Officer (principal
                                        financial and accounting
                                        officer)

        /s/ Eric L. Jones              Chairman of the Board of     March 15, 2001
______________________________________  Directors
            Eric L. Jones

     /s/ Richard E. Anderson           Director                     March 15, 2001
______________________________________
         Richard E. Anderson

        /s/ Rodney S. Bond             Director                     March 15, 2001
______________________________________
            Rodney S. Bond

       /s/ Jan H. Lindelow             Director                     March 15, 2001
______________________________________
           Jan H. Lindelow

       /s/ Terrence L. Rock            Director                     March 15, 2001
______________________________________
           Terrence L. Rock
</TABLE>

                                       30
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Active Power, Inc.

   We have audited the accompanying balance sheets of Active Power, Inc. (the
Company) as of December 31, 2000 and 1999, and the related statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

   We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

   In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Active Power, Inc. at
December 31, 2000 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2000, in
conformity with accounting principles generally accepted in the United States.

                                          /s/ Ernst & Young LLP

Austin, Texas
January 18, 2001

                                      F-1
<PAGE>

                               ACTIVE POWER, INC.

                                 BALANCE SHEETS
                (Thousands, except share and per share amounts)

<TABLE>
<CAPTION>
                                                      Year ended December 31,
                                                      ------------------------
                                                         2000         1999
                                                      -----------  -----------
<S>                                                   <C>          <C>
ASSETS

Current assets:
  Cash and cash equivalents.......................... $    92,720  $    24,856
  Short-term investments.............................      42,541        1,409
  Accounts receivable, net...........................       1,934           38
  Inventories, net...................................       2,343          934
  Prepaid expenses and other.........................       1,177            5
                                                      -----------  -----------
    Total current assets.............................     140,715       27,242
Property and equipment, net..........................       4,469        1,124
Long-term investments................................      10,948          --
                                                      -----------  -----------
    Total assets..................................... $   156,132  $    28,366
                                                      ===========  ===========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
  Accounts payable................................... $     2,133  $       196
  Accrued expenses...................................       1,610          597
  Notes payable......................................         --            55
                                                      -----------  -----------
    Total current liabilities........................       3,743          848
Other non-current liabilities........................         --             7
Warrants with redemption rights......................         --         3,614
                                                      -----------  -----------
Total liabilities....................................       3,743        4,469
Redeemable convertible preferred stock, zero and
 7,732,084 shares issued and outstanding in 2000 and
 1999, respectively..................................         --        54,235
Stockholders' equity (deficit):
  1992 Preferred Stock--$.001 par value, $.50
   redemption value: 420,000 shares designated,
   issued and outstanding; $210,000 liquidation
   value.............................................         --           --
  Preferred Stock, par value $.001 per share;
   25,000,000 shares authorized, none issued and
   outstanding.......................................         --           --
  Common Stock--$.001 par value; 400,000,000 shares
   authorized; 39,043,166 and 10,787,126 shares
   issued and outstanding in 2000 and 1999,
   respectively......................................          39           11
  Treasury stock, at cost; 34,599 shares.............          (2)          (2)
  Deferred stock compensation........................      (7,519)      (5,430)
  Additional paid-in capital.........................     212,601          803
  Accumulated deficit................................     (52,730)     (25,720)
                                                      -----------  -----------
    Total stockholders' equity (deficit).............     152,389      (30,338)
                                                      -----------  -----------
    Total liabilities and stockholders' equity
     (deficit)....................................... $   156,132  $    28,366
                                                      ===========  ===========
</TABLE>

                            See accompanying notes.

                                      F-2
<PAGE>

                               ACTIVE POWER, INC.

                            STATEMENTS OF OPERATIONS
                (Thousands, except share and per share amounts)

<TABLE>
<CAPTION>
                                               Year ended December 31,
                                          ------------------------------------
                                             2000         1999         1998
                                          -----------  -----------  ----------
<S>                                       <C>          <C>          <C>
Product revenue.........................  $     4,872  $     1,047  $      915
Cost of goods sold (excludes deferred
 stock compensation amortization of $698
 in 2000 and $195 in 1999)..............        7,966        3,006       1,238
                                          -----------  -----------  ----------
Product margin (loss)...................       (3,094)      (1,959)       (323)
Development funding.....................          --         5,000         --
Operating expenses:
Research and development (excludes
 deferred stock compensation
 amortization of $1,636 in 2000 and $910
 in 1999)...............................        9,864        4,441       4,045
Selling, general and administrative
 (excludes deferred stock compensation
 amortization of $4,358 in 2000 and $526
 in 1999)...............................        6,205        3,972       1,925
Amortization of deferred stock
 compensation...........................        6,692        1,631         --
                                          -----------  -----------  ----------
Total operating expenses................       22,761       10,044       5,970
                                          -----------  -----------  ----------
Operating loss..........................      (25,855)      (7,003)     (6,294)
Interest income.........................        4,365          439         339
Interest expense........................           (2)         (18)        (34)
Change in fair value of warrants with
 redemption rights......................       (1,562)      (3,614)        --
Other income............................          (50)           8          10
                                          -----------  -----------  ----------
Net loss................................  $   (23,104) $   (10,188) $   (5,979)
Cumulative undeclared dividends on
 preferred stock........................       (2,053)      (1,820)     (1,283)
Accretion on redeemable convertible
 preferred stock to redemption amounts..      (17,026)      (5,886)     (1,505)
Beneficial conversion feature on
 preferred stock issuance...............          --       (21,953)        --
                                          -----------  -----------  ----------
Net loss to common stockholders.........  $   (42,183) $   (39,848) $   (8,767)
                                          ===========  ===========  ==========
Net loss per share, basic and diluted...  $     (1.92) $     (3.98) $    (0.90)
Shares used in computing net loss per
 share, basic and diluted...............   21,928,874   10,009,554   9,789,407

Pro forma loss per share, basic and
 diluted, assuming conversion of
 convertible preferred stock to common
 stock (unaudited)......................  $     (0.71)
Shares used in computing pro forma loss
 per share, basic and diluted, assuming
 conversion of convertible preferred
 stock to common stock (unaudited)......   32,462,945
</TABLE>

                            See accompanying notes.

                                      F-3
<PAGE>

                              ACTIVE POWER, INC.

                 STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                  (Thousands)

<TABLE>
<CAPTION>
                           1992
                      Preferred Stock  Common Stock   Treasury Stock                                          Total
                      --------------- --------------- --------------    Deferred   Additional             Stockholders'
                       Number    Par  Number of  Par   Number    At      Stock      Paid-In   Accumulated     Equity
                      of Shares Value  Shares   Value of Shares Cost  Compensation  Capital     Deficit     (Deficit)
                      --------- ----- --------- ----- --------- ----  ------------ ---------- ----------- -------------
<S>                   <C>       <C>   <C>       <C>   <C>       <C>   <C>          <C>        <C>         <C>
Balance at December
31, 1997............     420    $--      9,932   $10      35    $ (2)   $   --      $    --    $ (6,750)    $ (6,742)
Exercise of stock
options.............     --      --        115   --      --      --         --            11        --            11
Preferred stock
issuance costs......     --      --        --    --      --      --         --           (11)       (14)         (25)
Accretion of
redeemable
convertible
preferred stock to
redemption amount...     --      --        --    --      --      --         --           --      (1,505)      (1,505)
Cumulative dividends
on redeemable
convertible
preferred stock.....     --      --        --    --      --      --         --           --      (1,283)      (1,283)
Net loss............     --      --        --    --      --      --         --           --      (5,979)      (5,979)
                         ---    ----   -------   ---     ---    ----    -------     --------   --------     --------
Balance at December
31, 1998............     420     --     10,047    10      35      (2)       --           --     (15,531)     (15,523)
Exercise of stock
options.............     --      --        740     1     --      --         --           134        --           135
Warrants issued for
services............     --      --        --    --      --      --         --         1,380        --         1,380
Preferred stock
issuance costs......     --      --        --    --      --      --         --           (66)       --           (66)
Deferred stock
compensation........     --      --        --    --      --      --      (7,061)       7,061        --           --
Amortization of
deferred stock
compensation........     --      --        --    --      --      --       1,631          --         --         1,631
Accretion of
redeemable
convertible
preferred stock to
redemption amount...     --      --        --    --      --      --         --        (5,886)       --        (5,886)
Cumulative dividends
on redeemable
convertible
preferred stock.....     --      --        --    --      --      --         --        (1,820)       --        (1,820)
Net loss............     --      --        --    --      --      --         --           --     (10,189)     (10,189)
                         ---    ----   -------   ---     ---    ----    -------     --------   --------     --------
Balance at December
31, 1999............     420     --     10,787    11      35      (2)    (5,430)         803    (25,720)     (30,338)
Exercise of stock
options.............     --      --      1,497     2     --      --         --           554        --           556
Exercise of
warrants............     --      --        432   --      --      --         --         5,206        --         5,206
Deferred stock
compensation........     --      --        --    --      --      --      (8,781)       8,781        --           --
Amortization of
deferred stock
compensation........     --      --        --    --      --      --       6,692          --         --         6,692
Accretion of
redeemable
convertible
preferred stock to
redemption amount...     --      --        --    --      --      --         --       (13,712)    (3,314)     (17,026)
Cumulative dividends
on redeemable
convertible
preferred stock.....     --      --        --    --      --      --         --        (1,461)      (592)      (2,053)
Conversion of
redeemable
convertible
preferred stock to
common stock........     --      --     17,462    17     --      --         --        73,296        --        73,313
Net proceeds from
initial public
offering............     --      --      8,900     9     --      --         --       139,134        --       139,143
Net loss............     --      --        --    --      --      --         --           --     (23,104)     (23,104)
                         ---    ----   -------   ---     ---    ----    -------     --------   --------     --------
Balance at December
31, 2000............     420    $--     39,078   $39      35    $ (2)   $(7,519)    $212,601   $(52,730)    $152,389
                         ===    ====   =======   ===     ===    ====    =======     ========   ========     ========
</TABLE>

                            See accompanying notes.

                                      F-4
<PAGE>

                               ACTIVE POWER, INC.

                            STATEMENTS OF CASH FLOWS
                                  (Thousands)

<TABLE>
<CAPTION>
                                                    Year ended December 31,
                                                   ---------------------------
                                                     2000      1999     1998
                                                   --------  --------  -------
<S>                                                <C>       <C>       <C>
Operating activities
Net loss.........................................  $(23,104) $(10,188) $(5,979)
  Adjustment to reconcile net loss to cash used
   in operating activities:
  Depreciation expense...........................     1,066       629      342
  Loss on disposal of assets.....................       --          1      --
  Warrants issued for services...................       --      1,380      --
  Amortization of deferred stock compensation....     6,692     1,631      --
  Changes in fair value of warrants with
   redemption rights.............................     1,562     3,614      --
  Changes in operating assets and liabilities:
    Accounts receivable, net.....................    (1,896)      181     (193)
    Inventories, net.............................    (1,409)     (126)      18
    Prepaid expenses and other assets............    (1,172)       11        7
    Accounts payable.............................     1,937       (57)    (253)
    Accrued expenses.............................     1,013       394      157
    Other non-current liabilities................        (7)      (51)     --
                                                   --------  --------  -------
Net cash used in operating activities............   (15,318)   (2,581)  (5,899)


Investing activities
Net maturity (purchase) of short-term
 investments.....................................   (52,080)    3,327     (965)
Purchases of property and equipment..............    (4,411)     (598)    (793)
                                                   --------  --------  -------
Net cash provided by (used in) investing
 activities......................................   (56,491)    2,729   (1,758)


Financing activities
Payments on notes payable........................       (55)     (114)     (98)
Net proceeds from issuance of common stock.......   139,698       136       11
Proceeds from issuance of convertible preferred
 stock, net of issuance costs....................       --     21,887    9,975
Net proceeds from exercise of warrants...........        30       --       --
                                                   --------  --------  -------
Net cash provided by financing activities........   139,673    21,909    9,888
                                                   --------  --------  -------
Increase in cash and cash equivalents............    67,864    22,056    2,231
Cash and cash equivalents, beginning of period...    24,856     2,800      569
                                                   --------  --------  -------
Cash and cash equivalents, end of period.........  $ 92,720  $ 24,856  $ 2,800
                                                   ========  ========  =======
Supplemental disclosure of cash flow information:
Interest paid....................................  $      2  $     18  $    33
                                                   ========  ========  =======
</TABLE>


                            See accompanying notes.

                                      F-5
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS
                               December 31, 2000

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. Significant Accounting Policies

 Use of Estimates

   The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

 Revenue Recognition

   Active Power recognizes revenue when title transfers and its obligations are
complete, usually when a unit is shipped. Active Power recognizes revenue
related to units shipped for evaluation by the customer at the time of customer
acceptance of the unit.

 Shipping and Handling Costs

   The Company classifies shipping and handling costs as cost of goods sold.

 Cash Equivalents

   Active Power considers liquid investments with a maturity of three months or
less when purchased to be cash equivalents.

 Short-Term and Long-Term Investments

   Short-term and long-term investments consist of debt securities with readily
determinable fair values. Active Power accounts for highly liquid investments
with maturities greater than three months but less than one year at date of
acquisition as short-term investments. Active Power classifies short-term and
long-term investments as available-for-sale. The carrying amount of Active
Power's short-term and long-term investments approximates fair value.

   Short term and long term investments at December 31, 2000 consist of the
following:

<TABLE>
<CAPTION>
                                                      Carrying Value
                                                      --------------
        <S>                                           <C>
        Corporate Notes..............................  $ 4,627,296
        Medium Term Notes............................   11,948,466
        Commercial Paper.............................   36,913,429
                                                       -----------
                                                       $53,489,191
                                                       ===========
</TABLE>


                                      F-6
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS

   The carrying value by contractual maturity, is shown below:

<TABLE>
        <S>                                              <C>
        Due in one year or less......................... $42,540,812
        Due after one year through five years...........  10,948,379
                                                         -----------
                                                         $53,489,191
                                                         ===========
</TABLE>

 Inventories

   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, before reserves, consist of the following:

<TABLE>
<CAPTION>
                                                          December 31,
                                                --------------------------------
                                                   2000       1999       1998
                                                ---------- ---------- ----------
   <S>                                          <C>        <C>        <C>
   Raw materials............................... $2,902,224 $1,287,031 $  662,436
   Work in process.............................    310,330    135,324    197,607
   Finished goods..............................      4,981    295,315     26,381
   Evaluation units............................        --      27,771    183,323
                                                ---------- ---------- ----------
                                                $3,217,535 $1,745,441 $1,069,747
                                                ========== ========== ==========
</TABLE>

   The following table summarizes the changes in inventory reserves:

<TABLE>
        <S>                                                 <C>
        Balance at December 31, 1997....................... $198,475
        Additions charged to costs and expenses............  105,000
        Write-off of inventory............................. (41,001)
                                                            --------
        Balance at December 31, 1998.......................  262,474
        Additions charged to costs and expenses............  549,275
        Write-off of inventory.............................      --
                                                            --------
        Balance at December 31, 1999.......................  811,749
        Additions charged to costs and expenses............   63,118
        Write-off of inventory.............................      --
                                                            --------
        Balance at December 31, 2000....................... $874,867
                                                            ========
</TABLE>

 Property and Equipment

   Active Power carries property and equipment at cost, less accumulated
depreciation. Active Power depreciates property and equipment using the
straight-line method over the estimated useful lives of the assets (generally
three to eight years).

 Other Liabilities

   The Company's other liabilities are made up of the following significant
components at December 31:

<TABLE>
<CAPTION>
                                                               2000      1999
                                                            ---------- --------
   <S>                                                      <C>        <C>
   Compensation and Benefits Accruals...................... $  917,001 $270,552
   Accrued Warranty Liability..............................    167,725   95,214
   Other Accrued Expenses..................................    525,567  231,236
                                                            ---------- --------
                                                            $1,610,293 $597,002
                                                            ========== ========
</TABLE>

                                      F-7
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS


 Patent Application Costs

   Active Power has not capitalized patent application fees and related costs
because of uncertainties regarding net realizable value of the technology
represented by the existing patent applications and ultimate recoverability.
All patent costs have been expensed through December 31, 2000.

 Accounting for Stock-Based Compensation

   As allowed by the Financial Accounting Standards Board's ("FASB") Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, Active Power accounts for its stock compensation arrangements
with employees under the provisions of the Accounting Principles Board's
Opinion No. 25, Accounting for Stock Issued to Employees. Deferred stock-based
compensation is amortized utilizing the accelerated method prescribed in FASB
Interpretation No. 28 over the vesting period which is generally four years.

 Income Taxes

   Active Power accounts for income taxes in accordance with the FASB's
Statement No. 109, Accounting for Income Taxes. Statement No. 109 prescribes
the use of the liability method whereby deferred tax asset and liability
account balances are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.

 Segment Reporting

   Active Power's chief operating decision maker allocates resources and
assesses the performance of its power management product development and sales
activities as one segment.

 Concentration of Credit Risk

   Financial instruments which potentially subject Active Power to
concentrations of credit risk consist of short-term investments and trade
receivables. Active Power's short-term investments are placed with high credit
quality financial institutions and issuers. Active Power performs limited
credit evaluations of its customers' financial condition and generally does not
require collateral. Active Power estimates an allowance for doubtful accounts
based on factors related to the credit risk of each customer. Credit losses
have not been significant to date.

   The following table summarizes the changes in the allowance for doubtful
accounts receivable:

<TABLE>
   <S>                                                                  <C>
   Balance at December 31, 1997........................................ $   463
   Additions charged to costs and expenses.............................   4,577
   Write-off of uncollectible accounts.................................     --
                                                                        -------
   Balance at December 31, 1998........................................   5,040
   Additions charged to costs and expenses.............................  20,936
   Write-off of uncollectible accounts.................................     --
                                                                        -------
   Balance at December 31, 1999........................................  25,976
   Additions charged to costs and expenses.............................  29,514
   Write-off of uncollectible accounts.................................     --
                                                                        -------
   Balance at December 31, 2000........................................ $55,490
                                                                        =======
</TABLE>

                                      F-8
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS


   The following customers accounted for a significant percentage of Active
Power's total revenue as follows:

<TABLE>
<CAPTION>
   Customer                                                      2000 1999  1998
   --------                                                      ---- ----  ----
   <S>                                                           <C>  <C>   <C>
   A............................................................  96%  39%   17%
   B............................................................   1   21   --
   C............................................................ --    16   --
   D............................................................   1   13   --
   E............................................................ --   --     24
   F............................................................ --   --     20
</TABLE>

 Economic Dependence

   The Company is heavily dependent on its relationship with Caterpillar. If
this relationship is unsuccessful, the business and revenue will suffer. The
loss or significant reduction in orders from Caterpillar, or the failure to
provide adequate service and support to the end-users of our products by
Caterpillar, would significantly reduce our revenue. Our operating results in
the foreseeable future will continue to depend on sales to a relatively small
number of OEM customers, primarily Caterpillar.

 Advertising Costs

   Active Power expenses advertising costs as incurred. These expenses were not
material in 2000, 1999 or 1998.

 Net Loss Per Share

   Active Power computes loss per share in accordance with the FASB's Statement
No. 128, Earnings Per Share, and SEC Staff Accounting Bulletin No. 98 ("SAB
98"). Under Statement No. 128 and SAB 98, basic loss per share is computed by
dividing net loss by the weighted average number of shares outstanding. Diluted
loss per share is computed by dividing net loss by the weighted average number
of common shares and dilutive common share equivalents outstanding. Active
Power's calculation of diluted loss per share excludes shares of common stock
issuable upon exercise of warrants and employee stock options because inclusion
would be antidilutive.

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

<TABLE>
<CAPTION>
                                               Year Ended December 31,
                                        ---------------------------------------
                                            2000          1999         1998
                                        ------------  ------------  -----------
<S>                                     <C>           <C>           <C>
Net loss to common stockholders.......  $(42,183,272) $(39,848,010) $(8,767,391)
Basic and diluted:
  Weighted-average shares of common
   stock outstanding..................    22,366,656    10,150,138    9,978,796
  Weighted-average shares of common
   stock subject to repurchase........      (437,782)     (140,584)    (189,389)
                                        ------------  ------------  -----------
Shares used in computing basic and
 diluted net loss per share...........    21,928,874    10,009,554    9,789,407
                                        ============  ============  ===========
Basic and diluted net loss per share..  $      (1.92) $      (3.98) $     (0.90)
                                        ============  ============  ===========
</TABLE>


                                      F-9
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS

3. Property and Equipment

   Property and equipment consist of the following at December 31:

<TABLE>
<CAPTION>
                                              2000         1999         1998
                                           -----------  -----------  ----------
<S>                                        <C>          <C>          <C>
Equipment................................. $ 3,440,102  $ 1,391,233  $1,036,883
Demonstration units.......................     171,252      107,321     107,321
Computers and purchased software..........     943,248      424,525     319,131
Furniture and fixtures....................      66,977       63,037      63,037
Leasehold improvements....................   2,092,050      316,541     179,825
                                           -----------  -----------  ----------
                                             6,713,629    2,302,657   1,706,197
Accumulated depreciation..................  (2,244,392)  (1,178,934)   (550,368)
                                           -----------  -----------  ----------
                                            $4,469,237  $ 1,123,723  $1,155,829
                                           ===========  ===========  ==========
</TABLE>

4. Stockholders' Equity and Preferred Stocks

   At December 31, 1999, Active Power had 10,420,000 shares of $.001 par value
preferred stock authorized and 8,152,084 shares outstanding. Upon closing of
the initial public offering in August 2000, all outstanding shares of Series A,
B, C, D and E redeemable convertible preferred stock were converted into an
aggregate of 17,461,883 shares of the Company's common stock. At December 31,
2000 Active Power has 25,420,000 shares of preferred stock authorized and
420,000 shares outstanding.

 1992 Preferred Stock

   Holders of the 1992 Preferred Stock are not entitled to dividends. The 1992
Preferred Stock shall be redeemed by Active Power at such time as the Board of
Directors determines, in its sole discretion, that Active Power has available
funds in excess of anticipated needs. No dividends may be declared or paid on
Common Stock so long as any shares of 1992 Preferred Stock are issued and
outstanding. The redemption price of the 1992 Preferred Stock is $0.50 per
share.

 Stock Split

   In March 2000, Active Power reincorporated in Delaware. In conjunction with
the reincorporation, all of the $0.01 par value shares held by the common and
preferred stockholders were automatically converted into two $0.001 par value
shares of the corresponding common or preferred stock of the Delaware
corporation. On July 13, 2000, Active Power's Board of Directors approved a
2.16-for-1 common stock split in the form of a dividend of 1.16 shares of
common stock for each share of common stock outstanding on July 20, 2000. All
share and per share amounts in the financial statements and accompanying notes
have been restated to reflect the reincorporation and stock split as if they
had taken place at the inception of Active Power.

 Warrants

   In November 1999, Active Power issued warrants to purchase 432,000 shares of
Common Stock to two purchasers of the Series E Preferred Stock in conjunction
with the placement of preferred stock and strategic alliance agreements with
those stockholders. The warrants have exercise prices of $5.25 per share. The
warrants were fully vested, non-forfeitable and exercisable upon issuance and
expire in November 2006. Active Power estimated the fair value of the warrants
using the Black-Scholes pricing model with the following assumptions: expected
volatility of 50%, expected life of 1 year, expected dividend yield of 0%, and
risk-free rate of 6%. Active Power expensed the estimated fair value of these
warrants of approximately $1.4 million in 1999. The exercise prices of the
warrants is to be adjusted only for capital restructures and stock splits, and
not for subsequent sales of Common Stock. The weighted average exercise price
of warrants outstanding at December 31, 2000 was $5.25 per share. The weighted
average fair value of warrants granted during the year ended December 31, 1999
was $3.19.

                                      F-10
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS


 Stock Option Agreements

   Active Power has reserved 5,636,178 shares of its Common Stock for issuance
under its 2000 Stock Incentive Plan. The options are immediately exercisable
upon grant and vest over periods ranging from immediate to four years. Active
Power has repurchase rights for unvested shares purchased by optionees. At
December 31, 2000, 1999 and 1998, 321,245, 217,957 and 149,066 shares,
respectively, that were purchased by optionees remained unvested and subject to
repurchase.

   A summary of Common Stock option activity during the years ended December
31, 2000, 1999 and 1998 is as follows:

<TABLE>
<CAPTION>
                                 Number of      Range of     Weighted-Average
                                   Shares    Exercise Prices Exercise Prices
                                 ----------  --------------- ----------------
   <S>                           <C>         <C>             <C>
   Outstanding at December 31,
    1997........................  2,371,680  $ .07 --  1.97       $ .15
     Granted....................    699,840    .16 --   .28         .23
     Exercised..................   (114,912)   .07 --   .28         .10
     Canceled...................    (56,160)   .09 --   .16         .16
                                 ----------  --------------       -----
   Outstanding at December 31,
    1998........................  2,900,448  $ .07 --  1.97       $ .18
     Granted....................  1,276,560    .42 --  1.04         .65
     Exercised..................   (739,735)   .07 --   .83         .19
     Canceled...................    (89,346)   .09 --  1.97         .29
                                 ----------  --------------       -----
   Outstanding at December 31,
    1999........................  3,347,927  $ .07 --  1.97       $ .35
     Granted....................  1,294,785   1.04 -- 68.50        5.04
     Exercised.................. (1,496,745)   .07 --  6.94         .37
     Canceled...................   (102,637)   .28 --  6.94        1.65
                                 ----------  --------------       -----
   Outstanding at December 31,
    2000........................  3,043,330  $ .07 -- 68.50       $2.42
                                 ==========  ==============       =====
</TABLE>

   At December 31, 2000, 2,592,848 shares were available for future grants.

   The following is a summary of options outstanding and exercisable as of
December 31, 2000:

<TABLE>
<CAPTION>
                                                            Weighted
                                                             Average
                                                            Remaining  Weighted
                                                           Contractual Average
                                                             Life (in  Exercise
Range of Exercise Prices                          Number      years)    Price
------------------------                         --------- ----------- --------
<S>                                              <C>       <C>         <C>
$  .07--$  .09..................................   242,404     5.5         .08
$  .16--$  .42.................................. 1,147,623     7.3         .23
$  .56--$ 1.39.................................. 1,124,721     8.9         .95
$ 1.85--$ 1.97..................................    30,240     2.9      $ 1.90
$ 4.17--$ 6.94..................................   385,401     9.4      $ 5.39
$17.00--$68.50..................................   112,941     9.8      $34.46
                                                 ---------     ---      ------
                                                 3,043,330     8.1      $ 2.42
                                                 =========     ===      ======
</TABLE>

   Stock options vested as of December 31, 2000, 1999, and 1998 were 1,274,526,
1,458,112, and 1,090,645 respectively.


                                      F-11
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS

   Of the stock options granted to employees during the year ended December 31,
1999, 1,275,480 had exercise prices below the fair value determined
subsequently by the board of directors of the underlying shares of Common Stock
on the date of grant. As a result, Active Power recorded unearned stock
compensation of $7,061,267 of which $1,631,068 was amortized to non-cash
compensation during the year ended December 31, 1999. The remaining unearned
compensation will be recognized as non-cash compensation over the remaining
vesting period of the options of approximately 3 years.

   During 2000, Active Power granted 1,101,924 stock options to employees with
exercise prices below the fair value determined subsequently by the board of
directors of the underlying shares and, accordingly, recorded $8,781,404
additional unearned stock compensation of which $6,692,173 was amortized to
non-cash compensation during the year ended December 31, 2000. The remaining
unearned compensation will be recognized as non-cash compensation over the
options' vesting period of four years.

   Pro forma information regarding net loss is required by Statement No. 123,
and has been determined as if Active Power had accounted for its employee stock
options under the fair value method of Statement No. 123. The fair value for
these options was estimated at the date of grant using a minimum value option
pricing model until the date of the initial public offering and the Black-
Scholes option pricing model thereafter, with the following assumptions:

<TABLE>
<CAPTION>
                                                    Year ended December 31,
                                                    -------------------------
                                                     2000     1999     1998
                                                    -------  -------  -------
   <S>                                              <C>      <C>      <C>
   Risk-free interest rate.........................     6.5%     6.5%     6.5%
   Weighted-average expected life of the options... 7 years  7 years  7 years
   Dividend rate...................................       0%       0%       0%
   Assumed volatility..............................     150%       0%       0%
   Weighted average fair value of options granted:
   Exercise price equal to fair value of stock on
    date of grant.................................. $ 32.52      --     $ .06
   Exercise price less than fair value of stock on
    date of grant.................................. $  8.90    $5.77      --
</TABLE>

   For purposes of pro forma disclosure, the estimated fair value of the
options is amortized to expense over the options' vesting period. Active
Power's pro forma information under Statement No. 123 follows:

<TABLE>
<CAPTION>
                                            Year ended December 31,
                                     ---------------------------------------
                                         2000          1999         1998
                                     ------------  ------------  -----------
   <S>                               <C>           <C>           <C>
   Pro forma stock-based
    compensation expense............ $  8,619,884  $  1,712,263  $    35,726
   Pro forma net loss............... $(25,032,060) $(10,269,539) $(6,014,504)
   Pro forma net loss to common
    stockholders.................... $(44,110,982) $(39,929,205) $(8,803,117)
   Pro forma basic and diluted loss
    per share....................... $      (2.01) $      (3.99) $      (.90)
</TABLE>

   Option valuation models incorporate highly subjective assumptions. Because
changes in the subjective assumptions can materially affect the fair value
estimate, the existing models do not necessarily provide a reliable single
measure of the fair value of Active Power's employee stock options. Because the
determination of fair value of all employee stock options granted after such
time as Active Power becomes a public entity will include an expected
volatility factor and because, for pro forma disclosure purposes, the estimated
fair value of Active Power's employee stock options is treated as if amortized
to expense over the options' vesting period, the effects of applying Statement
No. 123 for pro forma disclosures are not necessarily indicative of future
amounts.

                                      F-12
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS


   Common stock reserved at December 31, 2000 consists of the following:

<TABLE>
        <S>                                                <C>
        For exercise of Common Stock Warrants.............   432,000
        For issuance under the 1993/2000 Stock Option
         Plan............................................. 5,636,178
</TABLE>

5. Income Taxes

   At December 31, 2000, Active Power has net operating loss carryforwards of
approximately $30 million for federal tax reporting purposes and research and
development credit carryforwards of approximately $563,000. The net operating
loss and research and development credit carryforwards begin to expire in 2007
if not utilized.

   Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of
the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses and credits before utilization.

   Significant components of Active Power's deferred tax liabilities and assets
as of December 31 are as follows:

<TABLE>
<CAPTION>
                                                        2000         1999
                                                    ------------- -----------
   <S>                                              <C>           <C>
   Deferred tax assets:
     Capital expenses..............................       164,000      71,000
     Warrants......................................       511,000     511,000
     Reserves and allowances.......................       628,000     461,000
     Net operating loss and tax credit
      carryforwards................................    11,587,000   5,730,000
     Other.........................................           --       34,000
                                                    ------------- -----------
     Total deferred tax assets.....................    12,890,000   6,807,000
     Valuation allowance for net deferred tax
      assets.......................................  (12,890,000)  (6,807,000)
                                                    ------------- -----------
     Net deferred taxes............................ $         --  $       --
                                                    ============= ===========
</TABLE>

   Active Power has established a valuation allowance equal to the net deferred
tax assets due to uncertainties regarding the realization of deferred tax
assets based on the Company's lack of earnings history. The valuation allowance
increased by approximately $6,083,000 during 2000. Approximately $438,000 of
the valuation allowance for deferred tax assets relates to benefits for stock
option deductions, which when realized, will be allocated directly to
contributed capital.

   Active Power's benefit for income taxes differs from the expected tax
benefit amount computed by applying the statutory federal income tax rate of
34% to loss before taxes due to the following:

<TABLE>
<CAPTION>
                               Year Ended
                              December 31,
                            ---------------------
                            2000    1999    1998
                            -----   -----   -----
   <S>                      <C>     <C>     <C>
   Federal statutory
    rate................... (34.0)% (34.0)% (34.0)%
   Non-cash compensation
    expense................  12.1    17.4     --
   State taxes, net of
    federal benefit........  (1.9)   (1.5)   (3.0)
   Permanent items and
    other..................  (2.5)    (.6)   (1.8)
   Change in valuation
    allowance..............  26.3    18.7    38.8
                            -----   -----   -----
                              0.0%    0.0%    0.0%
                            =====   =====   =====
</TABLE>


                                      F-13
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS

6. Commitments

   Active Power leases its office and manufacturing facilities under operating
lease agreements. The office space and manufacturing facilities leases are
noncancelable and obligate Active Power to pay taxes and maintenance costs. In
addition, Active Power leases certain equipment such as copiers and phone
systems under noncancelable leases.

   Future minimum payments under these leases at December 31, 2000 are as
follows:

<TABLE>
        <S>                                               <C>
        2001.............................................  1,184,974
        2002.............................................  1,383,264
        2003.............................................  1,073,781
        2004.............................................    815,892
        2005.............................................    334,795
                                                          ----------
        Total future minimum lease payments.............. $4,792,706
                                                          ==========
</TABLE>

   Rent expense for the years ended December 31, 2000, 1999, and 1998 was
$489,597, $353,502, and $276,637 respectively.

   Active Power has a consulting services agreement with the Chairman of the
board of directors. In accordance with the consulting agreement, the Chairman
receives $6,250 in consulting fees monthly. During 2000, 1999, and 1998 Active
Power paid $75,000 in fees per year under this agreement.

7. Employee Benefit Plan

   In 1996, Active Power established a 401(k) Plan that covers substantially
all full-time employees. Company contributions to the plan are determined at
the discretion of the Board of Directors and vest ratably over five years of
service starting after the first year of employment. Active Power did not
contribute to this plan in 1998, 1999, and 2000.

8. Development Funding

   During January 1999, Active Power entered into a contract development
agreement with a third party. In accordance with the agreement, the third party
provided funding to allow Active Power to accelerate development of its
products in a certain market application in exchange for the third party
obtaining exclusive marketing rights for the product in that application. The
exclusive marketing rights are subject to the third party meeting specified
minimum orders of the product. The two companies share ownership of the
resulting intellectual property. Active Power completed the contract in 1999
and collected the full $5,000,000 development funding specified in the
contract, which it recognized as it achieved the product performance milestones
specified in the agreement. Active Power does not separately account for
efforts spent by its engineers on research and development by the various
project. Because this project involved development of Active Power's product
already contemplated by management and for which Active Power co-owns the
resulting intellectual property, all of the costs associated with this contract
are classified in research and development expense.

                                      F-14
<PAGE>

                               ACTIVE POWER, INC.

                         NOTES TO FINANCIAL STATEMENTS


9. Geographic Information

   Revenues for the year ended December 31 were as follows:

<TABLE>
<CAPTION>
                                                     2000       1999      1998
                                                  ---------- ---------- --------
   <S>                                            <C>        <C>        <C>
   United States................................. $3,392,607 $1,014,411 $867,775
   Foreign countries.............................  1,479,526     32,400   47,543
                                                  ---------- ---------- --------
   Total......................................... $4,872,133 $1,046,811 $915,318
                                                  ========== ========== ========
</TABLE>

   Revenues from foreign countries above represent shipments to customers
located primarily in Europe. Active Power has no property, plant or equipment
located outside the United States.

                                      F-15
<PAGE>

Supplementary Financial Information (Unaudited)

<TABLE>
<CAPTION>
                                           Year Ended December 31, 2000
                                         ------------------------------------
                                          First     Second    Third   Fourth
                                         Quarter   Quarter   Quarter  Quarter
                                         --------  --------  -------  -------
   <S>                                   <C>       <C>       <C>      <C>
   Product revenue...................... $    182  $    679  $ 1,343  $ 2,668
   Product margin (loss)................     (339)     (497)    (742)  (1,516)
   Net loss.............................   (4,857)   (6,208)  (5,789)  (6,250)
   Cumulative undeclared dividends on
    preferred stock.....................     (849)     (849)    (355)     --
   Accretion on redeemable convertible
    preferred stock to redemption
    amounts.............................   (6,383)   (7,329)  (3,314)     --
   Net loss to common stockholders...... $(12,089) $(14,386) $(9,458) $(6,250)
   Net loss per share, basic and
    diluted............................. $  (1.15)    (1.26)   (0.35)   (0.16)
</TABLE>

   Non-cash charges associated with redeemable preferred stock were recorded to
reflect dividend rights and accretion to redemption value prior to conversion
to common stock which occurred immediately prior to the Company's initial
public offering.