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UNITED STATESSECURITIES AND EXCHANGE
            COMMISSIONWashington, D.C. 20549

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### Form 10-K

### ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
            SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31,
            2001

Commission file number 000-30939

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

| |  | Delaware(State or other jurisdiction ofincorporation or organization) |  | 74-2961657(I.R.S. EmployerIdentification No.)
| |  | --------------------------------------------------------------------- |  | ---------------------------------------------

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
                   sharePreferred Share Purchase Rights(Title of each class) |  | Nasdaq
                   National Market(Name of each exchange on which registered)
| | --------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------

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

Indicate by 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, based upon the closing
            sale price of Common Stock on March 1, 2002, as reported on the Nasdaq National
            Market, was approximately $135,884,651 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, 2002, the Registrant
            had 40,878,426 outstanding shares of Common Stock.

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

|                                                                                                        | Incorporated byReference in Part No.
|------------------------------------------------------------------------------------------------------- | ------------------------------------
|Our proxy statement filed in connection with our 2002
                   Annual Meeting of Stockholders | III                                 

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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 and MAKING
            ELECTRICITY BETTER. 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

|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                                                                                       | 20
|ITEM 4. Submission of Matters
                   to a Vote of Security Holders                                  | 20
|PART II                                                                                                         | 21
|ITEM 5. Market for
                   Registrant's Common Equity and Related Stockholder Matters                | 21
|ITEM 6. Selected Financial
                   Data.                                                             | 22
|ITEM 7. Management's
                   Discussion and Analysis of Financial Condition and Results of Operation | 23
|ITEM 7A. Quantitative and
                   Qualitative Disclosures About Market Risk                          | 27
|ITEM 8. Financial Statements
                   and Supplementary Data                                          | 27
|ITEM 9. Changes in and
                   Disagreements With Accountants on Accounting and Financial Disclosure | 27
|PART III                                                                                                        | 28
|ITEM 10. Executive Officers of
                   the Registrant                                                | 28
|ITEM 11. Executive
                   Compensation                                                              | 29
|ITEM 12. Security Ownership of
                   Certain Beneficial Owners and Management                      | 29
|ITEM 13. Certain Relationships
                   and Related Transactions                                      | 29
|PART IV                                                                                                         | 30
|ITEM 14. Exhibits, Financial
                   Statement Schedules, and Reports on Form 8-K                    | 30

Note on Incorporation by Reference

Throughout this report, various
            information and data are incorporated by reference to portions of our 2002
            Proxy Statement. Any reference in this report to disclosures in our 2002 Proxy
            Statement shall constitute incorporation by reference of that specific material
            into this Form 10-K.

i

Special Note Regarding Forward-Looking Statements

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

- strategic relationships with third parties;
- customer demand for our products;
- growth and future operating results;
- developments in our markets and strategic focus;
- expansion of our product offerings;
- customer benefits attributable to our products;
- potential acquisitions and joint ventures and the integration of
              acquired businesses;
- technologies and operations;
- industry trends; 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

PART I

Item 1.    BUSINESS.

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 that is marketed under the Caterpillar brand name. As an
            extension to our existing products we are broadening our product offerings and
            expanding our available market by developing additional power quality systems
            to address customer needs at both higher and lower power levels.

Industry Background

Power Requirements of Today's Digital 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 other
            sensitive, semiconductor chip controlled equipment. The demand for high quality
            electricity exists across many industries and businesses, ranging from digital
            broadcasting stations to plastic extrusion facilities to tire manufacturers.
            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.



The recent terrorist acts in New York
            and Washington D.C. and other highly publicized power disturbance events have
            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 2001 study by the Electric Power Research Institute estimated
            that electric power problems annually cost U.S. industry between $119 and $188
            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.

1

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 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:



2

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 could be otherwise. 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

- 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;
- 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;
- 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; and
- 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.

3

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 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 in the flywheel 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
            500 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. In September 2001 we commercially launched the CleanSource2 DC. The
            CleanSource2 DC has a much faster recharge time, a reduced part count and uses
            a common platform to the Cat UPS. Our installed CleanSource DC and CleanSource2
            DC units have accumulated over 1.2 million 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. Our
            installed CleanSource UPS units have accumulated over 576,000 hours of field
            operation.

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 with 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.



Due to its unique design, CleanSource
            UPS can be competitively priced versus 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 2001, we are currently delivering
            CleanSource UPS units that span the power range from 250kVA up to 900kVA.

4

Future
            Products.    We are currently engaged in two new
            product initiatives. The first new product line is an extension of the existing
            CleanSource UPS product line and is being developed in conjunction with
            Caterpillar. The product line will include a high power electronics platform
            that can expand the power rating of the current Caterpillar UPS line to 2.4 MW.
            This initiative will also include a variable speed constant frequency (VSCF)
            system, which allows a genset to produce more power for a given engine size
            while also increasing fuel efficiency. We expect to release these new products
            in early 2003.

The second new product development is
            a product platform in the 150kVA power range. This new platform will include
            power conditioning and battery-free energy storage elements, and we expect to
            launch the first product within this family later this year.

Our Business Strategy

Our goal is to become a leading
            supplier of 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 electric power. We intend to expand our
            product line to meet customer needs at both higher and lower power levels, and
            are currently developing a new electronics platform that will increase the
            power output and fuel efficiency of distributed generation systems.

Distribute and Market our Existing 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 consolidated the domestic distribution of our CleanSource
            DC product with a leading UPS OEM, Powerware Corporation, a business unit
            within Invensys plc.

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, such as the use of dedicated UPS
            salespeople, or developing cooperative marketing programs with dealers in key
            areas of the country where backup power equipment is in most demand.

5

Outsource Components to Rapidly Scale Manufacturing

We intend to continue to outsource as
            many non-proprietary hardware and electronics components as possible by
            maintaining and building on multiple supplier relationships so that we can
            respond quickly to significant quantity increases. We intend to internally
            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 between $119 and $188
            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 $5.9 billion market for UPS. We believe
            that our products are superior alternatives to conventional UPS and CPS
            products and should be able to 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:

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, hospitals, broadcast TV, and government 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.

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 in 2000. Conventional CPS systems currently satisfy market demand
            using a combination of gensets, lead-acid batteries and power electronics. We
            are currently in the early stage of developing products to address the market's
            needs.

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.

6

Distributed
            Generation.    Fuel cells, gensets 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, genset 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, genset 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, genset or microturbine standby power in the event of a utility
            outage.

We are also working on a VSCF system,
            which will allow a genset to more efficiently use the power produced by a given
            engine, while also improving its fuel efficiency. We expect to release products
            with the VSCF technology in early 2003.

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. As an extension of this agreement, Caterpillar in 2001 agreed to provide
            another $5.0 million in funding for the development of a high power electronics
            platform that will complement the Cat UPS, and for VSCF technology that will
            enhance the performance of the genset. Development of this new product line is
            underway, with product shipments expected to commence in 2003.

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. Caterpillar or we may license to other
            entities the intellectual property that we jointly own without seeking the
            consent of the other and the licensing party will solely retain all licensing
            revenue generated by licensing the joint intellectual property. However, we may
            not license the joint intellectual property to specifically identified
            competitors of Caterpillar until January 1, 2007.

Distribution
            Agreement.    We also have a distribution agreement
            with Caterpillar. During 2000 and 2001, we received approximately 96% and 87%,
            respectively, 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 semi-annual sales requirements,
              we will not sell Cat UPS to specifically identified competitors of Caterpillar
              until January 1, 2007 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).

7

Caterpillar may continue to
            distribute Cat UPS until January 1, 2007. At such time the agreement will
            continue for additional six-month periods unless either party provides to the
            other, within ninety days of the end of a period, written notice of its
            decision not to renew the distribution agreement. The agreement may also be
            terminated by Caterpillar if we fail to cure any material breach by us, if the
            Cat UPS we manufacture 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.

Our Relationship with Powerware

We have consolidated the distribution
            channels for our CleanSource2 DC product by establishing a strategic
            relationship with Powerware. We granted Powerware the semi-exclusive right to
            distribute the CleanSource2 DC product in North America. Powerware is a global
            leader in power systems technology and has a broad range of UPS products and
            services available worldwide. Powerware will sell and service the CleanSource2
            DC product with its uninterruptible power systems, delivering an integrated
            battery-free power solution. Through Powerware's well established sales and
            service network, we believe that we will be able to more rapidly penetrate the
            market opportunity for battery-free power quality solutions and provide quality
            service to our end use customers.

Distribution
            Agreement.    We have a distribution agreement with
            Powerware for the CleanSource2. This agreement was entered into on August 28,
            2001, and has an initial term lasting through March 31, 2003. The principal
            provisions of this agreement are summarized below:

- Powerware has semi-exclusive North America distribution rights to the
              CleanSource2 DC with branding and marketing being joint between Powerware and
              Active Power;
- Powerware has committed to minimum levels of spending in marketing
              and sales to launch the product;
- Powerware's global service force will service the CleanSource2 DC
              units;
- Powerware's price from Active Power is volume dependent; and
- We will provide Powerware the same warranty Powerware provides its
              customers procuring power systems products.

The agreement provides for renewal
            terms of one year based on performance under the agreement and allows either
            party to terminate with 60 days notice prior to the expiration of the initial
            term or any renewal term.

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 rapid adoption
            of our current products that otherwise would take significantly longer for wide
            acceptance. 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 believe that focusing on product acceptance
            and support from OEMs provides the greatest opportunity for market penetration
            and sales growth with minimal resources. We employ a small, geographically
            dispersed sales force to develop leads and educate our OEM customers in their
            sales efforts. With our future product offerings, we intend to evaluate all
            distribution opportunities in an effort to maximize product acceptance and
            long-term product margin.

Our marketing efforts are currently
            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.

8

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 current product offerings. 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 these products. Our customer service and support organization
            also provides comprehensive and on-going 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 also recently entered into a semi-exclusive
            arrangement with Powerware to distribute our CleanSource2 DC product and expect
            this relationship to accelerate the volume of CleanSource2 DC units sold. We
            intend to continue to evaluate 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 plastics manufacturers, hospitals, credit card processors, advanced
            data centers, broadcasters, semiconductor manufacturers, pharmaceutical
            manufacturers, and electric utilities.

During 2000 and 2001, Caterpillar and
            its dealer network accounted for 96% and 87%, respectively, of our total
            revenue. No other customer accounted for more than 1% of our revenue during
            2000, or for more than 7% during 2001. Due to Caterpillar's semi-exclusive
            CleanSource UPS distribution rights, we anticipate that revenue from
            Caterpillar will comprise a majority of our revenue in 2002.

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 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.

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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.



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.

The CleanSource Family of Products

Our unique flywheel energy storage
            system device is being used in our two currently offered products: CleanSource2
            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.

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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 $4.4 million, $9.9 million and $14.9 million in 1999,
            2000 and 2001, respectively. We anticipate maintaining significant levels of
            research and development expenditures in the future, although our research and
            development expenses should decrease as a percentage of sales revenue as sales
            volume increases. At December 31, 2001, our research, development and
            engineering team consisted of 81 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 have engaged most of our suppliers
            in long-term agreements, 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. We and our power module supplier currently maintain
            buffer stocks, and our microprocessor demand is covered by purchase orders for
            the next two quarters. Lead times for ordering materials and components vary
            significantly and depend on factors such as specific supplier requirements,
            contract terms, the extensive production time required and current market
            demand for such components. We believe that we maintain enough inventory of the
            Motorola microprocessor to allow us to design a substitute microprocessor if we
            are no longer able to purchase the microprocessor from Motorola.

We have substantially expanded our
            manufacturing facilities and capacity in order to support our projected volume
            demand for our products. Although economic conditions and business levels
            during the second half of 2001 were slower than what is necessary for us to
            fully utilize our new facilities, we believe a healthier economy in 2002 and
            beyond will justify our increased capacity.

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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 35 patent applications before the United
            States Patent and Trademark Office, 30 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, which would
            include bringing legal actions if we deem it necessary.

We own the registered trademarks
            CLEANSOURCE and MAKING ELECTRICITY BETTER in the United States and have applied
            for a trademark on our name and logo. All other trademarks, service marks or
            trade names referred to in this document 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 for UPS applications. Substantially all of the sales
            of DC product for UPS applications are comprised of lead-acid batteries rather
            than battery-free technologies, such as CleanSource DC. Of the makers of
            battery-free products, Piller and Accumetrics 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 Piller and we each have approximately half of
            the installed flywheel units. 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, some of whom 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.

Employees

At December 31, 2001, we had 232
            employees, with 81 engaged in research, development and engineering, 95 in
            manufacturing, 25 in sales, 5 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.

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Risk Factors That May Affect Future Results

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

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

We have incurred operating losses
            since our inception and expect to continue to incur losses for the next several
            quarters. As of December 31, 2001, we had an accumulated deficit of $80.7
            million. To date, we have funded our operations principally through the sale of
            our stock, our product revenue and $6.0 million in development funding payments
            from Caterpillar. We will need to generate significant additional revenue to
            achieve profitability, and we cannot assure you that we will ever realize
            additional revenue at such levels. We also expect to incur significant product
            development, sales and marketing and administrative expenses and, as a result,
            we expect to continue to incur losses.

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

We have generated a total of $28.4
            million in product revenue since January 1, 1998, and we have sold
            approximately 540 CleanSource DC and Cat UPS products. We are uncertain whether
            our products will achieve market acceptance such that our revenues will
            increase or whether we will be able to achieve significant revenue. Therefore,
            we have a very limited ability to predict future revenue. Our limited operating
            experience, the uncertain market acceptance for our products, and other factors
            that are beyond our control make it difficult for us to accurately forecast our
            quarterly and annual revenue. However, we use our forecasted revenue to
            establish our expense budget. Most of our expenses are fixed in the short term
            or incurred in advance of anticipated revenue. As a result, we may not be able
            to decrease our expenses in a timely manner to offset any revenue shortfall.
            Further, we have expanded our staff and facilities and increased our expense
            levels in anticipation of future revenue growth. If our revenue does not
            increase as anticipated, we will incur significant losses.

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;

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- 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 Cat UPS and CleanSource2 DC
              products, as well as our other products, which are currently under development;
              and
- the rate of growth of the markets for our products.

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

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

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

We have only one principal product
            that has any significant operating history at customer sites, CleanSource DC,
            and we have only recently introduced our CleanSource2 DC and Cat UPS products.
            To grow our revenue, we must rely on Powerware and Caterpillar to successfully
            market our CleanSource2 DC and Cat UPS products, respectively, and we must
            develop and introduce to the 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 Cat UPS product is
            not successful, our business and revenue could suffer. Pursuant to a
            development agreement, Caterpillar has provided us with $6.0 million in funding
            through December 31, 2001, to support the development of our Cat UPS product
            and other development efforts. In exchange for this payment, Caterpillar
            received co-ownership of the proprietary rights in this product. Either
            Caterpillar or we may license to other entities the intellectual property that
            we jointly own without seeking the consent of the other and the licensing party
            will solely retain all licensing revenue generated by licensing this
            intellectual property. However, we may not license the joint intellectual
            property to

14

specifically identified competitors of Caterpillar until January 1, 2007.
            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 and 2001, our business level with Caterpillar and its dealer
            network accounted for 96% and 87% of our product revenue, respectively.
            Pursuant to the distribution agreement with Caterpillar, they are the exclusive
            distributor, subject to limited exceptions, of our Cat UPS product. Caterpillar
            is not obligated to purchase any Cat UPS units.

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

We rely on OEMs as a primary
            distribution channel because they are able to sell our products to a large
            number of end user organizations. We further rely on our OEMs to provide
            service and support to the end users of our products because they have the
            experience and personnel to perform such activities. We believe that the use of
            OEM channels will enable our products to achieve broad market penetration,
            while we devote a limited amount of our resources to sales, marketing and
            customer service and support. Our operating results in the foreseeable future
            will continue to depend on sales to a relatively small number of OEM customers,
            primarily Caterpillar. For example, in 2000 and 2001, our volume of business
            with Caterpillar and its dealer accounted for 96% and 87% of our product
            revenue, respectively. Therefore, the loss of our key OEM customer,
            Caterpillar, or a significant reduction in sales to Caterpillar and its
            dealers, would significantly reduce our revenue. We have granted Caterpillar
            semi-exclusive worldwide rights to distribute our Cat UPS product, provided
            that they meet minimum annual sales requirements. We have also granted
            Powerware semi-exclusive distribution rights to our CleanSource2 DC product in
            North America. These restrictions will further increase our dependence upon
            Caterpillar and Powerware. However, neither Caterpillar nor Powerware is
            obligated to purchase any Cat UPS or CleanSource2 DC units, respectively, under
            these agreements.

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

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

We have expanded our manufacturing facility based on our forecasted
            sales volumes in the future. If we do not achieve these forecasted sales
            volumes, we will underutilize our manufacturing capacity and our business will
            suffer.

We recently completed a 127,000
            square foot facility used for manufacturing and testing our three-phase product
            line, including the Cat UPS and CleanSource2 DC products. In order for us to
            fully utilize the capacity of the facility and spread out its associated
            overhead, we must achieve significantly higher sales volumes. If we do not
            reach our forecasted sales volumes, our revenues will suffer as will our
            ability to reach profitability.

15

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

Because of the nature of the power
            quality and reliability market, quality problems attributable to the
            CleanSource2 DC or Cat UPS product lines could significantly affect the
            market's perception of our technology and slow or limit their acceptance. This
            would substantially impair our revenue prospects. Moreover, quality problems
            for our product lines could cause us to delay or cease shipments of products,
            or recall products, thus impairing our revenue or cost targets.

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

To assure the availability of our
            products to our OEM customers, we outsource the manufacturing of components
            prior to the receipt of purchase orders from OEM customers based on their
            forecasts of their product needs. However, these forecasts do not represent
            binding purchase commitments, and we do not recognize revenue for such products
            until the product is shipped to the OEM. As a result, we incur inventory and
            manufacturing costs in advance of anticipated revenue. As demand for our
            products may not materialize, this product delivery method subjects us to
            increased risks of high inventory carrying costs, obsolescence and excess, 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. As a result, if our
            suppliers receive excess demand for their products, we may receive a low
            priority for order fulfillment as large volume customers will receive priority.
            If we are delayed in acquiring components for our products, the manufacture and
            shipment of our products also will be delayed. We are, however, trying to enter
            into long-term agreements with our sole suppliers and other key suppliers,
            using a rolling sales volume forecast to stabilize component availability. Our
            power module supplier currently maintains a buffer stock and, our
            microprocessor demand is covered by purchase orders for the next two quarters.
            Lead times for ordering materials and components vary significantly and depend
            on factors such as specific supplier requirements, contract terms, the
            extensive production time required and current market demand for such
            components. Some of these delays may be substantial. As a result, we purchase
            these components in large quantities to protect our ability to deliver finished
            products. If we overestimate our component requirements, we may have excess
            inventory, which will increase our costs. If we underestimate our component
            requirements, we will have inadequate inventory, which will delay our
            manufacturing and render us unable to deliver products to customers on
            scheduled delivery dates. If we are unable to obtain a component from a
            supplier or if the price of a component has increased substantially, we may be
            required to manufacture the component internally, which will result in delays.
            Manufacturing delays could negatively impact our ability to sell our products
            and could damage our customer relationships.

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

We believe our future success will
            depend in large part upon our ability to attract and retain highly skilled
            managerial, engineering and sales and marketing personnel. In particular, due
            to the relatively early stage of our business, we believe that our future
            success is highly dependent on Joseph F. Pinkerton, III, our founder, chairman
            of the Board and chief executive officer, 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 operating officer and
            chief financial officer, we do not

16

have long-term employment agreements in place with any of our employees.
            The loss of the services of any of our key employees, the inability to attract
            or retain qualified personnel in the future or delays in hiring required
            personnel, particularly engineers and sales personnel, could delay the
            development and introduction of, and negatively impact our ability to sell, our
            products.

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

There is a limited supply of skilled
            employees in the power quality industry. We have hired some of our current
            employees from our customers and our competitors. As a result, some of our
            current customers might begin to view us as competitors in the future, and one
            or more of our competitors could file lawsuits against us alleging the
            infringement of their trade secrets and other intellectual property. Although
            we do not believe we have infringed upon the intellectual property of our
            competitors, such lawsuits could divert our attention and resources from our
            business operations.

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

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

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

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

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

17

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.

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

18

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.

Provisions in our charter documents and of Delaware law, and
            provisions in our agreements with Caterpillar, could prevent, delay or impede a
            change in control of our company and may depress the market price of our common
            stock.

Provisions of our certificate of
            incorporation and bylaws could have the effect of discouraging, delaying or
            preventing a merger or acquisition that a stockholder may consider favorable.
            We also are subject to the anti-takeover laws of the State of Delaware, which
            may further discourage, delay or prevent someone from acquiring or merging with
            us. In addition, our agreement with Caterpillar for the distribution of
            CleanSource UPS provides that Caterpillar may terminate the agreement in the
            event we are acquired or undergo a change in control. The possible loss of our
            most significant customer could be a significant deterrent to possible
            acquirors and may substantially limit the number of possible acquirors. All of
            these factors may decrease the likelihood that we would be acquired, which may
            depress the market price of our common stock.

Our stock price may be volatile.

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

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

Terrorist attacks have contributed to economic instability in the
            United States; continued terrorist attacks, war or other civil disturbances
            could lead to further economic instability and depress our stock price.

On September 11, 2001, the United
            States was the target of terrorist attacks of unprecedented scope. These
            attacks have caused instability in the global financial markets, and have
            contributed to volatility in the stock prices of United States publicly traded
            companies, such as Active Power. These attacks may lead to armed hostilities or
            to further acts of terrorism and civil disturbances in the United States or
            elsewhere, which may further contribute to economic instability in the United
            States and could have a material adverse effect on our business, financial
            condition and operating results.

Item 2.    PROPERTIES.

As of December 31, 2001, 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 a lease agreement that
            expires in March 2003. Our manufacturing facility of approximately 105,000
            square feet is also located in Austin, Texas. Our manufacturing

19

facility will increase to approximately 127,000 square feet by the end of
            the lease term in May 2005. The total monthly lease payments due under all our
            facility leases are approximately $116,000. Our total monthly lease payments
            will increase to approximately $126,000 when we initially occupy the entire
            facility.

Item 3.    LEGAL PROCEEDINGS.

We are not party to any legal
            proceedings.

Item 4.    SUBMISSION OF MATTERS TO A VOTE OF
            SECURITY HOLDERS.

We did not submit any matters to the
            vote of our stockholders during the fourth quarter of fiscal 2001.

20

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 closing sales price for our common stock as reported by the
            Nasdaq National Market for the periods indicated:

| |                                                        | High   | Low   
| | ------------------------------------------------------ | ------ | ------
| | Fiscal Year Ended December 31,
                   2001
| | First
                   Quarter                       | $29.06 | $17.13
| | Second
                   Quarter                      | $29.95 | $15.50
| | Third
                   Quarter                       | $16.17 | $4.00 
| | Fourth
                   Quarter                      | $6.87  | $4.64 
| | Fiscal Year Ended December 31,
                   2000
| | Third
                   Quarter (from August 7, 2000) | $79.75 | $17.00
| | Fourth
                   Quarter                      | $63.50 | $12.75

As of March 1, 2002, there were
            40,878,426 shares of our common stock outstanding held by 836 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.

During the fourth quarter of 2001, we
            issued an aggregate of 115,696 shares of our common stock pursuant to exercises
            of stock options that were granted prior to August 7, 2000 with exercise prices
            ranging from $0.07 to $1.97 per share. These issuances were deemed exempt from
            registration under Section 5 of the Securities Act of 1933 in reliance upon
            Rule 701 thereunder and appropriate legends were affixed to the share
            certificates issued in each such transaction.

On December 13, 2001, the Board of
            Directors declared a dividend of one preferred share purchase right for each
            outstanding share of its common stock. The dividend was paid on December 26,
            2001 to the stockholders of record at the close of business on that date. Each
            right entitles the registered holder to purchase from the Company one unit
            consisting of one one-thousandth of a share of its Series A Junior
            Participating preferred stock of the Company, at a price of $40.00 per unit.

The rights generally will be
            exercisable only if a person or group acquires beneficial ownership of 15% or
            more of the Company's common stock or announces a tender or exchange offer
            which results in a person owning 15% or more of the Company's common stock. The
            Company will generally be entitled to redeem the rights at $0.01 per right at
            any time until 10 days, subject to extension, after a public announcement that
            a 15% position in the Company's common stock has been acquired. The Rights
            expire on December 26, 2011. For a more complete description of the terms of
            the rights, please see the rights agreement, dated as of December 13, 2001 by
            and between the Company and Equiserve Trust N.A., as rights agent, filed as an
            exhibit to Company's Current Report on Form 8-K dated December 13, 2001.

21

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, 2001,
            2000, and 1999 have been derived from the audited financial statements
            appearing elsewhere in this document. The data for the years ended December 31,
            1998 and 1997 have 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 Operation:

|                                                                                | Year ended December 31,
|------------------------------------------------------------------------------- | -----------------------
|
|
|Revenues:                                                                      
|Product revenue                                                                 | $21,562                
|Development contract                                                            | 1,000                  
|Total revenue                                                                   | $22,562                
|Operating expenses:                                                            
|Cost of product revenue                                                         | 25,796                 
|Cost of development
                   contract                                 | 283                    
|Research, development and
                   engineering                        | 14,930                 
|Selling, general &
                   administrative                            | 11,684                 
|Amortization of deferred stock
                   compensation                  | 4,003                  
|Total
                   operating expenses                                     | 56,696                 
|Operating loss                                                                  | (34,134)               
|Interest income/expense, net                                                    | 6,190                  
|Change in fair value of warrants with redemption
                   rights      |                       
|Other income (expense)                                                          | (18)                   
|Net loss                                                                        | $(27,962)              
|Preferred stock dividends, accretion, &
                   conversion           |                       
|Net loss to common stockholders                                                 | $(27,962)              
|Net loss per share, basic & diluted                                             | $(0.70)                
|Shares used in computing net loss per share, basic
                   & diluted | 39,781,031             

Balance Sheet Data:

|                                                          | Year ended December 31,
|--------------------------------------------------------- | -----------------------
|
|
|Cash, cash equivalents and
                   investments | $112,105               
|Working capital                                           | 83,060                 
|Total assets                                              | 139,376                
|Long-term obligations, less current portion               |                       
|Redeemable convertible preferred stock                    |                       
|Total stockholders' equity                                | 131,730                

22

Item 7.     MANAGEMENT'S DISCUSSION AND ANALYSIS
            OF FINANCIAL CONDITIONAND RESULTS OF OPERATION.

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. Among the important
            factors which could cause actual results to differ materially include: the
            potential for significant losses to continue; inability to accurately predict
            revenue and budget for expenses for future periods; fluctuations in revenue and
            operating results; overall market performance; a slowing global economy;
            limited product lines; inability to manufacture products of the quality
            necessary to be accepted in the power quality market; inability to expand our
            distribution channels; our dependence on our relationship with Caterpillar;
            inability to successfully integrate new OEM channel partners; competition;
            delays in research and development; inability to increase sales volumes to
            fully utilize our increased manufacturing capacity; inventory risks; risks of
            delay or poor execution from a variety of sources; limited resources;
            dependence upon key personnel; inability to protect our intellectual property
            rights; potential future acquisitions; and the volatility of our stock price.
            The discussion below addresses some of these factors. Additional risks and
            uncertainties that we are unaware of or that we currently deem immaterial also
            may become important factors that affect us.

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 plastic manufacturers, semiconductor manufacturers, hospitals,
            credit card processing centers, broadcasters, advanced data centers, and
            electric utilities.

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, 2001, we had generated an
            accumulated deficit of $80.7 million and expect to continue to sustain
            operating losses for the next several quarters. 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 $138.4
            million net of commissions and issuance costs, together with cash balances on
            hand prior to August 2000 will be sufficient to meet our capital requirements
            through at least the next 24 months. Our cash and investments position at
            December 31, 2001 was $112.1 million.

Since our inception, a small number
            of customers have accounted for the majority of our annual sales. During 1999,
            our four largest customers accounted for 89% of our sales, with our largest
            customer, Caterpillar and its dealer network, accounting for 39%. In 2000 and
            2001, our business level with Caterpillar and its dealer network grew
            substantially, accounting for 96% and 87%, respectively, of our revenue due to
            the commercial introduction of the CleanSource UPS product line. We expect to
            continue to be dependent on a few OEM customers, primarily Caterpillar, for the
            majority of our sales for the foreseeable future.

Since 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, the demand for our products has increased significantly. To address
            this growth in demand and to position us for anticipated future growth, we have
            increased the scale of our operations in the following ways:

23

- Expanded our manufacturing facilities and added manufacturing
              personnel to address increases in product demand;
- Increased our personnel levels in product development and engineering
              to accelerate time to market on new products and enhance existing product
              lines; and
- Added sales, service and marketing personnel to support our OEM
              customers and accelerate our other sales efforts.

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

Critical Accounting Policies

The Company believes the following
            represent its critical accounting policies:

Revenue Recognition

Active Power recognizes product
            revenue when title transfers and our obligations are complete, usually when a
            unit is shipped. Active Power recognizes product revenue related to units
            shipped for evaluation by the customer at the time of customer acceptance of
            the unit. Development funding revenue is recognized as we achieve development
            milestones specified in the respective agreements.

Bad Debt

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. If the financial
            condition of the Company's customers were to deteriorate, resulting in an
            impairment of their ability to make payments, additional allowances may be
            required.

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. If actual future
            demand or market conditions are less favorable than those projected by
            management, additional inventory write-downs may be required.

Warranty Costs

The Company provides for the
            estimated cost of product warranties at the time revenue is recognized. While
            the Company engages in product quality programs and processes, the Company's
            warranty obligation is affected by product failure rates, material usage and
            service delivery costs incurred in correcting a product failure. Should actual
            product failure rates, material usage or service delivery costs differ from
            estimates, revisions to the estimated warranty liability may be required.

Results of Operations

Comparison of 2001, 2000, and 1999

Product
            revenue.    Product revenue primarily consists of sales
            of our CleanSource power quality products. Sales increased $16.7 million, or
            343%, to $21.6 million in 2001 from $4.9 million in 2000. Sales increased $3.9
            million, or 365%, to $4.9 million in 2000 from $1.0 million in 1999. Both the
            2001 and 2000 increases are attributable to a growing market acceptance of our
            products and ramp up in the sales of our CleanSource UPS product line, with
            initial sales of this new product line beginning in the fourth quarter of 1999.
            During 2001 we sold 382 of our quarter-megawatt flywheel units versus 118 in
            2000 and 24 in 1999.

24

Development contract
            revenue.    Development contract revenue primarily
            consists of funding paid to Active Power by Caterpillar. In 1999 Active Power
            and Caterpillar entered into an agreement to develop the Cat UPS. As part of
            that agreement Caterpillar provided $5 million in funding for the successful
            completion of several develop milestones. In September 2001 we signed an
            extension to our development agreement with Caterpillar to expand the Cat UPS
            product line. The extension calls for an additional $5.0 million in funding
            upon successful completion of certain development milestones. In December 2001
            we completed the first milestone and collected $1.0 million.

Cost of product
            revenue.    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 $17.8 million, or
            223%, to $25.8 million in 2001 from $8.0 million in 2000. Cost of goods sold
            increased $5.0 million, or 165%, to $8.0 million in 2000 from $3.0 million in
            1999. Both the 2001 and 2000 increases were primarily attributable to increases
            in the volume of product sold and an increase in our manufacturing capacity to
            support an increase in sales volume and an anticipated further increase in
            demand for our products. Although the absolute dollar amounts of our cost of
            goods sold increased significantly year over year, we achieved substantial
            improvements in our gross margin in each period. These improvements are a
            result of supplier cost reductions associated with higher volume, changes in
            our supplier base, engineering design savings, and leverage gained from higher
            production volumes. In anticipation of future demand for our products, we have
            significantly expanded our manufacturing capacity by increasing our
            manufacturing facilities and production personnel, which has increased our
            fixed manufacturing expense base. This increase will adversely impact our gross
            margins until production volumes increase enough to cover these added costs.
            While our variable product margin (sales less materials and direct labor) was
            positive in 2001, our overall product margin was negative due, in large part,
            to the underutilization of our indirect manufacturing costs. Over time we
            believe gross margins will improve as our product volumes increase, and we
            achieve greater economies of scale in production and in purchasing component
            parts, and introduce engineering design savings.

Cost of development
            contract.    Cost of development contract primarily
            consists of engineering expenses incurred in relation to the joint development
            process with Caterpillar, through which we receive development funding. In
            2001, we incurred $283,000 in development contract expenses. We had no
            development contract expenses in 2000, and in 1999 development contract
            expenses were $2.9 million. The margins we achieve in our development funding
            activities can vary considerably depending on the difficulty of each
            development milestone, the level of contract development we purchase from third
            parties, and level of materials purchased.

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 $5.0 million, or 51%, to $14.9
            million in 2001 from $9.9 million in 2000. Research and development expense
            increased $8.4 million, or 555%, to $9.9 million in 2000 from $1.5 million in
            1999. The increase in research and development expense was primarily due to the
            increased product development of CleanSource UPS and other products, including
            our high power Cat product line extension, CleanSource2 DC and HIT 6 products.
            We believe that research and development expense will decrease over the next
            few quarters as we phase down spending on our HIT 6 development. Although many
            of the internal resources committed to this project will be redirected to other
            new product initiatives, the external funding associated with the HIT 6
            development will be eliminated, thereby reducing our overall spending levels.
            We believe that research and development expenses will decrease as a percentage
            of sales overtime as revenues increase.

Selling, general and
            administrative.    Selling, general and administrative
            expense is primarily comprised of compensation and related costs for sales,
            service, marketing and administrative personnel, selling and marketing
            expenses, professional fees and for product warranty and bad debt costs and
            reserves. Selling, general and administrative expense increased approximately
            $5.5 million,

25

or 88%, to $11.7 million in 2001 from $6.2 million in 2000. Selling,
            general and administrative expense increased approximately $2.2 million, or
            56%, to $6.2 million in 2000 from $4.0 million in 1999. In 2000, we increased
            personnel in our sales and service organizations in order to support our OEM
            channel partners and to address opportunities for sales of our CleanSource UPS
            product line. The increase of 2001 expenses over 2000 were principally due to a
            full year of higher administrative expenses as a public company and increased
            personnel in our sales, service and marketing organizations to support our main
            OEM channel partner's sales and service ramp up of the Cat UPS product line. We
            believe that selling, general and administrative expense will increase in
            future periods as we add sales, marketing and service personnel to position us
            for anticipated sales growth.

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 $4.0 million,
            $6.7 million and $1.6 million in 2001, 2000 and 1999, respectively. We expect
            the amortization expense to decrease after 2001, as the options for which we
            are amortizing this expense become fully vested, and to a smaller extent as
            some employees to whom these options were granted leave the company and any
            unvested options are canceled.

Interest
            income/expense.    Interest income net of interest
            expense increased $1.8 million, or 42%, to $6.2 million in 2001 from
            approximately $4.4 million in 2000. Interest income net of interest expense
            increased $3.9 million, or 936%, to $4.4 million in 2000 from approximately
            $421,000 in 1999. The increase in 2001 is principally due a higher post-IPO
            cash balance for an entire year as compared to the five months of 2000 with a
            post-IPO cash increase. The significant increase in 2000 is primarily due to
            increases in our average cash, cash equivalent and investment balances
            associated with the approximately $138.4 million raised as part of our August
            2000 initial public offering.

Change in fair value of
            warrants.    Due to the redemption feature of warrants
            we had outstanding 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. No such expenses were incurred in 2001.

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 subsequently determined by the board of directors totaling a
            $22.0 million discount. All of our preferred stock was converted to common at
            August 8, 2000.

Income Tax
            Expense.    As of December 31, 2001, our accumulated
            net operating loss carryforward was $70.2 million and our research and
            development credit carryforwards were approximately $1.2 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, 2001 consisted of $112.1 million of cash and investments. We
            have primarily funded our operations through our initial public offering in
            August 2000, resulting in net proceeds of $138.4 million, sales of shares of
            our preferred stock, which have resulted in gross proceeds of approximately
            $42.6 million, as well as $6 million in development funding received from
            Caterpillar since 1999. Cash used in operating activities in 2001 was $22.5
            million, a $7.2 million increase from the $15.3 million used in 2000. 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

26

increased level of cash usage in both years is primarily attributable to
            a higher level of product development, the expansion of our manufacturing
            operations and sales activities and an increase in our inventory levels to
            support both actual and anticipated revenue growth.

Capital expenditures were $15.2
            million, $4.4 million and $598,000 in 2001, 2000 and 1999, respectively. Our
            expenditures in 2001 were primarily focused on increasing our manufacturing
            capacity, including several new product test lines and leasehold improvements
            for our new manufacturing facility. Capital spending in 2000 was primarily
            related to expanding our engineering lab's test capacity and capability, test
            equipment, market demonstration units, and general computer and office
            equipment. We expect to spend $3 to $5 million in 2002 on additional
            engineering lab equipment and improvements, demonstration units, and general
            computer equipment and software for manufacturing, engineering and
            administrative purposes.

We believe our existing cash balances
            at December 31, 2001 will be sufficient to meet our capital requirements
            through at least the next 24 months, although we might elect to seek additional
            funding prior to that time. Beyond the next 24 months, our capital requirements
            will depend on many factors, including the rate of sales growth, the market
            acceptance of our products, the timing and level of development funding, 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 $1.1 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 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 information required by this item
            is included in Part IV, Item 14(a)(1) and (2).

Item 9.     CHANGES IN AND DISAGREEMENTS WITH
            ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

27

PART III

ITEM 10.    Executive Officers of the
            Registrant.

The following table sets forth
            certain biographical information concerning our current executive officers:

|Name                     | Age | Position(s)                                                                      
|------------------------ | --- | ---------------------------------------------------------------------------------
|Joseph F. Pinkerton, III | 38  | Chairman of the Board and Chief Executive
                   Officer             
|David S. Gino            | 43  | Chief Operating Officer, Chief Financial
                   Officer and Secretary
|James A. Balthazar       | 48  | Vice President of Sales and Marketing                                            

Joseph F. Pinkerton, III, our
            founder, has served as our Chief Executive Officer, President and director
            since August 1992. He was elected Chairman of the Board in December 2001. Mr.
            Pinkerton formed the company in 1992 as Magnetic Bearing Technologies, Inc.
            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.
            In 1996, the company's name was changed to Active Power, Inc. Prior to founding
            Active Power, Pinkerton was a principal with Fundamental Research Company
            (FRC), in Walled Lake, Michigan. While at FRC, 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 December
            1999. In December 2001, he took on the additional role of Chief Operating
            Officer. 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. In February 2002, Mr.
            Balthazar was promoted to Vice President of Sales and Marketing. Mr. Balthazar
            is responsible for worldwide sales, service and 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. While at Convex, Mr. Balthazar assisted in its growth from a
            small private company to an over $250 million company, which was purchased by
            Hewlett Packard in 1995. Mr. Balthazar has a Bachelor of Science degree from
            the University of Maryland, College Park and a M.S. in theoretical and applied
            mechanics from Cornell University, Ithaca, New York.

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."

28

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."

29

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:

|                                   | Page
|---------------------------------- | ----
|Report of Independent Auditors     | F-1 
|Financial Statements:             
|Balance Sheets                     | F-2 
|Statements of Operations           | F-3 
|Statements of Stockholders' Equity | F-4 
|Statements of Cash Flows           | F-5 
|Notes to Financial Statements      | F-6 

2. Exhibits.

|ExhibitNumber | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1*          | Amended and Restated Certificate of
                   Incorporation (filed as Exhibit 3.1 to Active Power's IPO Registration
                   Statement on Form S-l (SEC File No. 333-36946) (the "IPO Registration
                   Statement")                                                                                                                                                                                                                                                                                                               
|3.2*          | Amended and Restated Bylaws (filed as
                   Exhibit 3.2 to the IPO Registration Statement)                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|4.1*          | Specimen certificate for shares of Common
                   Stock (filed as Exhibit 4.1 to the IPO Registration Statement)                                                                                                                                                                                                                                                                                                                                                                                                                                         
|4.2*          | Rights Agreement, dated as of December
                   13, 2001, between the Active Power and Equiserve Trust N.A., which includes the
                   form of Certificate of Designation for the Series A Junior Participating
                   Preferred Stock as Exhibit A, the form of Rights Certificate as Exhibit B and
                   the Summary of Rights to Purchase Series A Preferred Stock as Exhibit C (filed
                   as Exhibit 4.1 to Active Power's Current Report on Form 8-K dated December 13,
                   2001).
|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)                                                                                                                                                                                                                                                                                                                                           
|10.6+*        | 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)                                                                                                                                                                                                                                                                                                                                                                                        

30

|ExhibitNumber | Description                                                                                                                                                                                                                                                                            
|------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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. (filed as Exhibit 10.17 to Active Power's Annual
                   Report on Form 10-K for the fiscal year ended December 31, 2000)                                                            
|10.18*        | Sixth Amendment to Lease Agreement by and
                   between Active Power, Inc. and Metropolitan Life Insurance Company (filed as
                   Exhibit 10.18 to the Active Power's Annual Report on Form 10-K dated March 16,
                   2001 (the "2000 10-K")) 
|10.19*        | Seventh Amendment to Lease Agreement by
                   and between Active Power, Inc. and Metropolitan Life Insurance Company (filed
                   as Exhibit 10.19 to the 2000 10-K)                                                                                         
|10.20*       | Distributor Agreement by and between
                   Active Power and Powerware Corporation dated October 28, 2001 (filed as Exhibit
                   10.20 to the Active Power's Quarterly Report on Form 10-Q dated November 9,
                   2001 (the November 2001 10-Q)
|10.21*       | Master Sourcing Agreement by and between
                   Active Power and General Electric Company (through its Digital Energy business
                   unit) dated July 13, 2001 (filed as Exhibit 10.21 to the November 2001 10-Q)                                             
|10.22       | Phase II & Phase III Purchase
                   Agreement by and between Active Power, Inc. and Caterpillar Inc. dated as of
                   [September 1, 2001]                                                                                                                   
|10.23       | Phase III Product Development Agreement
                   by and between Active Power, Inc. and Caterpillar Inc. dated as of [September
                   1, 2001]                                                                                                                   
|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                                                                                         

---

|*  | Incorporated by reference to the indicated filing.                                                             
|-- | ---------------------------------------------------------------------------------------------------------------
|  | Confidential treatment previously granted.                                                                     
| | Portions of this exhibit have been omitted pursuant to a request
                   for confidential treatment.

31

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.                                                                                   
| | -----------------------------------------------------------------------------------------------------
| | By:   /s/   JOSEPH F. PINKERTON, III                                                                 
| | Joseph F. Pinkerton, III,Chairman of the Board
                        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.

|Name                                                          | Title                                                                                                            | Date          
|------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | --------------
|/s/ JOSEPH F. PINKERTON, IIIJoseph F. Pinkerton, III          | Chairman of the Board
                   andChief Executive Officer(principal executive officer)                 | March 15, 2002
|                                                              |                                                                                                                  |               
|/s/ DAVID S.
                   GINODavid S. Gino             | Chief Operating Officer andChief
                   Financial Officer(principal financial andaccounting officer) | March 15, 2002
|                                                              |                                                                                                                  |               
|/s/ RICHARD E.
                   ANDERSONRichard E. Anderson | Director                                                                                                         | March 15, 2002
|                                                              |                                                                                                                  |               
|/s/ RODNEY S.
                   BONDRodney S. Bond           | Director                                                                                                         | March 15, 2002
|                                                              |                                                                                                                  |               
|/s/ ERIC L.
                   JONESEric L. Jones             | Director                                                                                                         | March 15, 2002
|                                                              |                                                                                                                  |               
|/s/ JAN H. LINDELOWJan H. Lindelow                            | Director                                                                                                         | March 15, 2002
|                                                              |                                                                                                                  |               
|/s/ TERRENCE L.
                   ROCKTerrence L. Rock       | Director                                                                                                         | March 15, 2002

32

REPORT OF INDEPENDENT AUDITORS

The Board of DirectorsActive Power, Inc.

We have audited the accompanying
            balance sheets of Active Power, Inc. (the Company) as of December 31, 2001 and
            2000, and the related statements of operations, stockholders' equity and cash
            flows for each of the three years in the period ended December 31, 2001. 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, 2001 and 2000, and the
            results of its operations and its cash flows for each of the three years in the
            period ended December 31, 2001, in conformity with accounting principles
            generally accepted in the United States.

/s/ Ernst & Young LLP

Austin, TexasJanuary 15, 2002

F-1

ACTIVE POWER, INC.BALANCE SHEETS(Thousands, except share
            and per share amounts)

|                                                                                                                                                                                                                                                                                           | December 31,
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------
|
|ASSETS                                                                                                                                                                                                                                                                                     |             
|                                                                                                                                                                                                                                                                                           |             
|Current assets:                                                                                                                                                                                                                                                                           
|Cash and cash
                   equivalents                                                                                                                                                                                                                                               | $80,401     
|Short-term
                   investments                                                                                                                                                                                                                                                  |            
|Accounts
                   receivable, net                                                                                                                                                                                                                                                | 1,723       
|Inventories,
                   net                                                                                                                                                                                                                                                        | 7,869       
|Prepaid expenses
                   and other                                                                                                                                                                                                                                              | 714         
|Total
                   current assets                                                                                                                                                                                                                                                    | 90,707      
|Property and equipment, net                                                                                                                                                                                                                                                                | 16,965      
|Long-term investments                                                                                                                                                                                                                                                                      | 31,704      
|Total
                   assets                                                                                                                                                                                                                                                            | $139,376    
|                                                                                                                                                                                                                                                                                          
|LIABILITIES AND STOCKHOLDERS'
                   EQUITY                                                                                                                                                                                                                                    |             
|                                                                                                                                                                                                                                                                                           |             
|Current liabilities:                                                                                                                                                                                                                                                                      
|Accounts
                   payable                                                                                                                                                                                                                                                        | $4,530      
|Accrued
                   expenses                                                                                                                                                                                                                                                        | 3,116       
|Total liabilities                                                                                                                                                                                                                                                                          | 7,646       
|Stockholders' equity:                                                                                                                                                                                                                                                                     
|1992 Preferred
                   Stock  $.001 par value, $.50 redemption
                   value:      420,000 shares designated;
                   $210,000 liquidation value; zero and 420,000 shares issued and outstanding in
                   2001 and       2000, respectively |            
|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; 40,646,766 and
                   39,043,166 shares issued and
                         outstanding in 2001 and 2000,
                   respectively                                                    | 41          
|Treasury stock, at
                   cost; 34,599 shares                                                                                                                                                                                                                                  | (2)         
|Deferred stock
                   compensation                                                                                                                                                                                                                                             | (2,575)     
|Additional paid-in
                   capital                                                                                                                                                                                                                                              | 214,637     
|Accumulated
                   deficit                                                                                                                                                                                                                                                     | (80,692)    
|Other accumulated
                   comprehensive income                                                                                                                                                                                                                                  | 321         
|Total
                   stockholders' equity                                                                                                                                                                                                                                              | 131,730     
|Total
                   liabilities and stockholders' equity                                                                                                                                                                                                                              | $139,376    

See accompanying notes.

F-2

ACTIVE POWER, INC.STATEMENTS OF OPERATIONS(Thousands,
            except share and per share amounts)

|                                                                                                                                                                       | Year ended December 31,
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------
|
|Revenues:                                                                                                                                                             
|Product
                   revenue                                                                                                                                     | $21,562                
|Development
                   contract                                                                                                                                | 1,000                  
|Total
                   revenue                                                                                                                                       | $ 22,562               
|Operating expenses:                                                                                                                                                   
|Cost of product
                   revenue (excludes deferred stock compensation amortization of $466 in 2001
                         and $698 in 2000)               | 25,796                 
|Cost of
                   development contract                                                                                                                        | 283                    
|Research and
                   development (excludes deferred stock compensation amortization of $1,030 in
                   2001         and $1,636 in 2000)        | 14,930                 
|Selling, general
                   & administrative (excludes deferred stock compensation amortization of
                   $2,507       in 2001 and $4,358 in 2000) | 11,684                 
|Amortization of
                   deferred stock compensation                                                                                                         | 4,003                  
|Total
                   operating expenses                                                                                                                            | 56,696                 
|Operating loss                                                                                                                                                         | (34,134)               
|Interest income                                                                                                                                                        | 6,190                  
|Interest expense                                                                                                                                                       |                       
|Change in fair value of warrants with
                   redemption rights                                                                                             |                       
|Other income (expense)                                                                                                                                                 | (18)                   
|Net loss                                                                                                                                                               | $(27,962)              
|Cumulative undeclared dividends on
                   preferred stock                                                                                                  |                       
|Accretion on redeemable convertible
                   preferred stock to redemption amounts                                                                           |                       
|Beneficial conversion feature on preferred
                   stock issuance                                                                                           |                       
|Net loss to common stockholders                                                                                                                                        | $(27,962)              
|Net loss per share, basic &
                   diluted                                                                                                                 | $(0.70)                
|Shares used in computing net loss per
                   share, basic & diluted                                                                                        | 39,781,031             
|                                                                                                                                                                      
|Comprehensive income (loss):                                                                                                                                          
|Net loss                                                                                                                                                               | $(27,962)              
|Unrealized
                   gain/loss  investments                                                                                                                  | 321                    
|Comprehensive
                   income (loss)                                                                                                                         | $(27,641)              

See accompanying notes.

F-3

ACTIVE POWER, INC.STATEMENTS OF STOCKHOLDERS'
            EQUITY(Thousands)

|                                                                                            | 1992Preferred
                   Stock | Common Stock | Treasury Stock | DeferredStockCompensation | AdditionalPaid-InCapital | AccumulatedDeficit | OtherAccumulatedComprehensiveIncome | TotalStockholders'Equity
|------------------------------------------------------------------------------------------- | -------------------------------------- | ------------ | -------------- | ------------------------- | ------------------------ | ------------------ | ----------------------------------- | ------------------------
|
|Balance at December 31,
                   1998                                             | 420                                    | $           | 10,047         | $10                       | 35                       | $(2)               | $                                  | $                      
|Exercise of stock options                                                                   |                                       |             | 740            | 1                         |                         |                   |                                    | 134                     
|Warrants issued for
                   services                                             |                                       |             |               |                          |                         |                   |                                    | 1,380                   
|Preferred stock issuance
                   costs                                           |                                       |             |               |                          |                         |                   |                                    | (66)                    
|Deferred stock
                   compensation                                              |                                       |             |               |                          |                         |                   | (7,061)                             | 7,061                   
|Amortization of deferred
                   stock compensation                              |                                       |             |               |                          |                         |                   | 1,631                               |                        
|Accretion of redeemable
                   convertible preferred stock to redemption amount |                                       |             |               |                          |                         |                   |                                    | (5,886)                 
|Cumulative dividends on
                   redeemable convertible preferred stock           |                                       |             |               |                          |                         |                   |                                    | (1,820)                 
|Net loss                                                                                    |                                       |             |               |                          |                         |                   |                                    |                        
|Balance at December 31,
                   1999                                             | 420                                    |             | 10,787         | 11                        | 35                       | (2)                | (5,430)                             | 803                     
|Exercise of stock options                                                                   |                                       |             | 1,497          | 2                         |                         |                   |                                    | 554                     
|Exercise of warrants                                                                        |                                       |             | 432            |                          |                         |                   |                                    | 5,206                   
|Deferred stock
                   compensation                                              |                                       |             |               |                          |                         |                   | (8,781)                             | 8,781                   
|Amortization of deferred
                   stock compensation                              |                                       |             |               |                          |                         |                   | 6,692                               |                        
|Accretion of redeemable
                   convertible preferred stock to redemption amount |                                       |             |               |                          |                         |                   |                                    | (13,712)                
|Cumulative dividends on
                   redeemable convertible preferred stock           |                                       |             |               |                          |                         |                   |                                    | (1,461)                 
|Conversion of redeemable
                   convertible preferred stock to common stock     |                                       |             | 17,462         | 17                        |                         |                   |                                    | 73,296                  
|Net proceeds from initial
                   public offering                                |                                       |             | 8,900          | 9                         |                         |                   |                                    | 139,134                 
|Net loss                                                                                    |                                       |             |               |                          |                         |                   |                                    |                        
|Balance at December 31,
                   2000                                             | 420                                    |             | 39,078         | 39                        | 35                       | (2)                | (7,519)                             | 212,601                 
|Exercise of stock options                                                                   |                                       |             | 1,098          | 2                         |                         |                   |                                    | 685                     
|Repurchase of Exercised
                   Stock Options                                    |                                       |             | (13)           |                          |                         |                   |                                    | (2)                     
|Exercise of warrants                                                                        |                                       |             | 432            |                          |                         |                   |                                    | 2,268                   
|Employee purchase of ESPP
                   shares                                         |                                       |             | 86             |                          |                         |                   |                                    | 846                     
|Amortization of deferred
                   stock compensation                              |                                       |             |               |                          |                         |                   | 4,944                               | (941)                   
|Redemption of 92 Preferred
                   Stock                                         | (420)                                  |             |               |                          |                         |                   |                                    | (210)                   
|IPO issuance costs                                                                          |                                       |             |               |                          |                         |                   |                                    | (610)                   
|Unrealized Gain/Loss
                    Investments                                       |                                       |             |               |                          |                         |                   |                                    |                        
|Net loss                                                                                    |                                       |             |               |                          |                         |                   |                                    |                        
|Balance at December 31,
                   2001                                             |                                       | $           | 40,681         | $41                       | 35                       | $(2)               | $(2,575)                            | $214,637                
|                                                                                           

See accompanying notes.

F-4

ACTIVE POWER, INC.STATEMENTS OF CASH FLOWS(Thousands)

|                                                                                                | Year ended December 31,
|----------------------------------------------------------------------------------------------- | -----------------------
|
|Operating activities                                                                           
|Net loss                                                                                        | $(27,962)              
|Adjustment to
                   reconcile net loss to cash used in operating activities:      
|Depreciation
                   expense                                                         | 2,675                  
|Loss on disposal
                   of assets                                                   |                       
|Warrants issued
                   for services                                                 |                       
|Amortization of
                   deferred stock compensation                                  | 4,003                  
|Changes in fair
                   value of warrants with redemption rights                     |                       
|Unrealized gain on
                   available-for-sale investments                            | 321                    
|Changes in
                   operating assets and liabilities:                                
|Accounts receivable, net                                                                        | 211                    
|Inventories, net                                                                                | (5,526)                
|Prepaid expenses and other
                   assets                                            | (147)                  
|Accounts payable                                                                                | 2,397                  
|Accrued expenses                                                                                | 1,506                  
|Other
                   non-current liabilities                                                |                       
|Net cash used in operating activities                                                           | (22,522)               
|                                                                                               
|Investing activities                                                                           
|Net maturity (purchase) of short-term
                   investments                            | 21,785                 
|Purchases of property and equipment                                                             | (15,171)               
|Net cash provided by (used in) investing
                   activities                          | 6,614                  
|                                                                                               
|Financing activities                                                                           
|Payments on notes payable                                                                       |                       
|Net proceeds from issuance of common
                   stock                                   | 1,531                  
|Proceeds from issuance of convertible
                   preferred stock, net of issuance costs |                       
|Redemption of 92 Preferred Stock                                                                | (210)                  
|Net proceeds from exercise of
                   warrants                                       | 2,268                  
|Net cash provided by financing
                   activities                                    | 3,589                  
|Increase (decrease) in cash and cash
                   equivalents                             | (12,319)               
|Cash and cash equivalents, beginning of
                   period                               | 92,720                 
|Cash and cash equivalents, end of
                   period                                     | $80,401                
|Supplemental disclosure of cash flow
                   information:                           
|Interest paid                                                                                   | $                     

See accompanying notes.

F-5

ACTIVE POWER, INC.NOTES TO FINANCIAL
            STATEMENTSDecember 31, 2001(Thousands)

1.    Organization

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

2.    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 product
            revenue when title transfers and our obligations are complete, usually when a
            unit is shipped. Active Power recognizes product revenue related to units
            shipped for evaluation by the customer at the time of customer acceptance of
            the unit. Development funding revenue is recognized as we achieve development
            milestones specified in the respective agreements.

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.

F-6

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

Short term and long term investments
            at December 31, 2001 consist of the following:

| |  |  |                          | Carrying Value
| |  |  | ------------------------ | --------------
| |  |  | Corporate Notes          | $9,588,743    
| |  |  | Corporate Bonds          | 5,088,236     
| |  |  | Foreign Debt Securities  | 1,535,288     
| |  |  | Medium Term Notes        | 13,525,229    
| |  |  | U.S. Government Agencies | 1,966,520     
| |  |  |                          | $31,704,016   

The carrying value by contractual
            maturity, is shown below:

| |  | Due in one year or less                                  | $ 0        
| |  | -------------------------------------------------------- | -----------
| |  | Due after one year through
                   five years | 31,704,016 
| |  |                                                          | $31,704,016

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:

|                 | Year ended December 31,
|---------------- | -----------------------
|
|Raw materials    | $4,326,357             
|Work in process  | 3,923,040              
|Finished goods   | 190,718                
|Evaluation units |                       
|                 | $8,440,115             

The following table summarizes the
            changes in inventory reserves:

| |  | 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  
| |  | Additions charged
                   to costs and expenses | 733,162  
| |  | Write-off of
                   inventory                  | 1,037,273
| |  | Balance at December 31, 2001                               | $570,756 

In 2000 we increased our inventory
            reserve to recognize the potential obsolescence of approximately $700,000 in
            CleanSource 1 DC inventory that was at risk once our next generation
            CleanSource 2 DC product line was commercialized. After the successful launch
            of our CleanSource 2 DC in September of 2001 we wrote off the vast majority of
            our CleanSource 1 DC inventory.

F-7

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

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:

|                                   | 2001       | 2000      
|---------------------------------- | ---------- | ----------
|Compensation and Benefits Accruals | $1,830,082 | $917,001  
|Accrued Warranty Liability         | 534,564    | 167,725   
|State Tax Accruals                 | 410,366    | 35,152    
|Other Accrued Expenses             | 341,225    | 490,415   
|                                   | $3,116,237 | $1,610,293

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, 2001.

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 theenacted 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

F-8

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

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:

| |  | 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 
| |  | Additions charged
                   to costs and expenses |       
| |  | Write-off of
                   uncollectible accounts     | 626    
| |  | Balance at December 31, 2001                               | $54,864

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

|Customer | 2001 | 2000 | 1999
|-------- | ---- | ---- | ----
|A        | 87%  | 96%  | 39% 
|B        | 7%   |     |    
|C        | 4%   |     | 6%  
|D        | 2%   | 1%   | 21% 
|E        |     |     | 16% 
|F        |     | 1%   | 13% 

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 2001, 2000 or 1999.

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.

F-9

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

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

|                                                                                 | Year Ended December 31,
|-------------------------------------------------------------------------------- | -----------------------
|
|Net loss to common stockholders                                                  | $(27,961,930)          
|Basic and diluted:                                                              
|Weighted-average
                   shares of common stock outstanding           | 39,985,229             
|Weighted-average
                   shares of common stock subject to repurchase | (204,198)              
|Shares used in computing basic and diluted
                   net loss per share | 39,781,031             
|Basic and diluted net loss per share                                             | $(0.70)                

3.    Property and Equipment

Property and equipment consist of the
            following at December 31:

|                                 | 2001        | 2000        | 1999       
|-------------------------------- | ----------- | ----------- | -----------
|Equipment                        | $9,566,053  | $3,440,102  | $1,391,233 
|Demonstration units              | 225,512     | 171,252     | 107,321    
|Computers and purchased software | 2,027,331   | 943,248     | 424,525    
|Furniture and fixtures           | 342,769     | 66,977      | 63,037     
|Technology License               | 1,100,000   |            |           
|Leasehold improvements           | 8,623,275   | 2,092,050   | 316,541    
|                                 | 21,884,940  | 6,713,629   | 2,302,657  
|Accumulated depreciation         | (4,920,076) | (2,244,392) | (1,178,934)
|                                 | $16,964,864 | $4,469,237  | $1,123,723 

4.    Stockholders' Equity and Preferred
            Stocks

At December 31, 1999, Active Power
            had 10,420,000 shares of $0.001 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, 2001, Active Power has
            25,420,000 shares of preferred stock authorized and no shares outstanding.

1992 Preferred Stock

The 1992 Preferred Stock was redeemed
            by Active Power in December 2001 as approved by the Board of Directors. The
            redemption price of the 1992 Preferred Stock was $0.50 per share, resulting in
            a total redemption amount of $210,000.

F-10

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

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 held by
            both holders were exercised during 2001. The warrants had exercise prices of
            $5.25 per share, and were fully vested, non-forfeitable and exercisable upon
            issuance. 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.

Stock Option Agreements

Active Power has reserved 5,321,595
            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, 2001, 2000, and 1999,
            260,552, 321,245, and 217,957 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, 2001, 2000 and 1999 is as follows:

|                                 | Numberof Shares | Range ofExercise Prices         | Weighted-AverageExercise Prices
|-------------------------------- | --------------- | ------------------------------- | -------------------------------
|Outstanding at December 31, 1998 | 2,900,448       | $  .07    1.97                 | $0.18                          
|Granted                          | 1,276,560       | .42 
                     1.04 | 0.65                           
|Exercised                        | (739,735)       | .07 
                     0.83 | 0.19                           
|Canceled                         | (89,346)        | .09    1.97                    | 0.29                           
|Outstanding at December 31, 1999 | 3,347,927       | $  .07    1.97                 | $0.35                          
|Granted                          | 1,294,785       | 1.04  68.50                    | 5.04                           
|Exercised                        | (1,496,745)     | .07 
                     6.94 | 0.37                           
|Canceled                         | (102,637)       | .28    6.94                    | 1.65                           
|Outstanding at December 31, 2000 | 3,043,330       | $  .07  68.50                  | $2.42                          
|Granted                          | 1,288,300       | 4.64  26.10                    | 16.25                          
|Exercised                        | (1,095,447)     | .07  21.94                     | 0.63                           
|Canceled                         | (146,483)       | .16  46.50                     | 10.06                          
|Outstanding at December 31, 2001 | 3,089,700       | $  .07  68.50                  | $8.33                          

At December 31, 2001, 2,232,035
            shares were available for future grants.

F-11

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

The following is a summary of options
            outstanding and exercisable as of December 31, 2001:

|Range of Exercise Prices               | Number    | WeightedAverageRemainingContractualLife
                   (in years) | WeightedAverageExercisePrice
|-------------------------------------- | --------- | --------------------------------------------------------------------- | ----------------------------
|$    .07 
                   $    .09 | 21,364    | 4.8                                                                   | $0.08                       
|$    .10 
                   $    .49 | 608,831   | 6.3                                                                   | 0.24                        
|$    .50 
                   $  2.00  | 799,054   | 7.9                                                                   | 0.99                        
|$  4.00 
                   $  6.99   | 575,426   | 8.9                                                                   | 6.07                        
|$  7.00  $24.99                       | 1,030,025 | 9.1                                                                   | 18.59                       
|$25.00  $68.50                        | 55,000    | 8.9                                                                   | 45.70                       
|                                       | 3,089,700 | 8.2                                                                   | $8.33                       

Stock options vested as of December
            31, 2001, 2000, and 1999 were 1,044,107, 1,274,526, and 1,458,112,
            respectively.

Prior to our initial public offering
            in August 2000, 2,377,404 of the stock options granted to employees 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 $15,842,671. Of
            this amount, $1,631,068, $6,692,173, and $4,002,913 was amortized to non-cash
            compensation during 1999, 2000 and 2001, respectively. The remaining unearned
            compensation will be recognized as non-cash compensation over the remaining
            vesting period of the options of approximately 2 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:

|                                                                                 | Year ended December 31,
|-------------------------------------------------------------------------------- | -----------------------
|
|Risk-free interest rate                                                          | 3.0%                   
|Weighted-average expected life of the
                   options                 | 7 years                
|Dividend rate                                                                    | 0%                     
|Assumed volatility                                                               | 125%                   
|Weighted average fair value of options
                   granted:              
|Exercise price equal to fair value of
                   stock on date of grant  | $10.35                 
|Exercise price less than fair value of
                   stock on date of grant | $                     

F-12

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

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:

|                                                              | Year ended December 31,
|------------------------------------------------------------- | -----------------------
|
|Pro forma stock-based compensation
                   expense | $15,742,971            
|Pro forma net loss                                            | $(39,701,971)          
|Pro forma net loss to common
                   stockholders  | $(39,701,971)          
|Pro forma basic and diluted loss per
                   share | $(1.00)                

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.

Common stock reserved at December 31,
            2001 consists of the following:

| | For issuance under the 1993/2000 Stock
                   Option Plan | 5,321,595
| | --------------------------------------------------------------------- | ---------

Stockholders' Rights Plan

On December 13, 2001, the Company's
            Board of Directors declared a dividend of one right for each outstanding share
            of the Company's common stock to stockholders of record at the close of
            business on December 26, 2001. Each right entitles the registered holder to
            purchase from the Company a unit consisting of one one-hundredth of a share of
            Series A Junior Participating Preferred Stock, par value $0.001 per share, at a
            purchase price of $40.00 per unit, subject to adjustment.

5.    Income Taxes

As of December 31, 2001, the Company
            had federal net operating loss carryforwards of approximately $70,215,000 and
            research and development credit carryforwards of approximately $1,202,000. The
            net operating loss and credit carryforwards will expire beginning in 2019, if
            not utilized.

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

F-13

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

Deferred income taxes reflect the net
            tax effects of temporary differences between the carrying amounts of assets and
            liabilities for financial reporting purposes and the amounts used for income
            tax purposes. Significant components of the Company's deferred taxes as of
            December 31 are as follows:

|                                                                   | 2001         | 2000        
|------------------------------------------------------------------ | ------------ | ------------
|Deferred tax assets:                                              
|Capital
                   expenses                                | $260,000     | $164,000    
|Warrants                                                           |             | 511,000     
|Reserves and
                   allowances                         | 697,000      | 628,000     
|Net operating
                   loss and tax credit carryforwards | 27,182,000   | 11,587,000  
|Total deferred tax assets                                          | 28,139,000   | 12,890,000  
|Valuation allowance for net deferred tax
                   assets | (28,139,000) | (12,890,000)
|Net deferred taxes                                                 | $           | $          

The Company has established a
            valuation allowance equal to the net deferred tax asset 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
            $15,249,000 during 2001. Approximately $6,217,000 of the valuation allowance
            relates to tax benefits for stock option deductions included in the net
            operating loss carryforward, which when realized, will be allocated directly to
            contributed capital to the extent the benefits exceed amounts attributable to
            deferred compensation expense.

The Company's provision for income
            taxes differs from the expected tax expense (benefit) amount computed by
            applying the statutory federal income tax rate of 34% to income before taxes
            due to the following:

|                                    | Year Ended December 31,
|----------------------------------- | -----------------------
|
|Federal statutory rate              | (34.0)%                
|State taxes, net of federal benefit | (2.6)                  
|Non-cash compensation expense       | 4.9                    
|Permanent items and other           | (2.2)                  
|Change in deferred tax items        | 33.9                   
|                                    | 0%                     

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.

F-14

ACTIVE POWER, INC.NOTES TO FINANCIAL STATEMENTS
            (Continued)December 31, 2001(Thousands)

Future minimum payments under these
            leases at December 31, 2001 are as follows:

| | 2002                                | $1,588,173 
| | ----------------------------------- | -----------
| | 2003                                | 1,294,803  
| | 2004                                | 1,085,253  
| | 2005                                | 791,440    
| | Total future minimum lease payments | $ 4,759,669

Rent expense for the years ended
            December 31, 2001, 2000, and 1999 was $1,668,278, $489,597, and $353,502
            respectively.

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 2001, 2000,
            and 1999.

8.    Development Funding

During January 1999, Active Power
            entered into a contract development agreement with Caterpillar, Inc. In
            accordance with the agreement, Caterpillar provided funding to allow Active
            Power to accelerate development of its products in a certain market application
            in exchange for Caterpillar obtaining exclusive marketing rights for the
            product in that application. The exclusive marketing rights are subject to
            Caterpillar 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. As an extension of this
            agreement, Caterpillar in 2001 agreed to provide another $5.0 million in
            funding for the development of a high power electronics platform that will
            complement the Cat UPS and a VSCF technology that will enhance the performance
            of the genset. Development of this platform is continuing at Active Power as of
            December 31, 2001, and product shipments are expected to commence in 2003.

9.    Geographic Information

Revenues for the year ended December
            31 were as follows:

|                  | 2001        | 2000       | 1999      
|----------------- | ----------- | ---------- | ----------
|United States     | $18,676,178 | $3,392,607 | $1,014,411
|Foreign countries | 2,885,768   | 1,479,526  | 32,400    
|Total             | $21,561,946 | $4,872,133 | $1,046,811

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

Supplementary Financial Information (Unaudited)

|                                                                                             | Year Ended December 31, 2000 | Year Ended December 31, 2001
|-------------------------------------------------------------------------------------------- | ---------------------------- | ----------------------------
|
|Total revenue                                                                                | $182                         | $679                        
|Total margin (loss)                                                                          | (339)                        | (497)                       
|Net loss                                                                                     | (4,857)                      | (6,208)                     
|Cumulative undeclared dividends on preferred stock                                           | (849)                        | (849)                       
|Accretion on redeemable convertible preferred stock to
                   redemption amounts | (6,383)                      | (7,329)                     
|Net loss to common stockholders                                                              | $(12,089)                    | $(14,386)                   
|Net loss per share, basic and diluted                                                        | $(1.15)                      | $(1.26)                     

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 immediately
            prior to the Company's initial public offering.