CAPSTONE TURBINE CORP, S-1/A, 2000-11-16

CAPSTONE TURBINE CORP
S-1/A, 2000-11-16
MOTORS & GENERATORS

Previous: I2 TECHNOLOGIES INC, 424B1, 2000-11-16

Next: CAPSTONE TURBINE CORP, S-1/A, EX-1.1, 2000-11-16

<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 16, 2000

REGISTRATION STATEMENT NO. 333-48524

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

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

AMENDMENT NO. 2

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

CAPSTONE TURBINE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
DELAWARE 3629 95-4180883
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) NO.)
</TABLE>

21211 NORDHOFF STREET
CHATSWORTH, CALIFORNIA 91311
(818) 734-5300
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICE)

DR. AKE ALMGREN
PRESIDENT AND CHIEF EXECUTIVE OFFICER
CAPSTONE TURBINE CORPORATION
21211 NORDHOFF STREET
CHATSWORTH, CALIFORNIA 91311
(818) 734-5300
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

COPIES TO:

<TABLE>
<S> <C>
BRIAN CARTWRIGHT ROBERT E. BUCKHOLZ, JR.
LATHAM & WATKINS SULLIVAN & CROMWELL
633 WEST 5TH STREET, SUITE 4000 125 BROAD STREET
LOS ANGELES, CALIFORNIA 90071 NEW YORK, NEW YORK 10004
(213) 485-1234 (212) 558-4000
</TABLE>

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.

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, 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, 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. [ ]
CALCULATION OF REGISTRATION FEE

<TABLE>
<S> <C> <C> <C> <C>
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
TITLE OF EACH CLASS OF PROPOSED MAXIMUM PROPOSED MAXIMUM
SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF
TO BE REGISTERED REGISTERED(1) PER UNIT(2) PRICE REGISTRATION FEE
-------------------------------------------------------------------------------------------------------------------------
Common Stock............. 8,050,000 $34.97 $281,498,438 $74,315.59(3)
-------------------------------------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) Includes 1,050,000 shares of common stock that the underwriters have the
option to purchase to cover over-allotments, if any.

(2) Estimated solely for the purpose of calculating the amount of the
registration fee in accordance with Rule 457(c) under the Securities Act of
1933 based on the average of the high and low sales prices of the
Registrant's common stock on the Nasdaq National Market on November 15,
2000.

(3) Previously paid.

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 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SEC, ACTING PURSUANT TO SECTION 8(a), MAY
DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2

THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND WE ARE NOT
SOLICITING OFFERS TO BUY SECURITIES, IN ANY STATE WHERE THE OFFER OR
SALE IS NOT PERMITTED.

SUBJECT TO COMPLETION, DATED NOVEMBER 16, 2000

[CAPSTONE LOGO] 7,000,000 Shares
CAPSTONE TURBINE CORPORATION
Common Stock
</TABLE>

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

Capstone Turbine Corporation is offering 1,000,000 shares and the selling
stockholders identified in this prospectus are offering an additional 6,000,000
shares. Capstone Turbine will not receive any of the proceeds from the sale of
the shares being sold by the selling stockholders.

The common stock is quoted on the Nasdaq National Market under the symbol
"CPST." The last reported sale price of our common stock on the Nasdaq National
Market on November 15, 2000 was $34.563 per share.

See "Risk Factors" beginning on page 6 to read about factors you should
consider before buying shares of the common stock.

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

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.

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

<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----
<S> <C> <C>
Initial Price to public..................................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Capstone Turbine.............. $ $
Proceeds, before expenses, to selling stockholders.......... $ $
</TABLE>

To the extent that the underwriters sell more than 7,000,000 shares of
common stock, the underwriters have the option to purchase up to an additional
1,050,000 shares from Capstone Turbine and the selling stockholders at the
public offering price, less the underwriting discount.

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

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

GOLDMAN, SACHS & CO. CREDIT SUISSE FIRST BOSTON
MERRILL LYNCH & CO.
MORGAN STANLEY DEAN WITTER

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

Prospectus dated , 2000.
<PAGE> 3

<TABLE>
<S> <C>
[IMAGE] CAPSTONE-ENERGIZED HYBRID ELECTRIC BUS:
NEW ZEALAND

[IMAGE] WASTEWATER RESOURCE RECOVERY WITH
MICRO-COGENERATION: PENNSYLVANIA

[IMAGE] NURSING HOME MICRO-COGENERATION: OH

[IMAGE] OILFIELD 2-PACK RESOURCE RECOVERY: CANADA

[IMAGE] ROOFTOP MICRO-COGENERATION CHILLING: JAPAN

[IMAGE] CONVENIENCE STORE PEAK-SHAVING/STANDBY: IL

[IMAGE] PUBLIC POOL MICRO-COGENERATION: THE NETHERLANDS
</TABLE>

<PAGE> 4

PROSPECTUS SUMMARY

The following summarizes information in other sections of our prospectus,
including our financial statements, the notes to those financial statements and
the other financial information appearing elsewhere in this prospectus. You
should read the entire prospectus carefully.

CAPSTONE TURBINE CORPORATION

CAPSTONE

We develop, design, assemble and sell Capstone(TM) MicroTurbines. Capstone
MicroTurbines are marketable worldwide in the multibillion dollar market for
distributed power generation. Capstone MicroTurbines provide power at the site
of consumption and to hybrid electric vehicles that combine a primary source
battery with an auxiliary power source, such as a microturbine, to enhance
performance. We are the first company to sell a proven, commercially available
power source using microturbine technology. The Capstone MicroTurbine combines
sophisticated design, engineering and technology to produce a reliable and
flexible generator of electricity and heat for commercial and industrial
applications and is a result of over ten years of research and development. We
believe the simple and flexible design of our microturbines will enable our
distributors and end users to develop an increasingly broad range of
applications to fit their particular power needs.

PRODUCTS

The Capstone MicroTurbine is a compact, environmentally friendly generator
of electricity and heat. Our state-of-the-art microturbines combine patented
air-bearing technology, advanced combustion technology and sophisticated power
electronics to produce an efficient and reliable electricity and heat production
system that requires little on-going maintenance. Our air-bearing technology
provides a clean, high-pressure field of air to lubricate the one moving
component of the microturbine rather than using traditional petroleum products
as in conventional bearings. Our microturbines can operate by remote control and
use a broad range of gaseous and liquid fuels, including previously unusable
fuels. Our microturbines are easily transportable and designed to allow multiple
units to run together to meet an end user's specific electrical and heat
requirements.

We also have applied our technology to hybrid electric vehicles such as
buses, industrial use and other passenger and commercial vehicles. Buses using
Capstone MicroTurbines have demonstrated greater range, less maintenance and
lower costs than other low emission buses. Our microturbines have been in
commercial use in buses since July 1999 and are currently being used in buses
operating in U.S. cities such as Los Angeles, Atlanta, Chattanooga, and Tempe
and international cities such as Christchurch, New Zealand.

We offer two microturbine product families: the 30-kilowatt family,
available in 24 configurations, and our 60-kilowatt microturbine family, which
we introduced in September 2000, currently available in one configuration. Both
the 30-kilowatt and 60-kilowatt units can be used for a variety of power
applications. For example, our 30-kilowatt unit provides power sufficient to
operate a typical convenience store. A typical fast food restaurant requires
approximately 90 kilowatts of power and could be powered by three 30-kilowatt
units or a 60-kilowatt unit used in combination with a 30-kilowatt unit.

TARGET MARKETS

The fundamental need for power, along with the global deregulation of the
electric power industry, an increasing need for better power quality and
reliability and significant advances in power technology, are creating many new
opportunities for Capstone MicroTurbine systems.

1
<PAGE> 5

STATIONARY APPLICATIONS

We believe the stationary applications for our microturbines are extremely
broad, either on a stand-alone basis or connected to the electric utility grid,
because of our microturbines' ability to adapt to fuels, load variations, and
various climates while operating in an environmentally friendly manner. We have
initially targeted markets which we believe will identify and employ our product
attributes quickly. As levels of acceptance and volumes increase, we expect to
enter larger, more diverse markets. Our initial target markets include:

- Resource Recovery

Oil and gas production creates fuel byproducts that traditionally have
been released or burned into the atmosphere. Capstone MicroTurbines can
burn these otherwise wasted gases, including gas with high sulfur
content, with minimal emissions and produce on-site electricity for these
activities. Our microturbines can also burn gas released from landfills
and gas produced from sludge digestion.

- Micro-Cogeneration/Combined Heat and Power

Using both the heat and electricity from the combustion of fuel improves
the overall efficiency of the generation process and can provide a
comprehensive solution to a customer's energy needs. Uses for the heat
include space heating, air conditioning and heating and cooling water. We
have identified the Japanese market as the most receptive for these
applications in the near term.

- Back-up and Standby Power/Peak Shaving

Many commercial and small industrial customers in developed countries
could reduce their electricity costs and/or improve their reliability of
electric power supply by installing a Capstone MicroTurbine to meet some
or all of their needs as a back-up power source. In addition, end users
also can use our microturbines to avoid temporary spikes in power prices
by producing their own power during periods when power demand and power
costs are high, known in the industry as peak shaving.

-- Power Quality and Reliability

An important and rapidly growing sector within the back-up and
standby power/peak shaving market is power quality and reliability.
Consumers worldwide, particularly industrial and commercial users,
are increasingly using power for digital based processes. These
systems are extremely intolerant of disturbances in their power
supply. Even momentary disruptions can cause material economic loss.
We believe that Capstone MicroTurbines have applications in this
market due to their operating flexibility, low emissions and modular
form. Our products can provide support for extended outages on a
cost effective basis.

- Developing Regions

Much of the world's population does not have access to electric power.
Utilities can install Capstone MicroTurbines at the end of the electric
utility grid to avoid building costly power lines. Additionally, our
microturbine can be a primary, stand-alone power source which burns a
variety of gaseous or liquid fuels.

HYBRID ELECTRIC VEHICLES

We believe that the hybrid electric vehicle market currently represents a
significant opportunity and will expand as governments and consumers demand
cost-efficient, reliable and environmentally friendly vehicles, particularly in
urban areas. The recent ban on diesel buses imposed by the City of Los Angeles
is indicative of this trend. In October 2000, we entered into a joint
development

2
<PAGE> 6

agreement with Hyundai Motor Company to demonstrate the feasibility of
integrating our microturbine technology into Hyundai sport utility vehicles and
buses.

OUR STRATEGY

Our objective is to remain a leading worldwide developer and supplier of
microturbine technology for the stationary power generation and hybrid electric
vehicle markets. Key elements of our strategy include the following:

- We believe the most effective way to penetrate our target markets is with
a business-to-business distribution strategy. We are forging alliances
with key distribution partners worldwide.

- We shipped the first commercial model of our family of 60-kilowatt
microturbine systems in September 2000. We intend to develop microturbine
families with power outputs of up to 125+ kilowatts. We also intend to
continue our research and development efforts to enhance our current
products.

- We believe that a policy of actively protecting our patents and other
intellectual property is an important component of our strategy to remain
the leader in microturbine technology and will provide us a long-term
competitive advantage.

- We expect our unit production costs and prices to decline substantially
as volumes increase. Our strategy is to use low cost materials and to
outsource all non-proprietary hardware and electronics to achieve high
volume, low cost production targets. We are pursuing a "tier one" supply
strategy whereby vendors are responsible for the supply of complete
subassemblies made up of parts purchased from other vendors. We will
retain manufacturing control over our proprietary air-bearing and
combustion components. We will begin to manufacture recuperator cores
over the course of the next nine to twelve months.

- We intend to minimize our financial and operational risk by maintaining
adequate capitalization levels.

- We intend to continue to add key personnel to complement our strong
management team, which has significant industry expertise.

3
<PAGE> 7

THE OFFERING

Shares offered by us.................... 1,000,000 shares

Shares offered by the selling
stockholders............................ 6,000,000 shares

Total................................... 7,000,000 shares

Common stock to be outstanding after
this offering........................... 75,938,602 shares

Use of proceeds......................... Our net proceeds from this offering
are estimated to be approximately
$32.3 million. We will use the net
proceeds for recuperator core
manufacturing activities. We will
not receive any proceeds from the
sale of the common stock by the
selling stockholders. See "Use of
Proceeds."

Nasdaq National Market symbol........... CPST

The number of shares of our common stock that will be outstanding after
this offering:

- includes 74,938,602 shares outstanding as of September 30, 2000; and

- excludes up to 9,207,727 shares of common stock either underlying options
granted or available for issue under our stock option plans, some of
which will be exercised in connection with this offering, and 900,000
shares reserved for issuance under our employee stock purchase plans.

Unless otherwise indicated, all information in this prospectus assumes the
underwriters option to purchase additional shares in this offering will not be
exercised.

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

We were incorporated in California in 1988. We reincorporated in Delaware
on June 22, 2000. Our principal executive offices are located at 21211 Nordhoff
Street, Chatsworth, California 91311. Our telephone number is (818) 734-5300.
Our internet address is www.capstoneturbine.com. This internet address is
provided for informational purposes only and is not intended to be useable as a
hyperlink. The information at this internet address is not a part of this
prospectus.

The name Capstone and the Turbine Blade logo are trademarks that belong to
us. This prospectus also contains the names of other entities which are the
property of their respective owners.

4
<PAGE> 8

SUMMARY FINANCIAL INFORMATION

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, -----------------------------
--------------------------------------------------- SEPTEMBER 30, SEPTEMBER 30,
1995 1996 1997 1998 1999 1999 2000
------- -------- -------- -------- -------- ------------- -------------
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
Total revenues.................. $ 920 $ 1,462 $ 1,623 $ 84 $ 6,694 $ 1,315 $ 16,029
Cost of goods sold.............. 199 2,179 8,147 5,335 15,629 4,570 20,658
------- -------- -------- -------- -------- -------- --------
Gross profit (loss)........... 721 (717) (6,524) (5,251) (8,935) (3,255) (4,629)
Operating costs and expenses:
Research and development...... 4,796 8,599 13,281 19,019 9,151 6,681 8,416
Selling, general and
administrative.............. 1,878 3,585 10,946 10,257 11,191 7,818 17,264
------- -------- -------- -------- -------- -------- --------
Income (loss) from
operations.................. (5,953) (12,901) (30,751) (34,527) (29,277) (17,754) (30,309)
Net income (loss)........... $(5,957) $(12,595) $(30,553) $(33,073) $(29,530) $(17,863) $(25,067)
======= ======== ======== ======== ======== ======== ========
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, -----------------------------
----------------------------------------------------- SEPTEMBER 30, SEPTEMBER 30,
1995 1996 1997 1998 1999 1999 2000
-------- -------- -------- -------- --------- ------------- -------------
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
BALANCE SHEET DATA:
Cash and cash equivalents..... $ 525 $ 1,464 $ 44,563 $ 4,943 $ 6,858 $ 4,454 $229,783
Working capital............... 255 1,773 41,431 6,919 6,294 10,140 225,428
Total assets.................. 1,351 6,820 56,989 25,770 36,927 28,397 289,516
Capital lease obligations..... -- 846 1,885 4,449 5,899 5,164 5,963
Long-term debt................ -- -- -- -- -- -- --
Redeemable preferred stock.... 11,242 25,975 99,720 101,624 156,469 125,716 --
Stockholders'
(deficiency)/equity......... (11,371) (24,176) (56,057) (91,151) (144,225) (112,543) 264,819
Total liabilities and
stockholders' equity........ $ 1,351 $ 6,820 $ 56,989 $ 25,770 $ 36,927 $ 28,397 $289,516
</TABLE>

5
<PAGE> 9

RISK FACTORS

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

RISKS RELATING TO OUR BUSINESS

WE HAVE A LIMITED OPERATING HISTORY CHARACTERIZED BY NET LOSSES, WE ANTICIPATE
CONTINUED LOSSES THROUGH AT LEAST 2001 AND WE MAY NEVER BECOME PROFITABLE

Since our inception in 1988, we have reported net losses for each year. Our
net losses were $30.6 million in 1997, $33.1 million in 1998, $29.5 million in
1999, and $25.1 million for the nine months ended September 30, 2000. We
anticipate incurring additional net losses through at least 2001. Since
inception through September 30, 2000, we have recorded cumulative losses of
approximately $141.5 million. We have only been commercially producing Capstone
MicroTurbines since December 1998 and have made only limited sales to date.
Also, because we are in the early stages of selling our products, we have
relatively few customers. Even if we do achieve profitability, we may be unable
to increase our sales and sustain or increase our profitability in the future.

A MASS MARKET FOR MICROTURBINES MAY NEVER DEVELOP OR MAY TAKE LONGER TO DEVELOP
THAN WE ANTICIPATE, WHICH WOULD ADVERSELY IMPACT OUR REVENUES AND PROFITABILITY

Our products represent an emerging market, and we do not know whether our
targeted customers will accept our technology or will purchase our products in
sufficient quantities to grow our business. If a mass market fails to develop or
develops more slowly than we anticipate, we may be unable to recover the losses
we have incurred to develop our products, we may be unable to meet our
operational expenses and we may be unable to achieve profitability. The
development of a mass market for our systems may be impacted by many factors
which are out of our control, including:

- the cost competitiveness of our microturbines;

- the future costs and availability of fuels used by our microturbines;

- consumer reluctance to try a new product;

- consumer perceptions of our microturbines' safety;

- regulatory requirements; and

- the emergence of newer, more competitive technologies and products.

IF WE ARE UNABLE TO MANUFACTURE RECUPERATOR CORES INTERNALLY, OUR ASSEMBLY AND
PRODUCTION OF MICROTURBINES MAY SUFFER DELAYS AND INTERRUPTIONS

Solar Turbines Incorporated has been our sole supplier of recuperator
cores, which are heat exchangers that preheat incoming air before it enters the
combustion chamber and are an essential component of our microturbines. Solar is
a wholly-owned subsidiary of Caterpillar Inc. At present we are not aware of any
other suppliers which could produce these cores to our specifications within our
time requirements. In September 2000, we exercised contractual rights to begin
using Solar's intellectual property to manufacture recuperator cores ourselves.
We estimate that the transition from purchasing recuperator cores from Solar to
manufacturing them ourselves will take approximately nine to twelve months to
complete. However, since we have never manufactured recuperator cores, the
transition period may be longer. We cannot assure you that this transition will
be without disruption. Any delays or disruptions in this transition process may
result in interruptions to the assembly and shipment of our products. Also, we
cannot assure you that Solar will honor the license agreement, that a court
would enforce it, or that we will be able to meet our obligations under it. If
we had to develop and produce our own recuperator cores without using Solar's
intellectual property, we estimate it could take up to three years to begin
production.

6
<PAGE> 10

WE MAY NOT BE ABLE TO CONTROL OUR WARRANTY EXPOSURE AND OUR WARRANTY RESERVE MAY
NOT BE SUFFICIENT TO MEET OUR WARRANTY EXPENSE, WHICH COULD IMPAIR OUR FINANCIAL
CONDITION

We sell our products with warranties. However, these warranties vary from
product to product with respect to the time period covered and the extent of the
warranty protection. Malfunctions of our product could expose us to significant
warranty expenses. Because we are in the early stages of production and few of
our products have completed a full warranty term, we cannot be certain that we
have adequately determined our warranty exposure. Moreover, as we develop new
configurations for our microturbines or as our customers place existing
configurations in commercial use for long periods of time, we expect to
experience product malfunctions that cause our products to fall substantially
below our 98% availability target level. While our microturbines have often
achieved this availability target when using high pressure natural gas, we are
still working to achieve this availability target across all of our units and
for all fuel sources. We recorded a warranty reserve charge of $4.1 million or
26% of revenue for the nine months ended September 30, 2000 and $2.6 million or
39% of revenue for the year ended December 31, 1999. While management believes
that the warranty reserve is reasonable, there can be no assurance that the
reserve will be sufficient to cover our warranty expenses in the future.
Although we attempt to reduce our risk of warranty claims through warranty
disclaimers, we cannot assure you that our efforts will effectively limit our
liability. Any significant incurrence of warranty expense could have a material
adverse effect on our financial condition.

WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT AND THE LOSS OF KEY MANAGEMENT COULD
PREVENT EFFECTIVE IMPLEMENTATION OF OUR EXPANSION PLAN

Our success depends in significant part upon the continued service of key
management personnel, such as Dr. Ake Almgren, our Chief Executive Officer, Mr.
Jeffrey Watts, our Chief Financial Officer, and Mr. William Treece, our Senior
Vice President of Strategic Technology Development. Currently, the competition
for qualified personnel is intense and we cannot assure you that we can retain
our existing management team. The loss of Dr. Almgren, Mr. Watts, Mr. Treece or
any other key management personnel could materially adversely affect our
operations.

WE MAY NOT BE ABLE TO HIRE AND RETAIN THE TECHNICAL PERSONNEL NECESSARY TO BUILD
OUR PRODUCTS, WHICH COULD DELAY PRODUCT DEVELOPMENT AND LOWER PRODUCTION

We have historically experienced, and expect to continue to experience,
delays in filling technical positions. Competition is intense for qualified
technical personnel, and in particular skilled engineers. As a result, we may
not be able to hire and retain engineering personnel that we need. Our failure
to do so could delay product development cycles, affect the quality of our
products, reduce the number of microturbines we can produce and/or otherwise
negatively affect our business.

IF WE DO NOT EFFECTIVELY IMPLEMENT OUR SALES AND MARKETING EXPANSION PROGRAM,
OUR SALES WILL NOT GROW AND OUR PROFITABILITY WILL SUFFER

We need to increase our internal sales and marketing staff in order to
enhance our sales efforts. We cannot assure you that the expense of such
internal expansion will not exceed the net revenues generated, or that our sales
and marketing team will successfully compete against the more extensive and
well-funded sales and marketing operations of our current and future
competitors. In addition, to grow our sales, we have begun to hire new
management team members to provide more sales and marketing expertise. Since
these management team members will not have a proven track record with us, we
cannot assure you that they will be successful in overseeing their functional
areas. Our inability to recruit, or our loss of, important sales and marketing
personnel, or the inability of new sales personnel to effectively sell and
market our microturbine systems could materially adversely affect our business
and results of operations.

7
<PAGE> 11

WE MAY NOT BE ABLE TO ESTABLISH STRATEGIC MARKETING RELATIONSHIPS, IN WHICH CASE
OUR SALES WOULD NOT INCREASE AS EXPECTED

We are in the early stages of developing our distribution network. In order
to expand our customer base, we believe that we must enter into strategic
marketing alliances or similar collaborative relationships, in which we ally
ourselves with companies that have particular expertise in or more extensive
access to desirable markets. Providing volume price discounts and other
allowances along with significant costs incurred in customizing our products may
reduce the potential profitability of these relationships. We may not be able to
identify appropriate distributors on a timely basis, and we cannot assure you
that the distributors with which we partner will focus adequate resources on
selling our products or will be successful in selling them. In addition, we
cannot assure you that we will be able to negotiate collaborative relationships
on favorable terms or at all. The lack of success of our collaborators in
marketing our products may adversely affect our financial condition and results
of operations.

WE HAVE LIMITED EXPERIENCE IN INTERNATIONAL SALES AND MAY NOT SUCCEED IN GROWING
OUR INTERNATIONAL SALES

We have limited experience in international sales and will depend on our
international marketing partners for these sales. Most of our marketing
partnerships are recently created and, accordingly, may not achieve the results
that we expect. If a dispute arises between us and any of our partners, we may
not achieve our desired sales results and we may be delayed or completely fail
to penetrate some international markets, and our revenue and operations could be
materially adversely affected. Any inability to obtain foreign regulatory
approvals or quality standard certifications on a timely basis could negatively
impact our business and results of operations. Also, as we seek to expand into
the international markets, customers may have difficulty or be unable to
integrate our products into their existing systems. As a result, our products
may require redesign. In addition, we may be subject to a variety of other risks
associated with international business, including:

- delays in establishing international distribution channels;

- difficulties in collecting international accounts receivables;

- difficulties in complying with foreign regulatory and commercial
requirements;

- increased costs associated with maintaining international marketing
efforts;

- compliance with U.S. Department of Commerce export controls;

- increases in duty rates;

- the introduction of non-tariff trade barriers;

- fluctuations in currency exchange rates;

- political and economic instability; and

- difficulties in enforcement of intellectual property rights.

THE 60-KILOWATT CAPSTONE MICROTURBINE MAY NOT REACH THE LEVEL OF SALES WE
ANTICIPATE OR IT MAY ERODE SALES OF OUR 30-KILOWATT UNIT

The successful launch of our next generation 60-kilowatt family of
microturbines, the Capstone 60, is very important to our market penetration
strategy. Factors that could hinder the successful launch of our Capstone 60
microturbine include potential engineering, production or performance problems,
including problems in developing the ability to operate on multiple fuels or in
multiple modes of operation, and an unstable supply or unsatisfactory quality of
components from vendors. We cannot guarantee you that demand for our 60-kilowatt
unit will develop or that if it does develop, that it will not diminish over
time. It is also possible that production of the 60-kilowatt unit

8
<PAGE> 12

could replace or diminish the sales of our 30-kilowatt unit. If so, our results
of operations could be adversely affected.

WE MAY BE UNABLE TO FUND OUR FUTURE OPERATING REQUIREMENTS, WHICH COULD FORCE US
TO CURTAIL OUR OPERATIONS

We are a capital intensive company and may need additional financing to
fund our operations. In the first nine months of 2000, our net cash used in
operations was $15.4 million and our net cash used in investing activities
totaled $22.5 million. As of September 30, 2000, we had approximately $229.8
million in cash and cash equivalents on hand. Our future capital requirements
will depend on many factors, including our ability to successfully market and
sell our products. To the extent that the funds generated by this offering are
insufficient to fund our future operating requirements, we will need to raise
additional funds, through further public or private equity or debt financings.
These financings may not be available or, if available, may be on terms that are
not favorable to us and could result in further dilution to our stockholders.
Downturns in worldwide capital markets may also impede our ability to raise
additional capital on favorable terms or at all. If adequate capital is not
available to us, we would likely be required to significantly curtail or
possibly even cease our operations.

WE MAY NOT BE ABLE TO EFFECTIVELY PREDICT OR REACT TO RAPID TECHNOLOGICAL
CHANGES THAT COULD RENDER OUR PRODUCTS OBSOLETE

The market for our products is characterized by rapidly changing
technologies, extensive research and new product introductions. We believe that
our future success will depend in large part upon our ability to enhance our
existing products and to develop, introduce and market new products. As a
result, we expect to continue to make a significant investment in product
development. We have in the past experienced setbacks in the development of our
products and our anticipated roll out of our products has accordingly been
delayed. If we are unable to develop and introduce new products or enhancements
to our existing products that satisfy customer needs and address technological
changes in target markets in a timely manner, our products will become
noncompetitive or obsolete.

WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR GROWTH OR IMPROVE OUR MANAGEMENT
INFORMATION SYSTEMS, WHICH WOULD IMPAIR OUR PROFITABILITY

If we are successful in executing our business plan, we will experience
growth in our business that could place a significant strain on our management
and other resources. Our ability to manage our growth will require us to
continue to improve our operational, financial and management information
systems, to implement new systems and to motivate and effectively manage our
employees. We cannot assure that our management will be able to effectively
manage this growth.

WE MAY NOT EFFECTIVELY EXPAND OUR PRODUCTION CAPABILITIES, WHICH WOULD
NEGATIVELY IMPACT OUR SALES

We anticipate a significant increase in our business operations which will
require expansion of our internal and external production capabilities. We may
experience delays or problems in our expected production expansion that could
significantly impact our business. Several factors could delay or prevent our
expected production expansion, including our:

- inability to purchase parts or components in adequate quantities or
sufficient quality;

- failure to increase our assembly and test operations;

- failure to hire and train additional personnel;

- failure to develop and implement manufacturing processes and equipment;

9
<PAGE> 13

- inability to find and train proper partner companies in other countries
with whom we can build product distribution, marketing or development
relationships;

- inability to manufacture recuperator cores on schedule, in quantities or
with the quality that we require; and

- inability to acquire new space for additional production capacity.

WE MAY NOT ACHIEVE PRODUCTION COST REDUCTIONS NECESSARY TO COMPETITIVELY PRICE
OUR PRODUCT, WHICH WOULD IMPAIR OUR SALES

We believe that we will need to reduce the unit production cost of our
products over time to maintain our ability to offer competitively priced
products. Our ability to achieve cost reductions will depend on low cost design
enhancements, obtaining necessary tooling and favorable vendor contracts, as
well as increasing sales volumes so we can achieve economies of scale. We cannot
assure you that we will be able to achieve any production cost reductions.

OUR SUPPLIERS AND MANUFACTURERS MAY NOT SUPPLY US WITH A SUFFICIENT AMOUNT OF
COMPONENTS OR COMPONENTS OF ADEQUATE QUALITY, AND WE MAY NOT BE ABLE TO PRODUCE
OUR PRODUCT

We depend on sole or limited source suppliers for key components of our
products, and if we are unable to obtain these components on a timely basis, we
will not be able to deliver our products to customers. Also, we cannot guarantee
that any of the parts or components that we purchase, if available at all, will
be of adequate quality or that the prices we pay for these parts or components
will not increase. For example, there is currently an industry-wide shortage of
several electronic components, some of which we use in our products. We may
experience delays in production of our Capstone MicroTurbines if we fail to
identify alternate vendors, or any parts supply is interrupted or reduced or
there is a significant increase in production costs, each of which could
materially adversely affect our business and operations.

OUR PRODUCTS INVOLVE A LENGTHY SALES CYCLE AND WE MAY NOT ANTICIPATE SALES
LEVELS APPROPRIATELY, WHICH COULD IMPAIR OUR PROFITABILITY

The sale of our products typically involves a significant commitment of
capital by customers, with the attendant delays frequently associated with large
capital expenditures. We are targeting, in part, customers in the utility
industry, which generally commit to a larger number of products when ordering
and which have a lengthy process for approving capital expenditures. We have
also targeted the hybrid electric vehicle market, which requires a significant
amount of lead time due to implementation costs incurred. For these and other
reasons, the sales cycle associated with our products is typically lengthy and
subject to a number of significant risks over which we have little or no
control. We expect to plan our production and inventory levels based on internal
forecasts of customer demand, which is highly unpredictable and can fluctuate
substantially. If sales in any period fall significantly below anticipated
levels, our financial condition and results of operations could suffer. In
addition, our operating expenses are based on anticipated sales levels, and a
high percentage of our expenses are generally fixed in the short term. As a
result of these factors, a small fluctuation in timing of sales can cause
operating results to vary from period to period.

WE FACE POTENTIAL SIGNIFICANT FLUCTUATIONS IN OPERATING RESULTS, WHICH COULD
IMPACT OUR STOCK PRICE

A number of factors could affect our operating results and thereby impact
our stock price, including:

- the timing of the introduction or enhancement of products by us or our
competitors;

- our reliance on a small number of customers;

10
<PAGE> 14

- the size, timing and shipment of individual orders;

- market acceptance of new products;

- potential delays in production as a result of the commencement of our
manufacturing of recuperator cores;

- customers delaying orders of our products because of the anticipated
release of new products by us;

- changes in our operating expenses, the mix of products sold, or product
pricing;

- the ability of our suppliers to deliver quality parts when we need them;

- development of our direct and indirect sales channels;

- loss of key personnel;

- political unrest or changes in the trade policies, tariffs or other
regulations of countries in which we do business that could lower demand
for our products; and

- changes in market prices for natural resources that could lower the
desirability of our products.

Because we are in the early stages of selling our products, with relatively few
customers, we expect our order flow to continue to be uneven from period to
period. Because a significant portion of our expenses are fixed, a small
variation in the timing of recognition of revenue can cause significant
variations in operating results from quarter to quarter.

POTENTIAL INTELLECTUAL PROPERTY, STOCKHOLDER OR OTHER LITIGATION MAY ADVERSELY
IMPACT OUR BUSINESS

Because of the nature of our business, we may face litigation relating to
intellectual property matters, labor matters, product liability and stockholder
disputes. Any litigation could be costly, divert management attention or result
in increased costs of doing business. Although we intend to vigorously defend
any future lawsuits, we cannot assure you that we would ultimately be
successful. An adverse judgment could negatively impact the price of our common
stock and our ability to obtain future financing on favorable terms or at all.

WE MAY BE EXPOSED TO PRODUCT LIABILITY OR OTHER TORT CLAIMS IF OUR PRODUCTS
FAIL, WHICH COULD SUBJECT US TO LIABILITY AND ADVERSELY IMPACT OUR RESULTS OF
OPERATIONS

Potential customers will rely upon our products for critical energy needs.
A malfunction or the inadequate design of our products could result in product
liability or other tort claims. Our microturbines run at high speeds and high
temperatures and use flammable fuels that are inherently dangerous substances.
Accidents involving our products could lead to personal injury or physical
damage. Although we attempt to reduce the risk of these types of losses through
liability limitation clauses in our agreements, we cannot assure you that our
efforts will effectively limit our liability. Any liability for damages
resulting from malfunctions could be substantial and could materially adversely
affect our business and results of operations. In addition, a well-publicized
actual or perceived problem could adversely affect the market's perception of
our products. This could result in a decline in demand for our products, which
would materially adversely affect our financial condition and results of
operations.

11
<PAGE> 15

RISKS RELATING TO OUR INDUSTRY

OUR COMPETITORS, WHO HAVE SIGNIFICANTLY GREATER RESOURCES THAN WE HAVE, MAY BE
ABLE TO ADAPT MORE QUICKLY TO NEW OR EMERGING TECHNOLOGIES OR TO DEVOTE GREATER
RESOURCES TO THE PROMOTION AND SALE OF THEIR PRODUCTS, AND WE MAY BE UNABLE TO
COMPETE EFFECTIVELY

Our competitors include several well established companies that have
substantially greater resources than we have and that benefit from larger
economies of scale and worldwide presence. Honeywell (AlliedSignal), NREC
(Ingersoll-Rand Company), and Elliot/General Electric Company are domestically
based competitors of Capstone who we believe have microturbines in various
stages of development. NREC (Ingersoll-Rand Company) has announced that it
expects to begin to commercially ship microturbine units in 2001. In addition to
these domestic microturbine competitors, AB Volvo and ABB Ltd. have a joint
venture in Europe, called Turbec, to develop a microturbine. A number of other
major automotive and industrial companies have in-house microturbine development
efforts, including Ishikawajima-Harima Heavy Industries, Mitsubishi Heavy
Industries, Ltd. and Turbo Genset Inc. We believe that all of these companies
will eventually have products which will compete with our microturbines. Some of
our competitors are currently developing and testing microturbines which they
expect to produce greater amounts of power than Capstone MicroTurbines, ranging
from 75 kilowatts up to 350 kilowatts, and which may have longer useful lives
than Capstone MicroTurbines. Capstone MicroTurbines also compete with other
existing technologies, including the electric utility grid, reciprocating
engines, fuel cells, and solar and wind powered systems. Many of the competitors
producing these technologies also have greater resources than we have. For
instance, reciprocating engines are produced in part by Caterpillar Inc.,
Interstate Detroit Diesel and Cummins Inc. We cannot assure you that the market
for distributed power generation products will not ultimately be dominated by
technologies other than ours.

Because of greater resources, some of our competitors may be able to adapt
more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the promotion and sale of their
products than we can. We believe that developing and maintaining a competitive
advantage will require continued investment by us in product development,
manufacturing capability and sales and marketing. We cannot assure you that we
will have sufficient resources to make the necessary investments to do so. In
addition, current and potential competitors have established or may in the
future establish collaborative relationships among themselves or with third
parties, including third parties with whom we have strategic relationships.
Accordingly, new competitors or alliances may emerge and rapidly acquire
significant market share.

WE OPERATE IN A HIGHLY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE
EFFECTIVELY DUE TO FACTORS AFFECTING THE MARKET FOR OUR PRODUCTS

The market for our products is highly competitive and is changing rapidly.
We believe that the primary competitive factors affecting the market for our
products include:

- operating efficiency;

- reliability;

- product quality and performance;

- life cycle costs;

- development of new products and features;

- quality and experience of sales, marketing and service organizations;

- availability and price of fuel;

- product price;

- emissions levels;

12
<PAGE> 16

- name recognition; and

- quality of distribution channels.

Several of these factors are outside our control. We cannot assure you that we
will be able to compete successfully in the future with respect to these or any
other competitive factors.

UTILITY COMPANIES COULD PLACE BARRIERS TO OUR ENTRY INTO THE MARKETPLACE AND WE
MAY NOT BE ABLE TO EFFECTIVELY SELL OUR PRODUCT

Utility companies commonly charge fees to industrial customers for
disconnecting from the grid, for using less electricity, or for having the
capacity to use power from the grid for back-up purposes. These types of fees
could increase the cost to our potential customers of using our systems and
could make our systems less desirable, thereby harming our revenue and
profitability.

WE DEPEND ON OUR INTELLECTUAL PROPERTY TO MAKE OUR PRODUCTS COMPETITIVE AND IF
WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, OUR BUSINESS WILL SUFFER

We rely on a combination of patent, trade secret, copyright and trademark
law, and nondisclosure agreements to establish and protect our intellectual
property rights in our products. At September 30, 2000, we possessed 31 United
States patents and two international patents and additional patents pending. In
particular, we believe that our patents and patents pending for our air-bearing
systems, digital power controller and our combustion systems are key to our
business. We believe that, due to the rapid pace of technological innovation in
turbine products, our ability to establish and maintain a position among the
technology leaders in the industry depends on both our patents and other
intellectual property and the skills of our development personnel. We cannot
assure you that any patent, trademark, copyright or license owned or held by us
will not be invalidated, circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to us or that any of our future
patent applications will be issued with the scope of the claims asserted by us,
if at all. Further, we cannot assure you that third parties or competitors will
not develop technologies that are similar or superior to our technology,
including our air bearing technology, duplicate our technology or design around
our patents. Also, another party may be able to reverse engineer our technology
and discover our intellectual property and trade secrets. We may be subject to
or may initiate proceedings in the U.S. Patent and Trademark Office, which can
require significant financial and management resources. In addition, the laws of
foreign countries in which our products are or may be developed, manufactured or
sold may not protect our products and intellectual property rights to the same
extent as the laws of the United States. Our inability to protect our
intellectual property adequately could have a material adverse effect on our
financial condition or results of operations.

IF WE ARE FOUND TO INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WE
MAY NOT BE ABLE TO PRODUCE OUR PRODUCTS OR MAY HAVE TO ENTER INTO COSTLY LICENSE
AGREEMENTS

Third parties may claim infringement by us with respect to past, current or
future proprietary rights. In particular, Honeywell (AlliedSignal), Sundstrand
Corporation and Solar Turbines Incorporated have patents in areas related to our
business and core technologies. Any infringement claim, whether meritorious or
not, could be time-consuming, result in costly litigation or arbitration and
diversion of technical and management personnel or require us to develop
non-infringing technology or to enter into royalty or licensing agreements.
Royalty or licensing agreements, if required, may not be available on terms
acceptable to us, or at all, and could significantly harm our business and
operating results. Litigation may also be necessary in the future to enforce our
patent or other intellectual property rights, to protect our trade secrets and
to determine the validity and scope of proprietary rights of others. For
example, in 1997, we were involved in a dispute with Honeywell (AlliedSignal)
regarding various disputed intellectual property rights. We entered into a
settlement agreement regarding these

13
<PAGE> 17

issues. These types of disputes could result in substantial costs and diversion
of resources and could materially adversely affect our financial condition and
results of operations.

WE OPERATE IN A HIGHLY REGULATED BUSINESS ENVIRONMENT AND CHANGES IN REGULATION
COULD IMPOSE COSTS ON US OR MAKE OUR PRODUCTS LESS ECONOMICAL

Our products are subject to federal, state, local and foreign laws and
regulations, governing, among other things, emissions to air as well as laws
relating to occupational health and safety. Regulatory agencies may impose
special requirements for implementation and operation of our products (e.g.,
connection with the electric grid) or may significantly impact or even eliminate
some of our target markets. We may incur material costs or liabilities in
complying with government regulations. In addition, potentially significant
expenditures could be required in order to comply with evolving environmental
and health and safety laws, regulations and requirements that may be adopted or
imposed in the future. Furthermore, our potential utility customers must comply
with numerous laws and regulations. The deregulation of the utility industry may
also create challenges for our marketing efforts. For example, as part of
electric utility deregulation, federal, state and local governmental authorities
may impose transitional charges or exit fees which would make it less economical
for some potential customers to switch to our products. Further, our ability to
penetrate the Japanese market will depend on our receipt of approvals and
changes to regulatory requirements surrounding power generation by Japan's
Ministry of International Trade and Industry, or MITI. We can provide no
assurances that we will be able to obtain these approvals and changes in a
timely manner, or at all.

RISKS RELATING TO THIS OFFERING

A LARGE NUMBER OF SHARES OF OUR COMMON STOCK WILL BECOME AVAILABLE FOR SALE IN
THE FUTURE, WHICH MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK

The market price of our common stock could decline as a result of sales of
a large number of shares in the market after this offering or the perception
that these sales could occur. These factors also could make it more difficult
for us to raise funds through future offerings of our common stock.

There will be 75,938,602 shares of common stock outstanding immediately
after this offering. Of these shares, the shares sold in this offering, along
with the shares sold in our initial public offering, will be freely transferable
without restriction or further registration under the Securities Act of 1933,
except for any shares purchased by our affiliates, sales of which will be
limited by Rule 144 under the Securities Act. Holders of restricted shares
generally will be entitled to sell these shares in the public market without
registration either under Rule 144 or any other applicable exemption under the
Securities Act. The holders of approximately 51.8 million shares of common stock
have entered into agreements not to sell those securities for 90 days after the
date of this prospectus without the prior written consent of Goldman, Sachs &
Co. Goldman, Sachs & Co. may, however, in its sole discretion, release all or
any portion of the securities subject to those lock-up agreements. In addition,
stockholders representing approximately an additional 6.1 million shares of
common stock who are not participating in this offering but are parties to our
investors right agreement are restricted during this 90 day period from selling
their shares of common stock.

Immediately after this offering, the holders of approximately 55.1 million
shares of common stock will have registration rights. If they exercise those
rights, shares covered by a registration statement can be sold in the public
market. After that registration statement is effective, shares issued upon
exercise of stock options to persons other than affiliates will be eligible for
resale in the public market without restriction, which could adversely affect
our stock price. Absent registration, those shares could nevertheless be sold,
subject to limitations on the manner of sale. Sales by affiliates could also
occur, subject to limitations, under Rule 144 of the Securities Act.

14
<PAGE> 18

portion of its shares of our common stock, including the shares included in this
offering by Awatea. All of the shares of our common stock held by Awatea, other
than the shares to be sold in this offering, are the subject of an agreement
with Goldman, Sachs & Co. restricting their transfer during a 90 day period
following the date of this prospectus. Fletcher Challenge has also announced
that, as part of its restructuring, it will sell or distribute to its
shareholders all remaining shares of our common stock which it holds. Fletcher
Challenge announced that it expects distribution of these shares to occur in the
first quarter of 2001. If the sale and distribution of our shares were to occur,
the market price of our common stock could decline as a result of the
introduction of these shares into the public market.

THE MARKET PRICE OF OUR COMMON STOCK IS HIGHLY VOLATILE AND MAY DECLINE
REGARDLESS OF OUR OPERATING PERFORMANCE

The market price of our common stock is highly volatile. Factors that could
cause fluctuation in our stock price may include, among other things:

- actual or anticipated variations in quarterly operating results;

- changes in financial estimates by securities analysts;

- conditions or trends in our industry;

- changes in the market valuations of other technology companies;

- the listing for trading of options on our common stock;

- announcements by us or our competitors of significant acquisitions,
strategic partnerships, divestitures, joint ventures or other strategic
initiatives;

- capital commitments;

- additions or departures of key personnel; and

- sales of common stock.

Many of these factors are beyond our control. These factors may cause the
market price of our common stock to decline, regardless of our operating
performance.

BECAUSE A SMALL NUMBER OF STOCKHOLDERS OWN A SIGNIFICANT PERCENTAGE OF OUR
COMMON STOCK, THEY MAY CONTROL ALL MAJOR CORPORATE DECISIONS AND OUR OTHER
STOCKHOLDERS MAY NOT BE ABLE TO INFLUENCE THESE CORPORATE DECISIONS

Following this offering, our eight executive officers and directors will
beneficially own approximately 19% of our outstanding common stock. In addition,
three other investors will beneficially own approximately 21% of our outstanding
capital stock after this offering. If these parties act together, they can
significantly influence the election of all directors and the approval of
actions requiring the approval of a majority of our stockholders. The interests
of our management or these investors could conflict with the interests of our
other stockholders.

15
<PAGE> 19

FORWARD-LOOKING STATEMENTS

We have made statements under the captions "Prospectus Summary," "Risk
Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," "Business" and elsewhere in this
prospectus that are forward-looking statements. You can identify these
statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "estimate" and "continue" or similar words.
Forward-looking statements may also use different phrases. Forward-looking
statements address, among other things:

- our future expectations;

- projections of our future results of operations or of our financial
condition; and

- other "forward-looking" information.

We believe it is important to communicate our expectations to our
investors. However, there may be events in the future that we are not able to
accurately predict or which we do not fully control that could cause actual
results to differ materially from those expressed or implied by our
forward-looking statements, including:

- changes in general economic and business conditions and in the technology
industry in particular;

- changes in our business strategies;

- product development delays;

- changes in future levels of government funding; and

- other factors discussed under "Risk Factors" and elsewhere.

16
<PAGE> 20

USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of 1,000,000 shares
of our common stock offered by us will be approximately $32.3 million, based on
an assumed public offering price of $34.563 per share and after deducting the
estimated underwriting discounts and commissions and our estimated offering
expenses. We estimate that our total net proceeds of approximately $32.3 million
will be used for establishing and developing our recuperator core manufacturing
activities.

Pending their use, we will invest these proceeds in short-term
investment-grade securities. We do not currently have any planned material
acquisitions. Although we currently intend to use the proceeds as set forth
above, management has broad discretion to vary the uses as it deems fit.

The common stock offered by the selling stockholders is being sold by the
selling stockholders for their own account, and we will not receive any of the
proceeds from the sale of the selling stockholders' common stock.

DIVIDEND POLICY

We have never declared or paid any dividends on our common stock. We
currently intend to retain our future earnings, if any, to finance the expansion
of our business and do not expect to pay any dividends.

Payment of future cash dividends, if any, will be at the discretion of our
board of directors after taking into account various factors, including our
financial condition, operating results, current and anticipated cash needs and
plans for expansion.

PRICE RANGE OF COMMON STOCK

Our common stock has been quoted on the Nasdaq National Market under the
symbol "CPST" since our initial public offering on June 29, 2000. Prior to that
time, there had not been a market for our common stock. The following table
shows the high and low per share sales prices of our common stock as reported on
The Nasdaq National Market for the periods indicated:

<TABLE>
<CAPTION>
COMMON STOCK
PRICE
------------------
FISCAL PERIOD HIGH LOW
------------- ------- -------
<S> <C> <C>
Year Ended December 31, 2000
Second Quarter (from June 29, 2000)....................... $51.750 $27.375
Third Quarter............................................. $98.500 $37.500
Fourth Quarter (through November 15, 2000)................ $69.750 $33.688
</TABLE>

On November 15, 2000, the last reported sale price for our common stock on
The Nasdaq National Market was $34.563. As of September 30, 2000, there were
approximately 431 holders of record of our common stock.

17
<PAGE> 21

CAPITALIZATION

The following table sets forth our actual and pro forma total
capitalization at September 30, 2000. Our pro forma capitalization gives effect
to:

- the issuance and sale of the 1,000,000 shares of common stock offered by
us in this offering; and

- the application of the estimated net proceeds from the sale of our common
stock payable to us based on an assumed public offering price of $34.563
per share and after deducting underwriting fees and estimated offering
expenses.

<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
--------------------------
ACTUAL PRO FORMA
----------- -----------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C>
Current liabilities......................................... $ 20,155 $ 20,155
Capitalized lease obligations, long term.................... 4,381 4,381
Long-term debt.............................................. 0 0
Other long-term liabilities................................. 161 161
Stockholders' (deficiency)/equity:
Common stock.............................................. 75 76
Additional paid-in capital................................ 495,818 528,074
Accumulated deficit....................................... (231,074) (231,074)
----------- -----------
Total stockholders' (deficiency)/equity................ 264,819 297,076
----------- -----------
Total capitalization................................... $ 289,516 $ 321,773
=========== ===========
Shares of common stock outstanding.......................... 74,938,602 75,938,602
</TABLE>

---------------
Our pro forma capitalization at September 30, 2000 set forth above excludes:

- 1,801,478 shares issuable upon exercise of stock options issued,
outstanding and exercisable at a weighted average exercise price of
$0.76, some of which will be exercised in connection with this offering,
plus an additional 3,686,360 shares issuable upon exercise of stock
options issued and outstanding at a weighted average exercise price of
$1.97, plus an additional 4,619,889 shares reserved for issuance in
connection with future stock options and other incentive plans.

18
<PAGE> 22

SELECTED HISTORICAL FINANCIAL DATA

The selected financial data shown below for, and as of the end of, each of
the years in the five-year period ended December 31, 1999 have been derived from
the audited financial statements of Capstone. The income statement data for the
years ended December 31, 1998 and 1999 and the balance sheet data at December
31, 1998 and 1999 have been derived from financial statements that have been
audited by Deloitte & Touche LLP, independent auditors. The income statement
data for the years ended December 31, 1995, 1996, and 1997 and the balance sheet
data at December 31, 1995, 1996 and 1997 have been derived from financial
statements that have been audited by other independent auditors. The selected
financial data as of and for the nine months ended September 30, 1999 and 2000
are derived from unaudited financial statements which appear elsewhere in this
prospectus. In the opinion of management, the unaudited financial statements
have been prepared on a basis consistent with our audited financial statements
and include all adjustments, which are only normal recurring adjustments,
necessary for a fair presentation of the financial position and the results of
operations for the unaudited periods. The historical results are not necessarily
indicative of the operating results to be expected in the future. The selected
financial data should be read in conjunction with "Risk Factors", "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the consolidated financial statements and related notes included elsewhere in
this prospectus for the statement of operations for the years ended December 31,
1997, 1998, and 1999 and the nine months ended September 30, 1999 and 2000 and
for the balance sheet data at December 31, 1998 and 1999 and September 30, 1999
and 2000.

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, -----------------------------
---------------------------------------------------- SEPTEMBER 30, SEPTEMBER 30,
1995 1996 1997 1998 1999 1999 2000
-------- -------- -------- -------- -------- ------------- -------------
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
Total revenues....................... $ 920 $ 1,462 $ 1,623 $ 84 $ 6,694 $ 1,315 $ 16,029
Cost of goods sold................... 199 2,179 8,147 5,335 15,629 4,570 20,658
-------- -------- -------- -------- -------- --------- --------
Gross profit (loss)................ 721 (717) (6,524) (5,251) (8,935) (3,255) (4,629)
Operating costs and expenses:
Research and development........... 4,796 8,599 13,281 19,019 9,151 6,681 8,416
Selling, general and
administrative................... 1,878 3,585 10,946 10,257 11,191 7,818 17,264
-------- -------- -------- -------- -------- --------- --------
Income (loss) from operations...... (5,953) (12,901) (30,751) (34,527) (29,277) (17,754) (30,309)
Net income (loss)................ $ (5,957) $(12,595) $(30,553) $(33,073) $(29,530) $ (17,863) $(25,067)
======== ======== ======== ======== ======== ========= ========
Net income (loss) per share of
common stock -- basic and
diluted........................ $ (4.87) $ (8.97) $ (18.82) $ (17.76) $ (24.53) $ (10.65) $ (16.11)
======== ======== ======== ======== ======== ========= ========
</TABLE>

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, -----------------------------
---------------------------------------------------- SEPTEMBER 30, SEPTEMBER 30,
1995 1996 1997 1998 1999 1999 2000
-------- -------- -------- -------- -------- ------------- -------------
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
BALANCE SHEET DATA:
Cash and cash equivalents............ $ 525 $ 1,464 $ 44,563 $ 4,943 $ 6,858 $ 4,454 $229,783
Working capital...................... 255 1,773 41,431 6,919 6,294 10,140 225,428
Total assets......................... 1,351 6,820 56,989 25,770 36,927 28,397 289,516
Capital lease obligations............ -- 846 1,885 4,449 5,899 5,164 5,963
Long-term debt....................... -- -- -- -- -- -- --
Redeemable preferred stock........... 11,242 25,975 99,720 101,624 156,469 125,716 --
Stockholders' (deficiency)/equity.... (11,371) (24,176) (56,057) (91,151) (144,225) (112,543) 264,819
Total liabilities and stockholders'
equity............................. $ 1,351 $ 6,820 $ 56,989 $ 25,770 $ 36,927 $ 28,397 $289,516
======== ======== ======== ======== ======== ========= ========
</TABLE>

19
<PAGE> 23

The following unaudited pro forma balance sheet data at September 30, 2000
reflects our receipt of the estimated net proceeds from the sale of 1,000,000
shares of common stock in this offering (based on an assumed offering price of
$34.563 per share), less underwriting fees, estimated expenses and the
application of the estimated net proceeds.

<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
------------------------------
ACTUAL PRO FORMA
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 229,783 $ 262,040
Working capital............................................. 225,428 257,685
Total assets................................................ 289,516 321,773
Capital lease obligations................................... 5,963 5,963
Long-term debt.............................................. -- --
Stockholders' (deficiency)/equity........................... 264,819 297,076
Total liabilities and stockholders' equity.................. $ 289,516 $ 321,773
Shares of common stock outstanding.......................... 74,938,602 75,938,602
</TABLE>

The pro forma balance sheet data at September 30, 2000, excludes:

20
<PAGE> 24

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

OVERVIEW

Capstone develops, manufactures and markets microturbine technology for use
in stationary, combined heat and power generation, resource recovery, hybrid
electric vehicle, and other power and heat applications in the multi-billion
dollar market for distributed power generation. Our microturbines provide power
at the site of consumption and to hybrid electric vehicles that combine a
primary source battery with an auxiliary power source, such as a microturbine,
to enhance performance. We believe the simple and flexible design of our
microturbines will enable our distributors and end users to develop an
increasingly broad range of applications to fit their particular power needs.
Capstone expects its microturbines to provide the commercial power generation
industry with clean, multifunctional, and scalable distributed power sources.

We began commercial sales of our units in 1998 targeting the emerging
distributed generation industry that is being driven by fundamental changes in
power requirements. We are currently focusing on strengthening our sales and
marketing efforts, developing new products, acquiring intellectual property
rights and expanding our manufacturing facilities, which will result in higher
operating expenses. We intend to achieve long-run profitability through
production efficiencies and economies of scale. Specifically, we have
consolidated our administrative and production operations into one building, we
are entering into new supplier contracts to reduce overall unit costs and we are
developing new higher profit margin products.

We sell complete microturbine units, subassemblies and components. Our
microturbines can be fueled by natural gas, propane, sour gas, kerosene and
diesel. We will continue investing significant resources to develop new products
and enhancements, including enhancements that enable greater kilowatt power
production, additional fuel capabilities and additional distributed power
generation solutions such as co-generation applications.

Since inception through September 30, 2000, we generated cumulative
operating losses of approximately $141.5 million and we expect to continue to
sustain operating losses through fiscal year 2001. Our sales cycles vary by
application and geographic region, and in many cases require long lead times
between identifying customer needs and providing commercially available
solutions. As a result of anticipated increases in our operating expenses
resulting from our expansion and the difficulty in forecasting revenue levels,
we expect our quarterly performance to fluctuate. We are also a young company
with respect to sales growth, and therefore period-to-period comparisons between
years may not necessarily be meaningful.

RESULTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1999

Revenues

Revenues for the nine-months ended September 30, 2000 increased $14.7
million to $16.0 million compared to $1.3 million for the nine-months ended
September 30, 1999. The increase in revenues is attributable to greater sales to
a larger customer base, resulting from our expanding marketing efforts. Revenues
for the nine-month periods ended September 30, 2000 and 1999 were derived almost
entirely from unit sales of our 30-kilowatt products. These units were used for
various commercial applications and operated using different fuel types. During
the nine-months ended September 30, 2000, we shipped 548 units, an increase of
508 units over the 40 units we shipped in the nine months ended September 30,
1999. Our backlog of orders at September 30, 2000 was 890 units, as compared to
173 units at September 30, 1999. In September 2000, we shipped our first
60-kilowatt unit.

21
<PAGE> 25

Gross Profit (Loss)

Cost of goods sold includes direct material costs, assembly and testing,
compensation and benefits, overhead allocations for facilities and
administration, and warranty reserve charges. Our gross loss increased $1.3
million, or 39%, to ($4.6) million for the nine-months ended September 30, 2000
from a gross loss of ($3.3) million for the nine-months ended September 30,
1999. Gross loss as a percentage of revenues declined as production overhead
costs were allocated over larger volumes of production. Costs for replacement
parts and systems are charged against our warranty reserve, which is accrued
through charges to costs of goods sold. The warranty reserve charge increased
$3.5 million to $4.1 million for the nine-months ended September 30, 2000 from
$622,000 for the nine-months ended September 30, 1999 due to an increase in unit
shipments. Warranty charges continued to decline on a per unit basis, as we
reduced our per unit warranty charge based on our actual warranty loss
experience.

Research and Development

Research and development expenses include compensation, the engineering
department overhead allocations for administration and facilities, and material
costs associated with development. Research and development expenses were for
expanding the functionality of our 30-kilowatt family of products, development
of the 60-kilowatt family of products and for next generation products. Research
and development expenses for the nine-months ended September 30, 2000 increased
$1.7 million, or 26%, to $8.4 million compared to $6.7 million for the
nine-months ended September 30, 1999.

Selling, General and Administrative

Selling, general, and administrative expenses include compensation and
related expenses in support of our general corporate functions, which include
human resources, finance and accounting, information systems and legal services.
Selling, general, and administrative expenses for the nine-months ended
September 30, 2000 increased $9.5 million, or 121%, to $17.3 million compared to
$7.8 million for the nine-months ended September 30, 1999. The primary cause of
the increase was 15 new employees and general overhead associated with our
growth. $1.2 million of the increase was attributable to non-cash, stock-based
compensation expense and $2.8 million to marketing rights amortization expense
relating to the repurchase of marketing rights from Fletcher Challenge Limited.
Stock-based compensation expenses will continue at least through 2004, as the
expense is based on the vesting period of the underlying instruments. Marketing
rights amortization expenses will continue through 2005, as the expense is being
amortized over the original tenure of the contract.

Interest and Other Income (Expense)

Interest and other income (expense) consists primarily of interest income
earned on our cash and cash equivalents and interest charges in connection with
our capital leases. Interest and other income (expense) for the nine-months
ended September 30, 2000 increased $5.3 million to $5.2 million compared to
($108,000) for the nine-months ended September 30, 1999. The increase is
primarily attributable to higher interest income from higher average investment
balances due to the funds received from our Series G preferred stock issuance in
February 2000 and our initial public offering in July 2000.

YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998

Revenues

Revenues in 1999 increased $6.6 million to $6.7 million from $84,000 for
1998. Commercial sales began in December 1998, and 1999 was the first complete
fiscal year that commercial units were available. During 1999, we shipped 211
units on customer orders totaling 521 units. Our backlog of orders at December
31, 1999 was 310 units.

22
<PAGE> 26

Gross Profit (Loss)

In 1999, our gross loss increased $3.6 million, or 70%, to ($8.9) million
for 1999 from a loss of ($5.3) million for 1998. The warranty reserve charge
increased $2.3 million to $2.6 million for 1999 from $261,000 for 1998 primarily
due to the increase in units shipped from three in 1998 to 211 in 1999. As of
December 31, 1999, a warranty reserve of approximately $3.2 million had been
accrued. The increases in warranty reserve charges were partially offset by
decreased inventory writedowns. The increase in the warranty charge of $2.3
million represents approximately 65% of the total increase in gross loss from
1998 to 1999. The remaining increase in gross loss was primarily the result of
substantially more unit shipments with a negative margin in 1999 versus 1998.
(The negative margin resulted from fixed costs spread over a small number of
units during early stage production.) Warranty charges decreased as a percentage
of both revenues and direct material costs. In 1998, we recognized a charge of
$4.2 million to writedown inventory to its estimated net realizable value. There
was no similar charge in 1999. Additionally, the provision for inventory
obsolescence increased $439,000, or 64%, to $1.1 million in 1999 from $681,000
in 1998.

Research and Development

Research and development expenses decreased $9.9 million, or 52%, to $9.1
million for 1999 from $19.0 million for 1998. With the beginning of commercial
production in 1999, a substantial portion of overhead allocable to research and
development decreased along with other general research and development expenses
associated with hardware and design.

Selling, General and Administrative

Selling, general and administrative expenses increased $934,000, or 9%, to
$11.2 million for 1999 from $10.3 million for 1998. This increase resulted
primarily from higher compensation and overhead expenses associated with our
general growth, including the development of our sales and marketing division.
At December 31, 1999, we had 156 full-time employees, up from 115 at December
31, 1998. The growth in employees was primarily in operations which added 26
people and selling, general and administrative which added 13 people.

Interest and Other Income (Expense)

Interest and other income (expense) decreased $1.7 million, or 117%, to
($252,000) for 1999 from $1.5 million for 1998. This decrease was due to lower
interest earned on lower average investment balances available during 1999. In
addition, higher outstanding capital lease balances resulted in higher interest
expense charges.

Income Tax Provision

At December 31, 1999, we had federal and state net operating loss
carryforwards of approximately $105.7 million and $88.2 million, respectively,
which may be utilized to reduce future federal taxable income through the year
2019, subject to limitations. Under the Tax Reform Act of 1996, the amounts of
and benefit from net operating losses are subject to an annual limitation due to
the ownership change limitations. We have provided a valuation allowance for
100% of our net deferred tax asset of $51.0 million at December 31, 1999.

YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997

Revenues

Revenues in 1998 and 1997 were derived from unit sales and contract
revenues. Unit sales were primarily pre-commercial units delivered to customers
for testing applications and integration into their own systems, while contract
revenues were derived from reimbursements for government sponsored programs
associated with engineering research and development. Sales decreased $1.5
million, or

23
<PAGE> 27

95%, to $84,000 for 1998 from $1.6 million for 1997. Revenues in 1997 consisted
of 40 units sold for new pre-commercial testing applications. Once we had a
sufficient number of these pre-commercial units running, we reduced new
shipments to monitor and improve the performance of those units. As a result, we
only shipped three units in the first eleven months of 1998. Following the
completion of our testing, we began selling commercial units in December 1998.

Gross Profit (Loss)

In 1998, gross loss decreased $1.3 million, or 20%, to ($5.3) million for
1998 from ($6.5) million for 1997. The warranty reserve charge decreased
$898,000 to $261,000 for 1998 from $1.2 million for 1997 primarily due to the
decrease in units shipped from 40 in 1997 to three in 1998. Additionally, the
provision for inventory obsolescence decreased $3.2 million, or 83%, to $681,000
in 1998 from $3.9 million in 1997. During 1998, we recognized a charge of $4.2
million to writedown inventory to its net realizable value. The writedown was
due to a significant increase in the cost of a component part during 1998 which
resulted in inventory cost exceeding the estimated net realizable value.

Research and Development

Research and development expenses increased $5.7 million, or 43%, to $19.0
million for 1998 from $13.3 million for 1997. The increase in 1998 resulted
primarily from expanded research and development efforts to initiate commercial
development. In addition, lower hardware expenses were offset by higher
engineering compensation costs.

Selling, General and Administrative

Selling, general and administrative expenses decreased $689,000, or 6%, to
$10.3 million for 1998 from $10.9 million for 1997. This decrease is primarily a
result of higher shared cost expenses allocated to the engineering and
production cost centers rather than to general and administrative cost centers.
Shared costs expenses are allocated based on cost center personnel counts. The
decrease was partially offset by higher compensation and facility expenses.

Interest and Other Income (Expense)

Interest and other income (expense) increased $1.3 million to $1.5 million
for 1998 from $199,000 for 1997. This increase resulted primarily from $564,000
in higher interest income from higher average investment balances due to the
timing of funds received in an equity issuance.

24
<PAGE> 28

QUARTERLY RESULTS OF OPERATIONS AND SEASONALITY

The following table presents unaudited quarterly financial information for
the eleven quarters ended September 30, 2000. This information was prepared in
accordance with generally accepted accounting principles, and, in the opinion of
management, contains all adjustments necessary for a fair presentation of such
quarterly information when read in conjunction with the financial statements
included elsewhere herein. As we increase commercial production, our operating
results for any prior quarters may not necessarily indicate the results for any
future periods.
<TABLE>
<CAPTION>
1998 1999 2000
-------------------------------------- -------------------------------------- -------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH FIRST
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------- ------- ------- ------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues.......... $ 30 $ 8 $ -- $ 46 $ 222 $ 334 $ 759 $ 5,379 $ 3,746
Cost of goods sold...... 60 36 104 5,135 1,233 1,347 1,990 11,059 5,124
------- ------- ------- -------- ------- ------- ------- -------- -------
Gross profit (loss).... (30) (28) (104) (5,089) (1,011) (1,013) (1,231) (5,680) (1,378)
Operating costs and
expenses:
Research and
development.......... 4,089 3,872 6,523 4,535 2,264 2,158 2,259 2,470 2,441
Selling, general and
administrative....... 2,209 2,173 3,291 2,584 2,502 2,568 2,748 3,373 4,384
------- ------- ------- -------- ------- ------- ------- -------- -------
Income (loss) from
operations........... (6,328) (6,073) (9,918) (12,208) (5,777) (5,739) (6,238) (11,523) (8,203)
Net income (loss)...... $(5,726) $(5,640) $(9,609) $(12,098) $(5,785) $(5,825) $(6,253) $(11,667) $(7,811)
======= ======= ======= ======== ======= ======= ======= ======== =======

<CAPTION>
2000
-------------------
SECOND THIRD
QUARTER QUARTER
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Total revenues.......... $ 6,086 $ 6,197
Cost of goods sold...... 8,256 7,278
-------- --------
Gross profit (loss).... (2,170) (1,081)
Operating costs and
expenses:
Research and
development.......... 3,022 2,953
Selling, general and
administrative....... 5,677 7,203
-------- --------
Income (loss) from
operations........... (10,869) (11,237)
Net income (loss)...... $ (9,175) $ (8,081)
======== ========
</TABLE>

The increase in cost of goods sold in the fourth quarter of 1998 is
primarily the result of a $4.2 million charge to writedown inventory to its net
realizable value. The increase in sales, and respective cost of goods sold, in
the third and fourth quarters of 1999 resulted from our increased sales efforts
to bring our commercial units to market.

LIQUIDITY AND CAPITAL RESOURCES

Our cash requirements depend on many factors, including our product
development activities, our production expansion and our commercialization
efforts. We expect to devote substantial capital resources to continue the
development of our sales and marketing programs, to hire and train production
staff, and to expand our research and development activities. We intend to incur
approximately $22.0 million of expenditures in the next 24 months in connection
with establishing a new facility for manufacturing recuperator cores. We believe
that our current cash balances and the net proceeds from this offering will
provide us with sufficient capital to fund operations at least through 2002.

We have financed our operations primarily through private equity offerings
and an initial public offering in July 2000. Through our initial public
offering, we raised approximately $153.6 million in net proceeds. In our private
equity financings, we raised $125.6 million through December 31, 1999 and an
additional $137.5 million in February 2000. Our primary cash requirements have
been to fund research and development, capital expenditures and production
costs. Net cash used in operating activities was $25.7 million, $36.2 million,
and $24.5 million for 1997, 1998 and 1999, respectively, and $15.4 million
through the third quarter of 2000. We have invested proceeds from the issuances
of securities to provide liquidity for operations and for capital preservation.
In addition, we use capital lease commitments to sell and leaseback various
fixed assets.

Pursuant to existing leasing arrangements, as of December 31, 1999, we had
$4.9 million outstanding under our lease line with Transamerica, $1.0 million
outstanding to Finova and $22,000 outstanding to other leasing institutions. As
of September 30, 2000, we had $5.4 million outstanding under our lease line with
Transamerica, $552,000 outstanding to Finova and $13,000 outstanding to other
leasing institutions.

25
<PAGE> 29

In August 2000, we entered into a Transition Agreement and an Amended and
Restated License Agreement with Solar Turbines, which grants to us a license to
use certain intellectual property held by Solar in the manufacturing of
recuperator cores. The Amended and Restated License Agreement has a seventeen
year term and supersedes our previous agreement with Solar Turbines, pursuant to
which we had $132.0 million of commitments to purchase components and
subassembly units from Solar Turbines. Pursuant to the Transition Agreement, we
are obligated to make an aggregate of $9.1 million in milestone payments to
Solar through April 2001 for the purchase of materials, equipment, training and
instruction on how to manufacture recuperator cores. Pursuant to the Amended and
Restated License Agreement, we are required to pay Solar a per unit royalty.

QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

FOREIGN CURRENCY

We currently develop products in the United States and market our products
in North America, Europe and Asia. As a result, factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets
could affect our financial results. As all of our sales and supplies are
currently made in U.S. dollars, we do not utilize foreign exchange contracts to
reduce our exposure to foreign currency fluctuations. We also have no foreign
currency translations in our reported financial statements. In the future, as
our customers and vendor bases expand, we anticipate that we will enter into
transactions that are denominated in foreign currencies.

INTEREST

We have no long-term debt outstanding and do not use any derivative
instruments.

INFLATION

We do not believe that inflation has had a material effect on our financial
position or results of operations during the past three years. However, we
cannot predict the future effects of inflation, including interest rate
fluctuations and market fluctuations.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments. It
requires the recognition of all derivatives as either assets or liabilities in
the statement of position and measurement of the instruments at fair value. We
are required to adopt SFAS No. 133, as amended, on January 1, 2001 and we are
currently evaluating the impact on the financial statements.

The Securities and Exchange Commission staff issued Staff Accounting
Bulletin Number 101 -- Revenue Recognition in Financial Statements ("SAB 101")
in December 1999. There was no impact on the Company's operating results as a
result of its adoption of SAB 101.

26
<PAGE> 30

BUSINESS

Capstone develops, designs, assembles and sells Capstone MicroTurbines for
worldwide applications in the multibillion dollar markets for on-site power
production, also known as distributed power generation, and for hybrid electric
vehicles that combine a primary power source battery with an auxiliary power
source, such as a microturbine, to enhance performance. We are the first company
to offer a proven, commercially available power source using microturbine
technology. Our 30-kilowatt and 60-kilowatt products are state-of-the-art
systems designed to produce electricity for commercial and small industrial
users. Our microturbines combine patented air-bearing technology, advanced
combustion technology and sophisticated power electronics to form efficient and
reliable electricity and heat production systems. Also, because of our advanced
technology, our microturbines can operate by remote control. Our 30-kilowatt
product can use a broad range of gaseous and liquid fuels in an environmentally
friendly manner. We intend to develop similar configurations for our 60-kilowatt
product.

We are a leading worldwide developer and supplier of microturbine
technology. As of September 30, 2000, we had shipped 761 commercial units, of
which two were shipped during 1998, 211 were shipped during 1999 and 548 were
shipped during the first three quarters of 2000, including 211 in the quarter
ended September 30, 2000.

Our commercial shipments have left us with a backlog of 890 units as of
September 30, 2000, all of which are for delivery within twelve months. We
expect our backlog of orders to be significant to our future operating results,
and we believe we will be able to accommodate these and future orders.
Additionally, we have purchase agreements for approximately 800 units, which we
expect to deliver after September 30, 2001. Generally, firm purchase orders must
be made every month and typically require a non-refundable downpayment of
between 10% and 30%. In September 2000, we shipped the first commercial unit of
our 60-kilowatt family of products.

We believe stationary applications for our microturbines, both independent
of or connected to the electric utility grid, are extremely broad. The primary
stationary markets we intend to target include:

- resource recovery -- using natural gas that is otherwise burned or
released directly into the atmosphere to produce power;

- micro-cogeneration/combined heat and power -- using both electricity and
heat, for example, for space heating, air conditioning and chilling
water, to maximize use of available energy;

- back-up and standby power/peak shaving -- providing a reliable back-up
power supply for increasingly electricity-dependent enterprises and
self-generation during hours when electricity prices spike;

-- power quality and reliability -- a rapidly growing sector within the
back-up and standby power/peak shaving market focused on power quality
and reliability requirements for users with extremely low tolerances
for power interruptions; and

- developing regions and other stationary power applications -- providing
power in areas with limited infrastructure.

We also have applied our technology to hybrid electric vehicles such as
buses, industrial use and other passenger and commercial vehicles. Capstone
MicroTurbine subassemblies are currently used in buses operating in U.S. cities
such as Los Angeles, Atlanta, Chattanooga and Tempe and international cities
such as Christchurch, New Zealand, and in tunnel carts and garbage trucks
currently being developed in Japan. We recently signed an agreement with Hyundai
Motor Corporation to demonstrate the feasibility of integrating our microturbine
technology into Hyundai sport utility vehicles and buses.

27
<PAGE> 31

Since our microturbine systems and subassemblies can be used as a power
source within larger energy "solutions" for our customers, we envision our
distributors and end users developing more applications for our products over
time. Our marketing strategy includes partnering with major companies with
strong connections to local markets. Where appropriate, primarily in resource
recovery applications, we intend to sell directly to the end user.

OUR PRODUCTS

Capstone MicroTurbines are compact, environmentally friendly generators of
electricity and heat. They operate on the same principle as a jet engine but can
use a variety of commercially available fuels, such as natural gas, diesel,
kerosene and propane, as well as previously unusable or underutilized fuels. For
example, our 30-kilowatt product can operate on low British thermal unit gas,
which is gas with low energy content, and can also operate on gas with a high
amount of sulfur, commonly known as sour gas. The small size and relatively
lightweight modular design of our microturbines allows for easy transportation
and installation with minimal site preparation.

Our microturbines incorporate three major design features:

- patented air-bearing technology;

- digital power electronics; and

- advanced combustion technology.

The air-bearing system allows our microturbines' single moving component to
produce power without the need for typical petroleum-based lubrication.
Air-bearings use a high-pressure field of air rather than petroleum lubricants,
which reduces maintenance attributable to oil changes and lubricating bearings
and improves reliability. Air-bearings also eliminate product malfunctions
caused by the extreme build-up of heat on metal parts when conventional
lubricants fail or are not replenished. The digital power controller manages
critical functions and monitors over 200 operating parameters of the
microturbine. For instance, the digital power controller controls the
microturbine's speed, temperature and fuel flow and communicates with external
computers and modems. All control functions are performed digitally, as opposed
to using analog electronics. The digital power controller optimizes performance,
resulting in lower emissions, higher reliability and consistent efficiency over
a variable power demand range.

Our Model 330 and Capstone 60 units are approximately the size of a large
refrigerator. Our Model 330 generates approximately 30-kilowatts of electrical
power which is enough power to run a convenience store, and approximately
300,000 kilojoules per hour of heat, enough energy to heat 20 gallons of water
per minute with a 20 degree Fahrenheit heat rise. We have the ability to vary
and modify our microturbines to accommodate a variety of applications and needs.

Our strategy is to develop products that can operate:

- connected to the electric utility grid;

- on a stand-alone basis; or

- in dual mode, where the microturbine operates connected to the grid or,
when the grid is unavailable, the microturbine automatically disconnects
itself from the grid and operates on a stand-alone basis.

Our Model 330 family of microturbines is available in three operational
modes: grid-connect, stand-alone and dual mode. In addition, each of our Model
330 units can be configured to operate on one of the following eight fuel types:

- low pressure natural gas

- high pressure natural gas

- low British thermal unit gas

- sour gas

- gaseous propane

- compressed natural gas

- diesel

- kerosene

28
<PAGE> 32

Three available operational modes, together with eight different fuel
types, result in a total of 24 possible configurations for our Model 330, all of
which are commercially available.

In September 2000, we shipped the first commercial unit of our Capstone 60
family of microturbine systems, a unit using high-pressure natural gas in
grid-connect mode. We intend to develop Capstone 60 units in all twenty-four of
the configurations in which our 30-kilowatt units are available.

We offer various accessories for our products including rotary gas
compressors with digital controls, batteries with digital controls for
stand-alone or dual-mode operation, packaging options, and miscellaneous parts
such as frames, exhaust ducting and installation hardware, if required. We also
sell microturbine components and subassemblies.

Our 30-kilowatt microturbine systems have accumulated hundreds of thousands
of hours of operation under varying climates and operating conditions. Our
products have a target availability of 98%, that is, the units will be available
to operate 98% of any given year. Our microturbines have often achieved this
availability target when using high pressure natural gas, and we are working to
achieve this availability target for other fuel sources.

PRODUCT DEVELOPMENT

We have spent more than ten years and 300 man years of research and
development to create a reliable, efficient generating system with broad fuel
capabilities and power applications. Some of our important milestones and
noticeable accomplishments include:

<TABLE>
<CAPTION>
DATE MILESTONE
---- ---------
<S> <C>
1988.... Capstone was organized to develop small single shaft gas
turbines for heat and electricity generation applications in
vehicles
1993.... Ben Rosen, then chairman of Compaq, and brother Harold
Rosen, former vice president of Hughes Aircraft, invested,
which resulted in a focus on microturbines for vehicle
applications
1994.... Expanded development of microturbines for stationary
distributed generation applications
1995.... Shipped first prototype microturbine to customers
1996.... Developed second generation microturbine and began field
testing
1997.... First installation of a Capstone MicroTurbine subassembly
set in a hybrid electric bus
First microturbine subassembly operated with compressed
natural gas in a hybrid electric vehicle
Began development of the digital power controller
1998.... Shipped first commercial product, the Model 330
1999.... Achieved the ability to operate in stand-alone and dual
modes and to burn sour gas
Had approximately $7 million in revenue with 211 systems
shipped and over 150 employees
2000.... Completed development of software which allowed for
scalability
Completed initial public offering of common stock
Shipped first commercial unit of our Capstone 60 family of
products
Had approximately $16 million in revenue with 548 systems
shipped and over 210 employees through September 30
</TABLE>

TARGET MARKETS

STATIONARY POWER APPLICATIONS

Worldwide stationary power generation applications vary from huge central
stationary generating facilities, above 1,000 megawatts, down to back-up uses
below 10 kilowatts. Historically, power generation in most developed countries
such as the United States has been part of a regulated system. A number of
developments related primarily to the deregulation of the industry as well as
significant technology advances has broadened the range of power supply choices
to customers. We

29
<PAGE> 33

believe our microturbines will be used in a variety of innovative electric power
applications requiring less than 2 megawatts and more immediately in those
requiring less than 300 kilowatts. Capstone has identified several markets with
characteristics that we believe would value our inherently flexible, distributed
electricity generating system. Stationary power applications for our
microturbines include:

- resource recovery;

- micro-cogeneration/combined heat and power;

- back-up and standby power/peak shaving;

-- power quality and reliability; and

- developing regions and other stationary power applications.

Each of these markets will adopt our products at different rates depending
upon several factors. We believe the resource recovery market generally and the
combined heat and power market in Japan have properties that are conducive to
the rapid acceptance of our microturbines. However, the combined heat and power
market in North America as well as the back-up and standby power and peak
shaving markets will take longer to penetrate due to changing competitive
conditions and the deregulating electric utility environment.

Resource Recovery

On a worldwide basis, there are thousands of locations where the production
of fossil fuels and other extraction and production processes creates fuel
byproducts which traditionally have been released or burned into the atmosphere.
Our Model 330 microturbine can burn these waste gases with minimal emissions
thereby avoiding the imposition of penalties incurred for pollution, while
simultaneously producing electricity for use in the oil fields themselves. Our
Model 330 has demonstrated effectiveness in this application and outperforms
conventional combustion engines in a number of circumstances, including when the
gas contains a high amount of sulfur. We intend to test our 60-kilowatt unit to
confirm its functionality under the severe conditions involved in resource
recovery operations.

During 2000, we expect a substantial portion of our units sold into the
resource recovery market to be used at oil and gas exploration and production
sites. We have also identified gas released from landfills and gas produced from
sludge digestion as well as seam gas from coal deposits as near term target
markets for our product.

Micro-Cogeneration/Combined Heat and Power

Micro-cogeneration, or combined heat and power, is an extensive market that
seeks to use both the heat energy and electric energy produced in the generation
process. Using the heat and electricity created from a single combustion process
increases the efficiency of the system from approximately 30% to approximately
60%-70%. The increased operating efficiency reduces overall emissions and,
through displacement of other separate systems, reduces variable production
costs. The most prominent uses of heat energy include space heating and air
conditioning, heating and cooling water, as well as drying and other
applications.

There are substantial existing markets for combined heat and power
applications in western Europe, Japan, and other parts of Asia, in addition to
an emerging market in North America. Many governments have encouraged more
efficient use of the power generation process to reduce pollution and the cost
of locally produced goods. Japan, which has some of the highest electric power
costs in the world, has been particularly active in exploring innovative ways to
improve the efficiency of generating electricity. To access this market, we have
entered into agreements with four distributors including Active Power,
Inc./Kanamoto Co. Ltd., Meidensha Corporation/Sumitomo Corporation, Mitsubishi
Corporation and Takuma Co. Ltd., which have engineered combined heat and power
packages that utilize the hot exhaust air of the microturbine for heating water.
30
<PAGE> 34

We believe that Capstone MicroTurbines provide an economic solution in
markets similar to Japan for delivering clean power when and where it is needed
without requiring a large capital investment. Capstone MicroTurbines and/or
subassemblies incorporated into a more comprehensive energy package should allow
us to penetrate these large and growing markets. In particular, we believe our
microturbine's ability to accept a wide range of fuel options will enhance our
market position and accelerate acceptance in these locations.

Back-up and Standby Power/Peak Shaving

With the trends of continuing deregulation in the electric utility industry
and increased reliance on sensitive digital electronics in day-to-day life,
industrialized societies are increasingly demanding high quality, high
reliability power. End-use customers with greater freedom of choice are
investigating alternative power sources to protect their business operations and
equipment from costly interruptions. Recent brown-outs and black-outs have
demonstrated the need to ensure high reliability. Along with deregulation has
come the initiation of competition in electricity generation and substantially
increased electricity price volatility. Spot electricity prices in the midwest
United States reached $8,000 per megawatt-hour during the summer of 1998 and
$5,000 per megawatt-hour during the summer of 1999. We believe an increasing
number of power marketers, energy service providers and end users will use
alternative power sources to protect against temporary price spikes by "peak
shaving" or self-generating when the price charged by the local utility company
gets too high. These load management applications give the user a unilateral
opportunity to reduce energy costs.

Our 60-kilowatt microturbine, which we expect to be the primary product in
these markets, will provide users great flexibility. The Capstone MicroTurbine
system architecture allows any user to determine its interface with the local
electric grid with minimal disruption. In applications where emissions, weight
or vibration are important considerations, the microturbine also has a
competitive advantage due to its low emissions and flexibility in siting. In
addition, microturbines can be managed and monitored remotely, thereby reducing
on-site maintenance costs.

Utilities also can take advantage of Capstone MicroTurbines to avoid costly
transmission and distribution system expansion or upgrades in uncertain growth
or "weak" areas in the electric utility grid. These companies can place our
microturbines where the electrical power is needed. The microturbines can supply
power in conjunction with the power provided by the utility's standard
generation and transmission equipment. Alternatively, the utility can use the
microturbines to provide power during times when demand for power is at its
highest, potentially reducing the need for expensive expansions to the central
power plant. Rural electric cooperatives and electric utilities may use our
microturbines as a stand-alone system to provide temporary or back-up power for
specific applications or to provide primary power for remote needs.

Power Quality and Reliability

An important and rapidly growing sector within the back-up and standby
power/peak shaving market is power quality and reliability. Due to the
potentially catastrophic consequences of even momentary system failure,
certain power users, such as high technology and information systems
companies, require particularly high levels of reliability in their power
service. Our microturbines can follow levels of demand and have low
emissions, which we believe permits them to be configured in multiple unit
arrays and used in combination to provide a highly reliable electricity
generating system. We believe that customers with particularly low
tolerances for power service interruptions, such as high technology and
information systems companies, represent a significant and growing
potential market for our microturbine products.

Developing Regions and Other Stationary Power Applications

Many people in less developed countries do not have access to electric
power. The ability of our microturbines to use a location's fuel of choice, for
example kerosene, diesel or propane, will allow

31
<PAGE> 35

countries to use their available fuel source infrastructure more efficiently. We
also have designed our microturbine to be a competitive, reliable primary power
source alternative compared to diesel generators and other technologies that
currently provide power to remote areas or areas with unreliable central
generation. The Capstone MicroTurbine is the only commercially available
microturbine that has demonstrated the ability to operate on a stand-alone
basis, an attractive feature in locations lacking significant transmission
infrastructure. This is due to our microturbines' "load following"
characteristic, meaning that our microturbines are able to match power output to
the served facility's need for power. In addition, while emissions have not been
a large market issue in these developing regions, we believe any increases in
environmental concerns or stricter emissions requirements would benefit us in
the long run. Furthermore, remote commercial and industrial applications,
including offshore oil and gas platform power, pipeline cathodic protection, and
resort and rural area electrification, can use our microturbine effectively.

Hybrid Electric Vehicle Power Market

We are actively pursuing the hybrid electric bus, industrial and other
passenger and commercial electric vehicle markets for our microturbines and
microturbine subassemblies. Hybrid electric vehicular applications of our
microturbine are competitive due to low emissions and low cost per mile of
operation. Using vehicles which recharge batteries at night reduces the cost of
electricity consumed and helps to load balance the grid.

We believe that the hybrid electric vehicle market segment represents a
significant opportunity and will expand as governments and consumers demand
cost-efficient, reliable and environmentally friendly mobile electric power,
particularly in urban areas. Transit authorities have already demonstrated
hybrid electric buses as a viable alternative to pure electric buses and to
diesel buses which emit relatively high levels of emissions.

Instead of working purely on a battery or other energy storage device,
hybrid electric vehicles combine a primary power source battery with an
auxiliary power source, such as a Capstone MicroTurbine, to enhance performance.
The hybrid electric vehicles use electricity from the battery and the Capstone
MicroTurbine recharges the battery on an as needed basis while in operation.
These vehicles have many of the positive attributes of pure electric vehicles
but provide the added benefits of longer operating periods and longer ranges
than pure electric vehicles using current technology.

Our microturbines have been used for over two years in vehicle
applications. Our system has been designed into four different manufacturers'
general production hybrid electric vehicle platforms which were put into service
in the United States beginning in 1997. The Capstone MicroTurbine in one such
hybrid electric vehicle application has logged more than 25,000 miles of
operation in a municipal bus without significant maintenance while providing a
cost-efficient, low emission alternative to higher cost, pure electric vehicles
and higher emissions reciprocating engines. The two significant advantages of
the microturbine as compared to the internal combustion engine are very low
emissions and very low maintenance.

In October 2000, we signed a joint development agreement with Hyundai Motor
Company to pursue two vehicle development programs. The first, which is intended
to be a demonstration project only, will test the feasibility and operation of
our microturbines on the Hyundai Santa Fe, a sport utility vehicle. The first
prototype model resulting from this project is expected to be produced in the
first half of 2001. The second program, scheduled to commence after the initial
test of the Santa Fe project, will involve the integration of our microturbines
into a mid-size bus model that Hyundai currently manufactures and exports from
Korea. We believe that the expansion of this application into Hyundai's
commercial buses will occur beginning in 2002.

Hybrid electric vehicles using the microturbine can recharge their
batteries using power from the electric utility grid at night when demand for
electricity is lowest, and use power generated by the microturbine during the
day when demand for grid power is highest. Electric utilities can therefore
benefit from the implementation of Capstone MicroTurbine-equipped hybrid
electric vehicles as a

32
<PAGE> 36

means of balancing intra-day demand for electricity. We are pursuing a strategy
of partnering with electric utilities to promote hybrid electric buses.

MICROTURBINE BENEFITS

MULTI-FUEL CAPABILITY

The Capstone MicroTurbine design provides flexibility for use with a
variety of possible fuels, including both gaseous and liquid fuels. This
multi-fuel capability increases the number of applications and geographic
locations in which our microturbines may be used. The Model 330 is currently
capable of being configured for low pressure natural gas, high pressure natural
gas, low British thermal unit gas like methane, high sulfur content (sour) gas,
gaseous propane and compressed natural gas, as well as liquid fuels such as
diesel and kerosene. Our initial Capstone 60 product uses high pressure natural
gas. We are developing similar fuel configurations for our 60-kilowatt model.

COST COMPETITIVE

We believe our microturbines are cost competitive in their target markets.
In the exploration and production markets, environmental penalties incurred for
flaring waste gas can be avoided by using our microturbines. Our low maintenance
microturbines can burn wellhead gas directly off the casing head, avoiding any
intermediary sulfur scrubbing devices, while competing devices require extra
maintenance and additional intermediary devices to do the same. In the landfill
gas digestion market, the microturbine can burn low British thermal unit and
sour gas while requiring minimal maintenance relative to competing technologies,
like reciprocating engines. In the coal seam gas market, our microturbines
require substantially less maintenance than reciprocating engines. The ability
of the microturbine to operate on a stand-alone basis allows for less capital
expenditures compared to the electric utility grid, which requires up-front
capital expenditures for additional distribution and transmission lines. In
combined heat and power applications, the microturbine's efficiency is
approximately 60 - 70% compared to approximately 30% efficiency when used only
to generate electricity. In the hybrid electric vehicle market, our microturbine
results in lower costs per mile, lower emissions, and load balancing of the grid
for electric utilities.

Because the applications for our microturbines are extremely broad and the
number of features which can influence capital cost is also large, estimates of
energy generation costs per kilowatt hour vary substantially depending on
assumptions. When used in resource recovery applications, our microturbine
operates with gas not otherwise useable as fuel. In some cases, consuming this
gas avoids environmental penalties. Assuming the units are grouped in operating
groups of four and run approximately 90% of the year, we estimate the generation
cost per kilowatt hour at slightly less than $0.047 per kilowatt hour. In
combined heat and power applications where gas costs are approximately $4.00 per
million British thermal units, we estimate the generation cost per kilowatt hour
at approximately $0.084 per kilowatt hour. The generation costs are highly
sensitive to the price of the fuel. Other applications including standby and
peak shaving depend greatly on the specific set of circumstances confronting a
potential end-user. Additionally, we believe that our new 60-kilowatt units will
exhibit better operating characteristics and lower electrical generation costs
than our 30-kilowatt units.

ENVIRONMENTALLY FRIENDLY

In stationary power generation configurations, our digital power controlled
combustion system produces less than nine parts per million per volume of
emissions of nitrogen oxides and unburned hydrocarbons at full power when
burning natural gas or propane, and less than 25 parts per million per volume of
emissions when using diesel fuel. We believe that these emission levels are less
than the emissions of any fossil fuel combustor without catalytic combustion or
other emissions reduction equipment. Due to our patented air-bearing technology,
our microturbines require no petroleum based lubricants, avoiding potential
ground contamination caused by lubricants used by conventional

33
<PAGE> 37

reciprocating engines, turbines and other similar technologies. Also, because
our system is air cooled, we avoid the use of toxic liquid coolants, such as
glycol.

AVAILABILITY AND RELIABILITY

Our microturbines provide both high availability and reliability when
compared to other power generation alternatives. We designed the microturbine
for a target availability of 98%. Our microturbines have often achieved this
availability target when using high pressure natural gas, and we are working to
achieve this availability target across all of our units and for other fuel
sources.

MINIMAL MAINTENANCE

Our patented air-bearing system, digital power controller and air cooled
design significantly reduce the maintenance cost of our microturbines. The air
bearings eliminate the need for lubrication, avoiding the need to change oil and
individually lubricate ball bearings or other similar devices. The digital power
controller's ability to continuously and remotely monitor our microturbine
performance avoids regularly scheduled diagnostic maintenance costs. The air
cooled design eliminates all of the maintenance related to liquid cooling
systems utilized with conventional power electronics technology and generator
cooling. Currently, the only scheduled maintenance for the Model 330 is periodic
cleaning or changing of the intake air filter and fuel filters every 8,000 hours
of operation and thermocouple, igniter and fuel injector inspection and possible
replacement every 12,000 hours of operation. We expect scheduled maintenance for
our 60-kilowatt unit to be similar.

REMOTE MONITORING AND OPERATING

The digital power controller allows users to efficiently monitor our
microturbines' performance, fuel input, power generation and time of operation
in the field from off-site locations by telephonic hook-up. In addition, the
operator can remotely turn the microturbine on and off, control the fuel flow
and vary the power output.

FLEXIBLE CONFIGURATION

Our Model 330 microturbine can be customized to serve a wide variety of
operating requirements. It can be connected to the electric utility grid or
operate on a stand-alone or dual mode basis. It can use a variety of fuel
sources and can be readily integrated into combined heating and power
applications. The microturbine can be sold either as a ready to use unit, or in
component and subassembly form for repackaging to the ultimate end user. The
microturbine can be operated as a single unit, or several units can be installed
together and operated in parallel as one unit. We expect to develop our
60-kilowatt family of microturbines to be available for use in all of these
configurations.

SCALEABLE POWER SYSTEM

Our microturbines are designed to allow multiple units to run together to
meet each customer's specific needs. This feature enables users to meet more
precisely their growing power demand requirements and thereby manage their
capital costs more efficiently.

RELATIVE EASE OF TRANSPORTATION AND INSTALLATION

Our microturbines are easy to transport, install and relocate. Their small
size allows great flexibility in siting. Our stationary systems in enclosures
are approximately six feet tall and weigh between 900 and 1,500 pounds,
depending upon model and optional equipment. Relative to competing technologies,
our microturbines are designed to minimize installation costs by simplifying and
standardizing installation procedures. Our microturbines require a fuel source
hook-up, a hook-up for the power generated, and proper venting or utilization of
exhaust. Larger multi-pack microturbine configurations may require concrete pads
to support the additional weight, but the hook-ups are similar.
34
<PAGE> 38

PROTECTION RELAY FUNCTIONALITY

Our microturbines have protective relay functions built into the digital
power controller such that in grid-connect or dual mode, the microturbine will
not send power out over the electric utility grid if the utility is not
supplying voltage over its grid. This feature minimizes the potential damage to
the local electric grid, which is one of incumbent utilities' major concerns
regarding the interconnection of distributed generation technologies. This
feature was recognized by the state of New York in approving our microturbines
to be connected to the New York grid.

BUSINESS STRATEGY

Our goal is to maintain our position as a leading worldwide developer and
supplier of microturbine technology for our target markets. The following are
key elements of our strategy to achieve this objective:

ENHANCE DISTRIBUTION ALLIANCES

We believe the most effective way to penetrate our target markets is with a
business-to-business distribution strategy. We are forging alliances with key
distribution partners worldwide. Some of our key distribution partners include
Interstate Detroit Diesel, Harza Engineering Company, Inc., PanCanadian
Petroleum Ltd., Mitsubishi Corporation, Takuma Co. Ltd., Meidensha Corporation,
Sumitomo Corporation and Alliant Energy Corporation. Capstone has developed
alliances with, among others, Advanced Vehicular Systems, Hyundai Motor Company
and DesignLine to develop the hybrid electric bus market.

BROADEN AND ENHANCE OUR PRODUCT LINE

We intend to broaden our product line by developing additional microturbine
products. In September 2000, we shipped the first commercial model of our
Capstone 60 family of products. We are currently developing additional models of
our Capstone 60 microturbine system for expected commercial shipments in the
next several quarters. We intend to develop a family of microturbines with power
output up to approximately 125+ kilowatts. We expect to leverage our scaleable
design architecture by developing microturbines and digital power controllers to
provide a superior performance-price ratio while simultaneously improving our
profitability.

In July 2000, we were awarded a $10 million grant from the United States
Department of Energy to develop an Advanced Microturbine System. The $10 million
grant, to be distributed over a five-year period based upon the satisfactory
completion of milestones, is the maximum amount available under the Department
of Energy's Advanced Microturbine Systems Program. We intend to leverage, in
part, the technology we develop using this grant in the development of our 125+
kilowatt microturbines, subject to any rights held pursuant to the grant by the
Department of Energy with respect to the technology.

We also intend to continue our research and development efforts to enhance
our current products by increasing performance and efficiency, and adding
features and functionality to our microturbines. Research and development
activities have also focused on development of related products and
applications, including gas compressors that enhance the microturbines'
multi-fuel capability and integration with energy storage devices like battery
packs for stand-alone applications.

AGGRESSIVELY PROTECT OUR PROPRIETARY INTELLECTUAL PROPERTY

We seek to identify and to aggressively protect our key intellectual
property, primarily through the use of patents. We believe that a policy of
actively protecting intellectual property is an important component of our
strategy of being the technology leader in microturbine system technology and
will provide us with a long-term competitive advantage. In addition, we
implement very tight security procedures at our plant and facilities and have
confidentiality agreements with each of our vendors, employees and visitors to
our facilities.

35
<PAGE> 39

ACHIEVE PRODUCTION EFFICIENCIES

Our efforts to be a low cost provider begin with the design process, where
our microturbine products are designed to facilitate high volume, low-cost
production targets. We manufacture proprietary microturbine components,
including our air-bearing systems and combustion system components. In August
2000, we entered into agreements with Solar, which will allow us to commence
manufacturing recuperator cores, a component critical to the production of our
microturbines. Our operating strategy is to outsource all non-proprietary
hardware and electronics, and we continue to establish a limited number of high
volume supplier alliances with companies that can quickly scale up to
significant quantities. We are pursuing a "tier one" supply strategy whereby we
contract with a few suppliers who are responsible for integrating various
subassemblies. We anticipate that the recuperator cores which we produce will be
incorporated into subassemblies by one of these suppliers.

SALES, MARKETING AND DISTRIBUTION

We are focused on selling microturbines in the worldwide stationary and
hybrid electric vehicular markets. We anticipate that our microturbines will be
used in a variety of electric power applications requiring less than 2 megawatts
and more immediately in applications requiring less than 300 kilowatts. Specific
early applications include resource recovery, combined heat and power, remote
and onsite power generation and hybrid electric vehicles. Focusing on these
target markets should help us build significant sales volume and reduce our unit
production costs. The current list price of our Model 330 is $27,000, or
approximately $900/kilowatt. We are initially targeting a price of approximately
$45,000 for the Capstone 60, or approximately $750/kilowatt. As we achieve
greater cost competitiveness, which we believe is under $600/kilowatt, we plan
to enter into the peak shaving, back-up/standby power and base load power
generation markets.

We believe the most effective way to penetrate these target markets is a
business-to-business distribution strategy. The four distribution agreements
that we have entered into with Japanese entities are typical of this approach.
These agreements allow our local country partners to distribute complete
microturbine systems in Japan. They can also incorporate subassemblies and
components into uniquely designed combined heat and power units and packages for
distribution within Japan and the rest of the world, excluding the United
States. Capstone has the right to distribute these uniquely designed packages
exclusively in the United States and nonexclusively in the rest of the world,
excluding Japan.

Elsewhere, our distribution agreements will be tailored to the particular
strengths of partners in various local country markets. In some target markets,
we will distribute our uniquely designed product solutions to major companies
directly.

Our approach for distribution within the hybrid electric vehicles market
has been to identify early adopters who can demonstrate the feasibility of the
microturbine technology. Our microturbine system was put into production
platforms used by four different manufacturers of hybrid electric vehicles
placed into service in 1999. These include smaller bus companies such as
Advanced Vehicular Systems, Designline, E-Bus and ISE Research. The Capstone
MicroTurbine, in one such hybrid electric vehicle application, has logged more
than 25,000 miles of operation in a municipal bus without significant
maintenance. Having demonstrated the performance of our technology, we have
established relationships with larger regional bus companies, such as Eldorado
National. Eldorado National is now delivering hybrid electric buses to the Los
Angeles Department of Water & Power for use in the Los Angeles basin. In October
2000, we entered into a joint development agreement with Hyundai Motor Company
to demonstrate the feasibility of integrating our microturbine technology into
Hyundai sports utility vehicles and buses.

Early adopters in the industrial hybrid electric vehicle market are
currently implementing the technology into the marketplace. Capstone
MicroTurbine subassemblies are currently used in tunnel service locomotives
being deployed by Tomoe and in garbage trucks being deployed by Mitsui &
Co./Fuji in Japan.
36
<PAGE> 40

Electric utilities can benefit from the implementation of Capstone
MicroTurbine-equipped hybrid electric vehicles as a means of balancing intra-day
demand for electricity. We intend to pursue a strategy of partnering with
electric utilities in promoting hybrid electric buses.

DISTRIBUTION AGREEMENTS

We intend to continue to enter into distribution arrangements with
knowledgeable distributors in our various target markets. We do not expect to
market directly to end users, except in the resource recovery market. Our
general strategy will be to enter into nonexclusive distribution agreements with
interested and qualified third parties who will use our microturbine and/or
subassemblies in their products and energy solutions. We intend to become a
supplier of critical components to the distributed energy solution industry as a
whole.

As part of this strategy and to increase the speed of adoption of our
products, we have 40 distributors, of which 28 are in North America, nine are in
Asia and three are in Europe.

The Japanese distribution agreements are substantially similar and provide
that these distributors will promote, market, sell, distribute and service our
complete microturbine units or some subassemblies, or both, generally in
connection with stationary applications. Typically, these agreements have a term
of approximately three years and allow the distributors to distribute complete
Capstone MicroTurbine systems in Japan. They can also incorporate subassemblies
and components into uniquely designed combined heat and power units and packages
for distribution within Japan and the rest of the world, excluding the United
States. Capstone has the right to distribute these uniquely designed packages
exclusively in the United States and nonexclusively in the rest of the world,
excluding Japan.

Under these agreements, each Japanese distributor prepaid for 100 complete
microturbine systems. We have granted to the distributors the right to use some
of our intellectual property, including our trademarks. In addition to
promoting, selling and distributing our products, the distributor must provide
specific services to end users including on-going maintenance and warranty
services in accordance with the warranty then in effect. Also, each employee of
a distributor who is to provide services to end users must attend our service
certification seminars and receive our services certification.

We entered into a supply agreement with Williams Distributed Power
Services, Inc. in June 1999 whereby Williams agreed to purchase up to 1,989
Capstone MicroTurbine Systems over three years depending upon annual forecasts.
Williams may resell or enter into sale-leaseback arrangements with its customers
and may integrate our product into Williams' products or services. Williams
acquired the exclusive right to sell to its affiliated entities. If at any time
we commence negotiations with another party for exclusive distribution rights in
a territory, Williams will also have the right to negotiate with us to
distribute our products in that territory. Williams may not distribute any
microturbine generating less than 250 kilowatts of electricity other than the
Capstone MicroTurbines during the agreement's three-year term.

37
<PAGE> 41

Listed below are some of our key distribution partners in our different
target markets:

<TABLE>
<CAPTION>
MICRO-COGENERATION/
COMBINED HEAT AND POWER RESOURCE RECOVERY
----------------------- -----------------
<S> <C>
- Active Power, Inc./Kanamoto Co. Ltd. - American Energy Savings Inc.
- BG Technology - Fletcher Challenge Energy
- G.A.S. Energietechnik GmbH - Hanover Compressor Company
- Meidensha Corporation/Sumitomo - Interstate Detroit Diesel
Corporation - Mariah Energy Corporation
- Mitsubishi Corporation - PanCanadian Petroleum Limited
- Nisource Inc. - Startec Consulting, Inc.
- N.V. Nederlandse Gasunie - The Williams Companies, Inc.
- Takuma Co. Ltd.
</TABLE>

<TABLE>
<CAPTION>
HYBRID ELECTRIC VEHICLES TRADITIONAL/OTHER
------------------------ -----------------
<S> <C>
- Advanced Vehicular Systems - Alliant Energy Corporation
- DesignLine - Cinergy Corp.
- Ebus - Harza Engineering Company, Inc.
- Hyundai Motor Company - New Jersey Resources Corporation
- ISE Research - PPL Corporation
- Mitsui & Co./Fuji - Southern Union Company
- Tomoe
</TABLE>

NORTH AMERICA

Our near-term focus in North America is to continue to sell into the
exploration and production segment of the resource recovery market. We are
developing strategic distribution partners in other distributed generation
markets which we believe will begin to generate significant sales in the next
three to five years. Our current strategic partners include electric utilities
like Hydro-Quebec, gas utilities like New Jersey Resources Corporation and
Southern Union Company, as well as energy service providers such as Alliant
Energy Corporation and The Williams Companies, Inc. and distributors of
reciprocating engines such as Interstate Detroit Diesel.

Current resource recovery customers/partners include Interstate Detroit
Diesel, PanCanadian Petroleum Ltd., and The Williams Companies, Inc.. We
currently have entered into distribution agreements with these companies to
distribute Capstone MicroTurbine systems. PanCanadian distributes our products
in Canada. Interstate Detroit Diesel and The Williams Companies are energy
solution providers selling into a variety of markets. The Capstone MicroTurbine
is a key component of the Williams ECU(TM), a total power generation, management
and storage package.

In 1999, the North American market generated approximately $4.8 million of
our revenue. In the three quarters ended September 30, 2000, the North American
market generated approximately $10.3 million of our revenue.

ASIA

Our sales and marketing strategy in Asia is to first enter the Japanese
market by developing significant corporate distribution partnerships within
Japan which will subsequently enable us to quickly enter other selected markets
along the Pacific Rim.

Our primary market focus in Japan is combined heat and power applications.
Within Japan, there is great demand for economic energy solutions seeking to
lower both the existing high cost of electricity and meet the greenhouse gas
emissions guidelines of the Kyoto accords. Our local partners recognize the
quickest and most practical way to accomplish this is through combined heat and
power applications which raise efficiencies from approximately 30% for pure
electrical generation to

38
<PAGE> 42

approximately 60 - 70% or more in combined heat and power applications. Each of
our partners is seeking to design applications using our microturbines and/or
subassemblies and components for their particular target combined heat and power
market.

We currently have substantially similar distribution agreements with Active
Power, Inc./Kanamoto Co. Ltd., Mitsubishi Corporation, Sumitomo Corporation
jointly with Meidensha Corporation and Takuma Co. Ltd. All of these agreements
permit the Japanese partner to distribute complete Capstone MicroTurbine units
within Japan or to incorporate Capstone MicroTurbine subassemblies and
components into individually designed combined heat and power packages for
distribution both within Japan and to the rest of the world excluding the United
States. We have exclusive distribution rights for these individually designed
units in the United States and have non-exclusive distribution rights in the
rest of the world, excluding Japan. All of these agreements required the
Japanese partner to purchase on a prepaid basis 100 Capstone Model 330
MicroTurbine systems for delivery within 12 months from the signing of the
agreement. We expect all 400 units to be delivered on or before December 31,
2000.

In 1999, the Asian market generated approximately $1.6 million of our
revenue. In the three quarters ended September 30, 2000, the Asian market
generated approximately $5.3 million of our revenue.

EUROPE

We currently have agreements in Europe with British Gas to investigate the
U.K. and Ireland markets, and with G.A.S. Energietechnik GmbH to investigate the
German market primarily for combined heat and power applications. In the
Netherlands, one of our microturbine systems is currently being used in a
recreation facility to provide both electrical power for the facility and heat
for a community swimming pool. We intend to broaden our distribution alliances
in Europe in 2000 and 2001. In 1999, the European market generated approximately
$275,000 of our revenue. In the three quarters ended September 30, 2000, the
European market generated approximately $504,000 of our revenue.

SOURCING AND MANUFACTURING

Our microturbines are designed to offer high volume, low-cost production
objectives and significant manufacturing advantages through the use of commodity
materials and conventional manufacturing processes. Our manufacturing designs
use conventional technology which has been proven in high volume automotive and
turbocharger production for many years. The microturbines are designed for
simple assembly and testing and to facilitate automated production techniques
using semi-skilled labor.

Our strategy of out-sourcing the manufacturing and assembly of our
nonproprietary product components to a proven vendor base allows for attractive
pricing, quick ramp-up and the use of just-in-time inventory management
techniques. We believe that we can realize both purchase economies from existing
vendors and economies of scale related to our product development costs as unit
volume increases. We manufacture the air-bearings and combustion system
components at our facilities in Chatsworth, California. We also assemble the
units at that location. We have primary and secondary sources for all of our
components other than the recuperator.

To date, Solar Turbines Incorporated, a wholly owned subsidiary of
Caterpillar Inc., has been our sole supplier of recuperator cores. At present we
are not aware of any other suppliers who could produce these cores according to
our specifications and within our time requirements. We are party to a license
agreement with Solar that contains an option that permits us to produce the
recuperator cores at any time, using Solar's intellectual property. In August
2000, we exercised this option and have begun to invest in the equipment and
resources to manufacture the recuperator cores ourselves. We are required to
make payments to Solar pursuant to the license at varying rates. Our transition
to becoming our own supplier of recuperator cores is expected to be completed
over the next nine to
39
<PAGE> 43

twelve months. However, since we have never before manufactured recuperator
cores, the transition period may be longer. Our production of recuperator cores
will be staged in a separate facility, located in nearby Van Nuys, California.
Recuperator cores in inventory, together with those available from Solar, are
expected to meet our requirements for approximately the next year. After that
time we expect to rely on recuperator cores from our new production facility.
There can be no assurances that this transition will not result in delays or
interruptions in production and shipment of our products. If the license
agreement were to be terminated and we had to develop and produce our own
recuperator cores without using Solar's intellectual property, we estimate it
could take up to three years to be in production. See "Risk Factors -- If we are
unable to manufacture recuperator cores internally, our assembly and production
of microturbines may suffer delays and interruptions."

Senior management has recognized the importance of quality control by
appointing a Vice President of Quality Control to oversee the implementation of
a rigorous quality control program, which includes the use of outside
consultants. 100% of all systems go through assembly test procedures before a
system is shipped. In addition, key subassemblies such as the digital power
controller undergo up to 15 hours of burn-in. All center section subassemblies
undergo complete spin test checks where they are spun at approximately 96,000
revolutions per minute to ensure perfect balance and operation. When a
microturbine is completely assembled, it is tested in one of our two fully
automated test cells.

Our facilities are currently designed to accommodate the production of
approximately 20,000 units per year.

INTELLECTUAL PROPERTY RIGHTS AND PATENTS

RESEARCH AND DEVELOPMENT

Our research and development activities have enabled us to become one of
the first companies to develop a commercially available microturbine that
operates in parallel with the grid. We are the first company to successfully
demonstrate a commercially available microturbine that operates on a stand-alone
basis. We believe that our more than ten years and over 300 man years of
research and development activities provide us with a significant advantage
relative to our competitors.

We have successfully integrated turbo-engineering and control and power
electronics. This is a direct result of the turbo-engineering research and
development and the electronics research and development occurring in the same
location. This has allowed us to immediately discover and solve integration
issues in-house without relying on outsourced research and development. We
believe that our continued in-house research and development, incorporating
turbo-engineering and control with power electronics, will provide us with a
competitive advantage relative to competitors that outsource research and
development of components that are critical to a viable microturbine.

In July 2000, we were awarded a $10 million grant from the United States
Department of Energy to develop an Advanced Microturbine System. The $10 million
grant, to be distributed over a five-year period based upon the satisfactory
completion of milestones, is the maximum amount available under the Department
of Energy's Advanced Microturbine Systems Program. The program is estimated to
cost $23.0 million over the five years, requiring approximately $13.0 million of
our own research and development expenditures. We intend to leverage, in part,
the technology we develop using this grant
40
<PAGE> 44

in the development of our 125+ kilowatt microturbines, subject to any rights
held pursuant to the grant by the Department of Energy with respect to the
technology.

Additionally, we are reviewing projects that will incorporate our
microturbine technology as part of a hybrid energy source solution combining our
microturbine with a traditional fuel cell.

CUSTOMERS

In 1999, sales to The Williams Companies, Inc., worth $1.9 million,
accounted for 28% of our sales revenue. We had accounts receivable due from
Williams and Advanced Vehicular Systems of approximately $275,000 and $277,000,
respectively, and each represented approximately 11% of total accounts
receivable at the end of 1999. Additionally, in 1999 and 2000, we entered into
agreements whereby each of our Japanese distributors, Active Power, Inc.,
Meidensha Corporation/Sumitomo Corporation, Mitsubishi Corporation and Takuma
Co. Ltd., is required to prepay for 100 microturbine units. These prepaid orders
account for approximately 25% of our contractual purchase commitments. Further,
in June 1999, we entered into a supply agreement with Williams in which Williams
agreed to purchase up to 1,989 Capstone MicroTurbine systems over three years,
depending upon annual forecasts. For the nine months ended September 30, 2000,
sales to Interstate Detroit Diesel, worth $3.0 million, accounted for 19% of our
sales revenue and sales to Advanced Vehicle Systems, worth $1.9 million,
accounted for 12% of our sales revenue. As of September 30, 2000, we had
accounts receivable due from Advanced Vehicular Systems of $875,000 and from
Interstate Detroit Diesel of $588,000, representing 26% and 17%, respectively,
of our total outstanding accounts receivable.

COMPETITION

The market for our products is highly competitive and is changing rapidly
with the interplay of a number of factors. Our microturbines compete with
existing technologies such as the utility grid and reciprocating engines, and
may also compete with emerging distributed generation technologies, including
solar power, wind powered systems, fuel cells and other microturbines. As many
of our distributed generation competitors are well established firms, they
derive advantages from production economies of scale, a worldwide presence and
greater resources which they can devote to product development or promotion.

Generally, power purchased from the electric utility grid is less costly
than power produced by distributed generation technologies, such as fuel cells
or microturbines. Utilities may also charge fees to attach to their power grid.
However, we compete with the power grid in instances in which the costs of
connecting to the grid from remote locations are high, reliability and power
quality are of critical importance, or in situations where peak shaving could be
economically advantageous due to highly variable electricity prices. Because the
Capstone MicroTurbine provides a reliable source of power and can operate on
multiple fuel sources, we believe it offers a level of flexibility and
reliability not currently offered by other current technologies such as
reciprocating engines.

Our competitors that produce reciprocating engines have products and
markets that are well developed and technologies that have been proven for some
time. A reciprocating engine is similar in design to internal combustion engines
used in automobiles. Reciprocating engines are popular for back-up power
applications but are not typically intended for primary use due to high levels
of emissions, noise and lower reliability. These technologies are currently
produced in part by Caterpillar Inc., Interstate Detroit Diesel and Cummins Inc.

Our microturbine may also compete with other distributed generation
technologies, including solar power and wind powered systems. Solar powered and
wind powered systems produce no emissions. The main drawbacks to solar powered
and wind powered systems are their dependence on weather conditions and their
high capital costs.

Although the market for fuel cells is still developing, a number of
companies are focused on the residential and vehicular fuel cell markets,
including Plug Power, Avista Labs, H Power and Ballard Power Systems. Other
developers of fuel cell technology, such as United Technologies Corporation
41
<PAGE> 45

and FuelCell Energy, are focused on developing fuel cell solutions for large
stationary power plants. Fuel cells have lower levels of nitrogen oxides
atmospheric emissions than our microturbines. We believe that none of these fuel
cell technologies will compete directly with our microturbines in the short run.
However, over the medium-to-long term, fuel cell technologies that compete
directly with our products may be introduced.

We may also compete with several well established companies developing
microturbines. We believe a number of major automotive and industrial companies
have in-house microturbine development efforts, including in part Honeywell
(AlliedSignal), Elliott/General Electric Company, NREC (Ingersoll-Rand), Toyota
Motor Corporation, Mitsubishi Heavy Industries, Ltd., AB Volvo/ABB Ltd.
(Turbec), Turbo Genset Inc. and Williams International. DTE Energy Co., Pratt &
Whitney Canada Corp. and Turbo Genset Inc. recently formed a joint venture for
developing a miniturbine. Although we believe these companies have established
microturbine development programs, we also believe we are the only company,
other than Honeywell (AlliedSignal), currently producing commercial units. We
expect all of these companies to enter into commercial production of
microturbines in the future.

We believe that our microturbine currently compares favorably to our
competitors' products. For example, competing microturbines lack our Model 330's
functionality in several important areas, including the ability to automatically
switch from operating with the utility power grid to stand-alone operation, the
ability to operate multiple units together in tandem when in stand-alone mode,
the ability to match power output to the served facility's need for power, the
ability to operate on gas with low energy content (less than 500 British thermal
units per cubic foot), and the ability to operate on sour gas. All of this
functionality is currently available with the Model 330 and we expect it also to
be available with our 60-kilowatt family of microturbines, except for the
capability to operate on sour gas, about which we are uncertain. Additionally,
our nitrogen oxides atmospheric emissions are less than 9 parts per million,
which is significantly lower than our primary competitor's specification of 50
parts per million. Low nitrogen oxides emissions are important because federal
environmental regulations limit nitrogen oxides emissions by electric utilities
in order to reduce acid rain and for other purposes. Competing microturbines may
currently cost less than our model, but we anticipate that our product will,
with higher production volume and higher kilowatt output products, become more
cost competitive. As competitors improve the functionality of their products, we
expect competition to become more intense.

COMPANY BACKGROUND

We were organized in 1988. On June 22, 2000, we reincorporated as a
Delaware corporation. In April 1993, Benjamin M. Rosen, then Chairman of Compaq
Computer Corporation, and his brother, Dr. Harold A. Rosen, former Vice
President of Hughes Aircraft Company, became interested in our Company for
vehicular applications. Since then, the Rosens, together with the Sevin Rosen
Funds and Canaan Partners, were joined by other investors including Rho
Management, Fletcher Challenge Limited (a New Zealand corporation), Vulcan
Ventures, Inc. (an affiliate of Paul Allen), Cascade Investments (an affiliate
of Bill Gates), Southern Union Company, Mitsubishi Corporation, Takuma Co. Ltd.,
Sumitomo Corporation, Meidensha Corporation, Active Power Inc., Hydro-Quebec,
Kyushya Electric EDPC and Star Ventures of Munich, Germany.

DETAILED MICROTURBINE DESCRIPTION

The Model 330 Capstone MicroTurbine is a reliable, compact, low emission,
power generation system which generates approximately 30 kilowatts of electric
power as a stand-alone power source or in conjunction with traditional power
sources. In September 2000, we shipped the first commercial model of our
Capstone 60 family of products which generate approximately 60 kilowatts of
electric power. As an alternative power source, our microturbines may replace or
efficiently supplement existing sources of electric power.

42
<PAGE> 46

The Capstone MicroTurbine consists of a turbogenerator and digital power
controller combined with ancillary systems such as a fuel system as shown below:

[System Overview Graphic]

The turbogenerator includes a mechanical combustor system and a single
moving part rotating on our patented air-bearings at up to 96,000 revolutions
per minute. The combustor system operates on a variety of fuels and at full
power achieves nitrogen oxides emissions levels in the exhaust of less than nine
parts per million per volume of nitrogen oxides and unburned hydrocarbons for
natural gas and less than 25 parts per million per volume for diesel,
significantly less than the 1,000 to 3,000 parts per million emission standard
of a reciprocating diesel fuel generator set. As a result of our patented
air-bearings, our microturbines do not require petroleum-based lubrication and
do not utilize liquid cooling, keeping maintenance costs throughout the
microturbine's estimated 40,000 hour life extremely low.

The digital power controller is a state-of-the-art, air cooled, insulated
gate bipolar transistor based inverter with advanced digital signal processor
based micro-electronics. The advantages of digital electronics over analog
electronics include accuracy, flexibility, and repeatability. In addition, we
are taking advantage of the example set by the computer industry: digital data
processing results in higher reliability with increasingly lower cost. The
digital power controller controls and manages the microturbine using proprietary
software and advanced algorithms. The digital power controller:

- starts the turbogenerator and controls its load;

- manages the speed, fuel flow and exhaust temperature of the microturbine;

- converts the variable frequency up to a maximum of 1,600 hertz, and
variable voltage power produced by the generator into a usable output of
either 50/60 hertz AC or optional DC; and

- provides digital communications to externally maintain and control the
equipment.

In addition, the digital power controller's application software provides
an advantage to end users by allowing them to remotely operate and manage the
microturbine. Unlike the technology of other power sources that require manual
monitoring and maintenance, the microturbine allows end users to remotely and
efficiently monitor performance, fuel input, power generation and time of
operation using our proprietary communications software which can interface with
standard personal computers using our application software. This remote
capability provides end users with power generation flexibility and cost
savings.

The Model 330 was initially designed to operate connected to an electric
utility grid and uses a high pressure, natural gas fuel source. We can easily
vary and modify the basic microturbine to accommodate a variety of applications
and needs. We have operated with different fuels including a variety of
carbon-based fuels such as propane, sour gas, kerosene and diesel. The combustor
system

43
<PAGE> 47

remains the same for all fuels, except for the fuel injectors, which currently
vary between liquid and gaseous fuels. The Capstone MicroTurbine's multi-fuel
capability provides significant competitive advantages with respect to the
markets in which we may operate. We offer other accessories including rotary gas
compressors with digital controls, batteries with digital controls for
stand-alone or grid connected operations, packaging options and miscellaneous
parts such as frames and exhaust ducting and installation hardware where
required.

TURBOGENERATOR AIR FLOWS

[CAPSTONE'S MICROTURBINE GENERATOR]

TYPICAL OPERATION OF A MICROTURBINE

Air is drawn into the air inlet by the compressor impeller. The compressor
impeller increases the pressure of the air and ejects it into the recuperator.
The recuperator is a heat exchanger that heats the air as it passes through it
to approximately 1,000 degrees Fahrenheit. Preheating the air substantially
lessens the amount of fuel needed, thus increasing the efficiency of the unit.
The preheated air leaves the recuperator and enters the combustion chamber where
it is mixed with the fuel and burned. The fuel is controlled and delivered to
the combustion chamber for ignition and combustion by injectors and the
combustor system. The mixture of combusted gas enters the turbine where it is
then expanded. As the mixture expands, it causes the turbine to rotate. The
turbine is directly coupled to the compressor and generator shaft, and as the
turbine rotates, the compressor and generator rotate at a speed of up to 96,000
revolutions per minute, and generate electricity. The combusted gas mixture
leaves the turbine in the form of exhaust at a temperature of up to
approximately 1,200 degrees Fahrenheit and flows through the recuperator where
it heats the cooler air brought into the compressor through the impeller. As the
combusted gas mixture mixes with that cooler air, the exhaust cools to a
temperature of approximately 600 degrees Fahrenheit and is discharged through
the exhaust pipe. In order to improve the energy efficiency further, we are
testing higher operating temperatures.

There is only one moving component in the entire turbogenerator, which
consists of the rotating generator shaft, the compressor impeller, and the
turbine rotor. This rotating component is supported by a combination of radial
air bearings and one double acting axial air bearing. Air bearings avoid the
need for oil lubrication resulting in low maintenance requirements and high
reliability. The entire system is air-cooled, which avoids liquid cooling,
thereby resulting in low maintenance requirements.

We have achieved Underwriters' Laboratories certification for our initial
Model 330 product and will continue to qualify our products under Underwriters'
Laboratories approval. We plan to achieve

44
<PAGE> 48

ISO 9001 certification in the future. The International Organization for
Standardization provides a methodology by which manufacturers can obtain quality
certification.

EMPLOYEES

At September 30, 2000, we employed 215 regular and contract employees. No
employees are covered by any collective bargaining arrangements. We believe that
our relationships with our employees are good.

FACILITIES

Our principal corporate offices, administrative, sales and marketing,
research and development and support facilities consist of approximately 98,370
square feet of office space, warehouse space and assembly and test space at
21211 Nordhoff Street in Chatsworth, California. Our lease for those premises
expires in 2010 and provides for payments of $30,000 per month for the first six
months, and will rise to $60,000 on the seventh month with incremental increases
thereafter. We lease an additional property at 6025 Yolanda Avenue in Tarzana,
California which consists of 12,120 square feet. This property currently serves
as our microturbine testing facility. This lease will expire on July 31, 2001
and our payment under this lease is $9,084 per month. We also recently entered
into a lease for a 78,711 square foot facility at 16700 Stagg Street in Van
Nuys, California which we intend to use as a manufacturing facility for our
recuperator cores. This lease will expire in 2010 and our payment under this
lease is $51,495 per month.

LEGAL PROCEEDINGS

On February 11, 1998, we filed a complaint against Michael Irvine, a former
employee, alleging trade secret misappropriation, breach of contract and other
related causes of action in the Superior Court for the County of Orange,
California. The former employee filed a cross-complaint alleging wrongful
termination, breach of contract and other related causes of actions. The relief
requested in the cross complaint included declaratory relief as well as lost
earnings and incidental, general, special, and punitive damages, but none of
these amounts were specified in the cross-complaint. We settled our claims
against the former employee receiving a permanent injunction that prevents that
former employee from disclosing or using any confidential information. With
respect to the cross-complaint, we prevailed on summary judgment in February
1999. The former employee has since filed a notice of appeal and the parties
have filed briefs on the issue. We intend to vigorously defend these claims.

TECHNICAL ADVISORY BOARD

We have established a Technical Advisory Board, made up of leading
scientists, scholars and researchers in the fields of mechanical, electrical and
aerospace engineering, combustion and propulsion research, and energy policy.
Members of our Technical Advisory Board advise us on technical, scientific and
commercialization issues. The members of our technical advisory board are as
follows:

Rik W. De Doncker, PhD Head of the Institute for Power Electronics and
Electrical Drives at Aachen University of Technology in Germany.

Nicholas Lenssen Senior Director of Primen's Distributed Energy and Power
Integrity information products.

Frank E. Marble, PhD Professor Emeritus of Mechanical Engineering and Jet
Propulsion at the California Institute of Technology.

Harold A. Rosen, PhD Former Vice President and member of the Policy Board
of Hughes Aircraft Company. Currently a principal of Volacom, LLC.

45
<PAGE> 49

Scott Samuelson, PhD Director of the Advanced Power and Energy Program and
professor of Mechanical, Aerospace and Environmental Engineering at the
University of California, Irvine.

Members of our Technical Advisory Board are reimbursed for reasonable
out-of-pocket expenses they incur in connection with board meetings and receive
consulting fees in the form of options to purchase our common stock.

46
<PAGE> 50

MANAGEMENT

DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES

Our executive officers, directors and key employees, their positions and
their ages as of September 30, 2000, are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Ake Almgren.................... 54 President, Chief Executive Officer and Director
Jeffrey Watts.................. 50 Senior Vice President, Finance & Administration,
Chief Financial Officer, Secretary
William Treece................. 59 Senior Vice President, Strategic Technology
Development
Paul Chancellor................ 46 Senior Vice President, Engineering
Mark Kuntz..................... 37 Vice President, Marketing
Joel Wacknov................... 31 Vice President, Power Electronics Group
Daniel Callahan................ 52 Vice President, Quality Development
Lloyd Kirchner................. 37 Vice President, Supply Management
Dominic Lucenta................ 47 Vice President, Human Resources
Paul Berner.................... 39 Director of Operations
David Duckhorn................. 33 Controller
Richard Aube................... 31 Director
John Jaggers................... 49 Director
Jean-Rene Marcoux.............. 55 Director
Benjamin M. Rosen.............. 67 Director
Eric Young..................... 44 Director
</TABLE>

AKE ALMGREN. Dr. Almgren joined us in July 1998 as President and Chief
Executive Officer after a 26 year career at ASEA Brown Boveri Limited, a
worldwide power solutions company. While there, Dr. Almgren held the position of
Business Area Manager for Distribution Transformers worldwide where he managed
the operation of 36 plants in 28 countries. He has also been President of ABB
Power T&D Company, President of ABB Power Distribution, and President of ABB
Power Systems during his tenure at ABB. In addition, Dr. Almgren has also been
President of Autoliv, an automotive restraint company. Dr. Almgren holds a Ph.D.
in Engineering from Linkopings Tekniska Hogskola in Sweden and a Masters of
Mechanical Engineering from the Royal Institute of Technology in Stockholm,
Sweden. He is a citizen of Sweden and has worked and lived in the United States
during the last nine years.

JEFFREY WATTS. Mr. Watts has been our Chief Financial Officer since 1995
and also serves as our Senior Vice President of Finance and Administration and
Secretary. Mr. Watts has over 20 years of experience in financial management and
strategic planning for companies including IBM Corporation, Deloitte & Touche
LLP, a professional services firm, and McKinsey & Company, Inc. Prior to joining
us, he was Senior Vice President and Chief Financial Officer of P-Com, Inc., a
telecommunications equipment supplier, where he led it through various private
financings, an initial public offering and its first secondary offering. He
holds a BA degree in Economics from the University of California Berkeley and an
MBA from the University of Chicago.

WILLIAM TREECE. Mr. Treece joined us in 1997 as our Vice President of
Engineering and in 1998 became our Senior Vice President of Engineering. Mr.
Treece became our Senior Vice President, Strategic Technology Development, in
March 2000. Prior to joining us, Mr. Treece had a 24 year career with Sundstrand
Aerospace, a large aerospace company, where he held a number of positions
including Director of Engineering, Director of Operations, and Director of
Commercial programs. During his career, Mr. Treece has worked on all aspects of
turbine development, manufacturing and marketing. He holds a BS in Mechanical
Engineering from Indiana Institute of Technology and has

47
<PAGE> 51

done graduate work in engineering and business at the University of Southern
California and San Diego State University.

PAUL CHANCELLOR. Mr. Chancellor joined us in 2000 as Senior Vice President
of Engineering. From July 1996 until the time he joined Capstone, Mr. Chancellor
served as Vice President of Support Services for ABB, Power Generation Inc.,
whose key products are gas and steam turbine generators. In this capacity he led
a group that included supply management, information systems, quality, and
document management through its formation period. Prior to this, from January
1995 through July 1996, Mr. Chancellor was Vice President of Engineering for
Power Generation Inc. where he led a group of 80 people and was responsible for
over $10 million in engineering time and $150 million in purchased materials and
equipment, annually. Mr. Chancellor earned his BS in Mechanical Engineering and
his MSME at Auburn University, as well as a diploma from the Von Karman
Institute in Brussels, Belgium.

MARK KUNTZ. Mr. Kuntz joined us in 2000 as Vice President, Marketing. Prior
to joining Capstone, Mr. Kuntz served as Vice President and General Manager of
Unicom Distributed Energy, a holding company for the utility Commonwealth
Edison, where he was responsible for bringing that company's turbogenerator
power system to market and for developing new business opportunities in
distributed generation. Before his position at Unicom, Mr. Kuntz was Director of
National Accounts for Lennox Industries, where he provided sales, marketing and
customer service, as well as distribution and technical support to retail,
restaurant and institutional customers. Mr. Kuntz received a BS in Mechanical
Engineering from Cal Poly, San Luis Obispo, and an MBA from Southern Methodist
University.

JOEL WACKNOV. Mr. Wacknov joined us in 1996 as an electrical engineer and
was subsequently promoted to Vice President in 1998. He previously worked with
AeroVironment, an electrical control company. Mr. Wacknov holds a BSEE from UCLA
and an MSEE from the University of Wisconsin.

DANIEL CALLAHAN. Mr. Callahan joined us in 2000 as Vice President of
Quality Development. Prior to his start with Capstone, Mr. Callahan spent over
16 years in quality control for a number of companies, including over ten years
with Hewlett-Packard and its related companies. Most recently, Mr. Callahan was
Quality and Reliability Manager, Optoelectronics Division, for LumiLeds
Lighting, which was recently spun off from Hewlett-Packard as part of Agilent
Technologies. From November 1999 to March 2000, Mr. Callahan was Quality Manager
for Agilent Technologies and from April 1995 to November 1999, Mr. Callahan was
Quality Manager for Hewlett-Packard. In this capacity, Mr. Callahan achieved
annual budget reductions from $6 million to $900,000 over a three year period,
implemented an electronic documentation system for a worldwide network, and
implemented industry quality control standards, including ISO 9000, TQM and TQC.
Mr. Callahan received a BS in Systems Engineering from the United States Naval
Academy and an MS in Physics from the U.S. Naval Postgraduate School.

LLOYD KIRCHNER. Mr. Kirchner joined us in 1997 as mechanical systems
engineer and was subsequently promoted to Vice President, Supply Management in
1999. Previously he was with Amoco Power Resources Corporation, an integrated
oil company, for over ten years. Mr. Kirchner holds a BSME from Rice University
and an MBA from the University of Chicago.

DOMINIC LUCENTA. Mr. Lucenta joined us in 2000 as Vice President, Human
Resources. Prior to his start at Capstone, Mr. Lucenta spent 20 years with Essex
Group, Inc., a manufacturer of electrical products. Mr. Lucenta holds a BS in
Organizational Psychology and an MA in Labor and Industrial Relations, both from
the University of Illinois, Urbana-Champaign.

PAUL BERNER. Mr. Berner joined us in 1995 as a design engineer. He has held
a variety of engineering and operations assignments since then and was named
Director of Operations in August 1999. He was formerly with Sundstrand
Aerospace, a large aerospace company, in a variety of engineering and operations
assignments. Mr. Berner holds a BS in Mechanical Engineering from San Diego
State University.

48
<PAGE> 52

DAVID DUCKHORN. Mr. Duckhorn joined us in 2000 as our Controller. Prior to
joining us, he served as Controller and then Chief Financial Officer and Vice
President of Administration for St. Helena Wine Company from 1996 to 2000, a
diversified vineyard, winery and marketing company. Before his position at St.
Helena Wine Company, he was a Commercial Banking Officer with Bank of America
from 1992 to 1995. Mr. Duckhorn holds a BS in Finance from California State
University, Fresno and an MBA from the University of California, Berkeley.

RICHARD AUBE. Mr. Aube became our director in 2000. Mr. Aube is currently a
Managing Director of The Beacon Group, LLC, a private investment and strategic
advisory firm based in New York. The Beacon Group was recently acquired by Chase
Manhattan Bank and is now part of Chase Capital Partners. Mr. Aube joined The
Beacon Group in 1993, focusing on the firm's investment activities in the energy
sector. Prior to joining The Beacon Group, Mr. Aube was an investment banker in
the Natural Resources Group at Morgan Stanley & Co. Incorporated. Mr. Aube is a
director of Generac Portable Products, Powercell Corporation and Proton Energy
Systems, a company which designs, develops and manufactures proton exchange
membrane technology.

JOHN JAGGERS. Mr. Jaggers has been our director since 1993. Mr. Jaggers is
also a general partner and the Chief Financial Officer of Sevin Rosen Funds, a
group of venture capital funds. Mr. Jaggers joined Sevin Rosen, a current
stockholder, in 1988, focusing on software and information services. Prior to
joining Sevin Rosen, Mr. Jaggers spent eight years in the venture capital and
corporate financing activities of Rotan Mosle Inc., where he specialized in new
technologies and small, rapidly growing companies. Mr. Jaggers received his
Bachelors and Masters degrees in Electrical Engineering from Rice University. He
received his MBA from Harvard University.

JEAN-RENE MARCOUX. Mr. Marcoux became our director in 2000. Mr. Marcoux
first joined Hydro-Quebec in 1969 and for over ten years occupied several
positions in IREQ, its research institute. Mr. Marcoux returned in 1997 to serve
as President and Chief Executive Officer of Hydro-Quebec CapiTech and General
Manager Technology Marketing and Affiliates for Hydro-Quebec, the fourth largest
utility in the world. Prior to that, he held positions related to business
development with GEC-Althom and ABB.

BENJAMIN M. ROSEN. Mr. Rosen has been our director since 1993. Mr. Rosen is
the former Chairman of the Board of Directors of Compaq Computer Corporation, a
personal computer manufacturer, and is also a co-founder of Sevin Rosen Funds, a
venture capital firm managing a several hundred million dollar portfolio. Mr.
Rosen is also a member of the Board of Directors of Ask Jeeves. Mr. Rosen is
vice-chairman of the Board of Trustees of the California Institute of
Technology, a member of the Board of Managers of Memorial Sloan-Kettering Cancer
Center, and a member of the Board of Overseers of Columbia Business School. Mr.
Rosen received a BS degree in Electrical Engineering from Caltech, an MS in
Electrical Engineering from Stanford University and an MBA from Columbia
University.

ERIC YOUNG. Mr. Young has been our director since 1993. Mr. Young is a
cofounder of Canaan Partners, a venture capital investment firm, and has served
as a general partner since its inception in 1987. From 1979 to 1987 Mr. Young
held various management positions with General Electric Co. and G.E. Venture
Capital, a venture capital investment firm and subsidiary of General Electric.
Mr. Young is also a director of several private entities. Mr. Young holds an MBA
from Northwestern University and a BS in Mechanical Engineering from Cornell
University.

BOARD COMPOSITION

The number of our directors is fixed at seven. At each annual meeting of
stockholders, directors will be elected for one-year terms.

49
<PAGE> 53

BOARD COMMITTEES

We have an Audit Committee and a Compensation Committee of our board of
directors. The members of the Audit Committee are Messrs. Aube and Young. The
Audit Committee is responsible for recommending to the board of directors the
engagement of our outside auditors and reviewing our accounting controls and the
results and scope of audits and other services provided by our auditors. The
Compensation Committee consists of Messrs. Jaggers and Rosen. The Compensation
Committee is responsible for reviewing and recommending to the board of
directors the amount and type of non-stock compensation to be paid to senior
management and establishing and reviewing general policies relating to
compensation and benefits of employees.

DIRECTOR COMPENSATION

Directors who are employees and non-employee directors receive no
compensation for their services as directors. However, they are reimbursed for
the expenses they incur in attending the board or committee meetings.

All directors are eligible to participate in our 2000 stock option plans.
Non-employee directors are eligible to participate in our 2000 equity incentive
plan, which provides that our non-employee directors will be granted initial
options to purchase 21,600 shares of common stock on the date of their initial
election to the board of directors. The 2000 plan further provides for
subsequent formula grants to our non-employee directors of options to purchase
21,600 shares of common stock on the date of the first annual meeting of our
stockholders that occurs in the third year after the non-employee director's
initial grant and at which the non-employee director is reelected to our board
of directors. These initial and subsequent options granted to our non-employee
directors are subject to vesting, in three equal installments over three years,
based upon continuing service as a director. Employee directors are eligible to
participate in our 2000 employee stock purchase plan as long as they meet
eligibility requirements, including not owning, immediately after an option is
granted, 5% or more of the voting power of all classes of stock. Our 1993 stock
incentive plan does not provide for grants of stock options to directors.

ACCELERATED VESTING

The board of directors has adopted an accelerated vesting schedule with
respect to options granted to Dr. Almgren, our chief executive officer, and Mr.
Watts, our chief financial officer, such that these executive officers' options
immediately vest upon an acquisition of Capstone or an acquisition of 50% of the
voting power or economic interest of Capstone.

LIMITATIONS OF LIABILITY AND INDEMNIFICATION MATTERS

Our certificate of incorporation in effect at the time of this offering
limits the liability of directors to the maximum extent permitted by Delaware
law. Delaware law provides that directors of a corporation will not be
personally liable for monetary damages for breach of their fiduciary duties as
directors, except liability for any of the following:

- any breach of their duty of loyalty to the corporation or its
stockholders;

- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;

- unlawful payments of dividends or unlawful stock repurchases or
redemptions; or

- any transaction from which the director derived an improper personal
benefit.

This limitation of liability does not apply to liabilities arising under
the federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.

50
<PAGE> 54

Our bylaws provide that we shall indemnify our directors and executive
officers and may indemnify our other officers and employees and other agents to
the fullest extent permitted by law. We believe that indemnification under our
bylaws covers at least negligence and gross negligence on the part of
indemnified parties. Our bylaws also permit us to secure insurance on behalf of
any officer, director, employee or other agent for any liability arising out of
his or her actions in such capacity, regardless of whether the bylaws would
permit indemnification.

We have entered into agreements to indemnify our directors and executive
officers, in addition to indemnification provided for in our bylaws. These
agreements, among other things, indemnify our directors and executive officers
for certain expenses, including attorneys' fees, judgments, fines and settlement
amounts incurred by any such person in any action or proceeding, including any
action by us arising out of such person's services as our director or executive
officer, any of our subsidiaries or any other company or enterprise to which the
person provides services at our request. We believe that these provisions and
agreements are necessary to attract and retain qualified persons as directors
and executive officers.

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers or persons controlling us as described
above, we have been advised that in the opinion of the SEC such indemnification
is against public policy as expressed in the Securities Act and is therefore
unenforceable.

EXECUTIVE COMPENSATION

The following table sets forth the total compensation paid in the year
ended December 31, 1999, to the following executive officers:

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
----------------------------
NUMBER
ANNUAL OF SECURITIES
COMPENSATION UNDERLYING
-------------------- OPTIONS ALL OTHER
NAME YEAR SALARY($) BONUS($) GRANTED(#) COMPENSATION
---- ---- --------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Ake Almgren....................... 1999 $200,000 $100,000 1,245,000 --
President and Chief Executive 1998 106,154 125,000 780,000 --
Officer
Jeffrey Watts..................... 1999 $153,462 $ -- 285,300 --
Senior Vice President Finance & 1998 145,000 -- -- --
Administration, Chief Financial 1997 136,222 -- -- --
Officer, Secretary
William Treece.................... 1999 $146,338 $ -- 120,000 --
Senior Vice President,
Engineering 1998 145,000 -- -- --
1997 94,135 -- 90,000 --
</TABLE>

51
<PAGE> 55

OPTION GRANTS IN LAST FISCAL YEAR

The following table sets forth information regarding stock options granted
during 1999 to our executive officers listed in the Summary Compensation Table.
During 1999, we granted options to purchase an aggregate of 2,952,720 shares of
common stock to employees. The exercise price per share for these options was
less than the fair market value of the common stock as of the grant date.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL OPTIONS
UNDERLYING GRANTED TO
OPTIONS EMPLOYEES IN EXERCISE MARKET EXPIRATION GRANT DATE
NAME GRANTED(1) FISCAL YEAR PRICE PRICE DATE PRESENT VALUE(2)
---- ---------- ------------- -------- ------ ---------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Ake Almgren............... 1,245,000 42% $0.33 $0.57 5/1/2009 $371,010
Jeffrey Watts............. 285,300 10% $0.33 $0.57 5/1/2009 $ 85,019
William Treece............ 120,000 4% $0.33 $0.57 5/1/2009 $ 35,760
</TABLE>

---------------
(1) All options were granted under our stock option plan and have a ten-year
term. All of the options shown in this table became exercisable upon our
initial public offering.

(2) The grant date present value was calculated using a minimum value option
valuation model, using the assumptions set forth in note 6 to the notes of
our financial statements.

FISCAL YEAR-END OPTION VALUES

The following table sets forth information concerning the number and value
of unexercised options to purchase common stock held as of December 31, 1999 by
our executive officers listed in the Summary Compensation Table. There was no
public trading market for our common stock as of December 31, 1999. Accordingly,
the values of the unexercised in-the-money options have been calculated on the
basis of $6.00 per share, the deemed fair market value of our common stock at
the end of fiscal year 1999, less the applicable exercise price multiplied by
the number of shares that may be acquired on exercise.

FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
SHARES DECEMBER 31, 1999(#) DECEMBER 31, 1999($)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Ake Almgren.......... -- -- 457,813 1,567,187 2,410,108 8,544,892
Jeffrey Watts........ -- -- 189,272 260,878 1,080,992 1,478,596
William Treece....... -- -- 52,500 157,500 262,500 867,500
</TABLE>

52
<PAGE> 56

STOCK OPTION PLANS

1993 INCENTIVE STOCK PLAN

We have a 1993 incentive stock option plan that allows some of our
employees and consultants the ability to acquire an ownership interest in our
company. Under this plan, we have reserved for issuance 7,800,000 shares of
common stock. The 1993 plan allows us to grant:

- incentive stock options;

- nonstatutory stock options; and

- stock purchase rights.

Options and stock purchase rights may be granted to employees and
consultants, while incentive stock options may be granted only to employees. As
of September 30, 2000, options to purchase 7,369,811 shares had been granted
under this plan, of which options for 5,477,538 shares remained outstanding. The
1993 plan will continue to be in effect with respect to outstanding options
granted under that plan until they are either exercised or expire in accordance
with their respective terms. Capstone plans to grant no further new options
under the 1993 plan, although to the extent options previously granted under the
1993 plan are subsequently forfeited or expire unexercised or otherwise become
available, they may be reissued under the 2000 equity incentive plan.

The exercise price of common stock underlying an option may be greater,
less than or equal to fair market value. The exercise price of an incentive
stock option granted to an employee who owns:

- 10% or less of the voting power of all classes of stock, may not be less
than 100% of the fair market value of the underlying shares of common
stock on the date of the grant; and

- more than 10% of the voting power of all classes of stock, may not be
less than 110% of the fair market value of the underlying shares of
common stock on the date of the grant.

The exercise price of common stock underlying a nonstatutory stock option
granted to an employee or consultant who owns:

- 10% or less of the voting power of all classes of stock, may not be less
than 85% of the fair market value of the underlying shares of common
stock on the date of the grant; and

- more than 10% of the voting power of all classes of stock, may not be
less than 110% of the fair market value of the underlying shares of
common stock on the date of the grant.

In the case of a stock purchase right, the per share exercise price of the
common stock underlying the right granted to a person who owns:

- 10% or less of the voting power of all classes of stock, may not be less
than 85% of the fair market value of the underlying shares of common
stock on the date of the grant; and

- more than 10% of the voting power of all classes of stock, may not be
less than 100% of the fair market value of the underlying shares of
common stock on the date of the grant.

The maximum term of an option is 10 years from the date of the grant,
though the option agreement may set forth a shorter term. The term is five years
for an option granted to an employee who, at the time of the grant, owns stock
representing more than 10% of the voting power of all classes of stock. Options
are typically subject to vesting schedules, which do not exceed five years.
Options may be exercised for specified periods, generally 30 days, after the
termination of the optionee's employment or other service relationship with us,
and are generally non-transferable. The term of a nonstatutory stock option may
be extended under some circumstances for a period of six months upon the death
of the optionee. If the board determines to grant a stock purchase right, a
stock purchase agreement or stock bonus agreement must be executed no later than
six months from the date of the grant. In some instances, we have a repurchase
option upon the purchaser's voluntary

53
<PAGE> 57

or involuntary termination. The repurchase price is the fair market value for
such shares on the date the right of repurchase is triggered.

Upon the exercise of options or the grant of a purchase right, the board
determines the method of payment, and may consist of:

- cash;

- check;

- promissory note or other deferred payment arrangement;

- delivery of shares of common stock that have a fair market value on the
date of surrender equal to the aggregate exercise price; or

- any combination of methods above or other method to the extent permitted
by section 408 or 409 of the California General Corporation Law.

The 1993 plan may be administered by the board of directors or a committee
appointed by the board. Subject to the provisions of the plan, the board may
select the individuals eligible to receive awards, determine or modify the terms
and conditions of the awards granted, determine fair market value and exercise
price within specific parameters, waive vesting provisions and generally
administer and interpret the plan.

Upon specified events, including a stock split, reverse stock split, stock
dividend, combination or reclassification, we will adjust proportionately:

- the number of shares of common stock covered by each outstanding option
or purchase right;

- the number of shares of common stock that have been authorized under the
plan but as to which no options or purchase rights have been granted or
which have been returned to the plan or repurchased upon a holder's
termination or otherwise; and

- the price per share of common stock covered by each outstanding option or
purchase right.

In the event of our dissolution or liquidation, all options and purchase
rights not previously exercised will terminate immediately prior to the
consummation of that action. In the event of certain transactions, we and the
other parties to the transactions may agree to treat all the outstanding awards
in a different manner. These transactions include a merger or consolidation in
which we are not the survivor or in which shares of our stock are converted into
cash, securities or other property; the sale of all or substantially all of our
assets; a liquidation or dissolution that we initiate; and a transaction in
which any person becomes the beneficial owner, directly or indirectly, of 30% or
more of our outstanding capital stock on a fully diluted and as-converted basis.

2000 EQUITY INCENTIVE PLAN

Our 2000 equity incentive plan was adopted by our board of directors on
June 19, 2000 and has also been approved by our stockholders as a successor plan
to our 1993 incentive stock plan. The 2000 plan provides for awards of up to
3,300,000 shares of common stock, plus the number of shares previously
authorized and remaining available under the 1993 plan as of the closing of our
initial public offering, plus any shares covered by options granted under the
1993 plan that are forfeited or expire unexercised. As of September 30, 2000,
options to purchase 10,300 shares had been granted under the 2000 Plan, all of
which were outstanding.

The 2000 plan is substantially the same as the 1993 plan. The 2000 plan
provides for the discretionary grant of awards to employees, consultants and
members of the board of directors. These awards can be incentive stock options
(as defined in Section 422 of the Internal Revenue Code), nonstatutory stock
options (that is, options that do not meet the definition of incentive stock
options), stock purchase rights and stock bonus rights. The 2000 plan provides
that our non-

54
<PAGE> 58

employee directors will be granted initial options to purchase 21,600 shares of
common stock on the date of their initial election to the board of directors.

The 2000 plan also provides for subsequent grants to our non-employee
directors of options to purchase 21,600 shares of common stock on the date of
the annual stockholders meeting in the third year after the director's initial
grant, if the director is reelected to our board. All of these options granted
to non-employee directors are subject to vesting, in three equal installments
over three years, based upon continuing service as a director. These options
will have an exercise price equal to the fair market value of the common stock
on the grant date, and a term of 10 years, subject to earlier expiration in
connection with termination of service.

Our board of directors or a committee of board members may administer the
2000 plan. The 2000 plan is administered by a committee composed of two or more
independent directors. The administrator determines the terms of the options or
other awards granted, including when they vest or may be exercised, the exercise
price, the number of shares subject to each option or other award (but not to
exceed 3,000,000 per year per participant), and the forms of payment permitted
upon exercise. The board of directors may amend, suspend or terminate the 2000
plan, except that no action may affect any share of common stock previously
issued and sold or any option previously granted under the 2000 plan without the
holder's consent. In addition, stockholder approval is generally required for
the board of directors to increase the number of shares that may be issued under
the 2000 plan. However, no stockholder approval is required in case of a merger,
recapitalization, spin-off, stock split, dissolution, disposition of
substantially all of our assets, or other transaction or event involving a
change in our capital structure. In these cases, the board also has discretion
to adjust the exercise price of any option or stock purchase right, as well to
adjust the number and kind of shares for which options or stock purchase rights
may be granted or which are subject to outstanding options, stock purchase
rights or restricted stock.

For any participant who owns stock possessing more than 10% of the voting
power of all classes of our outstanding capital stock, the per share exercise
price of a stock option must equal at least 110% of the fair market value of a
share of common stock on the grant date. However, the maximum term of a stock
option granted to such a participant differs depending upon the type of option:
If it is an incentive stock option the term must not exceed five years, but if
it is a nonstatutory stock option the term may not exceed 10 years. For all
other participants, the term of all other options granted under the 2000 plan
may not exceed 10 years, and the per share exercise price must equal

- at least 100% of the fair market value of a share of common stock on the
grant date, if the option is an incentive stock option, or

- at least 85% of the fair market value of a share on the grant date if the
option is a nonstatutory stock option. However, pursuant to a merger or
other corporate transaction, options may be granted with an exercise
price different from those set forth above.

Options and other awards granted under the 2000 plan generally are subject
to vesting conditions relating to continued service to Capstone. Vesting
conditions customarily provide that the award becomes exercisable over time in
stages corresponding to length of service as an employee, director or
consultant. Options and other awards generally are not transferable by the
optionee. Options granted under the 2000 plan generally must be exercised within
three months after the end of the optionee's status as an employee, director or
consultant, or within one year in case of disability or death. If an optionee's
status as an employee, director or consultant is terminated for cause, the
option terminates immediately.

The 2000 plan provides for the grant of stock purchase rights and stock
bonus rights. Stock purchase rights permit the grantee to enter into an
agreement with us to purchase restricted stock, subject to vesting conditions
relating to continued service. Unless the plan administrator determines
otherwise, the restricted stock purchase agreement will give us the option to
repurchase the restricted shares upon the voluntary or involuntary termination
of the purchaser's employment or consulting

55
<PAGE> 59

relationship with our company for any reason, including death or disability. We
intend that the restricted stock purchase agreement will provide that this
repurchase right would apply only to the shares covered by the unvested portion
of the purchaser's stock purchase right. The purchase price for shares
repurchased pursuant to a restricted stock purchase agreement, and the rate at
which the repurchase right lapses will be determined by the administrator and
set forth in the restricted stock purchase agreement. We intend that the
restricted stock purchase agreement provide that the purchase price for such
repurchased shares would be the original price paid by the purchaser.

If we merge with another corporation, the administrator may, but is not
required, to accelerate the vesting of each outstanding option and other award.
In a merger, the surviving corporation may assume any outstanding options or
other awards or may substitute similar stock awards, without accelerating the
vesting of outstanding awards. If the surviving corporation does not assume or
substitute for outstanding options and other awards, then:

- (1) for participants whose service has not been terminated prior to the
merger, awards will become fully vested and exercisable and all
restrictions on those awards will lapse at least 10 days before the
merger closes, and

- (2) for other participants, outstanding awards will terminate if not
exercised before the merger closes.

If the surviving corporation does assume or substitute for outstanding
awards, then a participant's awards will become immediately fully vested and
exercisable if, within nine months after the merger one of the following occurs:

- (1) the surviving corporation terminates the participant's employee or
director status without cause, or

- (2) an employee terminates employment either because his principal work
location moves more than 50 miles from his existing work location or
because there is a material reduction in his responsibilities.

General Federal Tax Consequences. In general under current federal laws,
participants in the 2000 plan who receive nonstatutory stock options, restricted
stock, deferred stock, and stock payments are taxable upon receipt of common
stock or cash with respect to those awards or grants. Subject to limitations
under section 162(m) of the Internal Revenue Code, discussed further below, we
will be entitled to a corporate income tax deduction for the amounts taxable to
those recipients. If a recipient of incentive stock options exercises those
options and then holds those options and option stock for certain minimum
holding periods, he generally has no taxable income on the receipt of common
stock, and we are not entitled to a deduction. Participants in the 2000 plan
will be provided with detailed information regarding the tax consequences
relating to the various types of awards and grants under the plan.

Section 162(m) Limitation. In general, under section 162(m) of the Internal
Revenue Code, income tax deductions of publicly held corporations may be limited
to the extent total compensation for certain executive officers in any one year
exceeds $1,000,000 (less any excess parachute payments as defined in section
280G of the Internal Revenue Code). For purposes of this general rule, total
compensation includes base salary, annual bonus, stock option exercises and
non-qualified benefits paid. However, under section 162(m), the deduction limit
does not apply to certain performance-based compensation established by an
independent compensation committee which is adequately disclosed to, and
approved by, stockholders. In particular, stock options will satisfy the
performance-based compensation exception if the awards are made by a qualifying
compensation committee, the plan sets the maximum number of shares any person
can be granted within a specified period, and the compensation is based solely
on an increase in the stock price after the grant date (that is, the option
exercise price is at least equal to the fair market value of the stock subject
to the award on the grant date). Rights or awards other than options will not
qualify as performance-based compensation for these purposes unless the rights
or awards are granted or vest
56
<PAGE> 60

upon preestablished objective performance goals whose material terms are
disclosed to and approved by the stockholders. Under a transition rule for
compensation plans of corporations which, like Capstone, are privately held and
which become publicly held in an initial public offering, the 2000 plan will not
be subject to section 162(m) until the earlier of (1) the material modification
of the 2000 plan; (2) the issuance of all employer stock and other compensation
that has been allocated under the 2000 plan; or (3) the first meeting of
stockholders at which directors are to be elected that occurs after December 31,
2003.

Based on current law, we have attempted to structure the 2000 plan so that
after December 31, 2003, subject to obtaining stockholder approval for the 2000
plan, the remuneration attributable to stock options which meet the other
requirements of section 162(m) will not be subject to the $1,000,000 limitation.
We have not, however, requested a ruling from the IRS or an opinion of counsel
regarding this issue.

EMPLOYEE STOCK PURCHASE PLAN

2000 EMPLOYEE STOCK PURCHASE PLAN

The 2000 employee stock purchase plan was adopted by our board of directors
on June 19, 2000 and has also been approved by our stockholders. A total of
900,000 shares of common stock may be sold under the purchase plan. As of the
date of this prospectus, no shares have been issued under the purchase plan. The
purchase plan is administered by a committee composed of not less than two
members of the board of directors who are "non-employee directors" within the
meaning of Rule 16b-3 adopted by the SEC under Section 16(b) of the Securities
Exchange Act of 1934.

The purchase plan, which is intended to qualify under section 423 of the
Internal Revenue Code, contains consecutive offer periods that are generally six
months in duration. The offer periods start on January 1 and July 1 and end on
the last day of June and December. Employees are eligible to participate if they
are customarily employed by us or any participating subsidiary for more than 20
hours per week and more than five months per year. However, no employee may be
granted a right to purchase stock under the purchase plan (1) to the extent
that, immediately after the grant of the right to purchase stock, the employee
would own, or be treated as owning, stock possessing 5% or more of the total
combined voting power or value of all classes of our capital stock, or (2) to
the extent that his or her rights to purchase stock under all of our employee
stock purchase plans accrues at a rate which exceeds $25,000 worth of stock for
each calendar year.

The purchase plan permits participants to purchase common stock through
payroll deductions of up to 15% of the participant's base compensation. Base
compensation is defined as the participant's total base compensation which he or
she receives on each payday as compensation for services to our company,
excluding overtime payments, sales commissions, incentive compensation, bonuses,
expense reimbursements, fringe benefits and other special payments. The maximum
number of shares a participant may purchase with respect to a single offer
period is 2,500 shares. Amounts deducted and accumulated by the participant are
used to purchase shares of common stock at the end of each offer period. The
price of stock purchased under the purchase plan is 85% of the lesser of the
fair market value of the common stock (1) the first day of the offer period or
(2) the last day of the offer period. Participants may end their participation
at any time other than the final 15 days of an offer period, and they will be
paid their payroll deductions to date. Purchase of stock by participants in the
purchase plan occurs automatically on the last day of each offer period.
Participation ends automatically upon termination of employment with us, and the
employee's payroll deductions to date will be refunded to the employee. However,
if employment is terminated by the employee's death, a refund of the employee's
payroll deductions to date requires a written request from the executor of the
employee's will or the administrator of the employee's estate before the next
date on which an offer period ends; otherwise the purchase of stock using the
employee's payroll deductions will occur on the last day of the offer period.

57
<PAGE> 61

Rights to purchase stock granted under the purchase plan are not
transferable by a participant other than by will, the laws of descent and
distribution, or as otherwise provided under the purchase plan. The purchase
plan provides that, upon certain specified events, such as a merger,
recapitalization, spin-off, stock split, dissolution, disposition of
substantially all of our assets, or other similar corporate transaction or
event, the board has discretion to adjust the exercise price of any option as
well as the number and kind of shares for which options may be granted or which
are subject to outstanding options. Our board of directors has the authority to
amend or terminate the purchase plan; however, stockholder approval is required
to amend the purchase plan either to change the number of shares of stock that
may be sold pursuant to the purchase plan (except upon certain specified events
involving a change in capital structure, such as those listed in the preceding
sentence), or to alter the requirements for eligibility to participate in the
purchase plan, or in any manner that would cause the plan to no longer be an
"employee stock purchase plan" within the meaning of Section 423(b) of the
Internal Revenue Code. The purchase plan will terminate on December 31, 2010,
unless terminated earlier in accordance with its provisions.

EMPLOYMENT AGREEMENTS

We have entered into a letter agreement with Ake Almgren, our President and
Chief Executive Officer. During his employment Dr. Almgren will receive a base
salary plus a bonus of up to $100,000 based on the achievement of annual
objectives and stock options under Capstone Turbine Corporation's Stock Option
Plan, originally granted in the amount of 780,000 shares vesting over four
years. Upon termination of his employment, Dr. Almgren will receive an amount
equaling the monthly rate of the base salary for the six months following
termination. For 1999, Dr. Almgren's base salary was $200,000.

58
<PAGE> 62

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

On May 16, 1995, we entered into a Preferred Stock Purchase Agreement for
Series B preferred stock pursuant to which Fletcher Challenge Distributed
Generation, Inc. purchased 3,333,334 shares of Series B preferred stock. In
connection with the Series B preferred stock financing, we and Fletcher
Challenge Power Marketing Limited, a New Zealand corporation and an affiliate of
Fletcher Challenge, entered into a Marketing and Licensing Agreement dated May
16, 1995. This agreement provided that Fletcher Challenge Power Marketing have
the exclusive marketing rights for seven years from the date in which Capstone
met a specified technological milestone. This milestone was met in 1999 and the
original agreement term, therefore, would have expired in 2006. The marketing
rights related to sales of our products throughout the world exclusive of the
United States, Canada, Mexico, Europe and Africa. We subsequently reacquired
these marketing and licensing rights under the terms of the Marketing Rights
Buyback Agreement, dated as of July 14, 1999, entered into by us, Awatea
Holdings Limited, Fletcher Challenge and Fletcher Challenge Power Marketing.
Among other things, the Buyback Agreement provided for our repurchase of
Fletcher Challenge's Power Marketing marketing rights and future royalties on
shipments in the specified territory. As part of the repurchase agreement, we
elected to make an upfront payment of $9.0 million, resulting in a royalty
obligation of 4%, up to a maximum of $11.0 million. The future royalty payments
accelerated at a qualifying public offering and, accordingly, we paid the
royalty maximum of $11 million from the proceeds of our initial public offering.
As further provided in the repurchase agreement, on February 24, 2000 we also
issued 1,250,000 shares of Series G preferred stock with a liquidation
preference of $4.00 per share for no additional consideration to Awatea. Peter
Steele is a former director designee of Fletcher Challenge to our board of
directors. Sales made to Fletcher Challenge and an affiliate were $247,000 in
1999.

On January 17, 1997, we issued 3,125,000 shares of our Series D preferred
stock to various investors, some of whom were our officers, directors or 5%
stockholders. On August 22, 1997 we issued 5,865,814 shares of our Series E
preferred stock to various investors. An additional 4,587,331 shares of Series E
preferred stock were issued on November 19, 1997. On May 31, 1999, we issued
11,095,496 shares of Series F preferred stock, in addition to warrants to
acquire 8,396,624 shares of common stock, to various investors, some of whom
were our directors or 5% stockholders. On February 24, 2000, we issued
35,683,979 shares of Series G preferred stock to various investors some of whom
were our officers, directors or 5% stockholders.

We have sold several of our products to Fletcher Challenge Energy, Canada
and Fletcher Challenge Power Marketing, New Zealand for aggregate proceeds of
approximately $357,000. Fletcher Challenge Power Marketing, New Zealand
purchased one microturbine in 1995 and three units in 1996 for proceeds of
approximately $110,000. In 1999, we sold six units to Fletcher Challenge Power
Marketing, New Zealand for resale to Japanese customers for approximately
$178,000. Fletcher Challenge Energy Canada purchased two microturbines in 1999
for aggregate proceeds of approximately $69,000, the same price other customers
paid.

During 1997 and 1998, Fletcher Challenge reimbursed us $137,000 and
$39,000, respectively, for the use of our office facilities as well as for other
expenses. As of December 31, 1998, we had a $17,000 receivable for these
expenses.

During 1997, we purchased from Rosen Motors, of which our present and
former directors Benjamin Rosen and Dr. Harold Rosen, respectively, were
principal officers, equipment and improvements in the amount of $590,000 and
assumed several leases.

The following members of our board of directors represent venture capital
firms that have invested in us. Richard Aube is a managing director of The
Beacon Group, LLC, a private investment and strategic advisory firm based in New
York. John Jaggers is a general partner and the Chief Financial Officer of Sevin
Rosen Funds, a group of venture capital firms that manages a several hundred
million dollar portfolio. Benjamin Rosen is a co-founder of Sevin Rosen Funds.
Eric Young is a co-founder of Canaan Partners, a venture capital investment
firm, and has served as a general
59
<PAGE> 63

partner. Jean-Rene Marcoux is President and Chief Executive Officer of
Hydro-Quebec CapiTech, the investment arm of Hydro-Quebec. Each of these firms
represented on our board of directors has invested in us. For a breakdown of
shareholding, please see "Principal and Selling Stockholders" following this
section.

60
<PAGE> 64

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth, as of September 30, 2000, and as adjusted
to reflect the sale of shares of common stock offered by this prospectus,
information regarding the beneficial ownership of our common stock by:

- all persons known by us to own beneficially 5% or more of our common
stock;

- each of our directors;

- the executive officers listed in the Summary Compensation Table;

- all directors and executive officers as a group; and

- the selling stockholders.

Unless otherwise indicated, the address for each stockholder on this table
is c/o Capstone Turbine Corporation, 21211 Nordhoff Street, Chatsworth,
California 91311. A person has beneficial ownership of shares if he has the
power to vote or dispose of the shares. This power can be exclusive or shared,
direct or indirect. In addition, a person is considered by SEC rules to
beneficially own shares underlying options that are presently exercisable or
will become exercisable within 60 days. Except in states where community
property laws apply or as indicated in the footnotes to this table, we believe
that each stockholder identified in the table possesses sole voting and
investment power with respect to all shares of common stock shown as
beneficially owned by such stockholder.

As of September 30, 2000, there were 74,938,602 shares of our common stock
outstanding. To calculate a stockholder's percentage of beneficial ownership, we
must include in the numerator and denominator those shares underlying options
that the stockholder is considered to beneficially own. Shares underlying
options held by other stockholders, however, are disregarded in this
calculation. Therefore, the denominator used in calculating beneficial ownership
among our stockholders may differ.

61
<PAGE> 65

<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
PRIOR TO THE OFFERING
----------------------------------------------- SHARES BENEFICIALLY
NUMBER OF OWNED
NUMBER OF SHARES SHARES AFTER THE OFFERING
OUTSTANDING UNDERLYING BEING --------------------
NAME OF BENEFICIAL OWNER SHARES OPTIONS TOTAL PERCENT OFFERED NUMBER PERCENT
------------------------ ----------- ---------- ---------- ------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
James Bennett........................ 1,500 -- 1,500 * 135 1,365 *
Paul Berner(11)...................... 6,000 26,250 32,250 * 4,203 28,047 *
JM & PJ Blundell..................... 1,903 -- 1,903 * 256 1,647 *
Robert W. Bosley(12)................. 85,126 1,459 86,585 * 679 85,906 *
Warwick Bosson....................... 3,253 -- 3,253 * 40 3,213 *
Don Burtis........................... 37,416 -- 37,416 * 551 36,865 *
Canaan Equity II Entrepreneurs
LLC(13)............................ 39,000 -- 39,000 * 16,646 22,354 *
Canaan Equity II L.P.(14)............ 491,250 -- 491,250 * 209,677 281,573 *
Canann Equity II L.P. (QP)(15)....... 219,750 -- 219,750 * 93,794 125,956 *
Cascade Investment LLC............... 992,849 -- 992,849 1.3 67,378 925,471 1.2
Catterton Capstone Partners LLC...... 37,500 -- 37,500 * 1,348 36,152 *
John Cavalier(16)(17)................ 139,950 -- 139,950 * 18,852 121,098 *
Heather Ann Chambers................. 6,000 -- 6,000 * 674 5,326 *
Jonathan Cho(16)..................... 4,875 -- 4,875 * 657 4,218 *
Tom Chung(16)(18).................... 2,208 -- 2,208 * 202 2,006 *
Redmon Paul Craig(19)................ 379,713 -- 379,713 * 26,951 352,762 *
William J. Craver(16)................ 17,250 -- 17,250 * 2,325 14,925 *
Ellen C. Crutcher.................... 3,136 -- 3,136 * 423 2,713 *
Allen Mattson Davis(16).............. 30,000 -- 30,000 * 4,043 25,957 *
Anthony DeLuise(16).................. 68,668 -- 68,668 * 2,482 66,186 *
DLJ Fund Investment Partners II,
L.P.(20)........................... 204,895 -- 204,895 * 27,611 177,284 *
DLJ Securities Corp.(20)............. 749,411 -- 749,411 1.0 100,987 648,424 *
DLJ Capital Corporation(20).......... 1,063 -- 1,063 * 143 920 *
DLJ Private Equity Employees Fund,
L.P.(20)........................... 18,753 -- 18,753 * 2,527 16,226 *
DLJ Private Equity Partners Fund,
L.P.(20)........................... 526,352 -- 526,352 * 70,929 455,423 *
Dominion Fund III.................... 53,635 -- 53,635 * 7,228 46,407 *
Matt Elias(16)....................... 11,850 -- 11,850 * 1,078 10,772 *
EnerTech Capital Partners LP......... 1,604,610 -- 1,604,610 2.1 216,230 1,388,380 1.8
Dietrich Erdmann..................... 434,085 -- 434,085 * 47,626 386,459 *
Angus Fletcher....................... 9,617 -- 9,617 * 337 9,280 *
James C. Furnivall................... 7,500 -- 7,500 * 1,011 6,489 *
Gas Research Institute............... 675,000 -- 675,000 * 90,960 584,040 *
Stephen L. Green(21)................. 15,000 -- 15,000 * 2,021 12,979 *
Jack Harrington...................... 11,788 -- 11,788 * 1,588 10,200 *
Mary P. Helmer....................... 3,000 -- 3,000 * 404 2,596 *
Debra Hemsey(16)..................... 3,750 -- 3,750 * 135 3,615 *
Hennigan, Bennett & Dorman........... 29,999 -- 29,999 * 4,043 25,956 *
Hillside Capital Incorporated........ 37,500 -- 37,500 * 5,053 32,447 *
Hobbes & Towne, Inc. ................ 32,933 -- 32,933 * 4,438 28,495 *
Russel Hundemer...................... 1,187 -- 1,187 * 160 1,027 *
David Hurwitz(16).................... 12,817 -- 12,817 * 1,727 11,090 *
Hydro-Quebec CapiTech Inc. .......... 1,200,000 -- 1,200,000 1.6 13,476 1,186,524 1.6
Anthony D. Hynes(22)................. 5,868 -- 5,868 * 117 5,751 *
Janice Ingram........................ 6,000 -- 6,000 * 809 5,191 *
Irell & Manella LLP(23).............. 337,620 -- 337,620 * 9,298 328,322 *
Michael D. Irvine(24)................ 92,000 -- 92,000 * 2,183 89,817 *
Hamilton E. James(16)(25)............ 15,000 -- 15,000 * 2,021 12,979 *
Deepak Kamra......................... 9,750 -- 9,750 * 1,314 8,436 *
Kingdon Offshore N.V.I(26)........... 296,700 -- 296,700 * 39,982 256,718 *
Kingdon Family Partnership(27)....... 15,600 -- 15,600 * 2,102 13,498 *
Kingdon Partners(28)................. 39,000 -- 39,000 * 5,255 33,745 *
Kingdon Associates(29)............... 61,200 -- 61,200 * 8,247 52,953 *
Lloyd G. Kirchner(30)................ 30,000 21,688 51,688 * 6,628 45,060 *
Louis Klevan(16)..................... 5,085 -- 5,085 * 685 4,400 *
Ronald A. Knapp...................... 16,899 -- 16,899 * 1,162 15,737 *
Gregory Kopchinsky................... 15,000 -- 15,000 * 2,021 12,979 *
</TABLE>

62
<PAGE> 66

<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
PRIOR TO THE OFFERING
----------------------------------------------- SHARES BENEFICIALLY
NUMBER OF OWNED
NUMBER OF SHARES SHARES AFTER THE OFFERING
OUTSTANDING UNDERLYING BEING --------------------
NAME OF BENEFICIAL OWNER SHARES OPTIONS TOTAL PERCENT OFFERED NUMBER PERCENT
------------------------ ----------- ---------- ---------- ------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Larry Lavine(16)..................... 67,500 -- 67,500 * 1,348 66,152 *
Kelly A. Leisten..................... 3,000 -- 3,000 * 270 2,730 *
Michael Lockitch(16)................. 7,125 -- 7,125 * 943 6,182 *
Antony Lundy......................... 63,750 -- 63,750 * 8,591 55,159 *
Robin Mackay & Valerie Mackay,
Trustees UA DTD 06/23/1989 by
Mackay Family Trust(31)............ 606,000 -- 606,000 * 81,662 524,338 *
Trevor Duncan Mackay................. 6,000 -- 6,000 * 674 5,326 *
John Clifford Mann................... 22,599 -- 22,599 * 910 21,689 *
John S. Mansfield(32)................ 41,406 -- 41,406 * 641 40,765 *
Ann D. Martin........................ 2,036 -- 2,036 * 40 1,996 *
Curtis C. Martin..................... 29,124 1,031 30,155 * 2,291 27,864 *
Pat McCloskey(16).................... 9,461 -- 9,461 * 606 8,855 *
Micro Generation Technology Fund
LLC................................ 1,380,073 -- 1,380,073 1.8 21,156 1,358,917 1.8
Joseph C. Migliorino................. 3,000 -- 3,000 * 404 2,596 *
Michael P. Migliorino................ 3,000 -- 3,000 * 404 2,596 *
Robert J. Migliorino(33)............. 1,500 -- 1,500 * 202 1,298 *
Albert J. Miller..................... 30,169 -- 30,169 * 4,065 26,104 *
Mitsubishi International
Corporation........................ 45,253 -- 45,253 * 6,098 39,155 *
MC Capital........................... 150,933 -- 150,933 * 20,339 130,594 *
Mitsubishi Corporation............... 105,589 -- 105,589 * 7,412 98,177 *
Garrett Moran(16).................... 15,000 -- 15,000 * 2,021 12,979 *
Heather Nicolau(16).................. 5,522 -- 5,522 * 744 4,778 *
NIG-Capstone Ltd.(34)................ 184,755 -- 184,755 * 20,213 164,542 *
NJR Energy Corporation............... 354,666 -- 354,666 * 4,779 349,887 *
James C. Noe......................... 624,000 -- 624,000 * 3,234 620,766 *
Nordhoff Investments................. 1,458,052 -- 1,458,052 1.9 20,777 1,437,275 1.9
Nth Power Technologies Fund I, LP.... 1,858,978 -- 1,858,978 2.5 26,951 1,832,027 2.4
Pachulski, Stang, Siehl, Young, &
Jones Professional Corporation..... 29,999 -- 29,999 * 4,043 25,956 *
Parnasa Partners..................... 233,474 -- 233,474 * 31,462 202,012 *
Niket Patankar(16)................... 1,500 -- 1,500 * 202 1,298 *
John William Pettit(35).............. 34,802 -- 34,802 * 67 34,735 *
Kathryn Susan Pettit(35)............. 34,802 -- 34,802 * 20 34,782 *
Peter Michael Pettit(35)............. 34,802 -- 34,802 * 1,011 33,791 *
Anne Plechner........................ 14,015 -- 14,015 * 1,078 12,937 *
Townes Pressler(16).................. 11,250 -- 11,250 * 1,516 9,734 *
Nancy Quinn.......................... 7,500 -- 7,500 * 438 7,062 *
Rabun Partners....................... 15,000 -- 15,000 * 2,021 12,979 *
Vern Raburn.......................... 9,090 310,975 320,065 * 1,225 318,840 *
Michael W. Ranger(16)................ 63,750 -- 63,750 * 1,348 62,402 *
Harry T. Rein........................ 15,000 -- 15,000 * 2,021 12,979 *
John Rice(16)........................ 28,245 -- 28,245 * 2,426 25,819 *
Mark Robson and Lois Robson JT TEN... 952 -- 952 * 61 891 *
Eric Andrew Rosen Trust.............. 68,576 -- 68,576 * 9,241 59,335 *
Harold A. Rosen(36).................. 378,737 625 379,362 * 34,925 344,437 *
Jeffrey Mark Rosen Trust............. 68,576 -- 68,576 * 9,241 59,335 *
Seymour Rubin........................ 1,586 -- 1,586 * 214 1,372 *
Frederic A. Rubinstein(37)........... 113,621 -- 113,621 * 15,311 98,310 *
Carolyn Fay Rudnik................... 3,750 -- 3,750 * 505 3,245 *
The L.J Sevin Trust Fund............. 821,902 -- 821,902 1.1 110,756 711,146 *
J.D. Sitton III...................... 15,000 -- 15,000 * 505 14,495 *
Stapleton Communications............. 26,496 -- 26,496 * 3,570 22,926 *
Margaret E. Stone Revocable Living
Trust.............................. 65,100 -- 65,100 * 445 64,655 *
Tom Sullivan(16)..................... 7,504 -- 7,504 * 404 7,100 *
Sumitomo Corporation................. 150,660 -- 150,660 * 5,390 145,270 *
David L. Townley(38)................. 11,250 -- 11,250 * 162 11,088 *
</TABLE>

63
<PAGE> 67

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

* Less than one percent.

(1)The numbers and percentages in this table assume that the underwriters do
not exercise their over-allotment option. The selling stockholders named in
the table below have granted the underwriters the option to purchase up to
the number of shares shown next to their names to cover over-allotments. If
the over-allotment option were exercised in full, the individuals would
beneficially own the number and percentage of shares of our common stock
shown in the table below.

64
<PAGE> 68

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER
THE OFFERING IF
OVER-ALLOTMENT
SHARES SUBJECT TO OPTION IS EXERCISED
OVER-ALLOTMENT -----------------------
NAME OF BENEFICIAL OWNER OPTION NUMBER PERCENT
------------------------ ----------------- ---------- -------
<S> <C> <C> <C>
James Bennett............................................... 20 1,345 *
Paul Berner................................................. 616 27,431 *
JM & PJ Blundell............................................ 38 1,609 *
Robert W. Bosley............................................ 100 85,806 *
Warwick Bosson.............................................. 6 3,207 *
Don Burtis.................................................. 81 36,784 *
Canaan Equity II Entrepreneurs LLC.......................... 2,441 19,913 *
Canaan Equity II L.P. ...................................... 30,752 250,821 *
Canann Equity II L.P. (QP).................................. 13,757 112,199 *
Cascade Investment LLC...................................... 9,882 915,589 1.2
Catterton Capstone Partners LLC............................. 197 35,955 *
John Cavalier............................................... 2,765 118,333 *
Heather Ann Chambers........................................ 99 5,227 *
Jonathan Cho................................................ 96 4,122 *
Tom Chung................................................... 30 1,976 *
Redmon Paul Craig........................................... 3,953 348,809 *
William J. Craver........................................... 340 14,585 *
Ellen C. Crutcher........................................... 62 2,651 *
Allen Mattson Davis......................................... 593 25,364 *
Anthony DeLuise............................................. 364 65,822 *
DLJ Fund Investment Partners II, L.P........................ 4,049 173,235 *
DLJ Securities Corp. ....................................... 14,812 633,612 *
DLJ Capital Corporation..................................... 21 899 *
DLJ Private Equity Employees Fund, L.P. .................... 371 15,855 *
DLJ Private Equity Partners Fund, L.P....................... 10,403 445,020 *
Dominion Fund III........................................... 1,060 45,347 *
Matt Elias.................................................. 158 10,614 *
EnerTech Capital Partners LP................................ 31,714 1,356,666 1.8
Dietrich Erdmann............................................ 6,985 379,474 *
Angus Fletcher.............................................. 49 9,231 *
James C. Furnivall.......................................... 148 6,341 *
Gas Research Institute...................................... 13,341 570,699 *
Stephen L. Green............................................ 297 12,682 *
Jack Harrington............................................. 233 9,967 *
Mary P. Helmer.............................................. 60 2,536 *
Debra Hemsey................................................ 20 3,595 *
Hennigan, Bennett & Dorman.................................. 592 25,364 *
Hillside Capital Incorporated............................... 741 31,706 *
Hobbes & Towne, Inc. ....................................... 651 27,844 *
Russel Hundemer............................................. 23 1,004 *
David Hurwitz............................................... 253 10,837 *
Hydro-Quebec CapiTech Inc. ................................. 1,976 1,184,548 1.6
Anthony D. Hynes............................................ 17 5,734 *
Janice Ingram............................................... 118 5,073 *
Irell & Manella LLP......................................... 1,364 326,958 *
Michael D. Irvine........................................... 320 89,497 *
Hamilton E. James........................................... 297 12,682 *
Deepak Kamra................................................ 193 8,243 *
Kingdon Offshore N.V.I...................................... 5,864 250,854 *
Kingdon Family Partnership.................................. 309 13,189 *
Kingdon Partners............................................ 771 32,974 *
Kingdon Associates.......................................... 1,210 51,743 *
Lloyd G. Kirchner........................................... 973 44,087 *
Louis Klevan................................................ 101 4,299 *
Ronald A. Knapp............................................. 170 15,567 *
Gregory Kopchinsky.......................................... 297 12,682 *
Larry Lavine................................................ 197 65,955 *
</TABLE>

65
<PAGE> 69

<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AFTER
THE OFFERING IF
OVER-ALLOTMENT
SHARES SUBJECT TO OPTION IS EXERCISED
OVER-ALLOTMENT -----------------------
NAME OF BENEFICIAL OWNER OPTION NUMBER PERCENT
------------------------ ----------------- ---------- -------
<S> <C> <C> <C>
Kelly A. Leisten............................................ 39 2,691 *
Michael Lockitch............................................ 139 6,043 *
Antony Lundy................................................ 1,260 53,899 *
Robin Mackay & Valerie Mackay, Trustees UA DTD 06/23/1989 by
Mackay Family Trust....................................... 11,977 512,361 *
Trevor Duncan Mackay........................................ 99 5,227 *
John Clifford Mann.......................................... 133 21,556 *
John S. Mansfield........................................... 94 40,671 *
Ann D. Martin............................................... 6 1,990 *
Curtis C. Martin............................................ 336 27,528 *
Pat McCloskey............................................... 89 8,766 *
Micro Generation Technology Fund LLC........................ 3,103 1,355,814 1.8
Joseph C. Migliorino........................................ 60 2,536 *
Michael P. Migliorino....................................... 60 2,536 *
Robert J. Migliorino........................................ 30 1,268 *
Albert J. Miller............................................ 597 25,507 *
Mitsubishi International Corporation........................ 894 38,261 *
MC Capital.................................................. 2,983 127,611 *
Mitsubishi Corporation...................................... 1,087 97,090 *
Garrett Moran............................................... 297 12,682 *
Heather Nicolau............................................. 109 4,669 *
NIG-Capstone Ltd............................................ 2,965 161,577 *
NJR Energy Corporation...................................... 701 349,186 *
James C. Noe................................................ 474 620,292 *
Nordhoff Investments........................................ 3,047 1,434,228 1.9
Nth Power Technologies Fund I, LP........................... 3,953 1,828,074 2.4
Pachulski, Stang, Siehl, Young, & Jones Professional
Corporation............................................... 592 25,364 *
Parnasa Partners............................................ 4,614 197,398 *
Niket Patankar.............................................. 30 1,268 *
John William Pettit......................................... 10 34,725 *
Kathryn Susan Pettit........................................ 3 34,779 *
Peter Michael Pettit........................................ 148 33,643 *
Anne Plechner............................................... 158 12,779 *
Townes Pressler............................................. 222 9,512 *
Nancy Quinn................................................. 64 6,998 *
Rabun Partners.............................................. 297 12,682 *
Vern Raburn................................................. 180 318,660 *
Michael W. Ranger........................................... 197 62,205 *
Harry T. Rein............................................... 297 12,682 *
John Rice................................................... 355 25,464 *
Mark Robson and Lois Robson JT TEN.......................... 9 882 *
Eric Andrew Rosen Trust..................................... 1,355 57,980 *
Harold A. Rosen............................................. 5,122 339,315 *
Jeffrey Mark Rosen Trust.................................... 1,355 57,980 *
Seymour Rubin............................................... 31 1,341 *
Frederic A. Rubinstein...................................... 2,246 96,064 *
Carolyn Fay Rudnik.......................................... 74 3,171 *
The L.J Sevin Trust Fund.................................... 16,244 694,902 *
J.D. Sitton III............................................. 74 14,421 *
Stapleton Communications.................................... 524 22,402 *
Margaret E. Stone Revocable Living Trust.................... 65 64,590 *
Tom Sullivan................................................ 60 7,040 *
Sumitomo Corporation........................................ 791 144,479 *
David L. Townley............................................ 23 11,065 *
Utech Climate Challenge Fund, LP............................ 1,552 677,906 *
Vulcan Ventures, Inc........................................ 69,965 2,992,997 3.9
Joel B. Wacknov............................................. 1,186 53,516 *
</TABLE>

66
<PAGE> 70

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

* Less than one percent.

(2)Represents 140,570 shares held by the Jeffrey Ross Watts & Julie Ann Watts
Family Trust and includes 60,000 shares beneficially owned by Mr. Watts'
children, over which Mr. Watts has sole voting and investment power.

(3)Represents 3,750,000 shares held by The Beacon Group Energy Investment Fund
II LP. Mr. Aube disclaims beneficial ownership of such shares except to the
extent of his pecuniary interest therein.

(4)Represents 4,135,120 shares held by various venture capital partnerships
managed by Sevin Rosen Funds. Mr. Jaggers disclaims beneficial ownership of
such shares except to the extent of his pecuniary interest therein.

(5)Represents 1,200,000 shares held by Hydro-Quebec CapiTech, Inc.. Mr. Marcoux
disclaims beneficial ownership of such shares except to the extent of his
pecuniary interest therein.

(6)Includes 2,375,531 shares held by the Canaan Partnership Funds. Mr. Young
disclaims beneficial ownership of such shares except to the extent of his
pecuniary interest therein.

(7)Excludes 26,800 shares held by Rho Management Trust IV, an affiliated
entity. We have been informed that Rho Management Company, Inc., a New York
corporation, which acts as investment advisor to Rho Management Trust I and
Rho Management Trust IV, may be deemed to be the beneficial owner of shares
registered in the name of Rho Management Trust I and Rho Management Trust
IV. Joshua Ruch is a controlling stockholder and executive officer of Rho
Management Company, and may therefore be deemed to have voting and
investment control over the shares registered in the name of Rho Management
Trust I and Rho Management Trust IV. Mr. Ruch disclaims beneficial ownership
of such shares except to the extent of his pecuniary interest therein.

(8)Represents 4,135,120 shares held by various venture capital partnerships
managed by Sevin Rosen Funds. The shares to be sold will come from Sevin
Rosen Fund V L.P.

(9)Includes 812 shares beneficially owned by Mr. Alder's spouse.

(10)Includes 2,113 shares beneficially owned by Ms. Alder's spouse.

(11)Mr. Berner is our Director of Operations.

(12)Includes 14,273 shares held by Mr. Bosley's spouse over which Mr. Bosley and
his spouse have shared voting and investment power.

67
<PAGE> 71

(13)Does not include 491,250 shares held by Canaan Equity II L.P. or 219,750
shares held by Canaan Equity II L.P. (QP). Canaan Equity II Entrepreneurs
LLC, Canaan Equity II L.P. and Canaan Equity II L.P. (QP) are controlled by
a common general partner or managing member.

(14)Does not include 39,000 shares held by Canaan Equity II Entrepreneurs LLC or
219,750 shares held by Canaan Equity II L.P. (QP). Canaan Equity II
Entrepreneurs LLC, Canaan Equity II L.P. and Canaan Equity II L.P. (QP) are
controlled by a common general partner or managing member.

(15)Does not include 491,250 shares held by Canaan Equity II L.P. or 39,000
shares held by Canaan Equity II Entrepreneurs LLC. Canaan Equity II
Entrepreneurs LLC, Canaan Equity II L.P. and Canaan Equity II L.P. (QP) are
controlled by a common general partner or managing member.

(16)Employee of DLJ Securities Corporation, which is an affiliate of Credit
Suisse First Boston Corporation.

(17)Mr. Cavalier was one of our directors from March 1999 to March 2000.

(18)Includes 708 shares held by DLJ Capital Corporation, over which Mr. Chung
may be deemed to have shared voting and investment power.

(19)Mr. Craig was our President from July 1996 to January 1998.

(20)DLJ Fund Investment Partners II, L.P., DLJ Securities Corp., DLJ Capital
Corporation, DLJ Private Equity Employees Fund, L.P. and DLJ Private Equity
Partners Fund, L.P. are affiliates of Credit Suisse First Boston Corporation
as of November 3, 2000.

(21)Excludes 1,463,825 shares held by Canaan Partners, over which Mr. Green may
be deemed to have shared voting and investment power.

(22)Mr. Hynes was a director and Senior Vice President, Marketing, prior to
1999.

(23)Irell & Manella has provided legal services to us during the last three
years.

(24)Mr. Irvine is our former Vice President, Marketing, and Vice President,
Corporate Development.

(25)Does not include 749,411 shares held by DLJ Securities Corporation, 204,895
shares held by DLJ Fund Investment Partners II, L.P., 18,753 shares held by
DLJ private Equity Employees Fund, L.P., or 526,352 shares held by DLJ
Private Equity Partners Fund, L.P. Mr. James expressly disclaims beneficial
ownership of all such shares except to the extent of his pecuniary interest
therein.

(26) Does not include 15,600 shares held by Kingdon Family Partnership, 39,000
shares held by Kingdon Partnership or 61,200 shares held by Kingdon
Associates. Kingdon Offshore N.V.I., Kingdon Family Partnership, Kingdon
Partnership and Kingdon Associates are investment funds under common
management.

(27) Does not include 296,700 shares held by Kingdon Offshore N.V.I., 39,000
shares held by Kingdon Partnership or 61,200 shares held by Kingdon
Associates. Kingdon Offshore N.V.I., Kingdon Family Partnership, Kingdon
Partnership and Kingdon Associates are investment funds under common
management.

(28) Does not include 296,700 shares held by Kingdon Offshore N.V.I., 15,600
shares held by Kingdon Family Partnership or 39,000 shares held by Kingdon
Partnership. Kingdon Offshore N.V.I., Kingdon Family Partnership, Kingdon
Partnership and Kingdon Associates are investment funds under common
management.

(29) Does not include 296,700 shares held by Kingdon Offshore N.V.I., 15,600
shares held by Kingdon Family Partnership or 39,000 shares held by Kingdon
Partnership. Kingdon Offshore

68
<PAGE> 72

N.V.I., Kingdon Family Partnership, Kingdon Partnership and Kingdon
Associates are investment funds under common management.

(30) Mr. Kirchner is our Vice President, Supply Management.

(31) Mr. Mackay, one of the trustees of the trust, was a director prior to March
2000.

(32) Mr. Mansfield was employed by us from July 1997 to June 1999.

(33) Does not include 3,000 shares owned by Joseph Migliorino 3,000 shares owned
by Michael Migliorino, as to which Robert Migliorino disclaims beneficial
ownership.

(34) Includes 34,755 shares held by two limited partnerships in which
NIG-Capstone Ltd. is a limited partner.

(35) Includes 2,617 shares held by John William Pettit, 952 shares held by
Kathryn Susan Pettit and 31,233 shares held by Peter Michael Pettit. Peter
Michael Pettit is the son of John William Pettit and the spouse of Kathryn
Susan Pettit.

(36) Includes 119,567 shares held by Mr. Rosen's spouse.

(37) Does not include 68,576 shares held by the Jeffrey Mark Rosen Trust or
68,576 shares held by the Eric Andrew Rosen Trust, of which Mr. Rubinstein
is the trustee.

(38) Mr. Townley was our Director, Marketing and Product Development, from
October 1996 to February 1998.

(39) Mr. Wacknov is our Vice President, Power Electronics Group.

(40) Mr. Wensley was a director prior to 1999.

(41) Mr. Weyant was employed by us from November 1998 to July 2000.

69
<PAGE> 73

DESCRIPTION OF CAPITAL STOCK

Upon completion of this offering, the Company will be authorized to issue
up to 415,000,000 shares of common stock, $0.001 par value per share, and
10,000,000 shares of preferred stock, $0.001 par value.

COMMON STOCK

As of September 30, 2000, our outstanding common stock consisted of
74,938,602 shares of common stock held by 431 stockholders of record. Holders of
common stock are entitled to one vote for each share held of record on all
matters on which stockholders may vote, and do not have cumulative voting rights
in the election of directors. Holders of common stock are entitled to receive,
as, when and if declared by the board of directors from time to time, such
dividends and other distributions in cash, stock or property from our assets or
funds legally available for such purposes subject to any dividend preferences
that may be attributable to our outstanding preferred stock.

No preemptive, conversion, redemption or sinking fund provisions apply to
the common stock. All outstanding shares of common stock are fully paid and
non-assessable. In the event of our liquidation, dissolution or winding up,
holders of common stock are entitled to share ratably in the assets available
for distribution.

PREFERRED STOCK

We have no outstanding shares of preferred stock. Our board of directors,
without further action by our stockholders, is authorized to issue an aggregate
of 10,000,000 shares of preferred stock. We have no plans to issue a new series
of preferred stock. Our board of directors may issue preferred stock with
dividend rates, redemption prices, preferences on liquidation or dissolution,
conversion rights, voting rights and any other preferences, which rights and
preferences could adversely affect the voting power of the holders of common
stock. The issuance of preferred stock, while providing desirable flexibility in
connection with possible acquisitions or other corporate purposes, could have
the effect of making it more difficult for a third party to acquire us, or could
discourage or delay a third party from acquiring control of us.

REGISTRATION RIGHTS

After the consummation of this offering, the holders of approximately 55.1
million shares of common stock will be entitled to registration rights with
respect to these shares of common stock. These rights are provided under the
terms of agreements between us and the holders of those securities. These
agreements provide demand registrations rights. In addition, pursuant to these
agreements, the holders of the securities are entitled to require us to include
their registrable securities in registration statements we file under the
Securities Act of 1933. Registration of shares of common stock pursuant to the
exercise of registration rights under the Securities Act would result in those
shares becoming freely tradable without restriction under the Securities Act
immediately upon the effectiveness of such registration.

These agreements provide that, during the three year period following our
initial public offering, we may require the holders of registration rights to
agree not to sell or otherwise dispose of any of their common stock or
securities convertible into or exchangeable for shares of common stock for a
period of up to 180 days following the completion of any registered offering of
our securities. Holders of registration rights will be subject to a 90 day
period following this offering, during which these restrictions will apply. In
connection with this offering, we have waived our rights to impose any further
restricted periods under the investor rights agreement between us and some of
our stockholders.

70
<PAGE> 74

PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS WHICH MAY HAVE AN
ANTI-TAKEOVER EFFECT

A number of provisions of our Certificate of Incorporation and By-laws
which will be effective upon completion of this offering concern matters of
corporate governance and the rights of stockholders, including a provision that
our stockholders may not take action by written consent but only at a duly
called meeting. These provisions, as well as the ability of our board of
directors to issue shares of preferred stock and/or to set the voting rights,
preferences and other terms, may be deemed to have an anti-takeover effect and
may discourage takeover attempts not first approved by our board of directors,
including takeovers which stockholders may deem to be in their best interests.
If takeover attempts are discouraged, temporary fluctuations in the market price
of our common stock, which may result from actual or rumored takeover attempts,
may be inhibited. These provisions, and the ability of our board of directors to
issue preferred stock without further stockholder action, also could delay or
frustrate the removal of incumbent directors or the assumption of control by
stockholders, even if the removal or assumption would be beneficial to our
shareholders. These provisions also could discourage or make more difficult a
merger, tender offer or proxy contest, even if favorable to the interests of
stockholders, and could depress the market price of our common stock. Our board
of directors believes that these provisions are appropriate to protect our
interests and those of our stockholders. In addition, we have not opted out of
Section 203 of the Delaware General Corporation Law, which prevents us, except
in limited circumstances, from engaging in any business combination with any
interested stockholder for a period of three years following the time a
stockholder becomes an interested stockholder. Our board of directors has no
present plans to adopt any further measures or devices which may be deemed to
have an "anti-takeover effect."

TRADING ON THE NASDAQ NATIONAL MARKET SYSTEM

Our common stock is quoted on the Nasdaq National Market under the symbol
"CPST."

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services, L.L.C.

SHARES ELIGIBLE FOR FUTURE SALE

Sales of substantial amounts of common stock in the public market following
the offering could adversely affect the market price of the common stock and
adversely affect our ability to raise capital at a time and on terms favorable
to us.

Of the approximately 76.0 million shares to be outstanding after this
offering, the shares sold in this offering, along with the shares sold in our
initial public offering, will be freely tradeable without restriction in the
public market unless such shares are held by "affiliates," as that term is
defined in Rule 144(a) under the Securities Act. For purposes of Rule 144, an
"affiliate" of an issuer is a person that, directly or indirectly through one or
more intermediaries, controls, or is controlled by or is under common control
with, such issuer. The remaining shares of common stock to be outstanding after
the offering are "restricted securities" under the Securities Act and may be
sold in the public market upon the expiration of specified holding periods under
Rule 144, subject to the volume, manner of sale and other limitations of Rule
144.

Following this offering, Holders of approximately 55.1 million shares of
our common stock are entitled to registration rights with respect to such shares
for resale under the Securities Act. If such holders, by exercising their
registration rights, cause a large number of shares to be registered and sold in
the public market, these sales could have an adverse effect on the market price
for the common stock.

71
<PAGE> 75

Fletcher Challenge Limited, through Awatea, one of our largest stockholders
and a Fletcher Challenge controlled entity, currently holds approximately 8.1
million shares of our common stock. Fletcher Challenge has announced that as
part of its corporate restructuring, it intends to sell a portion of its shares
of our common stock, including the shares included in this offering by Awatea.
All of the shares of our common stock held by Awatea, other than the shares to
be sold in this offering, are the subject of an agreement with Goldman, Sachs &
Co., described below, restricting their transfer during a 90 day period
following the date of this prospectus. Fletcher Challenge has also announced
that, as part of its restructuring, it will sell or distribute to its
shareholders all remaining shares of our common stock which it holds. Fletcher
Challenge announced that it expects distribution of these shares to occur in the
first quarter of 2001. If the sale and distribution of our shares were to occur,
the market price of our common stock could decline as a result of the
introduction of these shares into the public market.

LOCK-UP ARRANGEMENTS

Our executive officers and directors and the stockholders participating in
this offering have agreed not to sell or otherwise dispose of any shares of
common stock for a period of 90 days after the date of this prospectus without
the prior written consent of Goldman, Sachs & Co. As a result of these selling
restrictions, the total number of shares that are subject to lock-up agreements
with Goldman, Sachs & Co. in connection with this offering is approximately 51.8
million. In addition, stockholders representing approximately an additional 6.1
million shares of common stock who are not participating in this offering but
are parties to our investors rights agreement are restricted during this 90 day
period from selling their shares of common stock. We have also agreed not to
sell or otherwise dispose of any shares of our common stock for a period of 90
days after the date of this prospectus. See "Underwriting."

VALIDITY OF COMMON STOCK

The validity of the shares of common stock offered hereby will be passed
upon for us by Latham & Watkins, Los Angeles, California, and for the
underwriters by Sullivan & Cromwell, New York, New York.

EXPERTS

Deloitte & Touche LLP, independent auditors, have audited our financial
statements and financial statement schedules at December 31, 1998 and 1999, and
for each of the two years in the period ended December 31, 1999, as set forth in
their reports. We have included our financial statements and financial statement
schedules in this prospectus and elsewhere in the registration statement in
reliance on Deloitte & Touche LLP's reports, given on their authority as experts
in accounting and auditing.

Ernst & Young LLP, independent auditors, have audited our financial
statements and financial statement schedules at December 31, 1997, and for the
year ended December 31, 1997, as set forth in their report (which contains an
explanatory paragraph describing conditions that raise substantial doubt about
our ability to continue as a going concern as described in Note 1 to those
financial statements). We have included our financial statements and financial
statement schedules in this 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.

CHANGE OF AUDITORS

In August 1998, the Board of Directors elected to change our independent
auditors, from Ernst & Young, LLP, to Deloitte & Touche LLP. In connection with
Ernst & Young LLP's audit of the financial statements for the years ended
December 31, 1995, 1996 and 1997, and in connection with the
72
<PAGE> 76

subsequent period up to August 1998, there were no disagreements with Ernst &
Young LLP on any matters of accounting principles or practices, financial
statements disclosure or auditing scope or procedures, nor any reportable
events. Ernst & Young LLP's report on our financial statements for the years
ended December 31, 1995, 1996 and 1997 contained no adverse opinion or
disclaimer of opinion and was not modified or qualified as to uncertainty, audit
scope or accounting principles except for a going concern emphasis paragraph for
each of the three years. The decision to change auditors was approved by our
board of directors. We have provided Ernst & Young LLP with a copy of the
disclosure contained in this section of this prospectus.

UNDERWRITING

Subject to the terms and conditions stated in the underwriting agreement
dated , 2000, Capstone and the selling stockholders have
agreed to sell and each underwriter has severally agreed to purchase the number
of shares indicated in the following table. Goldman, Sachs & Co., Credit Suisse
First Boston Corporation, Merrill Lynch, Pierce, Fenner & Smith Incorporated and
Morgan Stanley & Co. Incorporated are the representatives of the underwriters.

<TABLE>
<CAPTION>
NUMBER OF
SHARES
UNDERWRITERS ---------
<S> <C>
Goldman, Sachs & Co.........................................
Credit Suisse First Boston Corporation......................
Merrill Lynch, Pierce, Fenner & Smith
Incorporated....................................
Morgan Stanley & Co. Incorporated...........................

--------
Total...........................................
========
</TABLE>

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
1,050,000 shares from Capstone and the selling stockholders 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 Capstone and the selling
stockholders. Such amounts are shown assuming both no exercise and full exercise
of the underwriters' option to purchase additional shares.

<TABLE>
<CAPTION>
PAID BY SELLING
PAID BY CAPSTONE STOCKHOLDERS TOTAL
-------------------- -------------------- --------------------
NO FULL NO FULL NO FULL
EXERCISE EXERCISE EXERCISE EXERCISE EXERCISE EXERCISE
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Per Share..................... $ $ $ $ $ $
Total......................... $ $ $ $ $ $
</TABLE>

Shares sold by the underwriters to the public will initially be offered at
the public offering price set forth on the cover page 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 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 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.

73
<PAGE> 77

The selling stockholders and Capstone, its directors and officers 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
90 days after the date of this prospectus, except with the prior written consent
of the representatives. This agreement does not apply to gifts or transfers to
affiliates or transactions under any existing employee benefit plans. See
"Shares Eligible for Future Sale" for a discussion of various transfer
restrictions.

The common stock is quoted on the Nasdaq National Market under the symbol
of "CPST".

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 the issuer 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 also may 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 the
issuer'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 Web sites
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. 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.

The underwriters do not expect sales to discretionary accounts to exceed 5%
of the total number of shares offered.

Capstone estimates that its share of the total expenses of the offering,
excluding underwriting discounts and commissions, will be approximately
$750,000.

Capstone and the selling stockholders have agreed to indemnify the several
underwriters against certain liabilities, including liabilities under the
Securities Act.

74
<PAGE> 78

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 (including the exhibits and schedules thereto) under the
Securities Act and the rules and regulations thereunder, for the registration of
the common stock offered hereby. This prospectus is part of the registration
statement. This prospectus does not contain all the information included in the
registration statement because we have omitted parts of the registration
statement as permitted by the Securities and Exchange Commission's rules and
regulations. For further information about us and our common stock, you should
refer to the registration statement. Statements contained in this prospectus as
to any contract, agreement or other document referred to are not necessarily
complete. Where the contract or other document is an exhibit to the registration
statement, each statement is qualified by the provisions of that exhibit.

You can inspect and copy all or any portion of the registration statement
or any reports, statements or other information we file at the public reference
facility maintained by the Securities and Exchange Commission at Room 1024, 450
Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's regional offices at
Seven World Trade Center, 13th Floor, New York, New York 10048 and 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You may call the Securities
and Exchange Commission at 1-800-SEC-0330 for further information about the
operation of the public reference rooms. Copies of all or any portion of the
registration statement can be obtained from the Public Reference Section of the
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. In addition, the registration statement is publicly
available through the Securities and Exchange Commission's site on the
Internet's World Wide Web, located at http://www.sec.gov.

We will also file annual, quarterly and current reports, proxy statements
and other information with the Securities and Exchange Commission. You can also
request copies of these documents, for a copying fee, by writing to the
Securities and Exchange Commission. We intend to furnish to our stockholders
annual reports containing audited financial statements for each fiscal year.

75
<PAGE> 79

CAPSTONE TURBINE CORPORATION

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report of Deloitte & Touche LLP....... F-2
Independent Auditors' Report of Ernst & Young LLP........... F-3
Financial Statements as of December 31, 1998 and 1999 and
September 30, 2000 (Unaudited) and for the Years Ended
December 31, 1997, 1998 and 1999 and the Nine Months Ended
September 30, 1999 (Unaudited) and 2000 (Unaudited):
Balance Sheets............................................ F-4
Statements of Operations.................................. F-5
Statement of Stockholders' (Deficiency) Equity............ F-6
Statements of Cash Flows.................................. F-7
Notes to Financial Statements............................. F-8
</TABLE>

F-1
<PAGE> 80

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders
Capstone Turbine Corporation:

We have audited the accompanying balance sheets of Capstone Turbine
Corporation (the "Company") as of December 31, 1998 and 1999, and the related
statements of operations, stockholders' deficiency, and cash flows for the years
then ended. 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 of America. 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, such financial statements present fairly, in all material
respects, the financial position of Capstone Turbine Corporation as of December
31, 1998 and 1999, and the results of its operations and its cash flows for the
years then ended in conformity with accounting principles generally accepted in
the United States of America.

/s/ DELOITTE & TOUCHE LLP

Los Angeles, California
March 20, 2000
(May 26, 2000 for paragraph 1 of Note 12)

F-2
<PAGE> 81

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders
Capstone Turbine Corporation:

We have audited the accompanying statement of operations, stockholders'
equity, and cash flows for the year ended December 31, 1997. 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 audit.

We conducted our audit 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 audit provides a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of Capstone Turbine Corporation's
operations and cash flows for the year ended December 31, 1997, in conformity
with accounting principles generally accepted in the United States.

The accompanying financial statements have been prepared assuming that the
Capstone Turbine Corporation will continue as a going concern. As more fully
described in Note 1, the Company has incurred significant operating losses and
continues to need to raise additional funding. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
The financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or amounts and
classification of liabilities that may result from the outcome of this
uncertainty.

/s/ ERNST & YOUNG LLP

Woodland Hills, California
April 3, 1998, except for paragraph 1
of Note 12, as to which
the date is May 26, 2000

F-3
<PAGE> 82

CAPSTONE TURBINE CORPORATION

BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- SEPTEMBER 30,
1998 1999 2000
------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents (Note 2)......................... $ 4,943,000 $ 6,858,000 $ 229,783,000
Accounts receivable, net of allowance for doubtful accounts
of $3,000 in 1998 and $50,000 in 1999.................... 79,000 2,425,000 3,384,000
Accounts receivable from related parties (Note 10)......... 17,000 -- --
Inventory (Note 3)......................................... 8,703,000 8,803,000 10,976,000
Prepaid expenses and other current assets.................. 808,000 2,217,000 1,440,000
------------ ------------- -------------
Total current assets..................................... 14,550,000 20,303,000 245,583,000
------------ ------------- -------------
Equipment and Leasehold Improvements (Notes 2 and 7):
Machinery, equipment, and furniture........................ 8,938,000 11,824,000 13,336,000
Leasehold improvements..................................... 182,000 137,000 2,902,000
Molds and tooling.......................................... 397,000 541,000 994,000
------------ ------------- -------------
9,517,000 12,502,000 17,232,000
Less accumulated depreciation and amortization............. 2,706,000 4,570,000 6,203,000
------------ ------------- -------------
Total equipment and leasehold improvements............... 6,811,000 7,932,000 11,029,000
------------ ------------- -------------
Deposits on Fixed Assets (Note 7)........................... 4,340,000 3,374,000 5,296,000
Other Assets................................................ 69,000 422,000 752,000
Intangible Assets, Net (Note 10)............................ 4,896,000 26,856,000
------------ ------------- -------------
Total.................................................... $ 25,770,000 $ 36,927,000 $ 289,516,000
============ ============= =============
LIABILITIES AND STOCKHOLDERS' (DEFICIENCY) EQUITY
Current Liabilities:
Accounts payable........................................... $ 1,230,000 $ 1,728,000 $ 4,581,000
Accrued salaries and wages................................. 520,000 677,000 1,026,000
Other accrued liabilities.................................. 3,957,000 2,340,000 978,000
Accrued warranty reserve................................... 873,000 3,168,000 6,037,000
Deferred revenue (Notes 2 and 10).......................... 4,696,000 5,951,000
Current portion of capital lease obligations (Note 7)...... 1,051,000 1,400,000 1,582,000
------------ ------------- -------------
Total current liabilities................................ 7,631,000 14,009,000 20,155,000
------------ ------------- -------------
Long-Term Portion of Capital Lease Obligations (Note 7)..... 3,398,000 4,499,000 4,381,000
------------ ------------- -------------
Other long-term liabilities................................. 161,000
------------ ------------- -------------
Accrued Dividends Payable (Note 5).......................... 4,268,000 6,175,000 --
------------ ------------- -------------
Commitments and Contingencies (Note 7)
Redeemable Preferred Stock, 80,000,000 Shares Authorized
(Notes 5 and 11):
Series A preferred stock, $.001 par value; 6,570,000 shares
issued and outstanding (involuntary liquidation
preference of $6,570,000, net of unamortized accretion of
origination fees of $49,000 and $37,000) at December 31,
1998 and 1999, respectively.............................. 6,521,000 15,183,000 --
Series B preferred stock, $.001 par value; 3,333,334 shares
issued and outstanding (involuntary liquidation
preference of $5,000,000, net of unamortized accretion of
origination fees of $44,000, and $34,000) at December 31,
1998 and 1999, respectively.............................. 4,956,000 8,928,000 --
Series C preferred stock, $.001 par value; 7,655,018 shares
issued and outstanding (involuntary liquidation
preference of $15,310,000, net of unamortized accretion
of origination fees of $341,000 and $266,000) at December
31, 1998 and 1999, respectively.......................... 14,969,000 23,324,000 --
Series D preferred stock, $.001 par value; 3,125,000 shares
issued and outstanding (involuntary liquidation
preference of $12,500,000, net of unamortized accretion
of origination fees of $18,000 and $14,000) at December
31, 1998 and 1999, respectively.......................... 12,482,000 14,313,000 --
Series E preferred stock, $.001 par value; 10,664,111
shares issued and outstanding (involuntary liquidation
preference of $63,985,000, net of unamortized accretion
of origination fees of $1,283,000 and $995,000) at
December 31, 1998 and 1999, respectively................. 62,696,000 62,984,000 --
Series F preferred stock, $.001 par value; 11,129,246
shares issued and outstanding (involuntary liquidation
preference of $22,258,000, net of unamortized accretion
of origination fees of $2,697,000) at December 31,
1999..................................................... -- 20,903,000 --
Promissory notes associated with Series G preferred stock... -- 10,834,000
------------ ------------- -------------
Total redeemable preferred stock......................... 101,624,000 156,469,000 --
------------ ------------- -------------
Stockholders' (Deficiency) Equity (Notes 5, 6, and 11):
Common stock, $.001 par value; 415,000,000 shares
authorized; 2,171,265, 2,377,826, and 74,938,602 shares
issued and outstanding at December 31, 1998, 1999, and
September 30, 2000, respectively......................... 2,000 2,000 75,000
Additional paid-in capital................................. -- -- 495,818,000
Accumulated deficit........................................ (91,153,000) (144,227,000) (231,074,000)
------------ ------------- -------------
Total stockholders' (deficiency) equity.................. (91,151,000) (144,225,000) 264,819,000
------------ ------------- -------------
Total.................................................... $ 25,770,000 $ 36,927,000 $ 289,516,000
============ ============= =============
</TABLE>

See accompanying notes to financial statements.
F-4
<PAGE> 83

CAPSTONE TURBINE CORPORATION

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------ ----------------------------
1997 1998 1999 1999 2000
------------ ------------ ------------ ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues (Notes 2 and 10):
Product revenue............ $ 1,510,000 $ 76,000 $ 6,694,000 $ 1,315,000 $ 16,029,000
Contract revenue........... 113,000 8,000 -- -- --
------------ ------------ ------------ ------------ -------------
Total revenues........... 1,623,000 84,000 6,694,000 1,315,000 16,029,000
Cost of Goods Sold (Note
3)......................... 8,147,000 5,335,000 15,629,000 4,570,000 20,658,000
------------ ------------ ------------ ------------ -------------
Gross Profit (Loss).......... (6,524,000) (5,251,000) (8,935,000) (3,255,000) (4,629,000)
Operating Costs and Expenses:
Research and development... 13,281,000 19,019,000 9,151,000 6,681,000 8,416,000
Selling, general, and
administrative........... 10,946,000 10,257,000 11,191,000 7,818,000 17,264,000
------------ ------------ ------------ ------------ -------------
Total operating costs and
expenses............... 24,227,000 29,276,000 20,342,000 14,499,000 25,680,000
Interest Income.............. 873,000 1,437,000 452,000 350,000 6,007,000
Interest Expense............. (168,000) (309,000) (721,000) (463,000) (733,000)
Other (Expense)/Income....... (506,000) 327,000 17,000 5,000 (31,000)
------------ ------------ ------------ ------------ -------------
Profit (Loss) Before Income
Taxes...................... (30,552,000) (33,072,000) (29,529,000) (17,862,000) (25,066,000)
Provision for Income Taxes
(Note 4)................... 1,000 1,000 1,000 1,000 1,000
------------ ------------ ------------ ------------ -------------
Net Income (Loss)............ (30,553,000) (33,073,000) (29,530,000) (17,863,000) (25,067,000)
------------ ------------ ------------ ------------ -------------
Preferred Stock Dividends and
Accretion.................. (1,419,000) (2,096,000) (26,700,000) (6,287,000) (559,862,000)
------------ ------------ ------------ ------------ -------------
Net Loss Attributable to
Common Stockholders........ $(31,972,000) $(35,169,000) $(56,230,000) $(24,150,000) $(584,929,000)
============ ============ ============ ============ =============
Weighted Average Common
Shares Outstanding......... 1,699,196 1,980,478 2,292,242 2,267,993 36,317,944
============ ============ ============ ============ =============
Net Loss Per Share of Common
Stock -- Basic and
Diluted.................... $ (18.82) $ (17.76) $ (24.53) $ (10.65) $ (16.11)
============ ============ ============ ============ =============
</TABLE>

See accompanying notes to financial statements.

F-5
<PAGE> 84

CAPSTONE TURBINE CORPORATION

STATEMENT OF STOCKHOLDERS' (DEFICIENCY) EQUITY

<TABLE>
<CAPTION>
COMMON STOCK
--------------------- ADDITIONAL
SHARES PAID-IN ACCUMULATED
OUTSTANDING AMOUNT CAPITAL DEFICIT TOTAL
----------- ------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1997 as previously
reported..................................... 2,588,732 $ 3,000 $ $ (24,179,000) $ (24,176,000)
Three-for-five common stock split.............. (1,035,493) (1,000) 1,000 --
---------- ------- ------------ ------------- -------------
Balance, January 1, 1997, As Adjusted.......... 1,553,239 2,000 1,000 (24,179,000) (24,176,000)
Issuance of common stock..................... 44,339 41,000 41,000
Exercise of stock options and warrants....... 237,076 50,000 50,000
Accretion of preferred stock................. (92,000) (114,000) (206,000)
Dividends accrued for Series A preferred
stock...................................... (297,000) (297,000)
Dividends accrued for Series B preferred
stock...................................... (143,000) (143,000)
Dividends accrued for Series C preferred
stock...................................... (302,000) (302,000)
Dividends accrued for Series D preferred
stock...................................... (209,000) (209,000)
Dividends accrued for Series E preferred
stock...................................... (262,000) (262,000)
Net loss..................................... (30,553,000) (30,553,000)
---------- ------- ------------ ------------- -------------
Balance, December 31, 1997..................... 1,834,654 2,000 -- (56,059,000) (56,057,000)
Exchange of common stock (Note 5)............ (182,639) (70,000) (70,000)
Exercise of stock options.................... 519,250 145,000 145,000
Accretion of preferred stock................. (75,000) (295,000) (370,000)
Dividends accrued for Series A preferred
stock...................................... (329,000) (329,000)
Dividends accrued for Series B preferred
stock...................................... (157,000) (157,000)
Dividends accrued for Series C preferred
stock...................................... (333,000) (333,000)
Dividends accrued for Series D preferred
stock...................................... (231,000) (231,000)
Dividends accrued for Series E preferred
stock...................................... (676,000) (676,000)
Net loss..................................... (33,073,000) (33,073,000)
---------- ------- ------------ ------------- -------------
Balance, December 31, 1998..................... 2,171,265 2,000 -- (91,153,000) (91,151,000)
Common stock warrants granted (Note 5)....... 2,969,000 2,969,000
Common stock options granted (Note 6)........ 135,000 135,000
Exercise of stock options and warrants....... 206,561 53,000 53,000
Accretion of preferred stock................. (3,157,000) (21,637,000) (24,794,000)
Dividends accrued for Series A preferred
stock...................................... (363,000) (363,000)
Dividends accrued for Series B preferred
stock...................................... (174,000) (174,000)
Dividends accrued for Series C preferred
stock...................................... (368,000) (368,000)
Dividends accrued for Series D preferred
stock...................................... (255,000) (255,000)
Dividends accrued for Series E preferred
stock...................................... (747,000) (747,000)
Net loss..................................... (29,530,000) (29,530,000)
---------- ------- ------------ ------------- -------------
Balance, December 31, 1999..................... 2,377,826 2,000 -- (144,227,000) (144,225,000)
Common stock warrants granted................ 8,132,000 8,132,000
Common stock options granted................. 1,239,000 1,239,000
Exercise of stock options and warrants....... 10,793,693 12,000 2,831,000 2,843,000
Repurchase of preferred stock................ 2,209,000 454,000 2,663,000
Accretion of preferred stock................. (13,883,000) (457,593,000) (471,476,000)
Dividends accrued for Series A preferred
stock...................................... (196,000) (196,000)
Dividends accrued for Series B preferred
stock...................................... (94,000) (94,000)
Dividends accrued for Series C preferred
stock...................................... (198,000) (198,000)
Dividends accrued for Series D preferred
stock...................................... (137,000) (137,000)
Dividends accrued for Series E preferred
stock...................................... (403,000) (403,000)
Beneficial conversion feature for Series G
preferred stock (Note 11).................. (89,567,000) (89,567,000)
Dividends waived on preferred stock.......... 440,000 6,309,000 6,749,000
Conversion of preferred stock................ 51,312,037 51,000 341,296,000 479,645,000 820,992,000
Issuance of common stock..................... 10,455,046 10,000 153,554,000 153,564,000
Net loss..................................... (25,067,000) (25,067,000)
---------- ------- ------------ ------------- -------------
Balance, September 30, 2000 Unaudited.......... 74,938,602 $75,000 $495,818,000 $(231,074,000) $ 264,819,000
========== ======= ============ ============= =============
</TABLE>

See accompanying notes to financial statements.

F-6
<PAGE> 85

CAPSTONE TURBINE CORPORATION

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------ ---------------------------
1997 1998 1999 1999 2000
------------ ------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................. $(30,553,000) $(33,073,000) $(29,530,000) $(17,863,000) $(25,067,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization............ 944,000 1,660,000 2,356,000 1,829,000 4,847,000
Provision for inventory reserve.......... 3,918,000 681,000 1,120,000 407,000
Inventory writedown to net realizable
value.................................. 4,225,000
Loss on sale of equipment.................. 150,000 30,000 239,000 179,000 35,000
Non-employee stock compensation............ 41,000 1,050,000 80,000 74,000 60,000
Employee stock compensation................ 131,000 70,000 1,239,000
Changes in operating assets and
liabilities:
Accounts receivable...................... 233,000 51,000 (2,329,000) (699,000) (959,000)
Prepaid expenses and other assets........ (864,000) 360,000 (1,328,000) (284,000) 447,000
Inventory................................ (5,638,000) (9,318,000) (1,220,000) (968,000) (2,580,000)
Accounts payable......................... 3,952,000 (3,856,000) 497,000 (300,000) 2,853,000
Accrued salaries and wages............... 206,000 106,000 157,000 215,000 349,000
Other accrued liabilities................ 2,178,000 1,930,000 (1,617,000) (3,192,000) (1,201,000)
Accrued warranty reserve................. 424,000 (55,000) 2,295,000 410,000 2,869,000
Deferred revenue......................... (707,000) (30,000) 4,696,000 665,000 1,255,000
------------ ------------ ------------ ------------ ------------
Net cash used in operating
activities........................... (25,716,000) (36,239,000) (24,453,000) (19,864,000) (15,446,000)
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of equipment and leasehold
improvements............................. (3,524,000) (4,016,000) (2,449,000) (3,020,000) (5,251,000)
Proceeds from sale of equipment............ 1,183,000 3,140,000 2,338,000 1,445,000 1,253,000
Deposits on fixed assets................... (2,207,000) (2,133,000) (78,000) 907,000 (1,922,000)
Intangible assets.......................... (5,000,000) (1,000,000) (16,550,000)
------------ ------------ ------------ ------------ ------------
Net cash used in investing
activities........................... (4,548,000) (3,009,000) (5,189,000) (1,668,000) (22,470,000)
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital lease obligations..... (226,000) (517,000) (1,119,000) (790,000) (1,150,000)
Exercise of stock options and warrants..... 50,000 145,000 53,000 44,000 3,549,000
Net proceeds from issuance of Series D
preferred stock.......................... 12,475,000
Net proceeds from issuance of Series E
preferred stock.......................... 61,064,000
Net proceeds from promissory notes
associated with Series F preferred
stock....................................
Net proceeds from issuance of Series F
preferred stock.......................... 21,789,000 21,789,000
Proceeds from promissory notes associated
with Series G preferred stock............ 10,834,000
Net proceeds from issuance of Series G
preferred stock.......................... 120,362,000
Repurchase of preferred stock.............. (15,492,000)
Net proceeds from issuance of common
stock.................................... 153,572,000
------------ ------------ ------------ ------------ ------------
Net cash provided by (used in)
financing activities................. 73,363,000 (372,000) 31,557,000 21,043,000 260,841,000
------------ ------------ ------------ ------------ ------------
Net Increase (Decrease) in Cash and Cash
Equivalents.............................. 43,099,000 (39,620,000) 1,915,000 (489,000) 222,925,000
Cash and Cash Equivalents, Beginning of
Year..................................... 1,464,000 44,563,000 4,943,000 4,943,000 6,858,000
------------ ------------ ------------ ------------ ------------
Cash and Cash Equivalents, End of Year..... $ 44,563,000 $ 4,943,000 $ 6,858,000 $ 4,454,000 $229,783,000
============ ============ ============ ============ ============
Supplemental Disclosures of Cash Flow
Information
Cash paid during the year for:
Interest............................... $ 168,000 $ 309,000 $ 630,000 $ 463,000 $ 588,000
Income taxes........................... $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000
</TABLE>

See accompanying notes to financial statements.

F-7
<PAGE> 86

CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS

1. DESCRIPTION OF THE COMPANY

Capstone Turbine Corporation (the "Company") was formed to develop,
manufacture, and market turbine generator sets for use in stationary, vehicular,
and other electrical distributed generation applications. The Company was
organized in 1988, but has only been commercially producing the turbine
generator sets since 1998. Because the Company is in the early stages of selling
the products with relatively few customers, the Company has had uneven order
flow from period to period.

The Company has incurred significant operating losses since its inception.
Management anticipates incurring additional losses until the Company can produce
sufficient revenues to cover costs. There can be no assurance that the Company
will achieve or sustain profitability or positive cash flow from its operations.

To date, the Company has funded its activities primarily through private
equity offerings. The Company received proceeds, net of origination fees, of
approximately $128,098,000 through the issuance of Series G preferred stock in a
private placement, which closed on February 24, 2000. The Company expects to
obtain additional funding through private or public equity offerings until such
time as it achieves positive cash flow from operations; however, there can be no
assurance that such financing will be available on terms satisfactory to the
Company or that positive operating cash flows will be achieved. (See Note 12).

UNAUDITED CONDENSED INTERIM FINANCIAL STATEMENTS -- The condensed financial
statements as of September 30, 2000 and for the nine months ended September 30,
1999 and 2000 are unaudited. In the opinion of management, the unaudited
financial statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of the financial position and the
result of operations as of such date and for such periods. Results of interim
periods are not necessarily indicative of the result to be expected for the
entire fiscal year.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CASH EQUIVALENTS -- The Company considers only those investments that are
highly liquid, readily convertible to cash, and mature within three months from
the date of purchase as cash equivalents.

DEPRECIATION AND AMORTIZATION -- Depreciation and amortization are provided
using the straight-line method over estimated useful lives of the related
assets, ranging from three to five years. Leasehold improvements are amortized
over the period of the lease or the estimated useful life of the asset,
whichever is shorter. Amortization of assets under capital leases is included
with depreciation and amortization expense. Depreciation and amortization
expense was $944,000, $1,660,000 and $2,356,000 for the years ended December 31,
1997, 1998 and 1999, respectively.

LONG-LIVED ASSETS -- The Company reviews the recoverability of long-lived
assets whenever events or changes in circumstances indicate that the carrying
value of such assets may not be recoverable. If the expected future cash flows
from the use of such assets (undiscounted and without interest charges) are less
than the carrying value, the Company's policy is to record a write-down, which
is determined based on the difference between the carrying value of the assets
and their estimated fair value.

PRODUCT AND CONTRACT REVENUES -- The Securities and Exchange Commission
staff (the "Staff") issued Staff Accounting Bulletin Number 101 -- Revenue
Recognition in Financial Statements ("SAB 101") in December 1999. Under the
Company's revenue recognition policy, product revenue

F-8
<PAGE> 87
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

is recognized upon shipment of the product to the customer. There are no rights
of return privileges on product sales. Therefore, there was no impact on the
Company's operating results as a result of its adoption of SAB 101.

WARRANTY POLICY -- Estimated future warranty obligations are provided for
by charges to operations in the period in which the related revenue is
recognized. The warranty reserve is based upon historical and projected product
failure rates, estimated costs to repair or replace a unit and the number of
units covered under the warranty period.

DEFERRED REVENUE -- Deferred revenue consists of customer deposits.
Deferred revenue will be recognized upon shipment of the product to the
customer.

ACCOUNTING FOR STOCK-BASED COMPENSATION -- Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," was effective for the Company beginning January 1, 1996. SFAS No.
123 requires expanded disclosures of stock-based compensation arrangements with
employees and encourages (but does not require) compensation cost to be measured
based on the fair value of the equity instrument awarded. Under SFAS No. 123,
the fair value of stock-based awards to employees is calculated through the use
of option pricing models even though such models were developed to estimate the
fair value of freely tradable and fully transferable options, without vesting
restrictions, which significantly differ from the Company's stock option awards.
Companies are permitted, however, to continue to apply Accounting Principle
Board Opinion ("APB Opinion") No. 25, "Accounting for Stock Issued to
Employees," which recognizes compensation cost based on the intrinsic value of
the equity instrument awarded. The Company has elected to continue to apply APB
Opinion No. 25 in its employee stock-based compensation arrangements (see Note
6). Expense for common stock options granted to non-employees is recorded based
upon the fair value of the equity instrument awarded calculated through the use
of an option-pricing model.

RISK CONCENTRATIONS -- Financial instruments that potentially subject the
Company to concentrations of credit risk consist primarily of cash equivalents
and accounts receivable. The Company places its cash equivalents with high
credit quality institutions.

Two customers account for 31% and 22% of the Company's revenues for the
year ended December 31, 1997. The Company had no other customers, which
represent 10% or more of its sales. The Company had sales to a single customer
of $1,858,000 that represented approximately 28% of the Company's revenues for
the year ended December 31, 1999. The Company has net accounts receivable from
two customers of approximately $275,000 and $277,000, respectively, that each
represented approximately 11% of total accounts receivable at December 31, 1999.

There is a sole source of recuperator cores, a key component, used in the
Company's products. The Company is not aware of any other suppliers who would
produce these cores to the Company's specifications and time requirements.
Although the Company has a license agreement, which would permit the production
of the cores in-house in the event the vendor terminates production, the Company
would not be able to assume production without significant delays and
interruptions (See Note 12).

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

NET LOSS PER COMMON SHARE -- Basic loss per common share is computed using
the weighted-average number of common shares outstanding for the period. Diluted
loss per common

F-9
<PAGE> 88
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

share reflects the potential dilution that could occur if securities were
exercised or converted into common stock. The weighted-average number of common
shares outstanding, was 1,699,196, 1,980,478 and 2,292,242 in 1997, 1998 and
1999, respectively. The impact of common stock options, outstanding preferred
stock, warrants for preferred stock, and warrants for common stock have not been
included for purposes of the computation of diluted earnings per share as their
inclusion would have had an antidilutive effect on the per-share amounts for the
periods presented; therefore, diluted loss per share is equal to basic loss per
share. Antidilutive common stock options and warrants were 2,625,508, 3,417,664
and 14,303,142 in 1997, 1998 and 1999, respectively.

SUPPLEMENTAL CASH FLOW INFORMATION -- During 1997, 1998 and 1999, the
Company financed machinery purchases of $1,230,000, $3,162,000 and $2,467,000,
respectively, through capital lease obligations.

During 1997, the Company issued 3,125,000 and 10,453,145 shares of Series D
and E preferred stock, respectively. During 1998, the Company issued 170,000,
53,407 and 209,966 additional shares of Series A, C and E preferred stock,
respectively. During 1999, the Company issued 1,000 additional shares of Series
E preferred stock and 11,129,246 shares of Series F preferred stock.

During 1998 and 1999, the Company issued approximately $1,534,000 and
$76,000, respectively, of preferred stock for services rendered by several
vendors, of which approximately $1,050,000 and $76,000 was expensed during 1998
and 1999, respectively, and approximately $484,000 was accrued at December 31,
1997. The expense was recorded at the fair value of services received.

During 1999, the Company granted 12,000 common stock options to a
consultant. The fair value of these options was determined to be $37,000 of
which $4,000 was recorded as expense in 1999. The remaining $33,000 will be
recognized over the vesting period.

SEGMENT REPORTING -- The Company is considered to be a single operating
segment in conformity with Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information." The
business activities of said operating segment are the development, manufacture
and sale of turbine generator sets. Following is the geographic revenue
information:

<TABLE>
<CAPTION>
(UNAUDITED)
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
--------------------------------- ------------------------
1997 1998 1999 1999 2000
---------- ------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
North America.................... $1,623,000 $84,000 $4,811,000 $1,059,000 $10,261,000
Asia............................. -- -- 1,608,000 161,000 5,264,000
Europe........................... -- -- 275,000 95,000 504,000
---------- ------- ---------- ---------- -----------
Total Revenues................. $1,623,000 $84,000 $6,694,000 $1,315,000 $16,029,000
========== ======= ========== ========== ===========
</TABLE>

NEW ACCOUNTING PRONOUNCEMENT -- In June 1998, the Financial Accounting
Standards Board issued SFAS No. 133, "Accounting for Derivative Instrument and
Hedging Activities." SFAS No. 133 establishes accounting and reporting standards
for derivative instruments. It requires the recognition of all derivatives as
either assets or liabilities in the statement of position and measurement of the
instruments at fair value. The Company is required to adopt SFAS No. 133, as
amended, on January 1, 2001 and is currently evaluating the impact on the
financial statements.

F-10
<PAGE> 89
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

3. INVENTORIES

Inventories are stated at the lower of standard cost (which approximates
actual cost on the first-in, first-out method) or market. The amounts below are
net of $2,537,000, $3,243,000 and $2,120,000 of obsolescence reserves at
December 31, 1998 and 1999 and September 30, 2000, respectively.

<TABLE>
<CAPTION>
DECEMBER 31, (UNAUDITED)
------------------------ SEPTEMBER 30,
1998 1999 2000
---------- ---------- -------------
<S> <C> <C> <C>
Raw materials......................... $7,954,000 $7,579,000 $ 8,788,000
Work in process....................... 749,000 1,036,000 1,694,000
Finished goods........................ 188,000 494,000
---------- ---------- -----------
$8,703,000 $8,803,000 $10,976,000
========== ========== ===========
</TABLE>

4. INCOME TAXES

Significant components of the Company's deferred income tax assets
(liabilities) and related valuation allowance at December 31, 1998 and 1999 are
as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1998 1999
------------ ------------
<S> <C> <C>
Current deferred income tax assets:
Inventory........................................ $ 2,820,000 $ 1,389,000
Warranty reserve................................. 374,000 1,356,000
Other............................................ 1,623,000 1,033,000
Current deferred income tax liabilities:
State taxes...................................... (2,733,000) (3,968,000)
Other............................................ (265,000) (549,000)
------------ ------------
Net current deferred income tax asset
(liability)...................................... 1,819,000 (739,000)
------------ ------------
Long-term deferred assets:
Net operating loss carryforwards................. 32,704,000 43,656,000
Tax credit carryforwards......................... 4,051,000 8,117,000
------------ ------------
Net long-term deferred income tax asset............ 36,755,000 51,773,000
Valuation allowance................................ (38,574,000) (51,034,000)
------------ ------------
Total deferred income tax asset............... $ -- $ --
============ ============
</TABLE>

Due to the uncertainty surrounding the timing of realizing the benefits of
its favorable tax attributes in future income tax returns, the Company has
placed a valuation allowance against its otherwise recognizable deferred income
tax assets.

F-11
<PAGE> 90
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

The Company's net operating loss and tax credit carryforwards for federal
and state income tax purposes at December 31, 1999 are as follows:

<TABLE>
<CAPTION>
EXPIRATION
PERIOD
------------
<S> <C> <C>
Federal NOL......................................... $105,742,000 2008 to 2019
State NOL........................................... 88,178,000 2000 to 2004
Federal tax credit carryforwards.................... 4,750,000 2008 to 2014
State tax credit carryforwards...................... 3,367,000 2008 to 2014
</TABLE>

The net operating losses and federal and state tax credits can be carried
forward to offset future taxable income, if any. Utilization of the net
operating losses and tax credits are subject to an annual limitation due to the
ownership change limitations provided by the Internal Revenue Code of 1986 and
similar state provisions.

A reconciliation of income tax benefit to the federal statutory rate
follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Federal income tax at the statutory
rate............................... $(10,388,000) $(11,245,000) $(10,040,000)
State taxes, net of federal
benefit............................ (2,121,000) (2,017,000) (2,610,000)
Other................................ (1,411,000) (3,277,000) 190,000
Valuation allowance.................. 13,920,000 16,539,000 12,460,000
------------ ------------ ------------
$ -- $ -- $ --
============ ============ ============
</TABLE>

5. CAPITAL STRUCTURE

The preferred stock is convertible into common stock at each holder's
option at any time after issuance. In the event of a public offering of the
Company's equity securities in the amount of $30 million or greater and at a
price no less than $13.33 per share (see Note 12), as adjusted, or an
affirmative vote of the stockholders of each class of stock, all preferred stock
will automatically be converted into common stock.

Preferred stock, in most circumstances, is convertible to common stock on a
one-for-one basis. The conversion rates may change in the event of a stock
split, combination or, if any additional shares are issued at less than an
earlier preferred stock series original issue price. If additional shares are
issued at a price less than earlier issuances, the conversion rate is increased
for those series by a factor based upon the original number of shares, the new
shares issued and the total amount of consideration received by the Company for
the new shares. As a result of the Series F preferred stock issuance on May 31,
1999, Series B, C, D, and E preferred stock were convertible at a factor of
1.17, 1.28, 1.50 and 1.59, respectively. The voting rights of the Series A,
Series B, Series C, Series D, Series E and Series F preferred stock are equal to
the number of shares of common stock into which such shares may be converted.

Preferred stock must be redeemed by the Company if it receives written
certification on or before August 30, 2002 that no less than 75 percent of the
preferred stockholders have elected in favor of redemption. The Series A, Series
B, Series C, Series D, Series E and Series F preferred stock redemption price is
equal to the greater of $1.00, $1.50, $2.00, $4.00, $6.00 and $2.00 per share,
respectively, or the fair market value per share at the redemption date. In the
event that the preferred stockholders elect in favor of redemption, the
preferred stock will be redeemed in two equal installments on or about January
1, 2003 and January 1, 2004.

F-12
<PAGE> 91
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

The Company is accreting the difference between the redemption value and
the net proceeds received in each preferred stock offering under the effective
interest method from the stock issuance date to the redemption dates. During
1999, the fair value of Series A, B, C, D and F exceeded the stated value which
resulted in additional accretion of $8,650,000, $3,962,000, $8,280,000,
$1,827,000 and $1,342,000, respectively.

Each share of Series A, B, C, D, E and F preferred stock entitles the
holder to receive dividends at an annual rate of $.10, $.15, $.20, $.40, $.60
and $.20 per share, respectively, at the discretion and declaration of the Board
of Directors. Dividends are payable in cash unless conversion to common stock
occurs prior to payment. Upon conversion, unpaid dividends shall be deemed
waived by the holders of all preferred stock. Until April 1, 1998, July 30,
2000, July 30, 2001, December 31, 2001, August 30, 2002, and February 26, 2004,
the rights to dividends upon the issued and outstanding shares of Series A, B,
C, D, E and F preferred stock, respectively, is non-cumulative, unless and until
such dividends have been declared by the Board of Directors. After April 1,
1998, July 30, 2000, July 30, 2001, December 31, 2001, August 30, 2002, and
February 26, 2004, the rights to dividends at a minimum of the respective rates
from that date become cumulative regardless of formal declaration from the Board
of Directors for Series A, B, C, D, E and F, respectively.

The Company records the preferred stock dividend accrual under the
effective interest method. The actual cash liability was $493,000 and $1,150,000
at December 31, 1998 and 1999, respectively. No dividends have been declared or
paid as of December 31, 1999.

In 1999, the Company received $10,834,000 in exchange for promissory notes
associated with the Series G preferred stock from various stockholders. These
notes represent promissory notes to the respective stockholders and bear
interest from the deposit date until stock issuance at 5.54%. Interest expense
associated with these notes was $90,000 for the year ended December 31, 1999 all
of which is payable on the stock issuance date.

During 1998, the Company issued 170,000 shares of Series A, 53,407 shares
of Series B and 80,992 shares of Series E preferred stock to various common
stockholders in a one-for-one exchange for common stock.

In the event of liquidation, dissolution, or winding up the Company, the
preferred stockholders, on a pro rata basis, shall be entitled to receive assets
available for distribution, prior to any distribution to common stockholders.

The following table summarizes the Company's common and preferred stock
warrants outstanding as of December 31, 1998 and 1999:

<TABLE>
<CAPTION>
1998 1999
------------------------------------------ --------------------------------------------
NUMBER OF NUMBER OF
COMMON SHARES EXERCISE COMMON SHARES EXERCISE
ISSUABLE PRICE EXPIRATION DATE ISSUABLE PRICE EXPIRATION DATE
------------- -------- --------------- ------------- -------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Common stock
warrants.............. 73,213 $0.17 July 31, 1999 8,396,624 $0.33 February 26, 2006
======
90,000 0.50 August 30, 2006
40,606 5.00 October 31, 2006
---------
8,527,230
=========
</TABLE>

F-13
<PAGE> 92
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

<TABLE>
<CAPTION>
1998 1999
----------------------------------------------- -----------------------------------------------
NUMBER OF NUMBER OF
PREFERRED EXERCISE PREFERRED EXERCISE
SHARES ISSUABLE PRICE EXPIRATION DATE SHARES ISSUABLE PRICE EXPIRATION DATE
--------------- -------- ------------------ --------------- -------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Preferred stock
warrants:
Series A........... 92,000 $1.00 December 5, 2003 92,000 $1.00 December 5, 2003
Series C........... 30,303 $3.30 July 31, 2001 30,303 $3.30 July 31, 2001
Series C........... 1,020,322 $2.00 February 28, 2003 1,020,322 $2.00 February 28, 2003
--------- ---------
1,142,625 1,142,625
========= =========
</TABLE>

In 1999, the Company granted 8,692,230 common stock warrants at a weighted
average exercise price of $0.36. 8,396,624 warrants at an exercise price of
$0.33 were issued to Series F preferred stock stockholders. The fair value on
the date of grant was approximately $2,645,000, which was recorded as additional
paid-in capital. 90,000 common stock warrants at an exercise price of $0.50 were
granted to two stockholders relating to the Series G financing. The fair value
on the date of grant was approximately $263,000, which was recorded as
additional paid-in capital. 40,606 common stock warrants at an exercise price of
$5.00 were granted to a lessor. The fair value on the date of grant was
approximately $61,000, which was recorded as a prepaid asset and additional
paid-in capital (see Note 10). The prepaid asset is being amortized as rent
expense over the related lease term. The Company also granted 165,000 warrants
at an exercise price of $0.50 to two stockholders relating to the Series G
financing. The fair value of $483,000 was recorded as a liability at December
31, 1999. Upon issuance in January 2000 the fair value was recorded as
additional paid-in capital. These common stock warrants expire on August 31,
2006. The fair value of the common stock warrants were determined using the
Black-Scholes model.

6. STOCK OPTION PLANS

The Company has an Incentive Stock Option Plan, which provides for the
granting of options for the purchase of up to 7,800,000 shares of the Company's
common stock. Under terms of the plan, options may be granted to employees,
non-employee directors and consultants. Options principally vest over periods up
to four years from the date of grant and generally expire ten years from such
grant.

Prior to 1999, the Company issued common stock options at exercise prices
equal to, or greater than, the fair value of its common stock. Accordingly, no
stock-based compensation was recorded for those periods.

During 1999, the Company issued common stock options at less than the fair
value of its common stock. Accordingly, the Company recorded stock-based
compensation of $131,000 to expense in 1999. This 1999 expense was included in
cost of goods sold, research and development and selling, general and
administrative expenses in the amount of $2,000, $24,000 and $105,000,
respectively. At December 31, 1999, the Company had $977,000 in deferred stock
compensation related to such options, which will be recognized as stock-based
compensation expense through 2003.

F-14
<PAGE> 93
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Information relating to the outstanding stock options is as follows:

<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Outstanding at January 1, 1997..................... 1,765,523 $0.27
Granted.......................................... 480,900 0.93
Exercised........................................ (237,076) 0.22
Canceled......................................... (142,627) 0.35
---------
Outstanding at December 31, 1997................... 1,866,720 0.43
Granted.......................................... 1,604,100 1.32
Exercised........................................ (519,250) 0.28
Canceled......................................... (292,694) 0.55
---------
Outstanding at December 31, 1998................... 2,658,876 0.98
Granted.......................................... 2,952,720 0.37
Exercised........................................ (133,348) 0.30
Canceled......................................... (387,911) 1.02
---------
Outstanding at December 31, 1999................... 5,090,337 0.63
=========
</TABLE>

Additional information regarding options outstanding at December 31, 1999,
is as follows:

<TABLE>
<CAPTION>
OPTIONS
OPTIONS OUTSTANDING EXERCISABLE
---------------------------------------- --------------
NUMBER OF SHARES
OUTSTANDING AT WEIGHTED-AVERAGE EXERCISABLE AT
DECEMBER 31, REMAINING CONTRACTUAL DECEMBER 31,
EXERCISE PRICES 1999 LIFE (IN YEARS) 1999
--------------- ---------------- --------------------- --------------
<S> <C> <C> <C>
$0.17.................... 28,782 4.7 28,782
0.25.................... 159,002 5.8 155,443
0.33.................... 3,085,601 9.1 575,434
0.50.................... 63,900 9.8
0.67.................... 85,200 7.3 55,294
1.00.................... 1,371,212 8.2 717,904
2.50.................... 296,640 8.8 79,737
--------- ---------
5,090,337 8.7 1,612,594
========= =========
</TABLE>

As of December 31, 1999, 1,612,594 shares were exercisable and 1,648,597
shares were available for future grant.

If the Company recognized employee stock option-related compensation
expense in accordance with SFAS No. 123 and used the minimum value method for
determining the fair value of options granted after December 31, 1994, its net
loss attributable to common stockholders and net loss per share -- basic and
diluted would have been $32,026,000 and $18.85, respectively, for the year ended
December 31, 1997, $35,370,000 and $17.86, respectively, for the year ended
December 31, 1998 and $56,739,000 and $24.75, respectively, for the year ended
December 31, 1999.

In computing the impact of SFAS No. 123, the weighted-average fair value of
$.27, $.37 and $.45 for 1997, 1998 and 1999 stock option grants, respectively,
was estimated at the dates of grant using the minimum value model with the
following assumptions for 1997, 1998 and 1999: risk-free

F-15
<PAGE> 94
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

interest rate of approximately 6.0, 5.3 and 5.4 percent, and no assumed dividend
yield. The weighted average expected life of the options was 6, 6, and 4 years
for 1997, 1998 and 1999, respectively.

For purposes of determining the SFAS No. 123 pro forma compensation
expense, the weighted-average fair value of the options is amortized over the
vesting period.

7. COMMITMENTS AND CONTINGENCIES

At December 31, 1998 and 1999, respectively, the Company had equipment
under capital leases with a cost of $5,235,000 and $7,703,000 and accumulated
amortization of $969,000 and $2,276,000, respectively. The lease terms range
from three to five years. The deferred gain on sale-leaseback capital lease
obligations was $167,000 and $122,000 as of December 31, 1998 and 1999,
respectively, which is being recognized as an offset to amortization expense
over the useful life of the asset. The capital lease obligations are
collateralized by the related assets.

The Company leases office, manufacturing and warehouse space under various
non-cancelable operating leases. Rent expense related to these leases amounted
to approximately $347,000, $819,000 and $954,000 for the years ended December
31, 1997, 1998 and 1999, respectively.

At December 31, 1999, the Company's commitments under non-cancelable
operating and capital leases were as follows:

<TABLE>
<CAPTION>
1999
----------------------------------
YEAR ENDING DECEMBER 31 OPERATING LEASES CAPITAL LEASES
----------------------- ---------------- --------------
<S> <C> <C>
2000........................................... $ 755,000 $2,098,000
2001........................................... 723,000 1,880,000
2002........................................... 756,000 1,477,000
2003........................................... 772,000 1,445,000
2004........................................... 794,000 595,000
Thereafter..................................... 4,578,000 --
---------- ----------
Total minimum lease payments................. $8,378,000 $7,495,000
==========
Less amount representing interest.............. 1,596,000
----------
Net present value.............................. 5,899,000
Less current portion........................... 1,400,000
----------
Long-term portion.............................. $4,499,000
==========
</TABLE>

At December 31, 1998 and 1999, the Company has approximately $134 million
and $132 million, respectively, of commitments under a long-term purchase
agreement for components and subassembly units, which expires on August 25,
2007. Purchases under this agreement were $4.2 million, $8.5 million and
$684,000 for the years ended December 31, 1997, 1998 and 1999, respectively.
There are no required minimum yearly purchases under this agreement (See Note
12). The Company also has $4,340,000 and $3,374,000 of deposits with several
companies for machinery and tooling for future production in the normal course
of business, respectively. The Company is committed to purchase approximately $2
million of the components and subassembly units in 2000.

The Company has a $1 million standby letter of credit, which serves as a
guarantee for one of the purchase commitments. This letter of credit expires on
March 31, 2000.

A stockholder of the Company alleges damages as a result of alleged
representations made by the Company and some of the Company's present and former
officers in connection with the Series E Preferred Stock offering in 1997. As of
March 20, 2000, it was not possible to determine what effect,

F-16
<PAGE> 95
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

if any, the ultimate resolution of this case would have on the Company's
financial statements. (See Note 12).

The Company is involved in various other legal proceedings, claims, and
litigation arising in the ordinary course of business. In the opinion of
management, the outcome of such legal proceedings, claims, and litigation will
not have a material adverse affect the Company's financial statements.

8. EQUIPMENT LEASE LINE

During 1997, the Company entered into an equipment lease line agreement
with a leasing institution that provides for sale-leaseback transactions up to a
cumulative maximum of $20,000,000. The equipment lease line was renewed during
1999 for one year and provides for sale-leaseback transactions up to a maximum
of $10,000,000. Under this revised agreement, $4,394,000 was available for
future financing transactions at December 31, 1999.

9. EMPLOYEE BENEFIT PLAN

The Company maintains a defined contribution 401(k) profit-sharing plan in
which all employees are eligible to participate. Employees may contribute up to
15 percent of their eligible compensation. Employees are fully vested in their
contributions to the plan. The plan also provides for both Company matching and
discretionary contributions, which are to be determined by the Board of
Directors. No Company contributions have been made to the plan since its
inception.

10. RELATED PARTY TRANSACTIONS

During 1997, an affiliated company ceased operations. The Company purchased
equipment and improvements in the amount of $590,000 from the affiliated
company. Additionally, the Company assumed leases for certain facilities
previously occupied by the affiliated company.

During 1997 and 1998, the Company was reimbursed $137,000 and $39,000,
respectively, by a related company, for the use of the Company's office facility
as well as for other expenses, and had a $17,000 receivable from that Company
for these expenses as of December 31, 1998.

In 1999, the Company entered into non-exclusive marketing agreements with
two distributors. These agreements include product purchase and equity
investment commitments in Series G preferred stock on behalf of the
distributors. Sales to these distributors were $1 million in 1999 and deferred
revenue amounted to approximately $4.2 million as of December 31, 1999.
Promissory notes related to Series G preferred stock from these distributors
amounted to $6.2 million as of December 31, 1999.

In conjunction with the Series B preferred stock issuance in 1995 a
shareholder acquired the exclusive marketing rights for certain territories. In
1999, the Company reacquired these marketing rights. As part of the agreement
the Company paid $5 million toward a variable upfront payment to determine
future royalty rates, which was capitalized as an intangible asset and is being
amortized over 6 years. Accumulated amortization was $104,000 as of December 31,
1999. In January 2000, the Company paid an additional $4 million toward the
variable upfront payment, which resulted in a future royalty rate of 4% to a
maximum of $11.0 million. The future royalty rate maximum payment is accelerated
in the event of a qualifying public offering. The agreement stipulates
additional stock consideration of $5 million, which is contingent upon future
stock issuances. The criteria for payment of the stock consideration were not
met as of December 31, 1999. On February 24, 2000, the Company issued 1,250,000
shares of the Series G preferred stock with a liquidation preference of $4.00
per share for no further consideration in fulfillment of the stock issuance
obligation (See Note 11). This stock issuance was part of the consideration paid
to reacquire the marketing rights
F-17
<PAGE> 96
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

and therefore was recorded at fair value in accordance with SFAS 123. This stock
consideration is in addition to the upfront payments and does not affect the
future royalty payments. The stock consideration, including the beneficial
conversion feature, was recorded as an intangible asset and is being amortized
over the six-year period of the agreement. Sales made to this stockholder and an
affiliate were $247,000 in 1999.

The Company has existing warrants with a lessor to purchase 30,303 shares
of Series C preferred stock at a per share price equal to $3.30 per share which
were issued in 1996.

During 1999, the Company granted a lessor 40,606 common stock warrants. The
fair value on the date of grant was approximately $61,000, which was recorded as
additional paid-in capital. Additional shares may be purchased by the lessor
upon the Company obtaining additional financing under the Equipment lease line
agreement. The lessor can exercise the warrants for no consideration and receive
in exchange the number of common stock shares, which represent the difference
between the fair market value on the date exercised and the exercise price.

Certain vendors of the Company are also stockholders to which payments of
$1,417,000, $4,587,000 and $3,370,000 were made during 1997, 1998 and 1999,
respectively. The accounts payable to stockholders was $290,000 and $189,000 as
of December 31, 1998 and 1999, respectively. Capital lease obligations to
stockholders were $4,423,000 and $5,633,000 as of December 31, 1998 and 1999,
respectively.

11. SERIES G PREFERRED STOCK ISSUANCE

On February 24, 2000, the company closed the Series G preferred stock
issuance for $4.00 per share in a private placement. Proceeds, net of
origination fees, to the Company approximated $128.1 million. 35,683,979 shares
of Series G were issued which includes 1,250,000 shares issued to an existing
stockholder for no consideration (see Note 10) and 58,979 shares issued to
holders of promissory notes for accrued interest. The Series G preferred stock
was issued with a beneficial conversion feature as the fair value of the common
stock into which the preferred stock is convertible exceeds the carrying value.
The beneficial conversion feature was determined to be approximately $89.6
million. This amount will be accounted for as an increase in and a charge to
additional paid-in capital and an in-substance dividend to the preferred
stockholders in the first quarter of 2000 and accordingly will increase the loss
applicable to common stockholders.

The Company is committed to issue 739,577 common stock warrants at a per
share exercise price of $0.67 to an investment banker for services rendered in
conjunction with the Series G preferred stock offering. The fair value of these
warrants will be recorded as origination fees at the time of issuance.

12. SUBSEQUENT EVENTS

On May 26, 2000 a three-for-five reverse split of the Company's outstanding
common stock became effective. All share and per share amounts in the
accompanying financial statements have been retroactively restated to reflect
this stock split. As a result of the stock split, Series A, B, C, D, E, F and G
preferred stock became convertible at a factor of .60, .70, .77, .90, .95, .60
and .60, respectively into common stock.

F-18
<PAGE> 97
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

UNAUDITED

Capital Structure

On June 28, 2000, the Company entered into an agreement to sell
approximately 10.5 million shares of common stock at an offering price of $16.00
per share through an initial public stock offering. All of the shares sold in
the offering were sold by the Company. The gross proceeds from the initial
public offering were $167.3 million and the Company incurred $13.7 million in
costs in connection with the offering.

Prior to the public offering, the Company had several series of preferred
stock outstanding. It therefore accreted the difference between the redemption
value of each series of preferred stock and the net proceeds received in each
preferred stock offering under the effective interest method from the respective
stock issuance date of each series to the respective redemption date. The
accretion was recorded as a component of loss attributable to common
shareholders. The Company also recorded the accrual of preferred stock dividends
under the effective interest method. In February 2000, the Company issued its
Series G preferred stock, which was issued with an $89.6 million beneficial
conversion feature, as the fair value of the common stock into which the
preferred stock was convertible exceeded the carrying value.

As a result of the Company's public offering, the remaining fair value
accretion with respect to its preferred stock of $471.5 million was recorded as
a component of loss attributable to common shareholders during the nine-month
period ended September 30, 2000. All outstanding shares of the Company's
preferred stock converted into approximately 51.3 million shares of common stock
as a result of the public offering. Of the $821.0 million carrying value of the
preferred stock, $479.6 million was recorded as an decrease to accumulated
deficit and $341.3 million was recorded as an increase to additional paid-in
capital, amounts equal to previously recorded accretion charges.

The Company accrued $1.0 million in preferred stock dividends, which were
recorded as a component of earnings attributable to common shareholders during
the nine-month period ended September 30, 2000. $6.7 million in accrued
preferred stock dividends were waived as a result of the automatic conversion of
preferred stock into common stock and were also reversed, which resulted in an
increase to accumulated deficit of $6.3 million and an increase to additional
paid-in capital of $440,000, amounts equal to previously recorded dividend
accrual charges.

As part of a stock repurchase and settlement agreement entered into by the
Company in May 2000, the Company reacquired 2,319,129 shares of Series E
preferred stock for $6.68 per share, which was less than the carrying value on
the reacquisition date. The excess carrying value over the reacquisition price
of $2.2 million was recorded as additional paid-in capital and included as a
component of net loss attributable to common shareholders during the nine-months
ended September 30, 2000.

10,793,693 shares of common stock were issued from the exercise of common
and preferred stock warrants during the nine-month period ended September 30,
2000.

Stock Option Plans

In June 2000, the Company adopted the 2000 Equity Incentive Plan, as a
successor plan to the 1993 Incentive Stock Plan. The 2000 Plan provides for
awards of up to 3,300,000 shares of common stock, plus the number of shares
previously authorized and remaining available under the 1993 plan. In June 2000,
the Company adopted the 2000 Employee Stock Purchase Plan, which provides for
the issuance of up to 900,000 shares.

F-19
<PAGE> 98
CAPSTONE TURBINE CORPORATION

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

During 1999 and the nine-months ended September 30, 2000, the Company
issued common stock options at less than the fair value of its common stock.
Accordingly, the Company recorded stock-based compensation expense of $70,000
and $1,239,000 for the nine-month periods ended September 30, 1999 and September
30, 2000, respectively. Stock-based compensation expense for the nine-month
period ended September 30, 1999 was included in cost of goods sold, research and
development and selling, general, and administrative expenses in the amounts of
$1,000, $13,000 and $56,000, respectively. Stock-based compensation expense for
the nine-month period ended September 30, 2000 was included in cost of goods
sold, research and development, and selling, general, and administrative
expenses in the amounts of $43,000, $233,000, and $963,000, respectively. As of
September 30, 2000, the Company had $6.6 million in deferred stock compensation
related to stock options, which will be recognized as stock-based compensation
expense through 2004.

1,191,000 stock options were granted at a weighted average exercise price
of $5.07 during the nine-month period ended September 30, 2000.

Commitments and Contingencies

In August 2000, the Company entered into a Transition Agreement and Amended
and Restated License Agreement with a supplier, requiring a total of $9.1
million in payments. $3.1 million was paid in August 2000 and the balance is
owed based on various milestones through April 2001. Under the terms of the
Agreements, the Company will acquire fixed assets and manufacturing technology,
which will provide the Company with the ability to manufacture components
previously purchased from the supplier. The Agreements require the Company to
pay a per unit royalty fee over a seventeen-year period. As a result of these
agreements, the Company and supplier mutually terminated any obligations under
their prior agreements.

Related Party Transactions

In addition, the agreement for the repurchase of the marketing rights
provided for the acceleration of future royalty payments in the event of an
initial public offering. In July 2000, the Company paid $11.0 million in royalty
payments, consisting of $204,000 in previously recorded royalty liability and
$10.8 million in accelerated royalty liability. As of September 30, 2000, the
Company has recorded as an intangible asset $25.3 million reflecting the
repurchase of the marketing rights, which are being amortized over the original
agreement period of 6 years. The Company recorded $2.8 million in amortization
expense relating to this intangible asset to selling, general, and
administrative expenses for the nine-month period ended September 30, 2000.

During June and July 2000, the Company loaned an aggregate of $300,000 to
two of its senior vice presidents. The loans are secured by deeds of trusts and
bear interest at 6.80%. As of September 30, 2000, $300,000 of the principal
amount of the loans were outstanding. The notes require repayment in four annual
installments beginning in 2001.

F-20
<PAGE> 99

[COLLAGE OF PHOTOS: TURBINE BLADE, CAPSTONE TURBINE PRODUCT CASING, OIL RIG,
BUS, CLOUDS, BRANCH WITH WET LEAVES, SCHEMATIC ENGINEERING DIAGRAM]
<PAGE> 100

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

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 DATES.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary...................... 1
Risk Factors............................ 6
Forward-Looking Statements.............. 16
Use of Proceeds......................... 17
Dividend Policy......................... 17
Price Range of Common Stock............. 17
Capitalization.......................... 18
Selected Historical Financial Data...... 19
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................ 21
Business................................ 27
Management.............................. 47
Certain Relationships and Related
Transactions.......................... 59
Principal and Selling Stockholders...... 61
Description of Capital Stock............ 70
Shares Eligible for Future Sale......... 71
Validity of Common Stock................ 72
Experts................................. 72
Change of Auditors...................... 72
Underwriting............................ 73
Where You Can Find More Information..... 75
Index to Financial Statements........... F-1
</TABLE>

----------------------------------------------------------
----------------------------------------------------------
----------------------------------------------------------
----------------------------------------------------------
7,000,000 Shares

CAPSTONE TURBINE CORPORATION
Common Stock
----------------------

[CAPSTONE LOGO]

----------------------
GOLDMAN, SACHS & CO.
CREDIT SUISSE FIRST BOSTON
MERRILL LYNCH & CO.
MORGAN STANLEY DEAN WITTER
Representatives of the Underwriters
----------------------------------------------------------
----------------------------------------------------------
<PAGE> 101

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the estimated expenses payable by us in
connection with the offering (excluding underwriting discounts and commissions):

<TABLE>
<CAPTION>
NATURE OF EXPENSE AMOUNT
----------------- --------
<S> <C>
SEC Registration Fee........................................ $102,286
NASD Filing Fee............................................. 30,500
Nasdaq National Market Listing Fee.......................... 10,000
Accounting Fees and Expenses................................ 100,000
Legal Fees and Expenses..................................... 300,000
Printing Expenses........................................... 100,000
Blue Sky Qualification Fees and Expenses Transfer Agent's
Fee....................................................... 52,500
Miscellaneous............................................... 54,714
--------
Total..................................................... $750,000
========
</TABLE>

The amounts set forth above, except for the Securities and Exchange Commission
and National Association of Securities Dealers, Inc. fees, are in each case
estimated.

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law allows for the
indemnification of officers, directors and any corporate agents in terms
sufficiently broad to indemnify such persons under certain circumstances for
liabilities (including reimbursement for expenses incurred) arising under the
Securities Act. Our certificate of incorporation and our bylaws provide for
indemnification of our directors, officers, employees and other agents to the
extent permitted by the Delaware General Corporation Law. We have also entered
into agreements with our directors and executive officers that require Capstone
among other things to indemnify them against certain liabilities that may arise
by reason of their status or service as directors and to maintain officers
liability insurance, which provides coverage against certain liabilities
including liabilities under the Securities Act.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

(a) Issuances of Shares of Preferred Stock and Preferred Stock Warrants

On August 22, 1997, and November 21, 1997, Capstone issued and sold
5,865,814 and 4,587,331 shares of its Series E Preferred Stock, respectively to
seventy-four accredited investors for an aggregate purchase price equal to
$63,979,000. This issuance was deemed to be exempt from registration under the
Securities Act in reliance on Section 4(2) of the Securities Act or Regulation D
promulgated thereunder as a sale by an issuer not involving a public offering.

On May 31, 1999, 11,095,496 shares of Series F preferred stock, in the
aggregate amount of $22,190,992, were issued to sixty-six accredited investors.
This issuance was deemed to be exempt from registration under the Securities Act
in reliance on Section 4(2) of the Securities Act or Regulation D promulgated
thereunder as a sale by an issuer not involving a public offering.

On February 24, 2000, Capstone issued and sold 35,683,979 shares of its
Series G Preferred Stock to 140 accredited investors for an aggregate purchase
price equal to $137,500,000. This issuance was deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act or Regulation D promulgated thereunder as a sale by an issuer not
involving a public offering.

II-1
<PAGE> 102

(b) Issuances of Common Stock and Common Stock Warrants

Between September 14, 1988 and March 31, 2000, Capstone issued 5,251,235
shares of its common stock, of which 2,303,584 shares were issued upon exercise
of warrants and 1,704,102 shares were issued upon exercise of stock options.
Capstone has remaining issued and unexercised warrants exercisable for 8,066,525
shares of its common stock. This amount includes warrants exercisable for 90,000
shares of common stock to two accredited investors as well as warrants
exercisable for 739,577 shares of common stock granted to Donaldson, Lufkin &
Jenrette Securities Corporation in connection with the Series G offering.
Certain warrants were issued in connection with the Bridge Notes convertible
into Series F Preferred Stock to sixty-one accredited investors. The issuance
was deemed to be exempt from registration under the Securities Act in reliance
on Section 4(2) of the Securities Act or Regulation D promulgated thereunder as
a sale by an issuer not involving a public offering.

Between September 14, 1988 and March 31, 2000, Capstone issued options
exercisable for 7,134,547 shares (net of cancellations) of its common stock
pursuant to Capstone's 1993 Incentive Stock Option Plan to approximately 120
individuals. Of this amount as of March 31, 2000, 1,704,102 options had been
exercised, 1,357,148 options are issued and exercisable, and 4,073,297 options
are issued and require further vesting before they are exercisable. Of the
issued shares of the Series C Preferred Stock, 35,000 shares were issued
pursuant to employment agreements and 18,407 shares were issued for consulting
services rendered. Of the shares of Series E Preferred Stock issued, 45,500
shares were issued through stock option agreements and 164,340 shares were
issued for services rendered and through other arrangements. These grants were
deemed to be exempt from registration under the Securities Act in reliance on
Rule 701 promulgated under Section 3(b) of the Securities Act as a transaction
pursuant to compensatory benefit plans and contracts relating to compensation as
provided under Rule 701. The recipients of securities in each of the foregoing
represented their intentions to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof and
appropriate legends were affixed to the instruments representing such securities
issued in such transaction.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1(1) Form of Underwriting Agreement.
3.1(2) Second Amended and Restated Certificate of Incorporation of
Capstone Turbine.
3.2(2) Amended and Restated Bylaws of Capstone Turbine.
4.1(2) Specimen stock certificate.
5.1(1) Opinion of Latham & Watkins as to the legality of the
securities being offered.
9.1(2) Investor Rights Agreement.
9.2(2) Amendment No. 1 to Investors Rights Agreement.
9.3(1) Amendment No. 2 to Investors Rights Agreement.
9.4(1) Amendment No. 3 to Investors Rights Agreement.
10.1(2) Lease between Capstone Turbine and Northpark
Industrial -- Leahy Division LLC, dated December 1, 1999,
for leased premises at 21211 Nordhoff Street, Chatsworth,
California.
10.2(2) 1993 Incentive Stock Option Plan.
10.3(2) Employee Stock Purchase Plan.
10.4(2) 2000 Equity Incentive Plan.
10.5(3) Transition Agreement, dated August 2, 2000, by and between
Capstone Turbine and Solar Turbines Incorporated.
10.6(3) Amended and Restated License Agreement, dated August 2,
2000, by and between Solar Turbines Incorporated and
Capstone Turbine.
</TABLE>

II-2
<PAGE> 103

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
16.1(2) Letter from Ernst & Young LLP regarding change in
independent auditors.
23.1(1) Consent of Deloitte & Touche LLP.
23.2(1) Consent of Ernst & Young LLP.
23.3(1) Consent of Latham & Watkins (included in exhibit 5.1).
24.1(4) Powers of Attorney (included on signature page).
27.1(4) Financial Data Schedule.
</TABLE>

---------------
(1) Filed herewith.

(2) Incorporated by reference to Capstone Turbine's Registration Statement on
Form S-1 (File No. 333-33024).

(3) Incorporated by reference to Capstone Turbine's Current Report on Form 8-K
filed October 16, 2000.

(4)Previously filed.

(b) Financial Statement Schedules

<TABLE>
<S> <C>
(1) Independent Auditors' Report of Deloitte & Touche LLP... S-1
(2) Independent Auditors' Report of Ernst & Young LLP....... S-2
(3) Schedule II -- Valuation and Qualifying Accounts........ S-3
</TABLE>

ITEM 17. UNDERTAKINGS

The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant 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, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.

The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act of
1933, 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 the registrant 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
of 1933, 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-3
<PAGE> 104

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 to Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Chatsworth, State of California, on November 15, 2000.

Capstone Turbine Corporation

By: /s/ JEFFREY WATTS
------------------------------------
Jeffrey Watts
Secretary and Chief Financial
Officer

Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to Registration Statement has been signed below by the following persons
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ AKE ALMGREN* President, Chief Executive November 15, 2000
----------------------------------------------------- Officer and Director
Ake Almgren (Principal Executive
Officer)

/s/ JEFFREY WATTS Chief Financial Officer November 15, 2000
----------------------------------------------------- (Principal Financial
Jeffrey Watts Officer and Principal
Accounting Officer)

/s/ RICHARD AUBE* Director November 15, 2000
-----------------------------------------------------
Richard Aube

/s/ JOHN JAGGERS* Director November 15, 2000
-----------------------------------------------------
John Jaggers

/s/ JEAN-RENE MARCOUX* Director November 15, 2000
-----------------------------------------------------
Jean-Rene Marcoux

/s/ BENJAMIN M. ROSEN* Director November 15, 2000
-----------------------------------------------------
Benjamin M. Rosen

/s/ ERIC YOUNG* Director November 15, 2000
-----------------------------------------------------
Eric Young

*By /s/ JEFFREY WATTS
-----------------------------------------------------
Jeffrey Watts
Attorney-In-Fact
</TABLE>

<PAGE> 105

INDEPENDENT AUDITORS' REPORT ON SCHEDULE

To the Board of Directors and Stockholders of
Capstone Turbine Corporation:

We have audited the financial statements of Capstone Turbine Corporation as of
and for the years ended December 31, 1998 and 1999, and have issued our report
thereon dated March 20, 2000 (May 26, 2000 for paragraph 1 of Note 12); such
report is included elsewhere in this Registration Statement. Our audits also
included the financial statement schedule listed in Item 16(b). The financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statement schedule
based on our audits. In our opinion, such financial statement schedule for the
years ended December 31, 1998 and 1999, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Los Angeles, California
March 20, 2000 (May 26, 2000 for paragraph 1 of Note 12)

S-1
<PAGE> 106

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We have audited the statement of operations, stockholders' equity, and cash
flows of Capstone Turbine Corporation for the year ended December 31, 1997, and
have issued our report thereon dated April 3, 1998, except for paragraph 1 of
Note 12, as to which the date is May 26, 2000 (included elsewhere in this
Registration Statement). Our audit also included the financial statement
schedule for the year ended December 31, 1997 listed in Item 16(b) of this
Registration Statement. This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audit.

In our opinion, the financial statement schedule for the year ended December 31,
1997 referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

/s/ ERNST & YOUNG LLP

Woodland Hills, California
April 3, 1998, except for paragraph 1
of Note 12, as to which
the date is May 26, 2000.

S-2
<PAGE> 107

SCHEDULE II

CAPSTONE TURBINE CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
THREE YEAR PERIOD ENDED DECEMBER 31, 1999

<TABLE>
<CAPTION>
BALANCE AT ADDITIONS DEDUCTIONS BALANCE
BEGINNING CHARGED TO FROM AT END
OF YEAR OPERATIONS RESERVES OF YEAR
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts year
ended:
December 31, 1997...................... $ -- $ 10,000 $ -- $ 10,000
December 31, 1998...................... 10,000 3,000 10,000 3,000
December 31, 1999...................... 3,000 50,000 3,000 50,000
Reserve for inventory obsolescence year
ended:
December 31, 1997...................... 180,000 3,918,000 48,000 4,050,000
December 31, 1998...................... 4,050,000 681,000 2,194,000 2,537,000
December 31, 1999...................... 2,537,000 1,120,000 414,000 3,243,000
Warranty reserve year ended:
December 31, 1997...................... 504,000 1,159,000 735,000 928,000
December 31, 1998...................... 928,000 261,000 316,000 873,000
December 31, 1999...................... 873,000 2,643,000 348,000 3,168,000
</TABLE>

S-3
<PAGE> 108

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1(1) Form of Underwriting Agreement.
3.1(2) Second Amended and Restated Certificate of Incorporation of
Capstone Turbine.
3.2(2) Amended and Restated Bylaws of Capstone Turbine.
4.1(2) Specimen stock certificate.
5.1(1) Opinion of Latham & Watkins as to the legality of the
securities being offered.
9.1(2) Investor Rights Agreement.
9.2(2) Amendment No. 1 to Investors Rights Agreement.
9.3(1) Amendment No. 2 to Investors Rights Agreement.
9.4(1) Amendment No. 3 to Investors Rights Agreement.
10.1(2) Lease between Capstone Turbine and Northpark Industrial --
Leahy Division LLC, dated December 1, 1999, for leased
premises at 21211 Nordhoff Street, Chatsworth, California.
10.2(2) 1993 Incentive Stock Option Plan.
10.3(2) Employee Stock Purchase Plan.
10.4(2) 2000 Equity Incentive Plan.
10.5(3) Transition Agreement, dated August 2, 2000, by and between
Capstone Turbine and Solar Turbines Incorporated.
10.6(3) Amended and Restated License Agreement, dated August 2,
2000, by and between Solar Turbines Incorporated and
Capstone Turbine.
16.1(2) Letter from Ernst & Young LLP regarding change in
independent auditors.
23.1(1) Consent of Deloitte & Touche LLP.
23.2(1) Consent of Ernst & Young LLP.
23.3(1) Consent of Latham & Watkins (included in exhibit 5.1).
24.1(4) Powers of Attorney (included on signature page).
27.1(4) Financial Data Schedule.
</TABLE>

---------------
(1) Filed herewith.

(2) Incorporated by reference to Capstone Turbine's Registration Statement on
Form S-1 (File No. 333-33024).

(3) Incorporated by reference to Capstone Turbine's Current Report on Form 8-K
filed October 16, 2000.

(4)Previously filed.