SEC Filing

View:

As filed with the Securities and Exchange Commission on August 2, 2000
Registration No. 333-36946
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Amendment No. 3 to
FORM S-1
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
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Active Power, Inc.
(Exact name of registrant as specified in its charter)
Delaware 3629 74-2642142
(State or other (Primary Standard Industrial (I.R.S. Employer
jurisdiction of Classification Code Number) Identification Number)
incorporation or
organization)
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Active Power, Inc.
11525 Stonehollow Dr.
Suite 110
Austin, TX 78758
Telephone: (512) 836-6464, Facsimile: (512) 836-4511
(Address, including zip code, and telephone number, including area code, of
the registrant's principal executive offices)
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Joseph F. Pinkerton, III
Chief Executive Officer
11525 Stonehollow Drive
Suite 110
Austin, TX 78758
Telephone: (512) 836-6464
Facsimile: (512) 836-4511
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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Copies to:
J. MATTHEW LYONS, P.C. ROBERT S. BAIRD
TED A. GILMAN JEFFREY A. CHAPMAN
Brobeck, Phleger & Harrison LLP SHANNA DINWIDDIE JONES
301 Congress Avenue, Suite 1200 Vinson & Elkins L.L.P.
Austin, Texas 78701 600 Congress Avenue
Telephone: (512) 477-5495 Austin, Texas 78701
Facsimile: (512) 477-5813 Telephone: (512) 495-8400
Facsimile: (512) 495-8612

Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this
Registration Statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933, as amended, or until the
Registration Statement shall become effective on such date as the Securities
and Exchange Commission, acting pursuant to such Section 8(a), may determine.
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. These securities may not be sold until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+preliminary prospectus is not an offer to sell nor does it seek an offer to +
+buy these securities in any jurisdiction where the offer or sale is not +
+permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Subject to Completion. Dated August 2, 2000.

8,000,000 Shares

[LOGO OF ACTIVE POWER APPEARS HERE]

Active Power, Inc.

Common Stock

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This is an initial public offering of shares of common stock of Active Power,
Inc. All of the 8,000,000 shares of common stock are being sold by Active
Power.

Prior to this offering, there has been no public market for the common stock.
We estimate that the initial public offering price per share will be between
$11.00 and $13.00. Our common stock has been approved for quotation on the
Nasdaq National Market under the symbol "ACPW".

See "Risk Factors" beginning on page 7 to read about factors you should
consider before buying shares of our common stock.

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Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the adequacy or
accuracy of this prospectus. Any representation to the contrary is a criminal
offense.

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Per
Share Total
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Initial public offering price ..................................... $ $
Underwriting discount.............................................. $ $
Proceeds, before expenses, to Active Power......................... $ $

To the extent that the underwriters sell more than 8,000,000 shares of common
stock, the underwriters have the option to purchase up to an additional 900,000
shares from Active Power and up to an additional 300,000 shares from a selling
stockholder identified in this prospectus, each at the initial public offering
price less the underwriting discount. Active Power will not receive any of the
proceeds from the sale of any shares sold by the selling stockholder.

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The underwriters expect to deliver the shares against payment in New York,
New York on , 2000.

Goldman, Sachs & Co.
Merrill Lynch & Co.
Morgan Stanley Dean Witter
CIBC World Markets

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Prospectus dated , 2000.

[INSIDE FRONT COVER GRAPHICS]

[Description of graphics: The inside front cover has three graphical
depictions.

The first graphic is located on the top half of the page and is captioned
"Active Power transforms unreliable, inconsistent electricity..." at the top of
the page and "...into high quality, dependable power," at the bottom of the
graphic in the middle of the page.

The left side of the graphic depicts sine waves representing the three problems
with power supplied from the electric utility grid. The first graphic shows a
steady sine wave that turns into a straight line. Above the straight line is
the word "Outage" with an arrow pointing at the straight line. Below this
graphic is a graphic of another sine wave which has smaller peaks and valleys
in the middle of the sine wave. Above the middle of the sine wave are the words
"Voltage Sag" with an arrow pointing at the center of the sine wave. Below this
graphic is a graphic of another sine wave which has larger peaks and valleys in
the middle of the sine wave. Above the middle of the sine wave are the words
"Voltage Surges" with an arrow pointing at the center of the sine wave.

In the center of the graphic is a rotor with the Active Power logo in the
middle. From the rotor to the right of the page is a smooth, continuous sine
wave.

At the left side of the bottom of the page is a graphic with the caption
"CleanSource UPS Technology". The graphic is a three-dimensional rendering of
our CleanSource UPS product showing the exposed internal components of the
product without its sheet-metal shell. The graphic shows the appearance and
relative size and location of the components of the product. The flywheel
energy storage component is visible at the bottom of the CleanSource UPS
product while the UPS electronics appear closer to the top.

At the right side of the bottom of the page is a graphic with the caption "CAT
branded CleanSource UPS". This graphic is a three-dimensional rendering of a
Caterpillar-branded CleanSource UPS product showing the external appearance of
the product with its painted sheet-metal shell. Caterpillar's "CAT" logo is
visible on the upper left of the front side of the product.]

PROSPECTUS SUMMARY

This summary provides an overview of the key aspects of the offering.
Because this is a summary, it may not contain all of the information that is
important to you.

Active Power, Inc.

Overview

Industry Background

The need for high quality electric power that is free of sags, surges and
power outages has been increasing rapidly in recent years. This demand for
power quality has been driven largely by the growth in the use of computers,
the Internet and telecommunications products. These sophisticated applications
are less tolerant of voltage disturbances than conventional uses of
electricity. A 1999 study by the Electric Power Research Institute estimated
that electric power problems annually cost U.S. industry more than $30 billion
in lost data, material and productivity. Therefore, end users of sophisticated
electronic equipment are seeking new solutions for their power quality and
reliability problems.

Conventional Power Quality Systems and Their Limitations

A variety of approaches currently exist that attempt to address the
problems associated with the poor quality of power delivered by the electric
utility grid. Conventional power quality systems have been constructed using
three main components, 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. The conventional patchwork approach to UPS and CPS has resulted
in inefficient systems that generally are expensive, unreliable and
environmentally unsound.

Active Power's Products

We believe that our current products are superior alternatives to
conventional UPS and CPS products and should be able to rapidly penetrate the
power quality industry. With our future products, we anticipate that we will be
able to compete in most segments of this industry.

CleanSource DC

Our first product, CleanSource DC, is a patented flywheel-based energy
storage system that is a cost-effective, reliable, non-toxic replacement for
the lead-acid batteries used in a UPS. Our

flywheel, powered with electricity from the utility grid, stores kinetic energy
by constantly spinning a compact rotor inside a low friction environment. When
the user requires power due to a power outage or sag, CleanSource DC converts
the kinetic energy of the spinning flywheel into electricity. For longer term
power outages, CleanSource DC can provide enough power to bridge the gap
between the power disturbance and the start-up of the genset which will deliver
long-term back-up power.

CleanSource UPS

Our second product, CleanSource UPS, is the primary focus of our current
sales efforts. It integrates UPS electronics, which detect any power quality
problems, with our flywheel-based energy storage system. As a result of the
efficiencies created by the significant component overlap in the two systems,
CleanSource UPS represents a more compact, reliable and efficient power quality
solution. When used with a genset, CleanSource UPS also provides a continuous
power solution. We have granted Caterpillar distribution rights to CleanSource
UPS, which is marketed under the Caterpillar brand name. While the power
quality market is generally conservative and reluctant to adopt new products,
we believe that our arrangement with Caterpillar will provide CleanSource UPS
the credibility it will need to overcome this reluctance and penetrate the
market.

Future Products

Fully Integrated Continuous Power System. Leveraging the technology and
design expertise developed in our earlier products, we are developing a fully
integrated CPS. This system will combine short and long term energy storage and
UPS functionality into one fully integrated system. We believe that this
product will provide customers with higher levels of power reliability and
lower operating costs than conventional patchwork, lead-acid battery based
approaches. The initial target market for this product is as a back-up power
source for distributed telecommunications applications. We anticipate
commercial availability of our first CPS product in the fourth quarter of 2001.

Distributed Power Technology. Under an agreement with Caterpillar, we are
also studying the potential benefits of a new type of electromechanical
technology that can be used in distributed power applications.

Market Opportunities

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 losses due to power disturbances. Industry sources also estimate that
market growth rates for power quality and reliability products will be 30% per
year. While more established companies currently serve the power quality
market, we believe that our products are superior alternatives. Our current
products, CleanSource DC and CleanSource UPS, are targeted at the $5.5 billion
market for UPS. Our development efforts for our existing and future products
will be focused on almost all of the remaining segments of this market.

With current and future products, we intend to focus on the following
market opportunities:

Internet Market

A study conducted by the University of Texas and released by Cisco Systems
projected that the U.S. Internet economy would grow to $850 billion in 2000, up
62% from 1999. To support this growth, internet service providers must
construct new facilities to house the equipment required to provide the service
demanded by their customers and are adding power quality equipment to ensure
continuous service around-the-clock.

Telecommunications Market

To ensure uninterrupted service, wireless telecommunications providers must
have continuous power at each cellular and PCS station. This segment represents
approximately $4.0 billion of the $11.0 billion power quality market. While
conventional CPS systems presently meet market demand, we are designing our
next generation product, a fully integrated CPS to service the specific needs
of telecommunications providers. While this product is still in development, we
believe that we will be able to rapidly penetrate this market.

Other Power Quality and Reliability Markets

Industrial. Manufacturing organizations are employing increasing levels of
automation. Even brief power disturbances, which result in lost material, lost
data, and worker and plant down time, can be very expensive. Industries where
we expect significant future opportunities include semiconductor and
pharmaceutical manufacturing, plastic and fiber extrusion, textiles, and
precision machining.

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

Retrofit Market. Caterpillar has the largest installed base of standby
generators in the world. Because even a short power disturbance can cause an
extended shutdown of sensitive electronic equipment, many of the customers that
have historically relied 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 a significant market opportunity exists to upgrade, or
retrofit, a portion of Caterpillar's approximately 250,000 installed gensets
worldwide by adding our CleanSource UPS, thereby creating a CPS.

Distributed Generation

We believe that employing our CleanSource products with fuel cells and
microturbines represent potential markets for our CleanSource products. These
new technologies, which allow users to bypass the electric utility grid by
generating power locally, cannot respond effectively to rapid changes in
electric power demands, or loads. CleanSource DC can absorb sharp peaks in
electrical demand, allowing a microturbine or fuel cell to be sized for the
average power requirement of the customer, rather than for peak power
requirements, thereby generating significant cost savings. In addition,
CleanSource UPS can seamlessly transfer a customer load from utility power to
fuel cell or microturbine standby power in the event of a utility outage.

Additional Factors You Should Consider

In addition to the information we provide in the "Risk Factors" section and
elsewhere in this prospectus, you should also consider the following factors
regarding our company.

Customer Concentration. Since our inception, a few customers have accounted
for the majority of our sales. During 1999, our four largest customers
accounted for 89% of our sales, with our largest, Caterpillar, accounting for
39%. In the first six months of 2000, Caterpillar accounted for

83% of our revenue as we have shifted focus to our CleanSource UPS product. We
expect to be dependent on a few original equipment manufacturer customers,
particularly Caterpillar, for most of our sales for the foreseeable future.

Limited Operating History. To date, we have primarily funded our operations
through sales of our preferred stock, which has resulted in gross proceeds of
approximately $42.8 million, as well as $5.0 million in development funding
which we received from Caterpillar in 1999. As of June 30, 2000, we had
generated an accumulated deficit of $37.0 million and expect to continue to
sustain operating losses for the next several years.

Corporate Information

We were founded as a Texas corporation in 1992. We changed our name from
Magnetic Bearing Technologies, Inc. to Active Power, Inc. in 1996 and we
reincorporated in Delaware in 2000.

Our principal executive offices are located at 11525 Stonehollow Drive,
Suite 110, Austin, Texas 78758. Our telephone number is (512) 836-6464.

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Assumptions that Apply to this Prospectus

This offering is for 8,000,000 shares. The underwriters have a 30-day
option to purchase up to 900,000 additional shares from us and up to 300,000
additional shares from a selling stockholder to cover over-allotments. Unless
we state otherwise, the information in this prospectus assumes that the
underwriters will not exercise the over-allotment option.

Except where we state otherwise, the information we present in this
prospectus:

. reflects a 2.16-for-1 split of our common stock which will be effected
prior to the consummation of this offering;

. reflects our reincorporation in Delaware in April 2000, at which time
each share of common stock and preferred stock issued by our predecessor
Texas corporation was exchanged for two shares of a similar series of
common stock or preferred stock in the successor Delaware corporation;
and

. reflects the conversion of all outstanding shares of preferred stock,
other than our 1992 preferred stock, into 17,461,883 shares of common
stock upon the closing of this offering.

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All references in this prospectus to "we", "us", "ours" and "Active Power"
are intended to include Active Power, Inc., including our predecessor Texas
corporation.

The Offering

Common stock we are offering........ 8,000,000 shares

Outstanding common stock after the 37,662,399 shares
offering...........................

Use of proceeds..................... We intend to use the net proceeds for
working capital and other general
corporate purposes, including increases
in both component and finished goods
inventory, expansion of our
manufacturing facilities and capacity,
capital expenditures, research and
development, sales and marketing, and
possible acquisitions and international
expansion. See "Use of Proceeds".

Proposed Nasdaq National ACPW
Market symbol......................

The number of shares of common stock to be outstanding after this offering
is based on the number of shares outstanding as of June 30, 2000, and assumes
the conversion of all of our preferred stock, other than our 1992 preferred
stock, into 17,461,883 shares of common stock. This number assumes no exercise
of the underwriters' over-allotment option and excludes:

. 3,423,194 shares of common stock issuable upon exercise of options
outstanding as of June 30, 2000 with a weighted average exercise price of
$1.08 per share;

. 101,740 additional shares of common stock reserved under our 1993 stock
option plan as of June 30, 2000, and an increase of an additional
2,592,000 shares of common stock reserved under our 2000 stock option
plan which was approved by our board of directions on July 13, 2000;

. 1,080,000 shares of common stock reserved for issuance under our employee
stock purchase plan; and

. 432,000 shares of common stock issuable upon exercise of outstanding
warrants as of June 30, 2000 with a weighted average exercise price of
$5.25 per share.

Summary Financial Information
(in thousands, except per share data)

Six Months Ended
Year Ended December 31, June 30,
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1997 1998 1999 1999 2000
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(unaudited)

Statement of Operations Data:
Product revenue................. $ 138 $ 915 $ 1,047 $ 473 $ 861
Product margin.................. (20) (323) (1,959) (886) (836)
Development funding............. -- -- 5,000 3,000 --
Total operating expenses........ 3,862 5,971 10,044 3,187 9,358
Operating loss.................. (3,882) (6,294) (7,003) (1,073) (10,194)
Net loss........................ (3,738) (5,979) (10,188) (2,439) (11,065)

The following table contains a summary of our unaudited balance sheet:

. on an actual basis at June 30, 2000;

. on a pro forma basis to reflect the conversion of all outstanding shares
of convertible preferred stock into 17,461,883 shares of common stock
upon the consummation of this offering, as if such conversion had
occurred on June 30, 2000; and

. on a pro forma as adjusted basis at June 30, 2000 to additionally reflect
estimated net proceeds from the sale of 8,000,000 shares of common stock
offered hereby at an assumed initial public offering price of $12.00 per
share.

June 30, 2000
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Pro Pro Forma
Actual Forma As Adjusted
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Balance Sheet Data:
Cash, cash equivalents and short-term
investments.................................... $ 17,749 $17,749 $105,749
Working capital................................. 18,586 18,586 106,586
Total assets.................................... 23,267 23,267 111,267
Redeemable convertible preferred stock.......... 69,645 -- --
Stockholders' equity (deficit).................. (48,084) 21,561 109,561

RISK FACTORS

You should carefully consider the following risks and all other information
contained in this prospectus before deciding to invest in our common stock.

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

We have incurred operating losses since our inception and expect to
continue to incur losses in the foreseeable future. As of June 30, 2000, we had
an accumulated deficit of $37.0 million. To date, our product revenue has been
insignificant, and we have funded our operations through sales of our stock and
a $5.0 million development funding payment from Caterpillar. We will need to
generate significant revenue to achieve profitability, and we cannot assure you
that we will ever realize sufficient revenue to achieve profitability. We also
expect to incur significant product development, sales and marketing and
administrative expenses and, as a result, we expect to continue to incur
losses.

Due to our limited operating history and the uncertain market acceptance of our
products, we may not ever achieve significant revenue and may have difficulty
accurately predicting revenue for future periods and appropriately budgeting
for expenses.

We have generated a total of $2.8 million in product revenue over the past
two and one-half years, and we have sold fewer than 100 CleanSource DC and
CleanSource UPS products. We are uncertain whether our products will achieve
market acceptance such that our revenues will increase or whether we will be
able to achieve significant revenue. Therefore, we have a very limited ability
to predict future revenue. In addition, we currently have only a small backlog
of orders. Our limited operating experience, the uncertain market acceptance
for our products, and other factors that are beyond our control make it
difficult for us to accurately forecast our quarterly and annual revenue.
However, we use our forecasted revenue to establish our expense budget. Most of
our expenses are fixed in the short term or incurred in advance of anticipated
revenue. As a result, we may not be able to decrease our expenses in a timely
manner to offset any revenue shortfall. Further, we are expanding our staff and
facilities and increasing our expense levels in anticipation of future revenue
growth. If our revenue does not increase as anticipated, we will incur
significant losses.

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

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

. the timing of orders from our customers and the possibility that these
customers may change their order requirements with little or no advance
notice to us;

. the rate of adoption of our flywheel-based energy storage system as an
alternative to lead-acid batteries;

. the deferral of customer orders in anticipation of new products from us
or other providers of power quality systems;

. the ongoing need for short term power outage protection in traditional
UPS systems;

. the uncertainty regarding the adoption of our current and future
products, including our recently introduced CleanSource UPS product and
our fully integrated CPS, which we expect to introduce in the fourth
quarter of 2001; and

. the rate of growth of the markets for our products.

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

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

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

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

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

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

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

If our relationship with Caterpillar is not successful, or if Caterpillar's
distribution of our CleanSource UPS product is not successful, our business and
revenue will suffer. Pursuant to a development agreement, Caterpillar provided
us with $5.0 million in funding to support the development of our CleanSource
UPS product. In exchange for this payment, Caterpillar received co-ownership of
the proprietary rights in this product. Either we or Caterpillar may license to
other entities the intellectual property that we jointly own without seeking
the consent of the other and all licensing revenue generated by licensing this
intellectual property will be solely retained by the licensing party. However,
we may not license the joint intellectual property to specifically identified
competitors of Caterpillar until January 1, 2005. Caterpillar may terminate
this agreement at any time by giving us 90 days' advance written notice. We
also have a distribution agreement with Caterpillar. During 1999 and the first
six months of 2000, we received approximately $412,000, or 39%, and $712,000,
or 83%, respectively, of our product revenue from Caterpillar. Pursuant to the
distribution agreement with Caterpillar, they are the exclusive distributor,
subject to limited exceptions, of our CleanSource UPS product. Caterpillar is
not obligated to purchase any CleanSource UPS units.

We depend on a limited number of OEM customers for the vast majority of our
revenue, and the loss of or significant reduction in orders from any key OEM
customer, particularly Caterpillar, would significantly reduce our revenue.

We rely on OEMs as a primary distribution channel as they are able to sell
our products to a large number of end-user organizations. 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 1999 sales to our four largest customers, Caterpillar, Powerware, Micron
Technologies and Lee Technologies, accounted for 39%, 21%, 16% and 13%,
respectively, of our revenue. In the first half of 2000, sales to Caterpillar
accounted for 83% of our revenue. Therefore, the loss of any of our key OEM
customers, primarily Caterpillar, or a significant reduction in sales to any
one of them, would significantly reduce our revenue. We also have granted
Caterpillar semi-exclusive worldwide rights to distribute our CleanSource UPS
product, provided that they meet minimum annual sales requirements. These
restrictions will further increase our dependence upon Caterpillar. However,
Caterpillar is not obligated to purchase any CleanSource UPS units under this
agreement.

OEMs may devote a limited amount of their resources to sales, marketing and
customer service and support of our products, which would adversely affect our
product revenues.

As a part of our OEM strategy, we do not make all of our products available
to all of our OEMs. Consequently, an OEM could sell one of our products and
compete with another product that we have not made available to it. For
example, because of our relationship with Caterpillar, none of our current or
potential future CleanSource DC OEMs, other than Caterpillar, is able to sell
CleanSource UPS. As a result, OEMs may devote a limited amount of resources to
sales, marketing and customer service and support of our products.

We may have difficulty managing the expansion of our operations.

We are undergoing rapid growth in the number of our employees, the size of
our physical facilities and the scope of our operations. For example, we had 38
employees on January 1, 1998 and had 126 employees on June 30, 2000. Such rapid
expansion is likely to place a significant strain on our senior management team
and other resources. Our business, prospects, results of operations or
financial condition could be harmed if we encounter difficulties in effectively
managing the budgeting, forecasting and other process control issues presented
by such a rapid expansion.

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

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

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

To assure the availability of our products to our OEM customers, we
outsource the manufacturing of components prior to the receipt of purchase
orders from OEM customers based on their forecasts of their product needs.
However, these forecasts do not represent binding purchase commitments, and we
do not recognize revenue for such products until the product is shipped to the

OEM. As a result, we incur inventory and manufacturing costs in advance of
anticipated revenue. As demand for our products may not materialize, this
product delivery method subjects us to increased risks of high inventory
carrying costs and obsolescence and may increase our operating costs. In
addition, we may from time to time make design changes to our products which
could lead to obsolescence of inventory.

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

We purchase a power module and a microprocessor for our products from sole
sources. We do not have long-term contracts with any of our suppliers, and to
date most of our component purchases have been made in relatively small
volumes. As a result, if our suppliers receive excess demand for their
products, we may receive a low priority for order fulfillment as large volume
customers will receive priority. If we are delayed in acquiring components for
our products, the manufacture and shipment of our products also will be
delayed. We generally use a twelve month forecast of our future product sales
to determine our component requirements. Lead times for ordering materials and
components vary significantly and depend on factors such as specific supplier
requirements, contract terms, the extensive production time required and
current market demand for such components. Some of these delays may be
substantial. As a result, we purchase these components in large quantities to
protect our ability to deliver finished products. If we overestimate our
component requirements, we may have excess inventory, which will increase our
costs. If we underestimate our component requirements, we will have inadequate
inventory, which will delay our manufacturing and render us unable to deliver
products to customers on scheduled delivery dates. If we are unable to obtain a
component from a supplier or if the price of a component has increased
substantially, we will be required to manufacture the component internally,
which will result in delays. Manufacturing delays could negatively impact our
ability to sell our products and could damage our customer relationships.

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

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

We have hired a substantial number 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 many 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 CPS systems in the United States, Canada and abroad,
including, among others, major electric and specialized electronics firms, as
well as universities, research institutions and foreign government-sponsored
companies. There are many companies located in the United States, Canada and
abroad that are developing flywheel-based energy storage systems and flywheel-
based power quality systems. We also compete indirectly with companies that are
developing other types of power technologies, such as superconducting magnetic
energy storage, ultra-capacitors and dynamic voltage restorers.

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

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

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

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

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

management's time and attention. Any potential intellectual property litigation
also could force us to take specific actions, including:

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

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

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

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

Although we are not currently negotiating any 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 this offering. We expect that the net proceeds of this
offering, together with our other available sources of working capital, will be
sufficient to fund development activities for at least 24 months. However,
unforeseen delays or difficulties in these activities could increase costs and
exhaust our resources prior to the full commercialization of our products under
development. We do not know whether we will be able to secure additional
funding, or funding on terms acceptable to us, to continue our operations as
planned. If financing is not available, we may be required to reduce, delay or
eliminate certain activities or to license or sell to others some of our
proprietary technology.

Insiders will continue to have substantial control over our company after this
offering and could delay or prevent a change in corporate control.

Upon completion of this offering, our executive officers and directors, and
their respective affiliates, will beneficially own, in the aggregate,
approximately 45.0% of our outstanding common stock. As a result, these
stockholders will be able to exert significant control over all matters
requiring stockholder approval, including the election of directors and
approval of significant corporate transactions. This concentration of voting
power could delay or prevent an acquisition of our company on terms which other
stockholders may desire.

Provisions in our charter documents and of Delaware law, and provisions in our
agreement 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. Please see "Description of Capital Stock--Anti-Takeover Effects" for
more information concerning the anti-takeover provisions applicable to us.

Our stock price may be volatile, and you may not be able to resell your shares
at or above the initial public offering price.

Prior to this offering, there has been no public market for our common
stock. Although we have applied to have our common stock quoted on the Nasdaq
National Market, an active trading market for our shares may never develop or
be sustained following this offering. The initial public offering price for our
common stock will be determined through negotiations between the underwriters
and us. This initial public offering price may vary from the market price of
our common stock after the offering. If you purchase shares of common stock,
you may not be able to resell those shares at or above the initial public
offering 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.

Of our total outstanding shares following this offering, 29,662,399, or 78.8%,
are restricted from immediate resale but may be sold into the market in the
near future. This could cause the market price of our common stock to drop
significantly, even if our business is doing well.

After this offering, we will have outstanding 37,662,399 shares of common stock
based on the number of shares outstanding at June 30, 2000. This includes the
8,000,000 shares we are selling in this offering, which may be resold in the
public market immediately. The remaining 29,662,399 shares will become
available for resale in the public market as shown in the chart below, which
assumes no exercise of the underwriters' over-allotment option.

Number of Shares/
% of Total Shares
Outstanding Date of availability for resale into the public market
----------------- -----------------------------------------------------------

8,000,000/21.2% Immediately (except to the extent purchased by our
affiliates).
5,028,658/13.4% 90 days after the date of this prospectus due to lock-up
agreements these stockholders have with the underwriters if
the conditions described under "Shares Eligible for Future
Sale--Lock-up Agreements" are satisfied.
5,034,617/13.4% 120 days after the date of this prospectus if additional
conditions described under "Shares Eligible for Future
Sale--Lock-up Agreements" are satisfied.
19,335,321/51.3% 180 days after the date of this prospectus due to the
release of the lock-up agreement these stockholders have
with the underwriters.
263,803/0.7% At some point after 180 days from the date of this
prospectus subject to vesting requirements and the
requirements of Rule 144 (subject, in some cases, to volume
limitations), Rule 144(k) or Rule 701.

As restrictions on resale end, the market price of our stock could drop
significantly if the holders of restricted shares sell them or are perceived by
the market as intending to sell them. For more detailed information, see
"Shares Eligible for Future Sale" on page 59.

Our management may apply the proceeds of this offering to uses that our
stockholders may not agree with and in ways that do not improve our efforts to
achieve profitability or increase our stock price.

Although in "Use of Proceeds" we have specified some ways in which we
initially intend to use a portion of the proceeds of this offering, our
management will have considerable discretion in the application of the net
proceeds received by us from this offering, and you will not have the
opportunity, as part of your investment decision, to assess whether the
proceeds are being used appropriately. You must rely on the judgment of our
management regarding the application of the proceeds of this offering. The net
proceeds may be used for corporate purposes that do not improve our efforts to
achieve profitability or increase our stock price. Pending application of the
net proceeds from this offering, they may be placed in investments that do not
produce income or that lose value.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve
substantial risks and uncertainties. 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 and other forward-
looking statements carefully because they discuss our future expectations, make
projections of our future results of operations or of our 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 "Risk Factors" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations", as
well as any cautionary language in this prospectus, provide examples of risks,
uncertainties and events that may cause our actual results to differ materially
from the expectations we describe in our forward-looking statements. Before you
invest in our common stock, you should be aware that the occurrence of the
events described in the "Risk Factors" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" sections and
elsewhere in this prospectus could have a material adverse effect on our
business, operating results and financial condition.

USE OF PROCEEDS

At the assumed initial public offering price of $12.00 per share, we will
receive approximately $88.0 million from our sale of 8,000,000 shares of common
stock, net of estimated offering expenses and underwriting discounts and
commissions payable by us. If the underwriters exercise their over-allotment
option in full, we will receive an additional $10.0 million in net proceeds and
the selling stockholder will receive approximately $3.3 million in net
proceeds. We will not receive any portion of the net proceeds received by the
selling stockholder from the sale of his shares upon exercise of the
underwriters' over-allotment option. See "Principal and Selling Stockholders".

The principal purposes of this offering are to increase our equity capital,
create a public market for our common stock under market conditions that we
believe are favorable, facilitate future access by us to public equity markets
and provide us with increased visibility in our markets. We estimate that we
will use the net proceeds of the offering for general corporate purposes,
including increases in both component and finished goods inventory, expansion
of our manufacturing facilities and capacity, capital expenditures, research
and development, sales and marketing and possible acquisitions and
international expansion. We anticipate using approximately $2.0 million of the
proceeds of this offering for general capital expenditures, such as the
buildout of additional office, engineering lab and manufacturing space and
investment in our information systems. In addition, we plan to purchase
approximately $2.0 million of capital equipment for use in our research and
development activities and to expand our manufacturing capacity. Additionally,
following this offering, our board of directors may determine to use $210,000
of our proceeds to redeem our 1992 preferred stock. As of the date of this
prospectus, we have not allocated any specific amount of proceeds for these
purposes.

Notwithstanding the estimates set forth above, our management will have
significant flexibility in applying the net proceeds of this offering. For
example, we may use a portion of the net proceeds to acquire businesses,
products or technologies that are complimentary to our current or future
business and product lines. Although we are not subject to any agreement or
letter of intent with respect to potential acquisitions, we have from time to
time engaged in acquisition discussions with other parties. Pending any such
uses of the proceeds of this offering, we will invest the net proceeds of this
offering in short-term, investment grade, interest-bearing instruments.

DIVIDEND POLICY

We have never declared or paid any dividends on our capital stock. We
expect to retain future earnings, if any, for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in
the foreseeable future. Any determination to pay dividends in the future will
be at the discretion of our board of directors and will depend upon, among
other factors, our results of operations, financial condition and capital
requirements. Our credit agreements prohibit us from paying cash dividends
while any borrowings are outstanding under the credit agreements.

CAPITALIZATION

The following table sets forth our short-term debt and capitalization:

. on an actual basis at June 30, 2000;

. on a pro forma basis at June 30, 2000 to reflect the conversion of all
outstanding shares of our preferred stock, other than the 1992 preferred
stock, into 17,461,883 shares of our common stock;

. on a pro forma as adjusted basis at June 30, 2000 to additionally
reflect estimated net proceeds from the sale of 8,000,000 shares of
common stock offered hereby at an assumed initial public offering price
of $12.00 per share.

You should read the following table in conjunction with our financial
statements and the notes to those statements which are included in this
prospectus.

As of June 30, 2000
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands, except share
data)
(unaudited)

Warrants with redemption rights................ $ -- -- --
Redeemable convertible preferred stock, $0.001
par value, 8,527,166 shares designated,
7,732,084 issued and outstanding, actual; no
shares designated, issued or outstanding, pro
forma and pro forma as adjusted............... 69,645 -- --
1992 preferred stock, $0.001 par value, 420,000
shares designated, issued and outstanding..... -- -- --
Stockholders' equity (deficit):
Common stock, $0.001 par value, 30,000,000
shares authorized; 12,200,516 shares issued
and outstanding, actual; 29,662,399 shares
issued and outstanding, pro forma;
37,662,399 shares issued and outstanding,
pro forma as adjusted....................... 12 30 38
Additional paid-in capital..................... -- 69,625 157,617
Deferred stock compensation.................... (11,072) (11,072) (11,072)
Accumulated deficit............................ (37,024) (37,022) (37,022)
-------- -------- --------
Total stockholders' equity (deficit)....... (48,084) 21,561 109,561
-------- -------- --------
Total capitalization..................... $ 21,561 $ 21,561 $109,561
======== ======== ========

- --------
The share information set forth above excludes, as of June 30, 2000:

. 432,000 shares issuable upon exercise of warrants with a weighted
average exercise price of $5.25 per share;

. 3,423,194 shares issuable upon exercise of outstanding options under
our stock option plan with a weighted average exercise price of $1.08
per share; and

. 101,740 additional shares of common stock reserved for issuance under
our stock option plan.

DILUTION

Our historical net tangible book deficit at June 30, 2000 was $48.1 million
or $3.94 per share. Historical net tangible book deficit per share is equal to
the amount of our total tangible assets less total liabilities, divided by the
number of shares of common stock outstanding as of June 30, 2000.

Our pro forma net tangible book value at June 30, 2000, was $21.6 million,
or $0.73 per share of common stock. Pro forma net tangible book value per share
is equal to the amount of our total pro forma tangible assets less total pro
forma liabilities, divided by the pro forma number of shares of common stock
outstanding as of June 30, 2000, after giving effect to the conversion of all
outstanding shares of our convertible preferred stock into 17,461,883 shares of
common stock.

Dilution in pro forma net tangible book value per share represents the
difference between the amount per share paid by purchasers of shares of common
stock in this offering and the pro forma net tangible book value per share of
common stock immediately after the completion of this offering. After giving
effect to our sale of 8,000,000 shares of common stock in this offering at an
assumed initial public offering price of $12.00 per share, and after deducting
underwriting discounts and commissions and estimated offering expenses payable
by us, our adjusted pro forma net tangible book value at June 30, 2000 would
have been $109.6 million, or $2.91 per share. This amount represents an
immediate increase in pro forma net tangible book value to our existing
stockholders of $2.18 per share and an immediate dilution to new investors of
$9.09 per share. The following table illustrates this per share dilution:

Assumed initial public offering price per share............. $12.00
Historical net tangible book deficit per share at June 30,
2000....................................................... $(3.94)
Increase attributable to conversion of preferred stock...... 4.67
------
Pro forma net tangible book value per share at June 30,
2000..................................................... .73
Increase in pro forma net tangible book value per share
attributable to this offering............................ 2.18
------
Pro forma net tangible book value per share after this
offering................................................... 2.91
------
Dilution per share to new investors......................... $ 9.09
======

If the underwriters exercise their over-allotment option in full, our
adjusted pro forma net tangible book value at June 30, 2000 would have been
$119.6 million, or $3.10 per share, representing an immediate increase in pro
forma net tangible book value to our existing stockholders of $2.37 per share
and an immediate dilution to new investors of $8.90 per share. Additionally, if
the options and warrants outstanding at June 30, 2000 were exercised in full,
our adjusted pro forma net tangible book value at June 30, 2000 would have been
$125.6 million, or $2.96 per share, representing an immediate increase in pro
forma net tangible book value to our existing stockholders of $2.23 per share
and an immediate dilution to new investors of $9.04 per share.

The following table summarizes, on a pro forma basis at June 30, 2000,
after giving effect to the pro forma adjustments described above, the
differences between the number of shares of common stock purchased from us, the
aggregate cash consideration paid to us and the average price per share paid by
our existing stockholders and by new investors purchasing shares of common
stock in this offering. The calculation below is based on an assumed initial
public offering price of $12.00 per share, before deducting underwriting
discounts and commissions and estimated offering expenses payable by us:

Shares Purchased Total Consideration Average
------------------ -------------------- Price Per
Number Percent Amount Percent Share
---------- ------- ------------ ------- ---------

Existing stockholders......... 29,662,399 78.8% $ 44,273,069 31.6% $ 1.49
New investors................. 8,000,000 21.2 96,000,000 68.4 12.00
---------- ----- ------------ -----
Total....................... 37,662,399 100.0% $140,273,069 100.0%
========== ===== ============ =====

This discussion and table assume no exercise of any stock options or
warrants outstanding at June 30, 2000. At June 30, 2000, there were warrants to
purchase 432,000 shares of common stock with a weighted average exercise price
of $5.25 per share, and options outstanding under our stock option plan to
purchase a total of 3,423,194 shares of common stock with a weighted average
exercise price of $1.08 per share. To the extent that any of these warrants or
options are exercised, there will be further dilution to new investors.

SELECTED FINANCIAL DATA

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 prospectus.

The statement of operations data set forth below for the years ended
December 31, 1997, 1998 and 1999 and the balance sheet data as of December 31,
1998 and 1999 are derived from, and qualified by reference to, our audited
financial statements appearing elsewhere in this prospectus. The statement of
operations data for the years ended December 31, 1995 and 1996 and the balance
sheet data as of December 31, 1995, 1996 and 1997 have been derived from
audited financial statements not included in this prospectus. The statement of
operations data for the six months ended June 30, 1999 and 2000 and the balance
sheet data as of June 30, 2000 are derived from unaudited financial statements
appearing elsewhere in this prospectus which, in the opinion of our management,
reflect all normal recurring adjustments that we consider necessary for a fair
presentation of such information in accordance with generally accepted
accounting principles. Operating results for the six months ended June 30, 2000
are not necessarily indicative of the results that may be expected for the full
fiscal year or future results.

Six Months
Ended
Year Ended December 31, June 30,
----------------------------------------------------------- -----------------------
1995 1996 1997 1998 1999 1999 2000
---------- ---------- ---------- ---------- ----------- ---------- -----------
(in thousands, except per share data)

Product revenue......... $ 120 $ -- $ 138 $ 915 $ 1,047 $ 473 $ 861
Cost of goods sold...... -- -- 158 1,238 3,006 1,359 1,697
---------- ---------- ---------- ---------- ----------- ---------- -----------
Product margin.......... $ 120 $ -- $ (20) $ (323) $ (1,959) $ (886) $ (836)
Development funding..... -- -- -- -- 5,000 3,000 --
Operating expenses:
Research and
development........... 430 968 2,598 4,045 4,441 2,074 3,658
Selling, general and
administrative........ 179 483 1,264 1,926 3,972 1,049 2,560
Amortization of
deferred stock
compensation.......... -- -- -- -- 1,631 64 3,140
---------- ---------- ---------- ---------- ----------- ---------- -----------
Total operating
expenses.............. $ 609 $ 1,451 $ 3,862 $ 5,971 $ 10,044 $ 3,187 $ 9,358
---------- ---------- ---------- ---------- ----------- ---------- -----------
Operating loss.......... $ (489) $ (1,451) $ (3,882) $ (6,294) $ (7,003) $ (1,073) $ (10,194)
Interest income......... 25 109 175 339 439 174 696
Interest expense........ -- -- (31) (34) (18) (13) (5)
Change in fair value of
warrants with
redemption rights...... -- -- -- -- (3,614) (1,532) (1,562)
Other income............ -- -- -- 10 8 5 --
---------- ---------- ---------- ---------- ----------- ---------- -----------
Net loss................ $ (464) $ (1,342) $ (3,738) $ (5,979) $ (10,188) $ (2,439) $ (11,065)
========== ========== ========== ========== =========== ========== ===========
Net loss to common
stockholders........... (517) (1,635) (4,564) (8,767) (39,848) (4,474) (26,475)
========== ========== ========== ========== =========== ========== ===========
Net loss per share of
common stock, basic and
diluted................ $ (0.06) $ (0.17) $ (0.48) $ (0.90) $ (3.98) $ (0.46) $ (2.41)
Shares used in computing
net loss per share,
basic and diluted...... 9,358,982 9,426,456 9,589,462 9,789,407 10,009,554 9,761,606 10,983,192

Balance Sheet Data:

As of December 31, As of
-------------------------------------- June 30,
1995 1996 1997 1998 1999 2000
---- ------ ------ ------- ------- --------

Cash, cash equivalents and
short-term investments...... $419 $2,434 $4,340 $ 7,536 $26,265 $17,749
Working capital.............. 384 2,470 4,565 8,008 26,394 18,586
Total assets................. 476 3,002 5,921 9,734 28,366 23,267
Long-term obligations, less
current portion............. -- -- 170 55 -- --
Redeemable convertible
preferred stock............. 918 4,960 11,786 24,575 54,235 69,645
Total stockholders' deficit.. (535) (2,167) (6,742) (15,524) (30,338) (48,084)

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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. Our products are sold for
use in the facilities of companies in many different industries that all share
a critical need for reliable, high quality power, such as Internet service
providers, semiconductor manufacturers, telecommunications providers,
pharmaceutical manufacturers, hospitals, electric utilities and broadcasters.
As an extension of these existing product lines, we are developing a fully
integrated continuous power system. The initial target market for this product
is the rapidly growing telecommunications industry.

To date, we have primarily funded our operations through sales of shares of
our preferred stock, which have resulted in gross proceeds of approximately
$42.8 million, as well as $5.0 million in development funding received from
Caterpillar in 1999. 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 June 30, 2000, we had generated an accumulated deficit of $37.0
million and expect to continue to sustain operating losses for the next several
years.

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, accounting for
39%. In the first six months of 2000, Caterpillar accounted for 83% of our
revenue as we shifted focus to our CleanSource UPS product. We expect to
continue to be dependent on a few OEM customers, primarily Caterpillar, for the
majority of our sales for the foreseeable future.

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

. Expand our manufacturing facilities and add manufacturing personnel to
address anticipated product demand;

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

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

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

In connection with the grant of stock options to our employees in 1999 and
during the six months ended June 30, 2000, we recorded deferred stock
compensation aggregating $15.8 million. Deferred stock compensation represents
the difference between the estimated fair value, determined subsequently by us,
of the common stock underlying the options and the options' exercise price on
the date of grant. We amortize deferred stock compensation to operating expense
over the vesting

period, generally four years. In 1999, we amortized $1.6 million of the
deferred stock compensation to expense and during the six months ended June 30,
2000 we amortized an additional $3.1 million to expense. We currently expect to
amortize the deferred stock compensation remaining at June 30, 2000 in the
periods below (in millions):

July 1, 2000 to December 31, 2000................ $ 3.6
January 1, 2001 to December 31, 2001............. 4.2
January 1, 2002 to December 31, 2002............. 2.2
January 1, 2003 to December 31, 2003............. 1.0
January 1, 2004 to December 31, 2004............. 0.1
-----
$11.1
=====

Comparison of 1999 to 1998

Product Revenue. Product revenue primarily consists of sales of our
CleanSource power quality products. Sales increased $131,000, or 14%, to $1.05
million in 1999 from $915,000 in 1998. This increase was attributable to the
continued acceptance of our first product, CleanSource DC, as well as the
initial sales of our second product, CleanSource UPS, in the fourth quarter of
1999. The average selling price of our products increased in 1999 due to the
introduction and the initial sales of our CleanSource UPS product, which
carries a higher selling price than our CleanSource DC product.

Cost of goods sold. Cost of goods sold includes the cost of component parts
of our product that are sourced from suppliers, personnel, equipment and other
costs associated with our assembly and test operations, shipping costs, and the
costs of manufacturing support functions such as logistics and quality
assurance. In addition, a portion of our occupancy expenses as well as product
warranty costs are allocated to cost of goods sold. Cost of goods sold
increased $1.8 million, or 143%, to $3.0 million in 1999 from $1.2 million in
1998. In anticipation of future demand for our products, we expanded our
manufacturing capacity in 1999. As a result, the additional manufacturing
overhead contributed to higher cost of goods sold in 1999. In addition, we
expensed approximately $549,000 in 1999 associated with components that we
determined to be in excess of our needs due to design changes made to our
CleanSource DC product. We expect that as our production volumes increase over
time, unit production costs will tend to decrease as we achieve greater
economies of scale in production and in purchasing component parts.

Development funding. Development funding consists of funds received from
Caterpillar to support the development of the CleanSource UPS product. In 1999,
we received $5.0 million in development funding. We did not receive any
development funding in 1998 or in 1997. We do not currently have any other
development funding contracts.

Research and development. Research and development expense primarily
consists of compensation and related costs of employees engaged in research,
development and engineering activities, as well as an allocated portion of our
occupancy costs. Research and development expense increased $396,000, or 10%,
to $4.4 million in 1999 from $4.0 million in 1998. The increase in research and
development expense was primarily due to the increased product development of
CleanSource UPS and other products. We believe that research and development
expense will continue to increase significantly in 2000 and thereafter as we
continue to develop new products and enhance existing product lines.

Selling, general and administrative. Selling, general and administrative
expense is primarily comprised of compensation and related costs for sales,
marketing and administrative personnel, an

allocable portion of occupancy costs, other promotional and marketing expenses,
professional fees and reserves for bad debt. Selling, general and
administrative expense increased approximately $2.0 million, or 106%, to $4.0
million in 1999 from $1.9 million in 1998. The increase in selling, general and
administrative expense was principally due to a charge of $1.4 million related
to warrants we issued to stockholders in conjunction with strategic alliance
agreements we entered into with them relating to their use, evaluation and
feedback of products they agreed to purchase and other business assistance.
Additionally, we increased personnel in our sales organization in order to
support our OEM channel partners and to address opportunities for sales of our
CleanSource UPS product line. We believe that selling, general and
administrative expense will increase in future periods as we add sales,
marketing and administrative personnel to position us for future sales growth.

Amortization of deferred stock compensation. Deferred stock compensation
reflects the difference between the exercise price of option grants to
employees and the estimated fair value determined subsequently by us of our
common stock at the date of grant. We are amortizing deferred stock
compensation as an operating expense over the vesting periods of the applicable
options, which resulted in amortization expense of $1.6 million in 1999. No
amortization of deferred stock compensation occurred in 1998 as, prior to 1999,
we believe that all options were granted at exercise prices equal to the fair
value of the underlying stock on the date of grant. We expect that this
amortization expense will increase in 2000 due to the vesting of options that
were granted in 1999 and 2000. However, we expect the amortization expense to
decrease after 2000, as the options that were granted at exercise prices less
than the estimated fair value determined subsequently by us become fully
vested.

Other expense. Other expense in 1999 includes a $3.6 million charge for the
change in fair value of outstanding warrants with redemption rights. Because of
the redemption feature, we reflect these warrants as a liability and record
fair value changes in current period losses. In 1999, the fair value of the
underlying common stock increased substantially, resulting in an increase in
the warrant value and corresponding expense. Prior to 1999, the underlying
common stock value approximated the value at the date of issuance of the
warrants.

Income tax expense. As of December 31, 1999, our accumulated net operating
loss carryforward was $14.4 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.

Comparison of 1998 to 1997

Product Revenue. Product revenue increased $778,000, or 565%, to $915,000
in 1998 from $138,000 in 1997. The increase was attributable to greater market
acceptance of our first product, CleanSource DC. In 1998, we experienced
increases in sales to new customers for this product as well as to existing
customers.

Cost of Goods Sold. Cost of goods sold increased $1.1 million, or 687%, to
$1.2 million in 1998 from $158,000 in 1997. The increase in cost of goods sold
was primarily due to the expansion of our manufacturing infrastructure to
support the increase in the 1998 sales volume of the CleanSource DC product.

Research and development. Research and development expense increased $1.4
million, or 56%, to $4.0 million in 1998 from $2.6 million in 1997. The
increase in research and development expense primarily was due to an increase
in our engineering staff from 17 employees at December 31, 1997 to 29 employees
at December 31, 1998, as well as increased product development expenses
associated with our CleanSource DC product.

Selling, general and administrative. Selling, general and administrative
expense increased $661,000, or 52%, to $1.9 million in 1998 from $1.3 million
in 1997. The increase in selling, general and administrative expense was
attributable to an increase in 1998 in the number of personnel within our
sales, marketing and administrative departments to support an anticipated
growth in sales volume.

Comparison of Six Months Ended June 30, 2000 to Six Months Ended June 30, 1999

Product Revenue. Product revenue increased $388,000, or 82%, to $861,000
from $473,000 for the six months ended June 30, 2000 and 1999, respectively, as
we began to generate greater sales from our CleanSource UPS product line,
particularly in the second quarter of 2000. For the six months ended June 30,
2000, Caterpillar accounted for 83% of our sales. We expect to continue to be
dependent on a few OEM customers, primarily Caterpillar, for the majority of
our sales for the foreseeable future.

Cost of Goods Sold. Cost of goods sold increased $337,000, or 25%, to $1.7
million from $1.4 million for the six months ended June 30, 2000 and 1999,
respectively. This increase is related to the increase in product revenue.

Research and Development. Research and development increased $1.6 million,
or 76%, to $3.7 million from $2.1 million for the six months ended June 30,
2000 and 1999, respectively. This increase was mainly due to an increase in
staffing to accelerate our product development efforts.

Selling, general and administrative. Selling, general and administrative
expenses increased $1.5 million, or 144%, to $2.6 million from $1.0 million for
the six months ended June 30, 2000 and 1999, respectively. This increase was
due to increasing our sales force to support our OEM channel partners, as well
as increasing our administrative staff in preparation for our anticipated sales
growth.

Other expense. Other expense in the six months ended June 30, 2000 includes
a $1.6 million charge for the change in fair value of outstanding warrants with
redemption rights as a result of an increase in the fair value of the
underlying common stock.

Liquidity and Capital Resources

Our principal sources of liquidity as of June 30, 2000 consisted of $17.7
million of cash, cash equivalents and short-term investments, as well as our
bank credit facility and an equipment financing line. Our bank credit facility
consists of a revolving line of credit with borrowing availability equal to the
lesser of $1.0 million or 80% of eligible accounts receivable. As of June 30,
2000, we had no amounts outstanding under this line of credit and a borrowing
availability of $179,849. Borrowings outstanding under the credit line will
bear interest at the bank's prime rate, which was 9.5% at June 30, 2000. The
equipment financing line was originated in March 1997 and is comprised of seven
separate schedules that are set to mature at various times between April 2001
and December 2001. The aggregate amount of equipment purchases that were
financed under the equipment financing line was approximately $400,000 as of
June 30, 2000.

To date, we have primarily funded our operations through sales of shares of
our preferred stock, which have resulted in gross proceeds of approximately
$42.8 million, as well as $5.0 million in development funding received from
Caterpillar in 1999. During 1999, cash used by operating activities was $2.6
million, which compares to $5.9 million and $3.9 million in 1998 and 1997. For
the six months ended June 30, 2000, cash used by operating activities was $6.7
million. The cash usage in each of these periods was primarily attributable to
our focus on the development of products and the expansion of our manufacturing
operations and sales activities.

Capital expenditures were $437,000, $793,000, $598,000 and $2.2 million in
1997, 1998, 1999 and the six months ended June 30, 2000. We made these
expenditures to acquire engineering test equipment, to develop market
demonstration units, and to purchase manufacturing equipment to facilitate
production testing, as well as for general computer equipment and software for
administrative purposes. We expect to incur approximately $2.0 million in
additional costs in 2000 in connection with the buildout of additional office,
engineering lab and manufacturing space. In addition, we expect to purchase
approximately $2.0 million of capital equipment in 2000 for use in our research
and development activities and to expand our manufacturing capacity.

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

Recent Accounting Pronouncements

In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation", an interpretation of APB Opinion No. 25. Interpretation No. 44
has an effective date of July 1, 2000. We do not believe Interpretation No. 44
will affect our accounting for transactions involving stock-based compensation.

In December 1999, the Staff of the Securities and Exchange Commission
released Staff Accounting Bulletin, or SAB, No. 101, entitled "Revenue
Recognition in Financial Statements", which provides guidance on the
recognition, presentation and disclosure of revenue in financial statements. In
June 2000, the Staff delayed the effective date of SAB No. 101 until October
2000. The Staff has disclosed that it is preparing a questions and answers
guide related to SAB No. 101. While we do not expect SAB No. 101 or the
questions and answers guide to have a material impact on our financial
statements, until the Staff issues the questions and answers guide we will not
be fully able to evaluate their impact.

Qualitative and Quantitative Disclosure 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. Therefore, we have concluded
that we do not have a material market risk exposure.

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,
which is marketed under the Caterpillar brand name. As an extension of these
existing product lines, we are developing a fully integrated continuous power
system. The initial target market for this product is the rapidly growing
telecommunications industry.

Industry Background

Power Requirements of the New Economy

The worldwide demand for high quality electricity has been increasing
rapidly in recent years, driven in large part by growth in the use of
computers, the Internet and telecommunications products. 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 influence of sophisticated digital electronics expands across all
industries, the need for very high levels of power reliability and quality also
increases. Most industries now rely on these highly sensitive electronics to
manage and control their manufacturing processes. However, despite this
increasingly dramatic change in the mix of electricity demand, the mechanisms
used to provide power have not changed. The power delivered over the
electricity 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 detrimental effects on the devices of
the new economy.

[GRAPHIC]

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

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

Electric utilities are unable to provide high quality, uninterrupted power
due in large part to the inherent limitations of the existing transmission and
distribution system. The electric utility grid is naturally exposed to
reliability and quality problems caused by severe weather, animals, accidents
and other external events. While substantial upgrades and other investment
could improve overall reliability, the absolute level of power quality required
for these sophisticated electronic applications may still remain difficult to
achieve.

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 utility grid and a back-up power
source, typically lead-acid batteries. The UPS electronics monitor the power
from the 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
activates 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
power falters.

The following diagrams depict a conventional UPS and CPS:

[GRAPHIC]

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

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

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

Limitations of Conventional UPS and CPS

Conventional UPS and CPS devices have evolved out of a makeshift combination
of diesel engines, generators, automobile batteries and UPS electronics. We
believe that this patchwork

approach to UPS and CPS has resulted in systems that are less efficient, less
reliable and more expensive than they otherwise could be. The lead-acid
batteries which provide ride-through, or temporary, power for the UPS and CPS,
are viewed as the weakest component of conventional power quality and
reliability solutions. Lead-acid batteries have numerous problems, including:

Reliability

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

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

Cost

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

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

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

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

Environmental

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

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

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

Active Power's Products

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

CleanSource DC

CleanSource DC is the first commercially viable, non-chemical replacement
for lead-acid batteries used for short-term power in power quality
installations. As opposed to the chemical energy stored by batteries, our
patented flywheel energy storage system stores kinetic energy by spinning
constantly in a patented low-friction environment. When the UPS electronics
detect a power disturbance, CleanSource DC draws upon the power stored as
kinetic energy to generate back-up power. Our CleanSource flywheel energy
storage system is compact, quiet and predictable.

CleanSource DC can run in conjunction with or can replace battery strings
used in UPS and CPS systems and can replace the batteries now used with fuel
cells and microturbines to meet peak power demands. This system is available in
a variety of delivered power ratings up to 480 kW per flywheel system. We also
can configure the units in parallel to achieve higher power. CleanSource DC has
been designed for much longer service intervals and more extreme environments
than typical lead-acid battery installations. Our first CleanSource DC unit was
placed in service in March 1997. Our installed CleanSource DC units have
accumulated over 235,000 hours of field operation.

CleanSource UPS

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

[GRAPHIC]

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

The CleanSource UPS design takes advantage of the many component
similarities between CleanSource DC and standard UPS electronics. Each system
requires power conversion electronics, fans for cooling, a frame for structural
support, a user display and data reporting, 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.

[GRAPHIC]

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

Due to its unique design, CleanSource UPS typically has a lower installed
cost than 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
systems. In conjunction with Caterpillar, we designed CleanSource UPS to be
compatible with new and installed standby generators, extending their
application to CPS. We are currently delivering CleanSource UPS units and have
plans to introduce higher power, parallel systems by the end of 2000.

Future Products

Fully Integrated Continuous Power System. We are developing an advanced CPS
for the distributed telecommunications market that combines short and long term
energy storage and UPS functionality into one fully integrated system. We
believe that benefits of this fully integrated CPS product will include
increased reliability, lower cost and less maintenance relative to the
piecemeal systems in use today. We anticipate commercial availability of our
first CPS product in the fourth quarter of 2001.

Distributed Power Technology. Under an agreement with Caterpillar, the
world's leading producer of distributed power systems, we are studying the
potential benefits of a new type of electromechanical technology that can be
used in distributed power applications.

Our Business Strategy

Our goal is to become the 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 product, CleanSource DC,
put this principle into practice. 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. 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 are designing a fully integrated CPS with applications in the
distributed telecommunications power quality and reliability market.
Additionally, we have entered into an agreement with Caterpillar to study the
feasibility of a new type of electromechanical technology for use in
distributed power applications.

Distribute and Market our Products through Established OEM Channels

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

product. We intend to continue to use development and distribution
relationships for our future products to achieve rapid market penetration.

Leverage Our Relationship with Caterpillar to Achieve Rapid Market Penetration

We believe that our distribution agreement with Caterpillar allows us to
rapidly penetrate the power quality and reliability market through
Caterpillar's worldwide network of over 200 dealers and over 1,500 branch
outlets. A portion of Caterpillar's large installed base of over 250,000
gensets also provides a significant retrofit opportunity by converting
installed standby systems to CPS with our CleanSource UPS. Our relationship
with Caterpillar should enhance our credibility among the generally
conservative customers within the power quality and reliability market. We
will continue to examine additional ways to leverage our relationship with
Caterpillar.

Outsource Components to Rapidly Scale Manufacturing

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

Aggressively Protect Our Intellectual Property

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

Market Opportunities

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

With our current and future products we intend to focus on the following
market opportunities:

Internet Market

A 1999 study conducted by the University of Texas and released by Cisco
Systems, Inc. found that the U.S. Internet economy grew at an estimated
average annual rate of 175% from 1995 to 1998. The June 2000 update to this
study also projected that the Internet economy would grow to $850 billion in
2000, up 62% from 1999. To support this growth, internet service providers
must construct new facilities to house the computers and communications
systems required to provide around-the-clock service to their customers. To
ensure continuous service, ISPs are adding power quality equipment to protect
these systems.

Telecommunications Market

To ensure uninterrupted service, wireless telecommunications providers
must have continuous power at each cellular and PCS station. The market for
back-up telecommunications power systems

represented approximately $4.0 billion of the $11.0 billion power quality
market in 1999. Conventional CPS systems currently satisfy market demand using
a patchwork of gensets, lead-acid batteries and UPS electronics. We are
designing our next generation product, a fully integrated CPS, to service the
specific needs of this market, although we expect broader market applications
in the future. We believe that our fully integrated CPS will be well positioned
to serve this market and will achieve rapid market penetration.

Other Power Quality and Reliability Markets

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

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

Retrofit Market. Caterpillar has the largest installed base of standby
generators, or generators which are not coupled with a UPS, in the world. As
even a short 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 250,000 installed gensets worldwide by
adding our CleanSource UPS, thereby creating a CPS, represents a significant
market opportunity.

Distributed Generation

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

Our Relationship with Caterpillar

We have established a strategic relationship with Caterpillar granting
Caterpillar the world wide right to distribute CleanSource 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 a Caterpillar 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 will be 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 CleanSource
UPS marketed under the Caterpillar brand name. Under the development agreement,
Caterpillar provided $5.0 million in funding to support the development of
CleanSource UPS.

While we retained sole ownership of the underlying flywheel energy storage
technology, we jointly own intellectual property associated with the
integration of UPS electronics with CleanSource DC with Caterpillar. Either we
or Caterpillar may license to other entities the intellectual property that we
jointly own without seeking the consent of the other and all licensing revenue
generated by licensing the joint intellectual property will be solely retained
by the licensing party. However, we may not license the joint intellectual
property to specifically identified competitors of Caterpillar until
January 1, 2005.

While this agreement has no expiration date, Caterpillar may terminate it
at any time by giving us 90 days' advance written notice. Upon termination of
the development agreement, the parties will have no further obligation to
engage in any future development efforts or study the applicability of any such
development. However, the ownership rights granted each party will survive any
such termination.

Distribution Agreement. We also have a distribution agreement with
Caterpillar. During 1999 and the first six months of 2000, we received
approximately $412,000, or 39%, and $712,000, or 83%, respectively, of our
product revenue from Caterpillar under this agreement. The principal provisions
of this agreement are summarized below:

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

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

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

Caterpillar may continue to distribute CleanSource UPS until
January 1, 2005. At such time the agreement will continue for additional six-
month periods unless either party provides written notice to the other within
ninety days of the end of the current period of its decision not to renew the
agreement. The agreement may also be terminated by Caterpillar for our uncured
material breach, if CleanSource UPS consistently and materially fails to meet
our published specifications, 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.

Feasibility Study. Under our development agreement with Caterpillar, we are
also studying the potential benefits of a new type of electromechanical
technology for use in distributed power applications.

Sales, Marketing and Support

Sales and Marketing

In the power quality industry, we believe that partnering with established
companies with significant relationships and service capabilities enables us to
promote the adoption of new

technology that otherwise would take significantly longer for wide application.
Our sales activity has focused principally on OEM adoption of our products
through extensive OEM testing, product qualification and early product
placement with select end users. We intend to continue to sell through OEMs to
gain acceptance of our proprietary and innovative power technologies. We
believe that focusing on product acceptance and support from OEMs provides the
greatest opportunity for market penetration and sales growth with minimal
resources. We are also expanding our international sales activities through our
multinational OEM sales channels. We employ a small, geographically dispersed
sales force to develop leads and educate our OEM customers in their sales
efforts.

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

Service and Support

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

Our Customers

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

End use industries for our products include Internet service providers,
semiconductor manufacturers, telecommunication providers, pharmaceutical
manufacturers, hospitals, electric utilities and broadcasters.

During 1999, Caterpillar accounted for 39% of our total revenue and sales
of our CleanSource DC product to our largest UPS OEM, Powerware, accounted for
21% of our revenue. Sales of CleanSource DC to Micron Technologies and Lee
Technologies also accounted for 16% and for 13% of our 1999 revenue,
respectively. No other customer accounted for more than 10% of our revenue
during 1999. Due to Caterpillar's semi-exclusive CleanSource UPS distribution
rights, we anticipate that revenue from Caterpillar will comprise a majority of
our revenue in 2000. In the six months ended June 30, 2000, Caterpillar
accounted for 83% of our revenue.

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.

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

[GRAPHIC]

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

The flywheel rotor is designed to spin in a near frictionless environment
by the use of a low-cost, combination magnetic and mechanical bearing system.
The friction in the spinning chamber is further reduced by the creation of a
partial vacuum, which reduces the amount of air in the chamber that otherwise
creates drag on the flywheel rotor. The flywheel rotor stores energy in the
form of kinetic energy by constantly rotating within the vacuum container. As
the flywheel rotor slows down when a user requires power, the rotor's magnetism
is increased as it rotates past copper coils

contained in the armature to generate constant output power. This enables the
flywheel system to provide between ten and sixty seconds of electricity during
power disturbances. While a lead-acid battery can typically provide back-up
power for a much longer period, this capability usually is not required. Our
flywheel-based system can provide ride-through, or temporary, power for the
majority of power disturbances, such as voltage sags and surges, and can bridge
the gap between a power outage and the time required to switch to generator
power.

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

The CleanSource Family of Products

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

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

Generator Start Enhancement

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

Research and Development

We believe that our research and development efforts are essential to our
ability to successfully deliver innovative products that address the needs of
our customers as the market for power quality products evolves. Our research
and development team works closely with our marketing and sales team and OEMs
to define product features and performance to address the specific needs. Our
research and development expenses were $2.6 million, $4.0 million and $4.4
million in 1997, 1998 and 1999, respectively. We anticipate maintaining
significant levels of research and development expenditures in the future. At
June 30, 2000, our research and development efforts employed 53 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 purchase all of our components on a purchase order basis and do not have
written or long-term agreements with any of our suppliers. Although we use
standard parts and components for our products where possible, we purchase a
particular type of power module from Semikron International and a
microprocessor from Motorola, both of whom are single source suppliers. If we
were unable to obtain these components, we believe it would take approximately
six months to develop a substitute power module and approximately four months
to develop a substitute microprocessor. We have an oral agreement with the
power module supplier to maintain at least three months inventory for us, and
we maintain an additional three months of inventory. We maintain approximately
three months of inventory of the Motorola microprocessor. We intend to seek
long-term agreements with key suppliers to ensure the adequate supply of
components.

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

Proprietary Rights

We rely on a combination of patents and trademarks, as well as
confidentiality agreements and other contractual restrictions with employees
and third parties, to establish and protect our proprietary rights. We
currently have filed 32 patents before the United States' Patent and Trademark
Office, 21 of which have issued, nine of which are pending, three of which have
been allowed, and two of which we abandoned. Additionally, we have made 25
filings under the Patent Cooperation Treaty, and before the European Patent
Office and the Japanese Patent Office. Of those patents prosecuted before the
United States' Patent and Trademark Office, 17 claim inventions related to our
CleanSource product line, eight of which have issued. Six of these issued
patents protect inventions related to a motor/generator for flywheel use, a
central component of our CleanSource product. Our patent strategy is critical
for preserving our rights in and to the intellectual property embodied in our
CleanSource product line. As a manufactured, tangible device that is sold
rather than licensed, the CleanSource product line does not qualify for
copyright or trade secret protection. To enforce our ownership of such
technology, we principally rely on the protection obtained through the patents
we own, as well as state unfair competition laws. We intend to aggressively
protect our patents, including by bringing legal actions if we deem it
necessary.

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

Competition

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

Our CleanSource DC product competes with makers of lead-acid batteries and
groups that are developing their own battery-free technologies. Industry
sources estimate that the 2000 U.S. UPS lead-acid battery market will be
approximately $400 million, substantially all of which will be comprised of
sales of lead-acid batteries rather than battery-free technologies designed to
replace lead-acid batteries, such as CleanSource DC. Of the makers of battery-
free products, Piller and International Computer Power are the only companies
currently offering flywheel energy storage systems that directly compete with
the CleanSource DC. The Piller flywheel is only available with Piller's
proprietary UPS system. In the 500kw and under power range, we believe that we
have a substantial majority of the installed base of flywheel products. In the
overall flywheel market, we believe that we and Piller each have approximately
half of the installed flywheel units. The CleanSource DC is the only flywheel
system that is sold and serviced by the major UPS

manufacturers--Powerware, Liebert and MGE UPS Systems. Examples of other
technologies potentially competitive with CleanSource DC include high-speed
composite flywheels, ultra capacitors and superconducting magnetic energy
storage. To date, however, we believe that none of these technologies has
achieved a sufficient presence in our market to be considered a competitor.

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

We expect our future CPS product to compete with manufacturers of CPS
equipment for the telecommunications market, such as Alpha Technologies and the
Lectro division of Invensys. While we believe that our future CPS product will
offer the telecommunications market a superior technology to what currently
exists, we may have difficulty competing with the existing product offerings in
this market and may never develop a competitive product offering.

Employees

At June 30, 2000, we had 126 employees, with 53 engaged in research and
development, 38 in manufacturing, 12 in sales, 7 in marketing and customer
support, and 16 in administration, information technology and finance. None of
our employees is represented by a labor union. We have not experienced any work
stoppages and consider our relations with our employees to be good.

Facilities

Our corporate headquarters facility, which houses our administrative,
advanced development, engineering, information systems, marketing, sales and
service and support groups, consists of approximately 23,500 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 15,000 square feet is also located in Austin, Texas. The lease on
this facility also expires in March 2003. The total monthly lease payments due
under our leases for our facilities in Austin, Texas are approximately $35,000.

Legal Proceedings

We are not party to any legal proceedings.

MANAGEMENT

Executive Officers, Directors and Key Employees

The following table sets forth certain information concerning our executive
officers and directors and certain of our key employees:

Name Age Position(s)
- ---- --- -----------

Directors and Executive
Officers:
Eric L. Jones.................. 65 Chairman of the Board of Directors

Joseph F. Pinkerton, III....... 36 President, Chief Executive Officer and
Director

David S. Gino.................. 42 Vice President of Finance, Chief Financial
Officer and Secretary

James A. Balthazar............. 47 Vice President of Marketing

William E. Ott, II............. 44 Vice President of Sales and Service

Richard E. Anderson............ 35 Director (1)

Rodney S. Bond................. 55 Director (2)

Lindsay R. Jones............... 39 Director

Jan H. Lindelow................ 54 Director (1)(2)

Terrence L. Rock............... 54 Director (1)(2)

Other Key Employees:
Mark Ascolese.................. 49 Senior Vice President

Daniel R. Brent................ 53 Vice President of Manufacturing

David B. Clifton............... 52 Vice President of Advanced Development

William C. Kainer.............. 49 Vice President of Business Development

Travis R. Williams............. 55 Vice President of Engineering

- --------
(1)Member of the compensation committee
(2)Member of the audit committee

Executive Officers and Directors

Eric L. Jones has served as the Chairman of our Board of Directors since
March 1995. Since April 1994, he has been a partner with SSM Venture Partners,
L.P., an Austin, Texas-based venture capital firm. Mr. Jones is currently a
director/chairman of several private companies including 360 Commerce and
Motive Communications. He is also the past chairman of the board of directors
of VTEL Corporation and Tivoli Systems. During a 25 year career at Texas
Instruments, Mr. Jones held various positions, including as a corporate vice
president and as president of TI's Data Systems Group. Mr. Jones holds a Ph.D.
in mechanical engineering from the University of Texas at Austin.

Joseph F. Pinkerton, III, our founder, has served as our Chief Executive
Officer, President and director since August 1992. From June 1989 to June 1992,
Mr. Pinkerton was a principal with FRC, a private research and development
company. Mr. Pinkerton holds numerous U.S. and foreign patents. Mr. Pinkerton
holds a B.A. in Physics from Albion College, in association with Columbia
University.

David S. Gino has served as our Chief Financial Officer, Vice President of
Finance and Secretary since December 1999. From August 1995 to November 1999,
Mr. Gino was the Chief Financial Officer and Executive Vice President of
Finance of DuPont Photomasks, a public semiconductor component manufacturer.
From October 1987 to August 1995, Mr. Gino held a

number of financial and business management positions with The DuPont Company.
Mr. Gino holds a B.A. in economics from the University of California and an MBA
from the University of Phoenix.

James A. Balthazar has served as our Vice President of Marketing since
October 1996. From March 1984 to August 1996, Mr. Balthazar held various
management positions, including Vice President of Marketing at Convex Computer
Corporation, a public supercomputer manufacturer. Mr. Balthazar holds a B.S.
from the University of Maryland, College Park and an M.S. in engineering from
Cornell University.

William E. Ott, II has served as our Vice President of Sales and Service
since September 1997. From July 1996 to September 1997, Mr. Ott served as
General Manager for Eastern United States, Canada and Latin America at US Data
Corp., a public manufacturer of automation software. From August 1995 to July
1996, he was the Southeastern Sales Director for Pyramid Technology Corp., a
public high performance UNIX server manufacturer, and from July 1994 to June
1995, he was the Southeastern United States Sales Manager for Sybase, Inc. Mr.
Ott holds a B.S. in electrical engineering and an M.B.A. from the University of
Missouri at Columbia.

Richard E. Anderson has served on our Board of Directors since 1992. In
1992, Mr. Anderson co-founded Hill Partners, Inc., a real estate development
and investment company, where he currently serves as a partner. Mr. Anderson
holds a B.A. in economics from Southern Methodist University.

Rodney S. Bond has served on our Board of Directors since September 1994.
Since May 1990, Mr. Bond has served in various capacities with VTEL
Corporation, a public digital video communications company. He currently serves
as the Vice President, Chief Strategic Officer and previously served as the
Vice President, Chief Financial Officer of VTEL. Mr. Bond holds a B.S. in
metalurgical engineering from the University of Illinois and an M.B.A. from
Northwestern University.

Lindsay R. Jones has served on our Board of Directors since December 1996.
Ms. Jones is a Vice President of Advent International Corp., a private equity
firm, which she joined in September 1990. Ms. Jones holds a B.A. in economics
from Middlebury College.

Jan H. Lindelow has served on our Board of Directors since February 1998.
Since May 1997 to the present, Mr. Lindelow has served as Chairman and CEO of
Tivoli Systems, Inc. From January 1995 to April 1997, he was a self-employed
management consultant. From 1988 to June 1994, Mr. Lindelow worked in various
management capacities at Asea Brown Boveri AG. Mr. Lindelow holds an M.S. in
electrical engineering from the Royal Institute of Technology in Stockholm,
Sweden.

Terrence L. Rock has served on our Board of Directors since 1997. Since
1996, Mr. Rock has served as a partner with CenterPoint Venture Partners. From
1983 to 1996, Mr. Rock worked for Convex Computer Corporation holding various
positions, including President and Vice President of Operations. Mr. Rock also
serves on the board at several private companies. Mr. Rock holds a B.S. in
mechanical engineering from South Dakota School of Mines and Technology.

Other Key Employees

Mark Ascolese has served as our Senior Vice President since March 2000.
From 1985 to March 2000, Mr. Ascolese served as President, Global Accounts, as
well as various other executive level positions at Invensys PLC's Powerware
subsidiary. Mr. Ascolese holds a B.S. in commerce from the University of
Louisville.

Daniel R. Brent has served as our Vice President of Manufacturing since
July 1996. From June 1984 until July 1996, Mr. Brent held various manufacturing
management positions, including manager

and director of technical support in the Austin, Texas and Fremont, California
divisions of Tandem Computers, Inc. Mr. Brent holds a B.S. in chemistry from
Wichita State University.

David B. Clifton has served as our Vice President of Advanced Development
since 1997. From 1994 to 1997, Mr. Clifton served as our Vice President of
Engineering. Prior to joining Active Power, Mr. Clifton was a founder and Vice
President of Engineering at Asoma Instruments. Mr. Clifton attended Texas Tech
University, Oklahoma University and the University of Texas at Austin.

William C. Kainer has served as our Vice President of Business Development
since January 1999. From October 1997 to January 1999, Mr. Kainer served as our
Vice President of Service. From January 1997 to October 1997, he served as Vice
President of Sales for Haystack Labs, a private security software company. From
November 1995 to September 1996, Mr. Kainer was the Vice President of Sales and
Marketing of General Computer Systems, a private pharmaceutical software
company. From July 1994 to October 1995, he was General Manager of the Americas
at Convex Computer Corporation. Mr. Kainer holds a B.A. in history from the
University of Houston.

Travis R. Williams has served as our Vice President of Engineering since
October 1997. Prior to this, Mr. Williams held various positions, including the
Manager of Development Engineering at the Wayne Division of Dresser Industries,
Inc., a public manufacturer of retail petroleum marketing systems, from
February 1988 to September 1997. Mr. Williams holds a B.S. in mechanical
engineering from Texas A&M University and an M.S. in electrical engineering
from the University of California at Los Angeles.

Our officers serve at the discretion of the board of directors, subject to
severance agreements with Messrs. Pinkerton and Gino, which are described
below. All of our current directors were elected pursuant to the Fourth Amended
and Restated Voting Agreement dated November 23, 1999 by and between us and
certain of our stockholders. The voting provisions of this agreement will
automatically terminate upon the closing of this offering. There are no family
relationships among any of our executive officers or directors.

Classified Board of Directors

Prior to the closing of this offering, we intend to file an amended
certificate of incorporation pursuant to which our board of directors will be
divided into three classes effective upon the closing of this offering. The
members of each class will serve for a staggered, three-year term. Upon the
expiration of the term of a class of directors, directors in that class will be
elected for three-year terms at the annual meeting of stockholders in the year
in which their term expires. The classes will be comprised as follows:

. Class I Directors. Richard E. Anderson, Rodney S. Bond and Lindsay R.
Jones will be Class I Directors whose terms will expire at the 2001
annual meeting of stockholders;

. Class II Directors. Jan H. Lindelow and Terrence L. Rock will be Class
II Directors whose terms will expire at the 2002 annual meeting of
stockholders; and

. Class III Directors. Eric L. Jones and Joseph F. Pinkerton, III will be
Class III Directors whose terms will expire at the 2003 annual meeting
of stockholders.

Committees of the Board of Directors

Our board of directors has established an audit committee and a
compensation committee.

Audit Committee. The audit committee reports to the board of directors with
regard to the selection of our independent auditors, the scope of our annual
audits, fees to be paid to the auditors, the performance of our independent
auditors, compliance with our accounting and financial policies,

and management's procedures and policies relative to the adequacy of our
internal accounting controls. The members of the audit committee are Messrs.
Bond, Lindelow and Rock.

Compensation Committee. The compensation committee reviews and makes
recommendations to the board regarding our compensation policies and all forms
of compensation to be provided to our directors, executive officers and certain
other employees. In addition, the compensation committee reviews bonus and
stock compensation arrangements for all of our other employees. The
compensation committee also administers our stock option and stock purchase
plans. The members of the compensation committee are Messrs. Anderson, Lindelow
and Rock.

Director Compensation

Each of our non-employee directors receives a fee of $5,000 per quarter for
his or her service as a director. In addition, non-employee directors will
receive stock option grants at periodic intervals under the automatic option
grant program of our 2000 Stock Incentive Plan. Non-employee and employee
directors will also be eligible to receive option grants under the
discretionary option grant program of the 2000 plan. Under the automatic option
grant program, each individual who first becomes a non-employee board member at
any time after this offering will receive an option grant to purchase 25,000
shares of common stock on the date such individual joins the board. In
addition, on the date of each annual stockholders meeting held after this
offering, each non-employee board member who continues to serve as a non-
employee board member will automatically be granted an option to purchase 7,500
shares of common stock, provided such individual has served on the board for at
least six months.

In May 1996, we entered into a consulting services agreement with
Eric L. Jones, the chairman of our board of directors. Mr. Jones receives a fee
of $6,250 per month for providing business and strategic advisory consulting
services to us. This agreement is terminable by either party upon 30 days'
advance written notice.

Compensation Committee Interlocks and Insider Participation

Our board's compensation committee consists of Messrs. Anderson, Lindelow
and Rock. To date, no member of our compensation committee has served as an
officer or employee of Active Power. No member of the compensation committee
serves as a member of the board of directors or compensation committee of any
entity that has one or more executive officers serving as a member of our board
of directors or its compensation committee.

Employment Agreements and Severance Arrangements

We have severance arrangements in place with the following executive
officers:

. Joseph F. Pinkerton, III. Pursuant to a resolution by our board of
directors, Mr. Pinkerton will receive six months of severance pay if he
is terminated without cause, which would result in a severance payment
of $105,000 based on Mr. Pinkerton's current salary. Additionally, if
after six months of an inability to perform his duties due to a
permanent disability Mr. Pinkerton is terminated, he will receive three
months of severance pay, which would result in a severance payment of
$52,500 based on Mr. Pinkerton's current salary.

. David S. Gino. Upon a change in corporate control that results in a
significant reduction in his role and/or responsibility within 12 months
of the change in corporate control, Mr. Gino will receive up to six
months of severance pay, which would result in a severance payment of
$100,000 based on Mr. Gino's current salary. Additionally, 75% of his
then unvested options will accelerate and vest immediately.

Limitation of Liability and Indemnification

Our certificate of incorporation limits the liability of our directors to
us or our stockholders for breaches of the directors' fiduciary duties to the
fullest extent permitted by Delaware law. In addition, our certificate of
incorporation and bylaws provide for mandatory indemnification of directors and
officers to the fullest extent permitted by Delaware law. We also maintain
directors' and officers' liability insurance and enter into indemnification
agreements with all of our directors and executive officers.

Executive Compensation

The following table provides the total compensation paid to our chief
executive officer and the next highest paid executive officers whose
compensation (salary and bonus) exceeded $100,000 in 1999.

Summary Compensation Table

Long-Term
Annual Compensation Compensation
------------------------------------- ------------
Securities
Other Annual Underlying
Name and Principal Position Salary ($) Bonus ($) Compensation ($) Options (#)
--------------------------- ---------- --------- ---------------- ------------

Joseph F. Pinkerton, III.... $157,308 $50,000 -- --
President and Chief
Executive Officer
James A. Balthazar.......... 128,750 254 -- 15,120
Vice President of Marketing
William E. Ott.............. 123,600 25,499 -- 28,080
Vice President of Sales and
Service

Option Grants in Last Fiscal Year

The following table provides information concerning individual grants of
stock options made during 1999 to each of our executive officers named in the
summary compensation table. We have never granted any stock appreciation
rights.

The exercise prices represent our board's estimate of the fair market value
of the common stock on the grant date. In establishing these prices, our board
considered many factors, including the book value of our common stock, the
price of the most recent sales of our preferred stock, the preferences given to
our preferred stock and the lack of marketability of our common stock.

The amounts shown as potential realizable value represent hypothetical
gains that could be achieved for the respective options if exercised at the end
of the option term. These amounts represent certain assumed rates of
appreciation in the value of our common stock. The 5% and 10% assumed annual
rates of compounded stock price appreciation are mandated by rules of the
Securities and Exchange Commission and do not represent our estimate or
projection of the future price of our common stock. The potential realizable
value is calculated based on the ten-year term of the option at its time of
grant. It is calculated based on the assumption that our initial public
offering price per share appreciates at the indicated annual rate compounded
annually for the entire term of the option and that the option is exercised and
sold on the last day of its term for the appreciated stock price. Actual gains,
if any, on stock option exercises depend on the future performance of our
common stock. The amounts reflected in the table may not necessarily be
achieved.

We granted these options under our 1993 Stock Option Plan. Each option has
a maximum term of 10 years, subject to earlier termination if the optionee's
services are terminated. Except as otherwise noted, these options are
immediately exercisable, but we have the right to repurchase, at the exercise
price, any shares that have not vested at the time the optionee terminates
employment

with us. The percentage of total options granted to our employees in the last
fiscal year is based on options to purchase an aggregate of 1,276,560 shares of
common stock granted in 1999. The following table sets forth information
concerning the individual grants of stock options to each of our named
executive officers in the year ended 1999.

Potential Realizable
Value of Assumed
Annual Rates of
Stock Price
Appreciation for
Individual Grants Option Term
------------------------------ ---------------------
Number of Percent of Total
Securities Options Granted
Underlying to Employees in Exercise
Options the Year Ended Price per Expiration
Name Granted(#)(1) 1999(%) Share Date 5%($) 10%($)
- ---- ------------- ---------------- --------- ---------- ---------- ----------

Joseph F. Pinkerton, III.. -- -- -- -- -- --
James A. Balthazar(2)..... 15,120 1.2% $1.04 12/9/09 $279,822 $454,884
William E. Ott(2)......... 28,080 2.2 1.04 12/9/09 519,669 884,784

Option Grants in 1999

- --------
(1)These options are fully exercisable, but if the employee leaves us before he
has vested in his option shares, we have the right to repurchase, at the
exercise price, any shares that have been purchased but which are not
vested.
(2)These options vested as to 6.25% on March 9, 2000 and 6.25% on June 9, 2000
and vest as to the remaining 87.5% in equal quarterly installments over the
following 14 quarters.

Fiscal Year-End Option Values

The following table provides information about stock options held as of
December 31, 1999 by each of our executive officers named in the Summary
Compensation Table. Actual gains on exercise, if any, will depend on the value
of our common stock on the date on which the shares are sold.

Year End 1999 Option Values

Number of Securities
Underlying Unexercised Value of Unexercised
Options at In-the-Money Options at
December 31, 1999(#) December 31, 1999($)(1)
------------------------- -------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------

Joseph F. Pinkerton, III... -- -- -- --
James A. Balthazar (2)..... 371,520 -- $4,405,740 --
William E. Ott (3)......... 240,840 -- 2,826,355 --

- --------
(1)There was no public trading market for our common stock as of December 31,
1999. Accordingly, we have based the value of unexercised in-the-money
options at December 31, 1999 on an assumed initial public offering price of
$12.00 per share, less the applicable exercise price per share, multiplied
by the number of shares underlying the options. Actual gains on exercise,
if any, will depend on the value of our common stock on the date on which
the shares are sold.
(2) As of December 31, 1999, Mr. Balthazar's options were exercisable as to all
371,520 shares, 250,424 of which were vested and 121,096 of which were
unvested. If Mr. Balthazar leaves us before all of his option shares vest,
we have the right to repurchase the unvested option shares at the exercise
price paid per share.
(3) As of December 31, 1999, Mr. Ott's options were exercisable as to all
240,840 shares, 81,877 of which were vested and 158,963 of which were
unvested. If Mr. Ott leaves us before all of his option shares vest, we
have the right to repurchase the unvested option shares at the exercise
price paid per share.

2000 Stock Incentive Plan

Introduction. The 2000 Stock Incentive Plan is the successor program to our
1993 Stock Option Plan. The 2000 plan became effective on July 13, 2000. At
that time, all outstanding options under the 1993 plan were transferred to the
2000 plan, and no further option grants will be made under the 1993 plan. The
transferred options will continue to be governed by their existing terms,
unless our compensation committee decides to extend one or more features of the
2000 plan to those options. Except as otherwise noted below, the transferred
options will have substantially the same terms as will be in effect for grants
made under the discretionary option grant program of our 2000 plan.

Share reserve. We have reserved 6,116,934 shares of our common stock for
issuance under the 2000 plan. This share reserve consists of the number of
shares carried over from the 1993 plan plus an additional increase of 2,592,000
shares. The share reserve under our 2000 plan will automatically increase on
the first trading day in January of each calendar year, beginning with calendar
year 2001, by an amount equal to two percent (2%) of the total number of shares
of our common stock outstanding on the last trading day of December in the
prior calendar year, but in no event will this annual increase exceed 1,080,000
shares. In addition, no participant in the 2000 plan may be granted stock
options, separately exercisable stock appreciation rights or direct stock
issuances for more than 1,080,000 shares of common stock in total in any
calendar year.

Programs. Our 2000 plan has three separate programs:

. the discretionary option grant program, under which eligible individuals
may be granted options to purchase shares of our common stock at an
exercise price less than, equal to or greater than the fair market value
of those shares on the grant date;

. the stock issuance program, under which eligible individuals may be
issued shares of common stock directly, upon the attainment of
performance milestones, the completion of a specified period of service
or as a bonus for past services; and

. the automatic option grant program, under which option grants will
automatically be made at periodic intervals to eligible non-employee
board members to purchase shares of common stock at an exercise price
equal to the fair market value of those shares on the grant date.

Eligibility. The individuals eligible to participate in our 2000 plan
include our officers and other employees, our non-employee board members and
any consultants or other independent advisors we hire.

Administration. The discretionary option grant and stock issuance programs
will be administered by our compensation committee. This committee will
determine which eligible individuals are to receive option grants or stock
issuances under those programs, the time or times when the grants or issuances
are to be made, the number of shares subject to each grant or issuance, the
status of any granted option as either an incentive stock option or a
nonstatutory stock option under the federal tax laws, the vesting schedule to
be in effect for the option grant or stock issuance and the maximum term for
which any granted option is to remain outstanding.

Plan features. Our 2000 plan includes the following features:

. The exercise price for any options granted under the plan may be paid in
cash, in shares of our common stock valued at the fair market value on
the exercise date or with a promissory note. The option may also be
exercised through a same-day sale program through an independent
brokerage firm without any cash outlay by the optionee.

. The compensation committee has the authority to cancel outstanding
options under the discretionary option grant program, including any
transferred options from our 1993 plan, in return for the grant of new
options for the same or different number of option shares with an
exercise price per share based upon the fair market value of our common
stock on the new grant date.

. Stock appreciation rights may be issued to selected optionees under the
discretionary option grant program. These rights will provide the
holders with the election to surrender their outstanding options for a
payment from us equal to the fair market value of the shares subject to
the surrendered options less the exercise price payable for these
shares. We may make the payments in cash or in shares of our common
stock. None of the options under the 1993 plan have any stock
appreciation rights.

Change in control. The 2000 plan includes the following change in control
provisions which may result in the accelerated vesting of outstanding option
grants and stock issuances:

. In the event that we are acquired by merger or asset sale or board-
approved sale by the stockholders of more than 50% of our outstanding
voting stock, each outstanding option under the discretionary option
grant program which is not to be assumed by the successor corporation or
otherwise continued in effect will immediately become exercisable for
all the option shares, and all outstanding unvested shares will
immediately vest, except to the extent our repurchase rights with
respect to those shares are to be assigned to the successor corporation
or otherwise continued in effect.

. The compensation committee will have complete discretion to grant one or
more options which will become exercisable for all the option shares in
the event those options are assumed in the acquisition but the
optionee's service with us or the acquiring entity is subsequently
involuntarily terminated. The vesting of any outstanding shares under
our 2000 plan may be accelerated upon similar terms and conditions.

. The compensation committee may grant options and structure repurchase
rights so that the shares subject to those options or repurchase rights
will immediately vest in connection with a hostile takeover effected
through a successful tender offer for more than 50% of our outstanding
voting stock or a change in the majority of our board through one or
more contested elections. Such accelerated vesting may occur either at
the time of such transaction or upon the subsequent termination of the
optionee's services.

. The options currently outstanding under our 1993 plan will immediately
vest in the event we are acquired by merger or asset sale, unless those
options are assumed by the acquiring entity and our repurchase rights
with respect to any unvested shares subject to those options are
assigned to such entity. If the options are so assumed by the acquiring
entity and our repurchase rights are so assigned to such entity, then no
accelerated vesting will occur at the time of the acquisition but, at
the discretion of our board of directors at the time of the option grant
or any time when the option is outstanding, the options will accelerate
and vest in full upon an involuntary termination of the optionee's
employment within a period no later than 18 months following the
acquisition.

Automatic option grant program. Each individual who first becomes a non-
employee board member at any time after the effective date of this offering
will receive an option grant to purchase 25,000 shares of common stock on the
date such individual joins the board. In addition, on the date of each annual
stockholders meeting held after the effective date of this offering, each non-
employee board member who is to continue to serve as a non-employee board
member, including each of our current non-employee board members, will
automatically be granted an option to purchase 7,500 shares of common stock,
provided such individual has served on the board for at least six months.

Each automatic grant will have an exercise price per share equal to the
fair market value per share of our common stock on the grant date and will have
a term of 10 years, subject to earlier termination following the optionee's
cessation of board service. The option will be immediately exercisable for all
of the option shares; however, we may repurchase, at the exercise price paid
per share, any shares purchased under the option which are not vested at the
time of the optionee's cessation of board service. The shares subject to each
initial 25,000-share automatic option grant will vest in a series of three
successive annual installments upon the optionee's completion of each year

of board service over the three-year period measured from the grant date. The
shares subject to each annual 7,500 share automatic grant will vest upon the
optionee's completion of one year of service measured from the grant date.
However, the shares will immediately vest in full upon certain changes in
control or ownership or upon the optionee's death or disability while then
serving as a board member.

The board may amend or modify the 2000 plan at any time, subject to any
required stockholder approval. The 2000 plan will terminate no later than July
12, 2010.

Change in Control Arrangements under 1993 Stock Option Plan

If we are acquired in a stockholder-approved transaction, whether by merger
or asset sale, then all of the outstanding options granted under our 1993 plan,
including those held by our executive officers, will accelerate in full, unless
those options are assumed by the successor company and our repurchase rights
with respect to unvested option shares are assigned to that company.

In addition, at the discretion of our board of directors, at the time of
the option grant or at any time when the option remains outstanding, if an
optionee who is deemed to be a key employee by our board of directors is
terminated other than for cause within a period not to exceed 18 months after
the acquisition, that key employee's options will accelerate and become fully
vested, and such options may be exercised at any time prior to the earlier of
the expiration date of the option or the earlier termination of the option.

Employee Stock Purchase Plan

Introduction. Our Employee Stock Purchase Plan was adopted by our board of
directors on July 13, 2000. After approval by our stockholders, the plan will
become effective immediately upon the signing of the underwriting agreement for
this offering. The plan is designed to allow our eligible employees to purchase
shares of common stock, at semi-annual intervals, with their accumulated
payroll deductions.

Share reserve. 1,080,000 shares of our common stock initially have been
reserved for issuance. The reserve will automatically increase on the first
trading day of January in each calendar year, beginning in calendar year 2001,
by an amount equal to one-half of one percent (0.5%) of the total number of
outstanding shares of our common stock on the last trading day of December in
the prior calendar year. In no event will any such annual increase exceed
325,000 shares.

Offering periods. The plan has a series of successive offering periods,
each with a maximum duration of 24 months. The initial offering period begins
on the date of the signing of the underwriting agreement for this offering and
ends on the last business day in July 2002. The next offering period will start
on the first business day in August 2002, and subsequent offering periods will
be set by our compensation committee.

Eligible employees. Individuals scheduled to work more than 20 hours per
week for more than five calendar months per year may join an offering period on
its start date or any semi-annual entry date within that period. Semi-annual
entry dates will occur on the first business day of February and August each
year. Individuals who become eligible employees after the start date of an
offering period may join the plan on any subsequent semi-annual entry date
within that offering period.

Payroll deductions. A participant may contribute up to 15% of his or her
base salary through payroll deductions, and the accumulated deductions will be
applied to the purchase of shares on each semi-annual purchase date. The
purchase price per share will be equal to 85% of the fair market value per
share on the participant's entry date into the offering period or, if lower,
85% of the

fair market value per share on the semi-annual purchase date. Semi-annual
purchase dates will occur on the last business day of January and July each
year. However, a participant may not purchase more than 5,400 shares on any one
semi-annual purchase date, and no more than 270,000 shares may be purchased in
total by all participants on any one semi-annual purchase date. Our
compensation committee will have the authority to change these limitations for
any subsequent offering period.

Reset feature. If the fair market value per share of our common stock on
any purchase date is less than the fair market value per share on the start
date of the two-year offering period, then that offering period will
automatically terminate, and a new two-year offering period will begin on the
next business day. All participants in the terminated offering will be
transferred to the new offering period.

Change in control. Should we be acquired by merger or sale of substantially
all of our assets or more than 50% of our voting securities, then all
outstanding purchase rights will automatically be exercised immediately prior
to the effective date of the acquisition. The purchase price will be equal to
85% of the market value per share on the participant's entry date into the
offering period in which an acquisition occurs or, if lower, 85% of the fair
market value per share immediately prior to the acquisition.

Termination and amendment of plan. The plan will terminate no later than
the last business day of July 2010. The board may at any time amend, suspend or
discontinue the plan. However, certain amendments may require stockholder
approval.

RELATED TRANSACTIONS

Private Placements of Equity

5% Stockholders, Directors and Executive Officers. Since our inception in
August 1992, we have raised capital primarily through the sale of our preferred
stock, including the following sales to holders of more than 5% of our
outstanding common stock and to directors and executive officers.

. In August 1992, we sold 100,000 shares of our non-voting 1992
preferred stock at a price of $0.50 per share to Richard E. Anderson.
Concurrently with this financing, Mr. Anderson became a director. The
1992 preferred stock is redeemable at such time as our board of
directors determines that we have available funds in excess of our
anticipated needs and is not convertible into common stock. Our board
of directors may determine to redeem the 1992 preferred stock upon the
consummation of this offering. As a result, Mr. Anderson would receive
$50,000 in proceeds.

. In March 1995, we sold an aggregate of 569,406 shares of our Series A
preferred stock at a price of $1.52 per share, of which 263,158 shares
were sold to SSM Venture Partners. We also issued to SSM a warrant to
purchase 432,000 shares of common stock at an exercise price of $0.07
per share, which they exercised in May 2000. Concurrently with the
closing of the financing, SSM Venture Partners became a 5% stockholder
and Eric L. Jones became the chairman of our board of directors. SSM
exercised this warrant in May 2000. Although the number of shares of
Series A preferred stock outstanding will not be affected by the 2.16-
for-1 split of our common stock, as a result of this stock split, each
share of Series A preferred stock will automatically adjust and become
convertible into 2.16 shares of our common stock. Accordingly, the
569,406 shares of Series A preferred stock will automatically convert
into approximately 1,229,917 shares of our common stock upon the
consummation of this offering, and the effective purchase price per
share of common stock to be received upon such conversion will be
$0.70.

. In May 1996, we sold an aggregate of 1,847,292 shares of our Series B
preferred stock at a price of $2.03 per share to funds affiliated with
Advent International, funds affiliated with Austin Ventures and SSM
Venture Partners. Concurrently with the closing of the financing,
investment funds affiliated with Advent International Corp. and
investment funds affiliated with Austin Ventures became 5%
stockholders.

In connection with our Series C preferred stock financing in July
1997, the terms of the Series B preferred stock were modified to
provide that the Series B preferred stock would be convertible into
common stock at a rate of approximately 1.19:1. In addition to this
adjustment, although the number of shares of Series B preferred stock
outstanding will not be affected by the 2.16-for-1 split of our common
stock, as a result of this stock split, each share of Series B
preferred stock will automatically adjust and become convertible into
approximately 2.57 shares of our common stock. Accordingly, the
1,847,292 shares of Series B preferred stock will automatically
convert into approximately 4,750,732 shares of our common stock upon
the consummation of this offering, and the effective purchase price
per share of common stock to be received upon such conversion will be
$0.79.

. In July 1997, we sold an aggregate of 1,726,620 shares of our Series C
preferred stock at a price of $3.475 per share to funds affiliated
with Austin Ventures, CenterPoint Venture Fund, funds affiliated with
Advent International Corp. and SSM Venture Partners. Concurrently with
the closing of the financing, CenterPoint Venture Fund I, became a 5%
stockholder and Terrence L. Rock became a director. Although the
number of shares of Series C preferred stock outstanding will not be
affected by the 2.16-for-1 split of our common stock, as a result of
this stock split, each share of Series C preferred stock will
automatically adjust and become convertible into 2.16 shares of our
common stock. Accordingly, the 1,726,620 shares of Series C preferred
stock will automatically convert

into approximately 3,729,499 shares of our common stock upon the
consummation of this offering, and the effective purchase price per
share of common stock to be received upon such conversion will be
$1.61.

. In June 1998, we sold an aggregate of 1,652,894 shares of our Series D
preferred stock at a price of $6.05 per share, of which 1,454,552
shares were sold to our 5% stockholders, directors and executive
officers, including: Rho Management Trust I, CenterPoint Venture Fund
I, SSM Venture Partners, funds affiliated with Austin Ventures, funds
affiliated with Advent International Corp. and our director Jan H.
Lindelow. Concurrently with the closing of the financing, Rho
Management Trust I became a 5% stockholder. Although the number of
shares of Series D preferred stock outstanding will not be affected by
the 2.16-for-1 split of our common stock, as a result of this stock
split, each share of Series D preferred stock will automatically adjust
and become convertible into 2.16 shares of our common stock.
Accordingly, the 1,652,894 shares of Series D preferred stock will
automatically convert into approximately 3,570,251 shares of our common
stock upon the consummation of this offering, and the effective
purchase price per share of common stock to be received upon such
conversion will be $2.80.

. In November 1999, we sold an aggregate of 1,935,872 shares of our
Series E preferred stock at a price of $11.34 per share, of which
948,466 shares were sold to our 5% stockholders, directors and
executive officers, including: Rho Management Trust I, funds affiliated
with SSM Venture Partners, funds affiliated with Austin Ventures,
CenterPoint Venture Fund II, L.P., funds affiliated with Advent
International Corp., our director Richard E. Anderson and his brother
Charles A. Anderson, and our chairman of the board Eric L. Jones.
Although the number of shares of Series E preferred stock outstanding
will not be affected by the 2.16-for-1 split of our common stock, as a
result of this stock split, each share of Series E preferred stock will
automatically adjust and become convertible into 2.16 shares of our
common stock. Accordingly, the 1,935,872 shares of Series E preferred
stock will automatically convert into approximately 4,181,484 shares of
our common stock upon the consummation of this offering, and the
effective purchase price per share of common stock to be received upon
such conversion will be $5.25.

The following table summarizes the shares of our convertible preferred
stock purchased by our 5% stockholders, directors and executive officers since
our inception and the aggregate number of shares of common stock into which
those shares of preferred stock will be converted upon the consummation of this
offering:

Aggregate Number of
Series A Series B Series C Series D Series E Shares of Common Stock
Preferred Preferred Preferred Preferred Preferred Issuable Upon Conversion
Investor Stock Stock Stock Stock Stock of Preferred Stock
- -------- --------- --------- --------- --------- --------- ------------------------

SSM Venture Partners.... 263,158 615,764 287,770 117,356 246,916 3,560,410
Advent International.... -- 615,764 287,770 57,520 17,636 2,367,498
Austin Ventures......... -- 615,764 575,540 99,174 176,366 3,421,911
CenterPoint Venture
Partners............... -- -- 575,540 330,578 176,366 2,338,165
Rho Management Trust I.. -- -- -- 809,924 264,550 2,320,864
Richard E. Anderson
(1).................... -- -- -- -- 49,312 106,514
Eric L. Jones (2)....... -- -- -- -- 17,320 37,411
Jan H. Lindelow......... -- -- -- 40,000 -- 86,400

- --------
(1)Includes shares purchased by Mr. Anderson's brother.
(2)Excludes shares purchased by funds affiliated with SSM Venture Partners,
with which Mr. Jones is affiliated.

Other Transactions

Consulting Agreement with Eric L. Jones. In May 1996, we entered into a
consulting services agreement with Eric Jones, the chairman of our board of
directors. In exchange for providing business and strategic advisory consulting
services to us, Mr. Jones receives a fee of $6,250 per month. This agreement is
terminable by either party with 30 days advance written notice.

Registration Rights. For more information on registration rights we have
granted to our 5% stockholders, other stockholders and some of our directors,
please see "Description of Capital Stock--Registration Rights".

Stock Options and Change in Control Arrangements. For more information
regarding the grant of stock options and the change in control arrangements
which may be available to directors and executive officers, please see
"Management--Director Compensation", "--Employment Agreements and Severance
Arrangements" and "--Executive Compensation".

Indemnification and Insurance. Our bylaws require us to indemnify our
directors and executive officers to the fullest extent permitted by Delaware
law. We have entered into indemnification agreements with all of our directors
and executive officers and have purchased directors' and officers' liability
insurance. In addition, our certificate of incorporation limits the personal
liability of our board members for breaches of their fiduciary duties.

We believe that each of the foregoing transactions were entered into on
terms which are no less favorable to us than could be obtained from
unaffiliated third parties.

PRINCIPAL AND SELLING STOCKHOLDERS

This table sets forth information regarding the beneficial ownership of our
common stock as of June 30, 2000, as adjusted to reflect the sale of common
stock in this offering for:

. each person known by us to own beneficially more than 5% of our common
stock;

. each executive officer named in the summary compensation table on page
43;

. each of our directors; and

. all of our directors and executive officers as a group.

Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting and investment power
with respect to the securities. Except as indicated in the notes following the
table, and subject to applicable community property laws, the persons named in
the table have sole voting and investment power with respect to all shares of
common stock shown as beneficially owned by them. The number of shares of
common stock used to calculate the percentage ownership of each listed person
includes the shares of common stock underlying options or warrants held by such
persons that are exercisable within 60 days of this offering. The percentage of
beneficial ownership before the offering is based on 29,662,399 shares,
consisting of 12,200,516 shares of common stock outstanding as of June 30,
2000, and 17,461,883 shares issuable upon the conversion of the convertible
preferred stock. Percentage of beneficial ownership after the offering is based
on 37,662,399 shares, including the 8,000,000 shares to be sold in this
offering.

Active Power and our founder and chief executive officer, Joseph F.
Pinkerton, III, may sell shares in connection with the exercise of the
underwriters' over-allotment option. Active Power may sell up to 900,000 shares
and Mr. Pinkerton may sell up to 300,000 shares. To the extent the
underwriters' over-allotment option is exercised for less than 1,200,000
shares, the shares to be sold will be allocated pro rata between Active Power
and Mr. Pinkerton. The post-offering ownership percentages in the table do not
take into account any exercise of the underwriters' over-allotment option.

Percentage of
Common Stock
Shares of Beneficially Owned (%)
Common Stock ---------------------------
Beneficially Before the After the
Name Owned (#) Offering Offering
- ---- ------------ ----------- -----------

Executive Officers and Directors:
Eric L. Jones.................... 4,240,421 14.3% 11.3%
Joseph F. Pinkerton, III......... 6,380,601 21.5 16.9
James A. Balthazar............... 371,520 1.2 1.0
William E. Ott, II............... 327,240 1.1 *
Richard E. Anderson.............. 360,750 1.2 1.0
Rodney S. Bond................... 83,700 * *
Lindsay R. Jones................. 2,367,496 8.0 6.3
Jan H. Lindelow.................. 129,600 * *
Terrence L. Rock................. 2,338,165 7.9 6.2
All directors and executive
officers as a group (10
persons)........................ 16,839,487 56.2 44.4
Other 5% Stockholders..............
Funds affiliated with Austin
Ventures........................ 3,421,911 11.5 9.1
Funds affiliated with Advent
International Corp. ............ 2,367,496 8.0 6.3
Funds affiliated with CenterPoint
Venture Partners................ 2,338,165 7.9 6.2
Funds affiliated with SSM Venture
Partners........................ 3,992,410 13.5 10.6
Rho Management Trust I........... 2,320,864 7.8 6.2

- --------
* Indicates beneficial ownership of less than 1% of the total outstanding
common stock.

Unless otherwise indicated in the notes below, the address for each person
set forth in the table above is c/o Active Power, Inc., 11525 Stonehollow
Drive, Suite 110, Austin, Texas 78758.

. Eric L. Jones. 3,992,410 shares indicated as owned by Mr. Jones are
included because of his association with funds affiliated with SSM
Venture Partners. Mr. Jones is a shareholder of SSM Corporation, the
general partner of SSM I, L.P., the general partner of (a) SSM Venture
Partners, L.P., (b) SSM Partners II, L.P. and (c) SSM Venture
Associates, L.P. Mr. Jones disclaims beneficial ownership of the shares
held by SSM Venture Partners, L.P., SSM Venture Partners II, L.P. and
SSM Venture Associates, L.P., except to the extent of his interest in
SSM Corporation. Mr. Jones has a small limited partnership interest in
CenterPoint Venture Fund II, L.P., but disclaims beneficial ownership of
any Active Power shares held by CenterPoint Venture Partners except to
the extent of his pecuniary interest in this fund, which is
indeterminate at this time. Moreover, 38,880 of the shares indicated as
owned by Mr. Jones are included because of his position as trustee of
various trusts for the benefit of his family members. Mr. Jones
disclaims beneficial ownership of these shares. Mr. Jones' address is
c/o SSM Corporation, 110 Wild Basin Rd., Suite 280, Austin, Texas 78734.

. Joseph F. Pinkerton, III. Includes 648,000 shares held by
Mr. Pinkerton's minor children. Mr. Pinkerton disclaims beneficial
ownership of these shares.

. James A. Balthazar. These shares include options to purchase 69,120
shares of common stock that are immediately exercisable. 37,800 shares
of common stock are currently unvested and are subject to our right to
repurchase them if Mr. Balthazar's services are terminated prior to
vesting.

. William E. Ott, II. These shares include options to purchase 154,440
shares of common stock that are immediately exercisable.

. Richard E. Anderson. 86,400 shares indicated as owned by Mr. Anderson
are included because of his association with Rita Investments. Mr.
Anderson also holds 100,000 shares, or 23.8%, of our non-voting 1992
preferred stock, which is not convertible into shares of our common
stock. These shares of 1992 preferred stock are not included in the
foregoing table. Mr. Anderson's address is c/o Hill Partners, 2800
Industrial Terrace, Austin, Texas 78758.

. Rodney S. Bond. These shares include options to purchase 27,000 shares
of common stock that are immediately exercisable. Mr. Bond's address is
c/o VTEL Corporation, 108 Wild Basin Road, Austin, Texas 78746.

. Lindsay R. Jones. All shares indicated as owned by Ms. Jones are
included because of her association with funds affiliated with Advent
International Corp. Ms. Jones is a Vice President of Advent
International Corporation, the general partner of (a) Advent
International Investors II Limited Partnership, (b) Advent International
Limited Partnership, the general partner of Envirotech Investment Fund I
Limited Partnership, and (c) Advent International Partnership, the
general partner of Adwest Limited Partnership. Ms. Jones disclaims
beneficial ownership of the shares held by Advent International
Investors II Limited Partnership, Envirotech Investment Fund I Limited
Partnership and Adwest Limited Partnership. Ms. Jones' address is c/o
Advent International Corporation, 75 State Street, 29th Floor, Boston
Massachusetts 02109.

. Jan H. Lindelow. These shares include options to purchase 43,200 shares
of common stock that are immediately exercisable. Mr. Lindelow's address
is c/o Tivoli Systems, 9442 Capital of Texas Highway North, Austin,
Texas 78759.

. Terrence L. Rock. All shares indicated as owned by Mr. Rock are included
because of his association with funds affiliated with CenterPoint
Venture Partners. Mr. Rock is (a) a limited partner of CenterPoint
Venture Partners, L.P. and CenterPoint Venture Fund II, L.P., (b) a
limited partner of Paluck Associates, L.P., the general partner of
CenterPoint Venture Partners, L.P., and (c) a general partner of
CenterPoint Associates II, L.P., the general partner of CenterPoint
Venture Fund II, L.P. Mr. Rock disclaims beneficial ownership of the
shares held by CenterPoint Venture Partners, L.P. and CenterPoint
Venture Fund II, L.P., except to

the extent of his pecuniary interest in these funds. Mr. Rock's address
is c/o CenterPoint Venture Partners, 13455 Noel Road, Suite 1670, Two
Galleria Tower, Dallas, Texas 75240.

. All directors and executive officers as a group. Includes 239,993 shares
owned by David S. Gino, our chief financial officer, who is not named in
the summary compensation table because he joined us in December 1999 and
therefore did not have in excess of $100,000 in annual compensation.
185,993 shares of common stock are currently unvested and are subject to
our right to repurchase them if Mr. Gino's services are terminated prior
to vesting. Also please see the other notes with respect to our
executive officers and directors above.

. Funds affiliated with Austin Ventures. Includes:

. 1,104,557 shares held by Austin Ventures IV-A, L.P.; and

. 2,317,354 shares held by Austin Ventures IV-B, L.P.

These funds may be deemed to beneficially own each other's shares
because the general partners of each partnership are affiliated. Each
partnership, however, disclaims beneficial ownership of the other's
shares, and each general partner of the funds or the general partners of
the funds disclaims beneficial ownership of the shares held by the
partnership except to the extent of his pecuniary interest. The address
of the investment funds affiliated with Austin Ventures is 114 West
Seventh Street, Suite 1300, Austin, Texas 78701.

. Funds affiliated with Advent International Corp. Includes:

. 1,894,004 shares held by Envirotech Investment Fund I Limited
Partnership;

. 464,031 shares held by Adwest Limited Partnership; and

. 9,463 shares held by Advent International Investors II Limited
Partnership.

Each of these partnerships is managed by Advent International
Corporation. Advent International Corporation exercises sole voting and
investment power with respect to all shares held by these funds. The
address of the investment funds affiliated with Advent International
Corporation is 75 State Street, Boston, Massachusetts 02109.

. Funds affiliated with CenterPoint Venture Partners. Includes:

. 1,957,214 shares held by CenterPoint Venture Partners, L.P. and

. 380,951 shares held by CenterPoint Venture Fund II, L.P.

These funds may be deemed to beneficially own each other's shares
because the general partners of each partnership are affiliated. Each
partnership, however, disclaims beneficial ownership of the other's
shares, and each general partner of the funds or the general partners of
the funds disclaims beneficial ownership of the shares held by the
partnerships except to the extent of his pecuniary interest. The address
of the investment funds affiliated with CenterPoint Venture Partners is
13455 Noel Road, Suite 1670, Two Galleria Tower, Dallas, Texas 75240.

. Funds affiliated with SSM Venture Partners. Includes:

. 3,611,456 shares held by SSM Venture Partners, L.P.;

. 318,703 shares held by SSM Venture Partners II, L.P.; and

. 62,251 shares held by SSM Venture Associates, L.P.

These funds may be deemed to beneficially own each other's shares because
they are controlled by affiliated entities. Each partnership, however,
disclaims beneficial ownership of the others' shares. The address of the
investment funds affiliated with SSM Ventures Partners is 845 Crossover
Lane, Suite 140, Memphis, Tennessee 38117.

. Rho Management Trust's address is 888 7th Avenue, Suite 4500, New York,
New York 10106.

DESCRIPTION OF CAPITAL STOCK

Upon completion of this offering, our authorized capital stock will consist
of 400,000,000 shares of common stock, par value $0.001 per share, and
25,420,000 shares of preferred stock, par value $0.001 per share. The rights
and preferences of the authorized preferred stock may be designated from time
to time by our board of directors. The following summary is qualified by
reference to our certificate of incorporation and our bylaws, forms of which
have been filed as exhibits to the registration statement of which this
prospectus is a part.

Common Stock

As of June 30, 2000, there were 12,200,516 shares of common stock
outstanding that were held of record by 145 stockholders. Holders of our common
stock are entitled to one vote per share on all matters to be voted upon by the
stockholders. The holders of common stock are not entitled to cumulate voting
rights with respect to the election of directors, and as a result, minority
stockholders will not be able to elect directors on the basis of their votes
alone. Subject to limitations under Delaware law and preferences that may apply
to any outstanding shares of preferred stock, holders of common stock are
entitled to receive ratably such dividends or other distribution, if any, as
may be declared by our board of directors out of funds legally available
therefor. In the event of our liquidation, dissolution or winding up, holders
of common stock are entitled to share ratably in all assets remaining after
payment of liabilities, subject to the liquidation preference of any
outstanding preferred stock. The common stock has no preemptive, conversion or
other rights to subscribe for additional securities of Active Power. There are
no redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are, and all shares of common stock to be
outstanding upon completion of the offering will be, validly issued, fully paid
and nonassessable. The rights, preferences and privileges of holders of common
stock are subject to, and may be adversely affected by, the rights of the
holders of shares of any series of preferred stock that we may designate and
issue in the future.

Preferred Stock

As of June 30, 2000, there were 7,732,084 shares of convertible preferred
stock and 420,000 shares of 1992 preferred stock outstanding. Upon the closing
of a public offering in which we receive proceeds of at least $20.0 million and
at an offering price of at least $7.88 per share, each share of our convertible
preferred stock, other than our Series B preferred stock, will automatically
convert into 2.16 shares of common stock. Each share of Series B preferred
stock will convert into approximately 2.57 shares of common stock. The 420,000
shares of 1992 preferred stock outstanding are not convertible into our common
stock. The 1992 preferred stock is redeemable at a price of $0.50 per share at
such time as our board of directors determines that we have available funds in
excess of anticipated needs. Our board of directors will determine whether to
redeem the 1992 preferred stock following this offering.

Upon the completion of this offering and the automatic conversion of our
convertible preferred stock into common stock, our board of directors will have
the authority, without further action by the stockholders, to issue up to
25,000,000 shares of preferred stock in one or more series, to fix the rights,
preferences, privileges and restrictions of the authorized preferred stock and
to issue shares of each such series. The issuance of preferred stock could have
the effect of restricting dividends on the common stock, diluting the voting
power for the common stock, impairing the liquidation rights of the common
stock or delaying or preventing our change in control without further action by
the stockholders. At present, we have no plans to issue any shares of preferred
stock.

Registration Rights

According to the terms of an investors' rights agreement between us, the
holders of our preferred stock (other than the 1992 preferred stock), and
certain members of our management who may be designated by the board of
directors from time to time, including our chief executive officer,

Joseph F. Pinkerton, III, beginning 180 days after the closing of this
offering, some of our stockholders, who will hold in the aggregate 17,893,883
shares of common stock, may require us to file a registration statement under
the Securities Act of 1933 with respect to the resale of their shares. To
demand such registration, stockholders' holding an aggregate of at least a
majority of these shares that are then outstanding for the first demand
registration, and stockholders holding an aggregate of at least 25% of these
shares that are then outstanding for the second demand registration, must
request that the registration statement register the resale of at least 20% of
these shares that are then outstanding. We are not required to effect more than
two demand registrations.

Additionally, the holders of 30,043,137 shares of common stock, including
the 17,893,883 shares of common stock discussed in the previous paragraph, and
members of our management and our chief executive officer Joseph F. Pinkerton,
III, will have piggyback registration rights with respect to future
registration of our shares of common stock under the Securities Act. If we
propose to register any shares of common stock under the Securities Act, the
holders of shares having piggyback registration rights are entitled to receive
notice of such registration and are entitled to include their shares in the
registration.

At any time after we become eligible to file a registration statement on
Form S-3 under the Securities Act, holders of demand registration rights may
require us to file up to six registration statements on Form S-3 with respect
to their shares of common stock, resulting in an aggregate offering of at least
$500,000 on each registration statement on Form S-3. We are not required to
file more than one registration statement on Form S-3 in any six-month period.

These registration rights are subject to conditions and limitations,
including the right of the underwriters of an offering to limit the number of
shares of common stock to be included in the registration. We are generally
required to bear all of the expenses of all registrations under the investors'
rights agreement, except underwriting discounts and commissions. The investors'
rights agreement also contains our commitment to indemnify the holders of
registration rights for losses they incur in connection with registrations
under the agreement. Registration of any of the shares of common stock held by
security holders with registration rights would result in those shares becoming
freely tradeable without restriction under the Securities Act.

Anti-Takeover Effects

Provisions of Delaware law, our certificate of incorporation, our bylaws
and certain contracts to which we are a party could have the effect of delaying
or preventing a third party from acquiring us, even if the acquisition would
benefit our stockholders. The provisions of Delaware law and in our certificate
of incorporation and bylaws are intended to enhance the likelihood of
continuity and stability in the composition of our board of directors and in
the policies formulated by the board of directors and to discourage certain
types of transactions that may involve an actual or threatened change of
control of Active Power. These provisions are designed to reduce our
vulnerability to an unsolicited proposal for a takeover that does not
contemplate the acquisition of all of our outstanding shares, or an unsolicited
proposal for the restructuring or sale of all or part of Active Power.

Delaware anti-takeover statute. We are subject to the provisions of Section
203 of the Delaware General Corporation Law, an anti-takeover law. Subject to
certain exceptions, the statute prohibits a publicly held Delaware corporation
from engaging in a "business combination" with an "interested stockholder" for
a period of three years after the date of the transaction in which the person
became an interested stockholder, unless:

. prior to such date, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
stockholder's becoming an interested stockholder;

. upon consummation of the transaction which resulted in the stockholder's
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of

the corporation outstanding at the time the transaction commenced,
excluding, for purposes of determining the number of shares outstanding,
those shares owned (1) by persons who are directors and also officers and
(2) by employee stock plans in which employee participants do not have
the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or

. on or after such date, the business combination is approved by the board
of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least 66- 2/3% of the outstanding voting stock which is not owned by the
interested stockholder.

For purposes of Section 203, a "business combination" includes a merger,
asset sale or other transaction resulting in a financial benefit to the
interested stockholder, and an "interested stockholder" is a person who,
together with affiliates and associates, owns, or within three years prior to
the date of determination whether the person is an "interested stockholder",
did own, 15% or more of the corporation's voting stock.

Charter and Bylaws. In addition, provisions of our certificate of
incorporation and bylaws may also have an anti-takeover effect. These
provisions may delay, defer or prevent a tender offer or takeover attempt of
our company that a stockholder might consider in his or her best interest,
including attempts that might result in a premium over the market price for the
shares held by our stockholders. The following summarizes these provisions.

Classified Board of Directors. Our certificate of incorporation provides
that, effective immediately upon the closing of this offering, our board of
directors will be divided into three classes of directors, as nearly equal in
size as is practicable, serving staggered three-year terms. As a result,
approximately one-third of the board of directors will be elected each year.
These provisions, when coupled with the provisions of our certificate of
incorporation and bylaws authorizing our board of directors to fill vacant
directorships or increase the size of our board, may deter a stockholder from
removing incumbent directors and simultaneously gaining control of the board of
directors.

Stockholder Action; Special Meetings of Stockholders. Our certificate of
incorporation eliminates the ability of stockholders to act by written consent
upon the closing of this offering. Our bylaws provide that special meetings of
our stockholders may be called only by a majority of our board of directors.

Advance Notice Requirements for Stockholder Proposals and Director
Nominations. Our bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for
election as directors at an annual meeting of stockholders, must provide us
with timely written notice of their proposal. To be timely, a stockholder's
notice must be delivered to or mailed and received at our principal executive
offices not less than 120 days before the first anniversary of the date we
released the notice of annual meeting to stockholders in connection with the
previous year's annual meeting. If, however, no meeting was held in the prior
year or the date of the annual meeting has been changed by more than 30 days
from the date contemplated in the notice of annual meeting, notice by the
stockholder, in order to be timely, must be received a reasonable time before
we release the notice of annual meeting to stockholders. Our bylaws also
specify certain requirements as to the form and content of a stockholder's
notice. These provisions may make it more difficult for stockholders to bring
matters before an annual meeting of stockholders or to make nominations for
directors at an annual meeting of stockholders.

Authorized but Unissued Shares. Our authorized but unissued shares of
common stock and preferred stock are available for our board to issue without
stockholder approval. We may use these additional shares for a variety of
corporate purposes, including future public offerings to raise

additional capital, corporate acquisitions and employee benefit plans. The
existence of our authorized but unissued shares of common stock and preferred
stock could render it more difficult or discourage an attempt to obtain control
of our company by means of a proxy context, tender offer, merger or other
transaction.

Supermajority Vote Provisions. The Delaware General Corporation Law
provides generally that the affirmative vote of a majority of the shares
entitled to vote on any matter is required to amend a corporation's certificate
of incorporation or bylaws, unless a corporation's certificate of incorporation
or bylaws, as the case may be, requires a greater percentage. Our certificate
of incorporation imposes supermajority vote requirements (two-thirds) in
connection with the amendment of certain provisions of our certificate of
incorporation, including the provisions relating to the classified board of
directors and action by written consent of stockholders.

Indemnification. Our certificate of incorporation and bylaws require us to
indemnify our directors and officers to the fullest extent permitted by
Delaware law. In addition, our charter limits the personal liability of our
board members for breaches by the directors of their fiduciary duties to the
fullest extent permitted under Delaware law. We also enter into indemnification
agreements with our officers and directors.

Caterpillar Termination Right. Caterpillar, our most significant customer,
has a right to terminate its CleanSource UPS distribution agreement with us in
the event we are acquired or undergo a change in control.

Transfer Agent and Registrar

The transfer agent and registrar for our common stock is EquiServe Trust
Company and its address is 150 Royall Street, Canton, MA 02021.

Nasdaq National Market Listing

Our common stock has been approved for quotation on the Nasdaq National
Market under the trading symbol "ACPW".

SHARES ELIGIBLE FOR FUTURE SALE

If our stockholders sell substantial amounts of our common stock in the
public market following this offering, the prevailing market price of our
common stock could decline. Furthermore, because we do not expect that any of
these shares will be available for sale for at least 90 days following this
offering as a result of the contractual and legal restrictions on resale
described below, sales of substantial amounts of our common stock in the public
market after these restrictions lapse could adversely affect the prevailing
market price of the common stock and our ability to raise equity capital in the
future.

Upon the closing of this offering, we will have outstanding an aggregate of
37,662,399 shares of our common stock, based upon the number of shares
outstanding as of June 30, 2000 and assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options and warrants. Of
these shares, all shares sold in this offering will be freely tradeable without
restriction or further registration under the Securities Act unless they are
purchased by our "affiliates", as that term is defined in Rule 144 under the
Securities Act. Our outstanding shares will be eligible for sale in the public
market as follows:

Number of Shares Date
---------------- ----

8,000,000 After the date of this prospectus, freely
tradeable shares sold in this offering.

5,028,658 After 90 days from the date of this prospectus,
20% of the shares subject to lock-up agreements
with the underwriters will be released if the
conditions described below under "--Lock-up
Agreements" are satisfied and will be eligible
for sale in the public market under Rule 144
(subject, in some cases, to volume limitations),
Rule 144(k) or Rule 701.

5,034,617 After 120 days from the date of this prospectus,
an additional 20% of the shares subject to lock-
up agreements with the underwriters will be
released if the conditions described below under
"--Lock-up Agreements" are satisfied and will be
eligible for sale in the public market under
Rule 144 (subject, in some cases, to volume
limitations), Rule 144(k) or Rule 701.

19,335,321 After 180 days from the date of this prospectus,
the lock-up agreements are released and these
shares are eligible for sale in the public
market under Rule 144 (subject, in some cases,
to volume limitations), Rule 144(k) or Rule 701.

263,803 After 180 days from the date of this prospectus,
subject to vesting requirements and the
requirements of Rule 144 (subject, in some
cases, to volume limitations), Rule 144(k) or
Rule 701.

Lock-up Agreements. All of our directors and officers and all of our
stockholders and option holders have signed or are otherwise subject to lock-up
agreements under which they have agreed not to transfer or dispose of, directly
or indirectly, any shares of our common stock or any securities convertible
into or exercisable or exchangeable for shares of our common stock for 180 days
after the date of this prospectus. However, if the last reported sale price of
our common stock is greater

than two times the initial public offering price per share for a specified
period of time ending on the 90th day after the date of this prospectus, then
20% of the shares, and shares underlying options, held by each stockholder or
option holder on the date of this prospectus shall be released from the 180-day
restriction, subject to delays as a result of the timing of our earnings
release and compliance with insider trading policies. In addition, if the last
reported sale price of our common stock is greater than two times the initial
public offering price per share for a specified period of time ending on the
120th day after the date of this prospectus, then an additional 20% of the
shares, and shares underlying options, held by each stockholder or option
holder on the date of this prospectus shall be released from the 180-day
restriction, subject to delays as a result of the timing of our earnings
release and compliance with insider trading policies. Transfers or dispositions
can be made sooner with the prior written consent of Goldman, Sachs & Co. or,
if the transferee agrees to sign an identical lock-up agreement and other
conditions are met: (a) if the transfer is a bona fide gift; (b) if the
transfer is to a trust for the benefit of the stockholder or option holder; or
(c) if the transfer is to certain other affiliates of the stockholder or option
holder. Goldman, Sachs & Co. may, in its sole discretion, at any time and
without prior notice, release all or any portion of the shares subject to the
lock-up agreements.

Rule 144. In general, under Rule 144 as currently in effect, beginning 90
days after the date of this prospectus, a person who has beneficially owned
shares of our common stock for at least one year, including the holding period
of certain prior owners other than affiliates, is entitled to sell within any
three-month period a number of shares that does not exceed the greater of (a)
1% of the number of shares of our common stock then outstanding, which will
equal approximately 376,624 shares immediately after the offering, or (b) the
average weekly trading volume of our common stock on the Nasdaq National Market
during the four calendar weeks preceding the filing of a notice on Form 144
with respect to that sale. Sales under Rule 144 are also subject to certain
manner-of-sale provisions, notice requirements and the availability of current
public information about us.

Rule 144(k). Under Rule 144(k), a person who is not deemed to have been one
of our affiliates at any time during the three months preceding a sale and who
has beneficially owned shares for at least two years, including the holding
period of certain prior owners other than affiliates, is entitled to sell those
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Therefore, unless otherwise
restricted, Rule 144(k) shares may be sold immediately upon the closing of this
offering.

Rule 701. In general, under Rule 701 of the Securities Act as currently in
effect, each of our directors, officers, employees, consultants or advisors who
purchased shares from us before the date of this prospectus in connection with
a compensatory stock plan or other written compensatory agreement is eligible
to resell such shares 90 days after the effective date of this offering in
reliance on Rule 144, but without compliance with certain restrictions,
including the holding period, contained in Rule 144.

Registration Rights. After this offering, the holders of 30,043,137 shares
of our common stock will be entitled to certain rights with respect to the
registration of their shares under the Securities Act. See "Description of
Capital Stock-Registration Rights". After any sale of shares pursuant to a
registration statement, such shares will be freely tradable without restriction
under the Securities Act. These sales could cause the market price of our
common stock to decline.

Stock Plans. As of June 30, 2000, options to purchase 3,423,194 shares of
common stock were outstanding under our 1993 plan. After this offering, we
intend to file a registration statement on Form S-8 under the Securities Act of
1933 covering shares of common stock reserved for issuance under our 2000 stock
incentive plan and our employee stock purchase plan. Based on the number of
options outstanding and shares reserved for issuance under our 2000 plan and
our employee stock purchase plan, the Form S-8 registration statement would
cover 7,196,934 shares. The Form S-8

registration statement will become effective immediately upon filing,
whereupon, subject to the satisfaction of applicable exercisability periods,
Rule 144 limitations applicable to affiliates and the lock-up agreements with
the underwriters referred to above, shares of common stock to be issued upon
exercise of outstanding options granted pursuant to our 2000 stock incentive
plan and shares of common stock issued pursuant to our employee stock purchase
plan (to the extent that such shares were not held by affiliates) will be
available for immediate resale in the public market.

UNDERWRITING

Active Power, the selling stockholder and the underwriters named below have
entered into an underwriting agreement with respect to the shares being
offered. Subject to certain conditions, each underwriter has severally agreed
to purchase the number of shares indicated in the following table. Goldman,
Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley
& Co. Incorporated, and CIBC World Markets Corp. are the representatives of the
underwriters.

Underwriters Number of Shares
------------ ----------------

Goldman, Sachs & Co. .......................................
Merrill Lynch, Pierce, Fenner & Smith Incorporated..........
Morgan Stanley & Co. Incorporated...........................
CIBC World Markets Corp.....................................
-----
Total.....................................................
=====

Under the terms and conditions of the underwriting agreement, the
underwriters are committed to take and pay for all of the shares offered
hereby, if any are taken.

If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional 900,000
shares from Active Power and up to an additional 300,000 shares from the
selling stockholder to cover such sales. They may exercise that option for 30
days. If any shares are purchased pursuant to this option, the underwriters
will severally purchase shares in approximately the same proportion as set
forth in the table above.

The following table shows the per share and total underwriting discounts
and commissions to be paid to the underwriters by Active Power and by the
selling stockholder. Such amounts are shown assuming both no exercise and full
exercise of the underwriters' option to purchase 900,000 additional shares from
Active Power and 300,000 additional shares from the selling stockholder.

Paid by Active Power No Exercise Full Exercise
-------------------- ----------- -------------

Per Share.......................................... $ $
Total.............................................. $ $

Paid by the Selling Stockholder No Exercise Full Exercise
------------------------------- ----------- -------------

Per Share.......................................... -- $
Total.............................................. -- $

Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus.
Any shares sold by the underwriters to securities dealers may be sold at a
discount of up to $ per share from the initial public offering price. Any
such securities dealers may resell any shares purchased from the underwriters
to certain other brokers or dealers at a discount of up to $ per share from
the initial public offering price. If all the shares are not sold at the
initial public offering price, the representatives may change the offering
price and the other selling terms.

Active Power, its officers, directors, stockholders and option holders have
agreed with the underwriters not to dispose of or hedge any of their common
stock or securities convertible into or exchangeable for shares of common stock
during the period from the date of this prospectus continuing through the date
180 days after the date of this prospectus, except with the prior written
consent of Goldman, Sachs & Co. on behalf of the representatives; provided,
however, that this

restriction shall terminate as to 20% of the shares held by officers,
directors, stockholders and option holders after 90 days and an additional 20%
of the shares held by officers, directors, stockholders and option holders
after 120 days after the prospectus, subject to delays as a result of the
timing of Active Power's earnings releases and compliance with insider trading
policies, in the event that, as of such dates, the reported last sale price of
common stock on the Nasdaq National Market is greater than twice the initial
public offering price specified in this prospectus for a certain period of
time ending on such dates. Further, the restrictions do not apply to shares of
common stock that may be purchased on the open market after completion of this
offering or that may be acquired through the directed share program described
below by stockholders or optionholders who are not subject to the reporting
requirements of Section 16 of the Securities Exchange Act of 1934. This
agreement does not apply to any existing employee benefit plans. See "Shares
Eligible for Future Sale" for a discussion of certain transfer restrictions.

Prior to this offering, there has been no public market for the shares.
The initial public offering price will be negotiated among Active Power and
the representatives. Among the factors to be considered in determining the
initial public offering price of the shares, in addition to prevailing market
conditions, will be Active Power's historical performance, estimates of the
business potential and earnings prospects of Active Power, an assessment of
Active Power's management and the consideration of the above factors in
relation to market valuation of companies in related businesses.

The common stock will be quoted on the Nasdaq National Market under the
symbol "ACPW".

In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include
short sales, stabilizing transactions and purchases to cover positions created
by short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. "Covered"
short sales are sales made in an amount not greater than the underwriters'
option to purchase additional shares from Active Power and the selling
stockholder in the offering. The underwriters may close out any covered short
position by either exercising their option to purchase additional shares or
purchasing shares in the open market. In determining the source of shares to
close out the covered short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the
overallotment option. "Naked" short sales are any sales in excess of such
option. The underwriters must close out any naked short position by purchasing
shares in the open market. A naked short position is more likely to be created
if the underwriters are concerned that there may be downward pressure on the
price of the common stock in the open market after pricing that could
adversely affect investors who purchase in the offering. Stabilizing
transactions consist of various bids for or purchases of common stock made by
the underwriters in the open market prior to the completion of the offering.

The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the
underwriting discount received by it because the representatives have
repurchased shares sold by or for the account of such underwriter in
stabilizing or short covering transactions.

Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of Active
Power's stock, and together with the imposition of the penalty bid, may
stabilize, maintain or otherwise affect the market price of the common stock.
As a result, the price of the common stock may be higher than the price that
otherwise might exist in the open market. If these activities are commenced,
they may be discontinued at any time. These transactions may be effected on
the Nasdaq National Market, in the over-the-counter market or otherwise.

A prospectus in electronic format may be made available on the Internet
websites maintained by one or more underwriters or securities dealers. The
representatives of the underwriters may agree to allocate a number of shares to
underwriters for sale to their online brokerage account holders. Any Internet
distribution will be allocated by the representatives to underwriters that may
make Internet distributions on the same basis as other allocations. In
addition, shares may be sold by the underwriters to securities dealers who
resell shares to online brokerage account holders. Merrill Lynch, Pierce,
Fenner & Smith Incorporated and Morgan Stanley & Co. Incorporated, through one
of its affiliates, intend to allocate a limited number of shares for sale to
their respective eligible online brokerage account holders.

At the request of Active Power, the underwriters are reserving up to
400,000 shares of common stock for sale at the initial public offering price
through a directed share program to certain employees, vendors, customers, and
other people and entities with whom we maintain business relationships. The
number of shares of common stock available for sale to the general public in
the public offering will be reduced to the extent these persons purchase these
reserved shares. Any shares not so purchased will be offered by the
underwriters to the general public on the same basis as the other shares
offered hereby.

The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.

Active Power estimates that its share of the total expenses of the
offering, excluding underwriting discounts and commissions, will be
approximately $1,161,534.

Active Power and the selling stockholder have agreed to indemnify the
several underwriters against certain liabilities, including liabilities under
the Securities Act of 1933.

LEGAL MATTERS

The validity of the common stock offered hereby will be passed upon for us
by Brobeck, Phleger & Harrison LLP, Austin, Texas. Certain legal matters in
connection with this offering will be passed upon for the underwriters by
Vinson & Elkins L.L.P., Austin, Texas.

EXPERTS

Ernst & Young LLP, independent auditors, have audited our financial
statements at December 31, 1998 and 1999 and for the three years in the period
ended December 31, 1999, as set forth in their report. We have included our
financial statements in the prospectus and elsewhere in the registration
statement in reliance on Ernst & Young LLP's report, given on their authority
as experts in accounting and auditing.

WHERE YOU CAN FIND ADDITIONAL INFORMATION ABOUT ACTIVE POWER

We have filed with the Securities and Exchange Commission a registration
statement on Form S-1, including exhibits, schedules and amendments, under the
Securities Act of 1933 with respect to the shares of common stock to be sold in
this offering. This prospectus does not contain all the information included in
the registration statement. For further information about us and the shares of
our common stock to be sold in this offering, please refer to this registration
statement. Complete exhibits have been filed with our registration statement on
Form S-1.

You may read and copy any contract, agreement or other document referred to
in this prospectus and any portion of our registration statement or any other
information from our filings at the Securities and Exchange Commission's public
reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can
request copies of these documents, upon payment of a duplicating fee, by
writing to the Securities and Exchange Commission. Please call the Securities
and Exchange Commission at 1-800-SEC-0330 for further information about the
public reference rooms. Our filings with the Securities and Exchange
Commission, including our registration statement, are also available to you on
the Securities and Exchange Commission's website, http://www.sec.gov.

As a result of this offering, we will become subject to the information and
reporting requirements of the Securities Exchange Act of 1934 and will file and
furnish to our stockholders annual reports containing financial statements
audited by our independent auditors, make available to our stockholders
quarterly reports containing unaudited financial data for the first three
quarters of each fiscal year, proxy statements and other information filed with
the Securities and Exchange Commission.

You may read and copy any reports, statements or other information on file
at the public reference rooms or at the Securities and Exchange Commission's
Website referenced above. You can also request copies of these documents, for a
copying fee, by writing to the Commission.

ACTIVE POWER, INC.

FINANCIAL STATEMENTS

Years ended December 31, 1998 and 1999
and six months ended June 30, 1999 and 2000 (unaudited and pro forma)

Contents

Report of Independent Auditors.............................................. F-2
Financial Statements:
Balance Sheets.............................................................. F-3
Statements of Operations.................................................... F-4
Statements of Stockholders' Deficit......................................... F-5
Statements of Cash Flows.................................................... F-6
Notes to Financial Statements............................................... F-7

F-1

REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Active Power, Inc.

We have audited the accompanying balance sheets of Active Power, Inc. (the
Company) as of December 31, 1998 and 1999, and the related statements of
operations, stockholders' deficit and cash flows for each of the three years in
the period ended December 31, 1999. 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, 1998 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.

/s/ Ernst & Young LLP

Austin, Texas

February 26, 2000, except for Note 12, as
to which the date is July 13, 2000

F-2

ACTIVE POWER, INC.

BALANCE SHEETS

Pro Forma
December 31 June 30 June 30
-------------------------- ------------ ------------
1998 1999 2000 2000
------------ ------------ ------------ ------------
(unaudited) (unaudited)

ASSETS
Current assets:
Cash and cash
equivalents.......... $ 2,800,145 $ 24,856,497 $ 1,467,129 $ 1,467,129
Short-term
investments.......... 4,735,815 1,408,822 16,281,758 16,281,758
Accounts receivable,
net of allowance for
doubtful accounts of
$5,040 and $25,976... 219,186 37,758 195,742 195,742
Inventories, net...... 807,273 933,692 1,883,713 1,883,713
Prepaid expenses and
other................ 16,184 5,331 464,626 464,626
------------ ------------ ------------ ------------
Total current as-
sets............... 8,578,603 27,242,100 20,292,968 20,292,968
Property and equipment,
net.................... 1,155,829 1,123,723 2,974,432 2,974,432
------------ ------------ ------------ ------------
Total assets........ $ 9,734,432 $ 28,365,823 $ 23,267,400 $ 23,267,400
============ ============ ============ ============
LIABILITIES AND STOCKHOLDERS'
(DEFICIT) EQUITY
Current liabilities:
Accounts payable...... $ 252,888 $ 195,680 $ 982,874 $ 982,874
Accrued expenses...... 203,091 597,002 723,845 723,845
Current portion of
notes payable........ 114,203 55,324 -- --
------------ ------------ ------------ ------------
Total current
liabilities........ 570,182 848,006 1,706,719 1,706,719
Note payable, net of
current portion........ 55,324 -- -- --
Other non-current lia-
bilities............... 57,593 6,843 -- --
Warrants with redemption
rights................. -- 3,614,000 -- --
------------ ------------ ------------ ------------
Total liabilities....... 683,099 4,468,849 1,706,719 1,706,719

Redeemable convertible
preferred stock,
6,216,212 shares issued
and outstanding in
1998, 7,732,084 shares
issued and outstanding
in 1999 and 2000
(25,420,000 shares
authorized, no shares
outstanding on an
unaudited pro forma
basis)................. 24,574,843 54,234,509 69,644,570 --
Stockholders' (deficit)
equity
1992 Preferred Stock--
$.001 par value, $.50
redemption value:
420,000 shares
designated, issued
and outstanding;
$210,000 liquidation
value................ 420 420 420 420
Common Stock--$.001
par value; 30,000,000
shares authorized;
10,047,391,
10,787,126 and
12,235,115 shares
issued and
outstanding in 1998,
1999 and 2000,
respectively
(60,000,000 shares
authorized,
29,696,998 shares
outstanding on a pro
forma basis,
unaudited)........... 10,047 10,787 12,235 29,697
Treasury stock, at
cost; 34,599 shares.. (2,403) (2,403) (2,403) (2,403)
Deferred stock
compensation......... -- (5,430,199) (11,071,796) (11,071,796)
Additional paid-in
capital.............. -- 803,778 -- 69,627,108
Accumulated deficit... (15,531,574) (25,719,918) (37,022,345) (37,022,345)
------------ ------------ ------------ ------------
Total stockholders'
(deficit) equity... (15,523,510) (30,337,535) $(48,083,889) $ 21,560,681
------------ ------------ ------------ ------------
Total liabilities
and stockholders'
(deficit) equity... $ 9,734,432 $ 28,365,823 $ 23,267,400 $ 23,267,400
============ ============ ============ ============

See accompanying notes.

F-3

ACTIVE POWER, INC.

STATEMENTS OF OPERATIONS

Six Months Ended
Year ended December 31 June 30
-------------------------------------- -------------------------
1997 1998 1999 1999 2000
----------- ----------- ------------ ----------- ------------
(unaudited)

Product revenue......... $ 137,590 $ 915,318 $ 1,046,811 $ 473,421 $ 861,190
Cost of goods sold
(excludes deferred
stock compensation
amortization of
$195,591 for the year
ended December 31, 1999
and $3,449 and $313,241
for the six months
ended June 30, 1999 and
2000, respectively).... 157,363 1,238,456 3,006,174 1,359,788 1,697,043
----------- ----------- ------------ ----------- ------------
Product margin.......... (19,773) (323,138) (1,959,363) (886,367) (835,853)
Development funding..... -- -- 5,000,000 3,000,000 --
Operating expenses:
Research and development
(excludes deferred
stock compensation
amortization of
$909,605 for the year
ended December 31, 1999
and $21,514 and
$740,905 for the six
months ended June 30,
1999 and 2000,
respectively).......... 2,597,520 4,045,103 4,440,983 2,073,707 3,657,655
Selling, general and
administrative
(excludes deferred
stock compensation
amortization of
$525,872 for the year
ended December 31, 1999
and $39,556 and
$2,085,661 for the six
months ended June 30,
1999 and 2000,
respectively).......... 1,264,277 1,925,288 3,971,503 1,048,523 2,560,446
Amortization of deferred
stock compensation..... -- -- 1,631,068 64,519 3,139,807
----------- ----------- ------------ ----------- ------------
Total operating
expenses............... 3,861,797 5,970,391 10,043,554 3,186,749 9,357,908
----------- ----------- ------------ ----------- ------------
Operating loss.......... (3,881,570) (6,293,529) (7,002,917) (1,073,116) (10,193,761)
Interest income......... 174,969 338,753 438,964 174,102 696,484
Interest expense........ (31,817) (33,892) (17,947) (12,564) (5,997)
Change in fair value of
warrants with
redemption rights...... -- -- (3,614,000) (1,532,000) (1,562,000)
Other income............ -- 9,890 7,556 4,892 --
----------- ----------- ------------ ----------- ------------
Net loss................ $(3,738,418) $(5,978,778) $(10,188,344) $(2,438,686) $(11,065,274)
Dividends on preferred
stock--all in arrears.. (573,076) (1,283,213) (1,820,421) (824,621) (1,698,066)
Accretion of redeemable
convertible preferred
stock to redemption
amounts................ (252,707) (1,505,400) (5,886,480) (1,211,168) (13,711,995)
Beneficial conversion
feature on preferred
stock issuance......... -- -- (21,952,765) -- --
----------- ----------- ------------ ----------- ------------
Net loss to common
stockholders........... $(4,564,201) $(8,767,391) $(39,848,010) $(4,474,475) $(26,475,335)
=========== =========== ============ =========== ============
Net loss per share,
basic and diluted...... $ (0.48) $ (0.90) $ (3.98) $ (0.46) $ (2.41)
Shares used in computing
net loss per share,
basic and diluted...... 9,589,462 9,789,407 10,009,554 9,761,606 10,983,192
Pro forma loss per
share, basic and
diluted, assuming
conversion of
convertible preferred
stock to common stock
(unaudited)............ $ (1.68) $ (0.93)
Shares used in computing
pro forma loss per
share, basic and
diluted, assuming
conversion of
convertible preferred
stock to common stock
(unaudited)............ 23,706,740 28,445,075

See accompanying notes.

F-4

ACTIVE POWER, INC.

STATEMENTS OF STOCKHOLDERS' DEFICIT

1992
Preferred
Stock Common Stock Treasury Stock
------------- ------------------ -----------------
Number Deferred Additional Total
of Par Number of Par Number of Stock Paid-In Accumulated Stockholders'
Shares Value Shares Value Shares At Cost Compensation Capital Deficit (Deficit) Equity
------- ----- ---------- ------- --------- ------- ------------ ----------- ------------ ----------------

Balance at
December 31,
1996............ 420,000 $420 9,715,939 $ 9,716 34,599 $(2,403) $ -- $ 717,299 $ (2,892,273) $ (2,167,241)
Exercise of
stock options... -- -- 216,540 216 -- -- -- 18,834 -- 19,050
Preferred stock
issuance costs.. -- -- -- -- -- -- -- (30,000) -- (30,000)
Accretion of
redeemable
convertible
preferred stock
to redemption
amount.......... -- -- -- -- -- -- -- (252,706) -- (252,706)
Cumulative
dividends on
redeemable
convertible
preferred
stock........... -- -- -- -- -- -- -- (453,427) (119,649) (573,076)
Net loss........ -- -- -- -- -- -- -- -- (3,738,418) (3,738,418)
------- ---- ---------- ------- ------ ------- ------------ ----------- ------------ ------------
Balance at
December 31,
1997............ 420,000 420 9,932,479 9,932 34,599 (2,403) -- -- (6,750,340) (6,742,391)
Exercise of
stock options... -- -- 114,912 115 -- -- -- 11,157 -- 11,272
Preferred stock
issuance costs.. -- -- -- -- -- -- -- (11,157) (13,843) (25,000)
Accretion of
redeemable
convertible
preferred stock
to redemption
amount.......... -- -- -- -- -- -- -- -- (1,505,400) (1,505,400)
Cumulative
dividends on
redeemable
convertible
preferred
stock........... -- -- -- -- -- -- -- -- (1,283,213) (1,283,213)
Net loss........ -- -- -- -- -- -- -- -- (5,978,778) (5,978,778)
------- ---- ---------- ------- ------ ------- ------------ ----------- ------------ ------------
Balance at
December 31,
1998............ 420,000 420 10,047,391 10,047 34,599 (2,403) -- -- (15,531,574) (15,523,510)
Exercise of
stock options... -- -- 739,735 740 -- -- -- 135,592 -- 136,332
Warrants issued
for services.... -- -- -- -- -- -- -- 1,380,000 -- 1,380,000
Preferred stock
issuance costs.. -- -- -- -- -- -- -- (66,180) -- (66,180)
Deferred stock
compensation.... -- -- -- -- -- -- (7,061,267) 7,061,267 -- --
Amortization of
deferred stock
compensation.... -- -- -- -- -- 1,631,068 -- -- 1,631,068
Accretion of
redeemable
convertible
preferred stock
to redemption
amount.......... -- -- -- -- -- -- -- (5,886,480) -- (5,886,480)
Cumulative
dividends on
redeemable
convertible
preferred
stock........... -- -- -- -- -- -- -- (1,820,421) -- (1,820,421)
Net loss........ -- -- -- -- -- -- -- -- (10,188,344) (10,188,344)
------- ---- ---------- ------- ------ ------- ------------ ----------- ------------ ------------
Balance at
December 31,
1999............ 420,000 420 10,787,126 10,787 34,599 (2,403) (5,430,199) 803,778 (25,719,918) (30,337,535)
(unaudited)
Exercise of
stock options... -- -- 1,015,989 1,016 -- -- -- 382,158 -- 383,174
Deferred stock
compensation.... -- -- -- -- -- -- (8,781,404) 8,781,404 -- --
Amortization of
deferred stock
compensation.... -- -- -- -- -- -- 3,139,807 -- -- 3,139,807
Accretion of
redeemable
convertible
preferred stock
to redemption
amount.......... -- -- -- -- -- -- -- (13,711,995) -- (13,711,995)
Cumulative
dividends on
redeemable
convertible
preferred
stock........... -- -- -- -- -- -- -- (1,460,913) (237,153) (1,698,066)
Exercise of
warrants with
redemption
rights.......... -- -- 432,000 432 -- -- -- 5,205,568 -- 5,206,000
Net loss........ -- -- -- -- -- -- -- -- (11,065,274) (11,065,274)
------- ---- ---------- ------- ------ ------- ------------ ----------- ------------ ------------
Balance at June
30, 2000........ 420,000 $420 12,235,115 $12,235 34,599 $(2,403) $(11,071,796) $ -- $(37,022,345) $ 48,083,889
======= ==== ========== ======= ====== ======= ============ =========== ============ ============
Pro forma at
June 30, 2000... 420,000 $420 29,696,998 $29,697 34,599 $(2,403) $(11,071,796) $69,627,108 $(37,022,345) $ 21,560,681
======= ==== ========== ======= ====== ======= ============ =========== ============ ============

See accompanying notes.

F-5

ACTIVE POWER, INC.

STATEMENTS OF CASH FLOWS

Six months ended
Year ended December 31 June 30
-------------------------------------- -------------------------
1997 1998 1999 1999 2000
----------- ----------- ------------ ----------- ------------
(unaudited)

Operating activities
Net loss................ $(3,738,418) $(5,978,778) $(10,188,344) $(2,438,686) $(11,065,274)
Adjustment to reconcile
net loss to cash used
in operating
activities:
Depreciation expense.. 111,877 342,476 629,288 300,314 361,652
Loss on disposal of
assets............... -- -- 903 -- --
Warrants issued for
services............. -- -- 1,380,000 -- --
Amortization of
deferred stock
compensation......... -- -- 1,631,068 64,519 3,139,807
Changes in fair value
of warrants with
redemption rights.... -- -- 3,614,000 1,532,000 1,562,000
Changes in operating
assets and
liabilities:
Accounts receivable,
net................ (26,600) (192,586) 181,428 (46,222) (157,984)
Inventories, net.... (658,283) 18,204 (126,419) (112,270) (950,021)
Prepaid expenses and
other assets....... (2,727) 7,149 10,853 13,684 (459,295)
Accounts payable.... 353,878 (252,665) (57,208) 97,979 787,194
Accrued expenses.... 46,172 156,919 393,911 77,885 126,843
Other non-current
liabilities........ -- -- (50,750) (25,375) (6,843)
----------- ----------- ------------ ----------- ------------
Net cash used in
operating activities... (3,914,101) (5,899,281) (2,581,270) (536,172) (6,661,921)
Investing activities
Net maturity (purchase)
of short-term
investments............ (2,341,468) (965,471) 3,326,993 3,810,887 (14,872,936)
Purchases of property
and equipment.......... (436,580) (792,580) (598,085) (252,217) (2,212,361)
----------- ----------- ------------ ----------- ------------
Net cash provided by
(used in) investing
activities............. (2,778,048) (1,758,051) 2,728,908 3,558,670 (17,085,297)
Financing activities
Proceeds from issuance
of notes payable....... 350,000 -- -- -- --
Payments on notes
payable................ (82,215) (98,258) (114,203) (64,524) (55,324)
Proceeds from issuance
of Common Stock........ 19,050 11,272 136,332 5,237 383,174
Proceeds from issuance
of Convertible
Preferred Stock, net of
issuance costs......... 5,970,004 9,975,008 21,886,585 (8,930) --
Proceeds from exercise
of warrants............ -- -- -- -- 30,000
----------- ----------- ------------ ----------- ------------
Net cash provided by
(used in) financing
activities............. 6,256,839 9,888,022 21,908,714 (68,217) 357,850
----------- ----------- ------------ ----------- ------------
Increase (decrease) in
cash and cash
equivalents............ (435,310) 2,230,690 22,056,352 2,954,281 (23,389,368)
Cash and cash
equivalents, beginning
of period.............. 1,004,765 569,455 2,800,145 2,800,145 24,856,497
----------- ----------- ------------ ----------- ------------
Cash and cash
equivalents, end of
period................. $ 569,455 $ 2,800,145 $ 24,856,497 $ 5,754,426 $ 1,467,129
=========== =========== ============ =========== ============
Supplemental disclosure
of cash flow
information:
Interest paid......... $ 31,817 $ 32,653 $ 17,947 $ 12,564 $ 1,701
=========== =========== ============ =========== ============

See accompanying notes.

F-6

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS
December 31, 1999

1. Organization

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

2. Significant Accounting Policies

Unaudited Interim Information and Pro Forma Information

The financial information as of June 30, 2000 and for the six month periods
ended June 30, 1999 and 2000 is unaudited, but reflects all adjustments,
consisting of normal recurring accruals which are, in the opinion of
management, necessary to fairly present such information in accordance with
generally accepted accounting principles. Other assets at June 30, 2000
includes approximately $400,000 in deferred costs related to preparation for an
anticipated initial public offer of common stock.

Active Power's historical capital structure is not indicative of its
prospective structure due to the automatic conversion of all shares of
redeemable convertible preferred stock into common stock concurrent with the
closing of the anticipated initial public offering of its common stock.
Accordingly, Active Power has presented a pro forma balance sheet as if all
outstanding shares of redeemable convertible preferred stock had converted into
common stock as of June 30, 2000. Additionally, Active Power has presented pro
forma basic and diluted loss per share assuming the conversion of all
outstanding shares of redeemable convertible preferred stock into common stock
from their respective dates of issuance.

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 generally recognizes revenue at the date a unit is shipped.
Active Power recognizes revenue related to units shipped for evaluation by the
customer at the point of customer acceptance of the unit.

Cash Equivalents

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

Short-Term Investments

Short-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
investments as held-to-maturity (due primarily to the limited time to maturity)
and accordingly reports them at adjusted cost basis, which approximates fair
value, using the specific identification method for securities sold.

F-7

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

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:

December 31,
--------------------- June 30,
1998 1999 2000
---------- ---------- -----------
(unaudited)

Raw materials................................. $ 662,436 $1,287,031 $1,502,772
Work in process............................... 197,607 135,324 998,264
Finished goods................................ 26,381 295,315 194,426
Evaluation units.............................. 183,323 27,771 --
---------- ---------- ----------
$1,069,747 $1,745,441 $2,695,462
========== ========== ==========

The following table summarizes the changes in inventory reserves:

Balance at December 31, 1996....................................... $ --
Additions charged to costs and expenses.......................... 198,475
Write-off of inventory........................................... --
--------
Balance at December 31, 1997....................................... 198,475
Additions charged to costs and expenses.......................... 105,000
Write-off of inventory........................................... (41,001)
--------
Balance at December 31, 1998....................................... 262,474
Additions charged to costs and expenses.......................... 549,275
Write-off of inventory........................................... --
--------
Balance at December 31, 1999....................................... $811,749
========

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 seven years).

Patent Application Costs

Active Power has not capitalized patent appreciation 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, 1999.

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.

F-8

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Income Taxes

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

Segment Reporting

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

Concentration of Credit Risk

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

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

Balance at December 31, 1996........................................ $ --
Additions charged to costs and expenses........................... 463
Write-off of uncollectible accounts............................... --
-------
Balance at December 31, 1997........................................ 463
Additions charged to costs and expenses........................... 4,577
Write-off of uncollectible accounts............................... --
-------
Balance at December 31, 1998........................................ 5,040
Additions charged to costs and expenses........................... 20,936
Write-off of uncollectible accounts............................... --
-------
Balance at December 31, 1999........................................ $25,976
=======

The following customers accounted for a significant percentage of Active
Power's total revenue as follows (customer H is a stockholder):

Customer 1997 1998 1999
-------- ---- ---- ----

A............................................................ -- 17% 39%
B............................................................ -- -- 21%
C............................................................ -- -- 16%
D............................................................ 23% -- 13%
E............................................................ -- 24% --
F............................................................ 36% 20% --
G............................................................ 23% -- --
H............................................................ 18% -- --

F-9

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Advertising Costs

Active Power expenses advertising costs as incurred. These expenses were
not material in 1997, 1998 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. Except for the three months ended March 31, 2000, 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.

Under SAB 98, all options, warrants or other potentially dilutive
instruments issued for nominal consideration prior to the anticipated effective
date of an initial public offering are required to be included in the
calculation of basic and diluted loss per share as if they were outstanding for
all periods presented. Active Power has not issued any such securities for
nominal consideration.

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

Six Months
Year Ended December 31 Ended June 30,
-------------------------------------- --------------
1997 1998 1999 2000
----------- ----------- ------------ --------------
(unaudited)

Net loss to common
stockholders........... $(4,564,201) $(8,767,391) $(39,848,010) (26,475,335)
=========== =========== ============ ===========
Basic and diluted:
Weighted-average
shares of common
stock outstanding.... 9,798,036 9,978,796 10,150,138 11,374,608
Weighted-average
shares of common
stock subject to
repurchase........... (208,574) (189,389) (140,584) (391,416)
----------- ----------- ------------ -----------
Shares used in
computing basic and
diluted net loss per
share................ 9,589,462 9,789,407 10,009,554 10,983,192
=========== =========== ============ ===========
Basic and diluted net
loss per share......... $ (0.48) $ (0.90) $ (3.98) $ (2.41)
=========== =========== ============ ===========
Pro forma (unaudited):
Shares used above... 10,009,554 10,983,192
Pro forma adjustment
to reflect assumed
conversion of
convertible
preferred stock.... 13,697,186 17,461,883
------------ -----------
Shares used in
computing pro forma
basic and diluted
net loss per
share.............. 23,706,740 28,445,075
============ ===========
Pro forma basic and
diluted net loss per
share.................. $ (1.68) $ (0.93)
============ ===========

F-10

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

3. Property and Equipment

Property and equipment consist of the following at December 31:

1998 1999
---------- -----------

Equipment........................................... $1,036,883 $ 1,391,233
Demonstration units................................. 107,321 107,321
Computers and purchased software.................... 319,131 424,525
Furniture and fixtures.............................. 63,037 63,037
Leasehold improvements.............................. 179,825 316,541
---------- -----------
1,706,197 2,302,657
Accumulated depreciation............................ (550,368) (1,178,934)
---------- -----------
$1,155,829 $ 1,123,723
========== ===========

4. Stockholders' Equity and Redeemable Preferred Stocks

At December 31, 1999, Active Power has authorized 10,420,000 shares of
$.001 par value preferred stock as follows (shares designated are the same as
shares issued except for Series E for which 2,730,954 are designated):

Convertible
to Number Cumulative
Shares Carrying Liquidation of Common Dividends
Issued Value Value Shares in Arrears
--------- ----------- ----------- ----------- ----------

1992 Preferred Stock.... 420,000 $ 2,100 $ 210,000 -- $ --
Series A................ 569,406 2,099,396 1,194,955 1,229,917 329,457
Series B................ 1,847,292 7,582,452 4,246,072 4,750,732 1,096,438
Series C................ 1,726,620 9,201,127 7,163,841 3,729,499 1,163,836
Series D................ 1,652,894 12,129,507 11,233,982 3,570,251 1,233,974
Series E................ 1,935,872 23,222,027 22,123,945 4,181,484 171,180
--------- ----------- ----------- ---------- ----------
8,152,084 $54,236,609 $46,172,795 17,461,883 $3,994,885
========= =========== =========== ========== ==========

1992 Preferred Stock

Holders of the 1992 Preferred Stock are not entitled to dividends. The 1992
Preferred Stock shall be redeemed by Active Power at such time as the Board of
Directors determines, in its sole discretion, that Active Power has available
funds in excess of anticipated needs. No dividends may be declared or paid on
Common Stock so long as any shares of 1992 Preferred Stock are issued and
outstanding. The redemption price of the 1992 Preferred Stock is $0.50 per
share. Subject to the rights of the Series A, Series B, Series C, Series D and
Series E Convertible Preferred Stock, in the event of involuntary liquidation,
holders of the 1992 Preferred Stock shall be entitled to receive $0.50 per
share, before any distribution of assets is made to holders of Common Stock.

Redeemable Convertible Preferred Stock

The Series A, Series B, Series C, Series D, and Series E Redeemable
Convertible Preferred Stock is convertible into Common Stock at the option of
the holder at any time based upon the conversion price defined in the related
Preferred Stock agreements. Each share of Convertible

F-11

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Preferred Stock shall automatically be converted into shares of Common Stock in
the event of a public offering whose offering price and whose gross proceeds
equals or exceeds $7.88 per share and $20.0 million.

Redemption Rights

Beginning in August 2002, the holders of the Series A, Series B, Series C,
Series D and Series E Convertible Preferred Stock, upon proper election by the
holders and notification to Active Power, may require Active Power to redeem
such preferred stock in the following amounts:

Redemption Period Number of Shares
----------------- ----------------

60 days after the date of the Redemption One-third of the shares outstanding
Notice (the "First Mandatory Redemption
Date")
First anniversary of the First Mandatory One-half of the shares outstanding
Redemption Date
Second anniversary of the First All remaining shares outstanding
Mandatory Redemption Date

Upon redemption, the holders of the Series A, Series B, Series C, Series D
and Series E Convertible Preferred Stock shall be entitled to receive the
greater of (i) the fair market value of the shares or (ii) $0.70, 0.94, 1.61,
2.80, and 5.25, respectively, plus any accrued or declared but unpaid dividends
as of the redemption date. The redemption price shall be adjusted for all
redemptions of shares made subsequent to the initial Redemption Date to include
accrued interest at the prime rate published in The Wall Street Journal. The
carrying value of redeemable convertible preferred stock is accreted to the
estimated fair value using the interest method to the redemption date. The
accretion is reflected as a charge to loss to common stockholders.

In the event of voluntary or involuntary liquidation of Active Power, the
holders of the Series A, Series B, Series C, Series D and Series E Convertible
Preferred Stock shall be entitled to receive, prior and in preference to any
distributions of any of the assets of Active Power to the holders of the 1992
Preferred Stock and Common Stock, an amount for each share of $0.70, 0.94,
1.61, 2.80, and 5.25, respectively, plus accrued or declared but unpaid
dividends.

Beneficial Conversion Feature

The Series E Convertible Preferred Stock issuance price (after giving
effect to the 2.16-for-1 Common Stock split ratio discussed in Note 12) was
lower than the value determined subsequently by the board of directors. Active
Power recorded this difference as a beneficial conversion feature, increasing
net loss to common stockholders.

Voting Rights and Dividends

The holders of Series A, Series B, Series C, Series D and Series E
Convertible Preferred Stock are entitled to voting rights equal to Common Stock
and shall accrue annual cumulative cash dividends of $0.056, $0.075, $0.129,
$0.224 and $0.42 per share, respectively, payable prior and in preference to
any dividends on Common Stock out of funds legally available. Cumulative
dividends with respect to the Series A, Series B, Series C, Series D and Series
E Preferred Stock shall cease to be payable if the Series A, Series B, Series
C, Series D and Series E Convertible Preferred Stock are converted to Common
Stock prior to August 2002 in connection with Active Power's sale of shares of
Common Stock in a firm commitment underwritten initial public offering or upon
approval of a sufficient number of Series A, Series B, Series C, Series D and
Series E Convertible Preferred stockholders as determined in Active Power's
Certificate of Incorporation.

F-12

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Changes in redeemable stocks are as follows:

Number of Carrying
Shares Value
--------- -----------

Balance at December 31, 1996......................... 2,416,698 $ 4,960,436
Stock issued for cash.............................. 1,726,620 6,000,004
Accretion of redeemable convertible preferred stock
to redemption amount.............................. -- 252,706
Cumulative dividends............................... -- 573,076
--------- -----------
Balance at December 31, 1997......................... 4,143,318 11,786,222
Stock issued for cash.............................. 1,652,894 10,000,008
Accretion of redeemable convertible preferred stock
to redemption amount.............................. -- 1,505,400
Cumulative dividends............................... -- 1,283,213
--------- -----------
Balance at December 31, 1998......................... 5,796,212 24,574,843
Stock issued for cash.............................. 1,935,872 21,952,765
Accretion of redeemable convertible preferred stock
to redemption amount.............................. -- 5,886,480
Cumulative dividends............................... -- 1,820,421
--------- -----------
Balance at December 31, 1999......................... 7,732,084 $54,234,509
========= ===========

Warrants

In March 1995, Active Power issued a warrant to purchase 432,000 shares of
Common Stock with an exercise price of $0.07 per share. The warrant is
exercisable from the date of issuance until the earlier of the consummation of
a public offering of Common Stock or March 2002. In the event the holders of
the Series A Convertible Preferred Stock have elected to require Active Power
to redeem the outstanding Series A Convertible Preferred Stock, then the
holders of Common Stock purchased under this warrant may require Active Power
to repurchase such Common Stock at the greater of the exercise price plus any
declared and unpaid dividends or the fair market value of the Common Stock at
the Redemption Date. Because of this redemption provision, Active Power has
classified these warrants as a liability at their estimated fair value and
recorded the changes in fair value of $3.6 million against income in 1999.
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%.

In November 1999, Active Power issued warrants to purchase 432,000 shares
of Common Stock to two purchasers of the Series E Preferred Stock in
conjunction with the placement of preferred stock and strategic alliance
agreements with those stockholders. The warrants have exercise prices of $5.25
per share. The warrants were fully vested, non-forfeitable and exercisable upon
issuance and expire in November 2006. Active Power estimated the fair value of
the warrants using the Black-Scholes pricing model with the following
assumptions: expected volatility of 50%, expected life of 1 year, expected
dividend yield of 0%, and risk-free rate of 6%. Active Power expensed the
estimated fair value of these warrants of approximately $1.4 million in 1999.

At December 31, 1998 and 1999, 432,000 and 864,000 warrants to purchase
shares of common stock were outstanding and exercisable, respectively.

F-13

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

The exercise prices of the warrants is to be adjusted only for capital
restructures and stock splits, and not for subsequent sales of Common Stock.
The weighted average exercise price of warrants outstanding at December 31,
1999 was $2.67 per share. The weighted average fair value of warrants granted
during the year ended December 31, 1999 was $3.19.

Stock Option Agreements

Active Power has reserved approximately 5,443,200 shares of its Common
Stock for issuance under its 1993 Stock Option 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, 1998 and 1999, 149,066 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, 1997, 1998 and 1999 is as follows:

Number of Range of Weighted-Average
Shares Exercise Prices Exercise Prices
--------- --------------- ----------------

Outstanding at December 31,
1996......................... 1,136,160 $.07 - $1.97 $ .15
Granted..................... 1,452,060 .09 - .16 .15
Exercised................... (216,540) .07 - .09 .09
Canceled.................... -- -- --
--------- ------------ -----
Outstanding at December 31,
1997......................... 2,371,680 .07 - 1.97 .15
Granted..................... 699,840 .16 - .28 .23
Exercised................... (114,912) .07 - .28 .10
Canceled.................... (56,160) .09 - .16 .16
--------- ------------ -----
Outstanding at December 31,
1998......................... 2,900,448 .07 - 1.97 .18
Granted..................... 1,276,560 .42 - 1.04 .65
Exercised................... (739,735) .07 - .83 .19
Canceled.................... (89,346) .09 - 1.97 .29
--------- ------------ -----
Outstanding at December 31,
1999......................... 3,347,927 $.07 - 1.97 $ .35
========= ============ =====

At December 31, 1999, 748,038 shares were available for future grants.

The following is a summary of options outstanding and exercisable as of
December 31, 1999:

Weighted
Average
Remaining Weighted
Range of Contractual Average
Exercise Life (in Exercise
Prices Number years) Price
-------- --------- ----------- --------

$1.85 - $1.97................................ 30,240 3.9 $1.90
$ .07 - $ .09................................ 853,200 6.5 .09
$ .16 - $ .42................................ 1,680,407 8.4 .25
$ .56 - $1.04................................ 784,080 9.9 .79
--------- --- -----
3,347,927 8.2 $ .35
========= === =====

F-14

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Stock options vested as of December 31, 1998 and 1999 were 1,535,579 and
2,574,431, respectively.

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

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 with the following assumptions.

Year ended December 31
-------------------------
1997 1998 1999
------- ------- -------

Risk-free interest rate......................... 6.5% 6.5% 6.5%
Weighted-average expected life of the options... 7 years 7 years 7 years
Dividend rate................................... 0% 0% 0%
Assumed volatility.............................. 0% 0% 0%
Weighted average fair value of options granted:
Exercise price equal to fair value of stock on
date of grant................................ $ .06 $ .06 $ --
Exercise price less than fair value of stock
on date of grant............................. $ -- $ -- $ 5.77

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
--------------------------------------
1997 1998 1999
----------- ----------- ------------

Pro forma stock-based compensation
expense.......................... $ 15,977 $ 35,726 $ 1,712,263
Pro forma net loss................ $(3,754,395) $(6,014,504) $(10,269,539)
Pro forma net loss to common
stockholders..................... $(4,580,178) $(8,803,117) $(39,929,205)
Pro forma basic and diluted loss
per share........................ $ (.48) $ (.90) $ (3.99)

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

F-15

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Common stock reserved at December 31, 1999 consists of the following:

For conversion of Convertible Preferred Stock..................... 18,423,266
For exercise of Common Stock Warrants............................. 864,000
For issuance under the 1993 Stock Option Plan..................... 5,443,200

5. Income Taxes

At December 31, 1999, Active Power has net operating loss carryforwards of
approximately $14,432,000 for federal tax reporting purposes and research and
development credit carryforwards of approximately $391,000. The net operating
loss and research and development credit carryforwards begin to expire in 2007.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of
the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses and credits before utilization.

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

1998 1999
----------- -----------

Deferred tax liabilities:
Capital expenses............................... $ 35,000 $ --
Deferred tax assets:
Capital expenses............................... -- 71,000
Deferred compensation.......................... 19,000 511,000
Reserves and allowances........................ 128,000 461,000
Net operating loss and tax credit
carryforwards................................. 4,787,000 5,730,000
Other.......................................... 3,000 34,000
----------- -----------
Total deferred tax assets........................ 4,937,000 6,807,000
Valuation allowance for net deferred tax assets.. (4,902,000) (6,807,000)
----------- -----------
Net deferred taxes............................... $ -- $ --
=========== ===========

Active Power has established a valuation allowance equal to the net
deferred tax assets because of uncertainties regarding its ability to generate
sufficient taxable income during the carryforward period to utilize the net
operating loss carryforwards.

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

Year Ended
December 31
---------------------
1997 1998 1999
----- ----- -----

Federal statutory rate.. (34.0)% (34.0)% (34.0)%
Non-cash compensation
expense................ -- -- 17.4
State taxes, net of
federal benefit........ (3.0) (3.0) (1.5)
Permanent items and
other.................. (1.3) (1.8) (.6)
Change in valuation
allowance.............. 38.3 38.8 18.7
----- ----- -----
0.0% 0.0% 0.0%
===== ===== =====

F-16

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

6. Note Payable

On March 21, 1997, Active Power entered into a $350,000 note payable
agreement with a financial institution. This note bears interest at 15.132%, is
secured by furniture and equipment and is payable in monthly installments of
principal and interest of $11,013 maturing March 1, 2000 with a final payment
of $35,000.

7. Commitments

Active Power leases its office facility under an operating lease agreement.
The office space and manufacturing facilities lease is noncancelable and
obligates Active Power to pay taxes and maintenance costs. In addition, Active
Power leases certain equipment under a noncancelable lease.

Future minimum payments under these leases at December 31, 1999 are as
follows:

2000............................................................. $ 341,393
2001............................................................. 380,817
2002............................................................. 392,777
2003............................................................. 98,194
----------
Total future minimum lease payments.............................. $1,213,181
==========

Rent expense for the years ended December 31, 1997, 1998, and 1999 was
$147,324, $276,637, and $353,502, respectively.

Active Power entered into a consulting services agreement with the Chairman
of the board of directors. In accordance with the consulting agreement, the
Chairman receives $6,250 in consulting fees monthly. During 1997, 1998 and
1999, Active Power paid $75,000 in fees per year under this agreement.

8. 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 1997, 1998, and 1999.

9. Line of Credit

On August 3, 1999, Active Power entered into a line of credit agreement
with a financial institution in the amount of $1,000,000. There are no amounts
outstanding under this line of credit at December 31, 1999. The line of credit
bears interest at the lender's prime rate and matures on August 2, 2000. The
line of credit is secured by Active Power's tangible property.

10. Development Funding

During January 1999, Active Power entered into a contract development
agreement with a third party. In accordance with the agreement, the third party
provided funding to allow Active Power to accelerate development of its
products in a certain market application in exchange for the third party
obtaining exclusive marketing rights for the product in that application. The
exclusive marketing

F-17

ACTIVE POWER, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

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

11. Geographic Information

Revenues for the year ended December 31 were as follows:

1997 1998 1999
-------- -------- ----------

United States................................... $137,590 $867,775 $6,014,411
Foreign countries............................... -- 47,543 32,400
-------- -------- ----------
Total......................................... $137,590 $915,318 $6,046,811
======== ======== ==========

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.

12. Subsequent Events

During the six months ended June 30, 2000, Active Power granted 1,101,924
stock options to employees with exercise prices below the fair value determined
subsequently by the board of directors of the underlying shares and,
accordingly, recorded $8,781,404 additional unearned stock compensation which
will be recognized as non-cash compensation over the options' vesting period of
four years.

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.

F-18

[INSIDE BACK COVER]

[Description of graphics: This graphic depicts "The CleanSource Flywheel
Technology" and is an expanded view with a cross-section showing the components
of the Active Power flywheel assembly.]

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

No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You
must not rely on any unauthorized information or representations. This
prospectus is an offer to sell only the shares offered hereby, but only under
circumstances and in jurisdictions where it is lawful to do so. The
information contained in this prospectus is current only as of its date.

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

TABLE OF CONTENTS

Page
----

Prospectus Summary....................................................... 1
Risk Factors............................................................. 7
Cautionary Note Regarding Forward-Looking
Statements.............................................................. 15
Use of Proceeds.......................................................... 16
Dividend Policy.......................................................... 16
Capitalization........................................................... 17
Dilution................................................................. 18
Selected Financial Data.................................................. 20
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 21
Business................................................................. 26
Management............................................................... 39
Related Transactions..................................................... 49
Principal and Selling Stockholders....................................... 52
Description of Capital Stock............................................. 55
Shares Eligible for Future Sale.......................................... 59
Underwriting............................................................. 62
Legal Matters............................................................ 65
Experts.................................................................. 65
Where You Can Find Additional Information About Active Power............. 65
Index to Financial Statements............................................ F-1

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

Through and including , 2000 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether
or not participating in this offering, may be required to deliver a
prospectus. This is in addition to a dealer's obligation to deliver a
prospectus when acting as an underwriter and with respect to an unsold
allotment or subscription.

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

8,000,000 Shares
Active Power, Inc.
Common Stock

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

[ACTIVE POWER LOGO]

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

Goldman, Sachs & Co.
Merrill Lynch & Co.
Morgan Stanley Dean Witter
CIBC World Markets

Representatives of the Underwriters

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

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

Item 13. Other Expenses of Issuance and Distribution.

The following table sets forth the costs and expenses, other than the
underwriting discount, payable by us in connection with the sale of common
stock being registered. All amounts are estimates except the SEC registration
fee and the NASD filing fee. No portion of the costs and expenses is being
borne by the selling stockholder.

SEC registration fee............................................. $ 31,574
NASD fee......................................................... 12,460
Nasdaq National Market listing fee............................... 90,000
Printing and engraving expenses.................................. 250,000
Legal fees and expenses.......................................... 500,000
Accounting fees and expenses..................................... 250,000
Blue sky fees and expenses....................................... 2,500
Transfer agent fees.............................................. 10,000
Miscellaneous.................................................... 15,000
----------
Total.......................................................... $1,161,534
==========

Item 14. Indemnification of Directors and Officers.

Section 145 of the Delaware General Corporation Law (the "DGCL") provides,
in effect, that any person made a party to any action by reason of the fact
that he is or was our director, officer, employee or agent may and, in certain
cases, must be indemnified by us against, in the case of a non-derivative
action, judgments, fines, amounts paid in settlement and reasonable expenses
(including attorneys' fees) incurred by him as a result of such action, and in
the case of a derivative action, against reasonable expenses (including
attorneys' fees), if in either type of action he acted in good faith and in a
manner he reasonably believed to be in or not opposed to our best interests.
This indemnification does not apply, in a derivative action, to matters as to
which it is adjudged that the director, officer, employee or agent is liable to
us, unless upon court order it is determined that, despite such adjudication of
liability but in view of all the circumstances of the case, he is fairly and
reasonably entitled to indemnity for expenses, and, in a non-derivative action,
to any criminal proceeding in which such person had reasonable cause to believe
his conduct was unlawful.

Article V of our Amended and Restated Certificate of Incorporation provides
that no director shall be liable to us or our stockholders for monetary damages
for breach of fiduciary duty as a director to the fullest extent permitted by
the DGCL.

Reference is made to Section 8 of the underwriting agreement, the form of
which is filed as Exhibit 1.1 hereto, pursuant to which the underwriters have
agreed to indemnify our officers and directors against certain liabilities
under the Securities Act.

We have entered into Indemnification Agreements with each director, a form
of which is filed as Exhibit 10.1 to this Registration Statement. Pursuant to
such agreements, we will be obligated, to the extent permitted by applicable
law, to indemnify such directors against all expenses, judgments, fines and
penalties incurred in connection with the defense or settlement of any actions
brought against them by reason of the fact that they were our directors or
assumed certain responsibilities at the direction of us. We also intend to
purchase additional directors and officers liability insurance in order to
limit our exposure to liability for indemnification of directors and officers.

II-1

Item 15. Recent Sales of Unregistered Securities

Since April 1, 1997, we have issued unregistered securities to a number of
people as described below. None of these transactions involved any
underwriters, underwriting discounts or commissions, or any public offering,
and we believe that each transaction was exempt from the registration
requirements of the Securities Act in reliance on Section 4(2) thereof,
Regulation D promulgated thereunder or Rule 701 in accordance with compensatory
benefit plans and contracts relating to compensation as provided under Rule
701. The recipients of securities in each transaction represented their
intention to acquire the securities for investment purposes only and not with a
view to or for sale in connection with any distribution thereof, and
appropriate legends were affixed to the share certificates and instruments
issued in the transactions. All recipients had adequate access, through their
relationship with us, to information about us. The following common stock share
amounts, the weighted average exercise price and the exercise price per share
of the shares of common stock issued under our 1993 Stock Option Plan, as
amended, are adjusted to reflect the exchange of each share of common stock and
preferred stock issued by our predecessor Texas corporation for two shares of a
similar series of common stock or preferred stock in the successor Delaware
corporation. In addition, although the number of shares of preferred stock will
not be affected by our 2.16-for-1 common stock split to be effected prior to
the date of this offering, as a result of this stock split each share of our
Series C, Series D and Series E preferred stock will automatically adjust and
become convertible into 2.16 shares of our common stock upon the consummation
of this offering.

1. In July 1997, we issued 1,726,620 shares of Series C Convertible
Preferred Stock for $3.475 per share, for an aggregate purchase price
of $6,000,004. The following stockholders purchased our Series C
Convertible Preferred Stock: CenterPoint Venture Partners, L.P.; funds
affiliated with Advent International Corporation; SSM Venture
Partners, L.P.; and funds affiliated with Austin Ventures.

2. In June 1998, we issued 1,652,894 shares of Series D Convertible
Preferred Stock for $6.05 per share, for an aggregate purchase price
of $10,000,008. The following stockholders purchased our Series D
Convertible Preferred Stock: Rho Management Trust I; CenterPoint
Venture Partners, L.P.; funds affiliated with Advent International
Corporation; SSM Venture Partners, L.P.; funds affiliated with Austin
Ventures; Sevin Rosen Management Company; and several accredited
investors.

3. In November 1999, we issued 1,935,872 shares of Series E Convertible
Preferred Stock for $11.34 per share, for an aggregate purchase price
of $21,952,765. The following stockholders purchased our Series E
Convertible Preferred Stock: Stephens-Active Power, LLC; ECT Merchant
Investments Corp.; Rho Management Trust I; CenterPoint Venture Fund
II, L.P.; funds affiliated with SSM Venture Partners; funds affiliated
with Austin Ventures; funds affiliated with Advent International
Corporation; and a number of accredited investors.

4. In November 1999, in connection with the sale of Series E preferred
stock, we issued warrants to purchase an aggregate of 432,000 shares
of Common Stock at an exercise price of $5.25 per share to Enron North
America Corp. and Stephens Group, Inc.

5. Through June 30, 2000, we have issued and sold 2,350,266 shares of our
Common Stock to directors, employees and consultants upon the exercise
of options granted under our 1993 Stock Option Plan at a weighted
average exercise price of $0.23.

6. In May 2000, we issued 432,000 shares of our common stock at an
exercise price of $0.07 per share to SSM Venture Partners upon the
exercise of a warrant issued to SSM Venture Partners in 1995.

II-2

7. From time to time during the past three years, we have granted options
to purchase common stock to employees, directors and consultants. The
following table sets forth information regarding these grants.

Number of Exercise Price
Shares Per Share
--------- --------------

September 17, 1997 to April 30, 1998............. 1,466,640 $ .16
June 11, 1998 to December 10, 1998............... 393,120 .28
March 1, 1999 to June 17, 1999................... 468,720 .42
September 9, 1999................................ 192,240 .56
November 11, 1999................................ 518,400 .83
December 9, 1999 to February 29, 2000............ 737,424 1.04
March 9, 2000.................................... 129,600 1.39
April 13, 2000................................... 235,440 4.17
May 11, 2000 to June 30, 2000.................... 174,420 6.94

Item 16. Exhibits and Financial Statement Schedules.

(a) Exhibits.

1.1* Form of Underwriting Agreement

3.1* Form of Amended and Restated Certificate of Incorporation

3.2* Form of Amended and Restated Bylaws

4.1* Specimen certificate for shares of Common Stock

4.2* Warrant to Purchase Common Stock issued to Enron North America Corp.

4.3* Warrant to Purchase Common Stock issued to Stephens Group, Inc.

5.1* Opinion of Brobeck, Phleger & Harrison LLP

10.1* Form of Indemnity Agreement

10.2* Active Power, Inc. 2000 Stock Incentive Plan

10.3* Active Power, Inc. 2000 Employee Stock Purchase Plan

10.4* Second Amended and Restated Investors' Rights Agreement by and between
Active Power, Inc. and certain of its stockholders

10.5* Consulting Services Agreement by and between Active Power and Eric L.
Jones

10.6+* Phase II Development and Phase III Feasibility Agreement by and between
Active Power, Inc. and Caterpillar Inc.

10.7* Credit Terms and Conditions by and between Active Power, Inc. and
Imperial Bank

10.8* Security and Loan Agreement by and between Active Power, Inc. and
Imperial Bank

10.9* Lease Agreement by and between Active Power, Inc. and Braker Phase III,
Ltd.

10.10* First Amendment to Lease Agreement by and between Active Power, Inc.
and Braker Phase III, Ltd.

10.11* Second Amendment to Lease Agreement by and between Active Power, Inc.
and Braker Phase III, Ltd.

10.12* Third Amendment to Lease Agreement by and between Active Power, Inc.
and Braker Phase III, Ltd.

II-3

10.13* Fourth Amendment to Lease Agreement by and between Active Power, Inc.
and Metropolitan Life Insurance Company

10.14* Fifth Amendment to Lease Agreement by and between Active Power, Inc.
and Metropolitan Life Insurance Company

10.15* Sublease Agreement by and between Active Power, Inc. and Video
Associates Laboratories, Inc.
10.16* Employee offer letter (including severance arrangements) from Active
Power, Inc. to David S. Gino

23.1** Consent of Ernst & Young LLP

23.2* Consent of Brobeck, Phleger & Harrison LLP (Reference is made to
Exhibit 5.1)

24.1* Power of Attorney (see page II-5)

27.1* Financial Data Schedule

- --------
* Previously filed.
** Filed herewith.
+ Application has been made to the Commission to seek confidential treatment of
certain provisions of this exhibit. Omitted material for which confidential
treatment has been requested has been filed separately with the Commission.

Item 17. Undertakings.

The undersigned registrant hereby undertakes to provide to the underwriter
at the closing specified in the underwriting agreements, certificates in such
denominations and registered in such names as required by the underwriter to
permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Securities Act") may be permitted to our directors,
officers and controlling persons pursuant to the DGCL, our Certificate of
Incorporation or our Bylaws, the underwriting agreement or otherwise, we have
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act,
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by us of expenses incurred or
paid by one of our directors, officers, or controlling persons in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered hereunder, we will, unless in the opinion of our counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by us is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.

We hereby undertake that:

1. For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained
in a form of prospectus filed by us pursuant to Rule 424(b)(1) or (4)
or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.

2. For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering
thereof.

II-4

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, as amended, we
have duly caused this registration statement to be signed on our behalf by the
undersigned, thereunto duly authorized, in the city of Austin, state of Texas,
on August 2, 2000.

ACTIVE POWER, INC.

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

Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:

Name Title Date
---- ----- ----

/s/ Joseph F. Pinkerton, III President, Chief Executive August 2, 2000
______________________________________ Officer and Director
Joseph F. Pinkerton, III (Principal Executive
Officer)

/s/ David S. Gino Chief Financial Officer August 2, 2000
______________________________________ (Principal Financial and
David S. Gino Accounting Officer)

* Chairman of the Board August 2, 2000
______________________________________
Eric L. Jones

* Director August 2, 2000
______________________________________
Richard E. Anderson

* Director August 2, 2000
______________________________________
Rodney S. Bond

* Director August 2, 2000
______________________________________
Lindsay R. Jones

* Director August 2, 2000
______________________________________
Jan H. Lindelow

* Director August 2, 2000
______________________________________
Terrence L. Rock

/s/ David S. Gino
*By: _________________________________
David S. Gino

Attorney-in-Fact

II-5

INDEX TO EXHIBITS

Exhibit
No. Description
------- -----------

1.1* Form of Underwriting Agreement

3.1* Form of Amended and Restated Certificate of Incorporation

3.2* Form of Amended and Restated Bylaws

4.1* Specimen certificate for shares of Common Stock

4.2* Warrant to Purchase Common Stock issued to Enron North America Corp.

4.3* Warrant to Purchase Common Stock issued to Stephens Group, Inc.

5.1* Opinion of Brobeck, Phleger & Harrison LLP

10.1* Form of Indemnity Agreement

10.2* Active Power, Inc. 2000 Stock Incentive Plan

10.3* Active Power, Inc. 2000 Employee Stock Purchase Plan

10.4* Second Amended and Restated Investors' Rights Agreement by and between
Active Power, Inc. and certain of its stockholders

10.5* Consulting Services Agreement by and between Active Power and Eric L.
Jones

10.6+* Phase II Development and Phase III Feasibility Agreement by and
between Active Power, Inc. and Caterpillar Inc.

10.7* Credit Terms and Conditions by and between Active Power, Inc. and
Imperial Bank

10.8* Security and Loan Agreement by and between Active Power, Inc. and
Imperial Bank

10.9* Lease Agreement by and between Active Power, Inc. and Braker Phase
III, Ltd.

10.10* First Amendment to Lease Agreement by and between Active Power, Inc.
and Braker Phase III, Ltd.

10.11* Second Amendment to Lease Agreement by and between Active Power, Inc.
and Braker Phase III, Ltd.

10.12* Third Amendment to Lease Agreement by and between Active Power, Inc.
and Braker Phase III, Ltd.

10.13* Fourth Amendment to Lease Agreement by and between Active Power, Inc.
and Metropolitan Life Insurance Company

10.14* Fifth Amendment to Lease Agreement by and between Active Power, Inc.
and Metropolitan Life Insurance Company

10.15* Sublease Agreement by and between Active Power, Inc. and Video
Associates Laboratories, Inc.

10.16* Employee offer letter (including severance arrangements) from Active
Power, Inc. to David S. Gino

23.1** Consent of Ernst & Young LLP

23.2* Consent of Brobeck, Phleger & Harrison LLP (Reference is made to
Exhibit 5.1)

24.1* Power of Attorney (see page II-5)

27.1* Financial Data Schedule



                                                                    Exhibit 23.1

                        Consent of Independent Auditors

    We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated February 26, 2000 (except for Note 12, as to which
the date is July 13, 2000) in the Registration Statement (Form S-1 No. 333-
36946) and related Prospectus of Active Power, Inc. for the registration of
8,000,000 shares of its common stock.

                                          /s/ Ernst & Young LLP

Austin, Texas
August 1, 2000