As filed with the Securities and Exchange Commission July 3 , 2008
Registration Statement No. 333-150901
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

AMENDMENT NO. 1
TO
REGISTRATION STATEMENT
ON FORM S-1
UNDER
THE SECURITIES ACT OF 1933

AXION POWER INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
65-0774638
2121
(State or other jurisdiction of
(I.R.S. Identification Number)
(Primary Standard Industrial
incorporation or organization)
 
Classification Code Number)
 
3601 Clover Lane
New Castle, Pennsylvania 16105
Telephone (724) 654-9300
 
(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

Thomas Granville
3601 Clover Lane
New Castle, Pennsylvania 16105
Telephone (724) 654-9300
 
(Name, address, including zip code, and telephone number,
including area code, of agent for service)

Copies to:
Quentin Collin Faust, Esq.
Andrews Kurth LLP
1717 Main Street, Suite 3700
Dallas, Texas 75201
Telephone (214) 659-4400
 
Approximate Date of Commencement of Proposed Sale to the Public: At such time or times after the effective date of this registration statement as the Selling Stockholders shall determine.
 
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. þ  
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o  
 
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.  o  
 
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.  o  
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “small reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer    o (Do not check if a smaller reporting company)
Smaller reporting company x
 
 
CALCULATION OF REGISTRATION FEE
                   
Title of Each Class of Securities to be Registered
 
Amount to be
Registered
 
Proposed
Maximum
Offering Price
per Unit(1)
 
Proposed
Maximum
Aggregate
Offering Price
 
Amount of
Registration Fee
 
Common Stock, par value $0.0001 per share
   
2,782,837
 
$
1.60
 
$
4,452,539
 
$
174.98
(2)
 
(1)
Estimated for the purpose of determining the registration fee pursuant to Rule 457(c), based on the average of the bid and asked price as of June 30, 2008.
 
(2) Previously paid with the initial filing.
 
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 or until this registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
 
 
The information in the prospectus is not complete and may be changed. The selling stockholders 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 and is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
 
Subject to Completion, dated July 3, 2008
PROSPECTUS
 
AZION POWER  

2,782,837 Shares of Common Stock
 
This prospectus relates to the offer and sale of up to 2,097,835 shares of common stock of Axion Power International, Inc., a Delaware corporation, issued to The Quercus Trust (“Quercus”) pursuant to a Securities Purchase Agreement, dated January 14, 2008 between Quercus and the Company and 685,002 shares of common stock issued to the Second Amended Stockholders Trust of Mega-C Corporation in 2003 and 2005 (the “Mega-C Trust”, and together with Quercus, the “Selling Stockholders”) offered and sold from time to time by the Selling Stockholders described in this prospectus under “Selling Stockholders and Plan of Distribution” or by pledgees, donees, transferees, assignees or other successors-in-interest that receive any of the shares as a gift, distribution, or other non-sale related transfer. Unless otherwise noted, the terms “the Company,” “our Company,” “Axion,” “we,” “us” and “our” refer to Axion Power International, Inc. and its subsidiaries.
 
The Selling Stockholders may offer their shares from time to time directly or through one or more underwriters, broker-dealers or agents, in the over-the-counter market at market prices prevailing at the time of sale, in one or more negotiated transactions at prices acceptable to the Selling Stockholders, or otherwise.
 
We will not receive any proceeds from the sale of shares by the Selling Stockholders. In connection with any sales of the common stock offered hereunder, the Selling Stockholders, any underwriters, agents, brokers or dealers participating in such sales may be deemed to be “underwriters” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”).
 
We will pay the expenses related to the registration of the shares covered by this prospectus. The Selling Stockholders will pay any commissions and selling expenses they may incur.
 
On July 3, 2008, our common stock resumed trading on the Over the Counter Bulletin Board (the “OTCBB”) under the symbol “AXPW.OB”. Prior to resuming trading on the OTCBB, our common stock was traded on the Over the Counter Bulletin Board Pink Sheets (“OTC Pink Sheets”) under the symbol “AXPW.PK.” The closing sale price on the OTC Pink Sheets on July 2, 2008, was $1.80 per share.
 
Investing in the common stock offered by this prospectus is speculative and involves a high degree of risk. See “Risk Factors” beginning on page 3.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
 
The date of this prospectus is ___________, 2008

 
TABLE OF CONTENTS
 
PROSPECTUS SUMMARY
1
   
RISK FACTORS
3
   
USE OF PROCEEDS
9
   
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
9
   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 
AND RESULTS OF OPERATIONS
14
   
BUSINESS
26
   
LEGAL PROCEEDINGS
35
   
MANAGEMENT
38
   
EXECUTIVE COMPENSATION
43
   
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
48
   
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
49
   
THE SELLING STOCKHOLDERS AND PLAN OF DISTRIBUTION
51
   
DESCRIPTION OF SECURITIES
52
   
LEGAL MATTERS
59
   
EXPERTS
59
   
WHERE YOU CAN FIND MORE INFORMATION
59
   
AXION POWER INTERNATIONAL, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED
 
FINANCIAL STATEMENTS
F-1
   
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
ABOUT THIS PROSPECTUS
 
This prospectus is part of a registration statement that we filed with the Securities and Exchange Commission (the “Commission”) using the Commission’s registration rules for a delayed or continuous offering and sale of securities. Under the registration rules, using this prospectus and, if required, one or more prospectus supplements, the Selling Stockholders named herein may distribute the shares of common stock covered by this prospectus. This prospectus also covers any shares of common stock that may become issuable as a result of stock splits, stock dividends or similar transactions.
 
A prospectus supplement may add, update or change information contained in this prospectus. We recommend that you read carefully this entire prospectus, especially the section entitled “Risk Factors” beginning on page 3, and any supplements before making a decision to invest in our common stock.
 
i
 
 
PROSPECTUS SUMMARY
 
This summary highlights important information about this offering and our business. It does not include all information you should consider before investing in our common stock. Please review this prospectus in its entirety, including the risk factors and our financial statements and the related notes, before you decide to invest.
 
Our Company
 
Axion Power Corporation (“APC”) was formed in September of 2003 to acquire and develop certain innovative battery technology. Since inception APC has been engaged in research related to the development of new technology for the production of lead-acid-carbon energy storage devices that we refer to as our proprietary lead/carbon “PbC” devices. In December 2003, APC engaged in a reverse acquisition with a public shell company whereby APC became a wholly-owned subsidiary of the shell company. The shell company was originally incorporated in Delaware in January 1997 as Tamboril Cigar Company (“Tamboril”), which operated a wholesale cigar business until December 1998 and was an inactive public shell thereafter until December 2003. The information presented herein relates to the successors of this new and innovative battery technology. Tamboril, the legal acquirer, changed its name to Axion Power International, Inc. immediately following the reverse acquisition.
 
Our Business
 
We are a development stage company that has invested four years and approximately $9.5 million in research and development (“R&D”) expenses to develop a patented energy storage device that uses carbon electrode assemblies to replace the lead-based negative electrodes found in conventional lead-acid batteries. The end result is the PbC battery prototype, a battery-supercapacitor hybrid that combines the simplicity of lead-acid batteries and the faster recharge rates and longer cycle lives of supercapacitors in a low-cost device that can be designed to deliver maximum power for fast discharge applications; maximum energy for slow discharge applications; or a range of balances between the two.
 
We believe our PbC technology will be uniquely situated to exploit the current problems facing the North American lead-acid battery industry. Our New Castle, Pennsylvania facility has a permitted manufacturing capacity of 3,000 batteries per day and has operational production lines for both sealed and flooded lead-acid batteries. The ability to produce both types of batteries in a variety of sizes enables us to target our excess capacity at high-margin products which experience smaller levels of demand compared to conventional battery products, such as deep cycle industrial batteries, classic and racing automobile batteries and other products that support specialized niche markets. Over the next 18 to 24 months, we plan to exploit the manufacturing capacity deficit in the lead-acid battery industry by producing these high margin lead-acid products while we complete development of our PbC technology. As additional capacity comes on-line in the broader industry, we plan to transition our manufacturing focus from lead-acid products to our reduced-lead, enhanced-performance PbC products.
 
1


The Offering
 
Common stock offered by the Selling Stockholder:
 
 
2,782,837 shares of common stock, par value $0.0001 per share.
 
Offering prices:
 
 
 
The shares offered by this prospectus may be offered and sold at prevailing market prices or such other prices as the Selling Stockholders may determine.
 
Common stock outstanding:
 
 
 
25,868,884 shares as of June 30, 2008.
 
Dividend policy:
 
 
 
Dividends on our common stock may be declared and paid when and as determined by our board of directors. We have not paid and do not expect to pay dividends on our common stock.
 
OTCBB symbol:
 
 
 
AXPW.OB
 
Use of proceeds:
 
 
 
We are not selling any of the shares of common stock being offered by this prospectus and will receive no proceeds from the sale of the shares by the Selling Stockholders. All of the proceeds from the sale of common stock offered by this prospectus will go to the Selling Stockholders at the time they sell their shares.
 
 
Risk Factors
 
See “Risk Factors” beginning on page 3 for a discussion of factors you should carefully consider before deciding to invest in our common stock.
 
Our Address
 
Our principal executive offices are located at 3601 Clover Lane, New Castle, Pennsylvania 16105, and our telephone number is (724) 654-9300.
 
2
 
RISK FACTORS
 
Investing in our common stock is very speculative and involves a high degree of risk. You should carefully consider all of the information in this prospectus before making an investment decision. The following are among the risks we face related to our business, assets and operations. They are not the only risks we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also arise. Any of these risks could materially and adversely affect our business, results of operations and financial condition, which in turn could materially and adversely affect the trading price of our common stock. You should not purchase our shares unless you can afford to lose your entire investment.
 
Risks related to our business
 
We are a transition stage company and our business and prospects are extremely difficult to evaluate.

Since our inception in September 2003, the majority of our resources have been dedicated to our R&D efforts and have only recently begun to transition into the very early stages of commercial prototype production. We do not have a stable operating history that you can rely on in connection with your evaluation of our business and our future business prospects. Our business and prospects must be carefully considered in light of the limited history of PbC technology and the many business risks, uncertainties and difficulties that are typically encountered by development stage companies that have sporadic revenues and are committed to focusing on research, development and product testing for an indeterminate period of time. Some of the principal risks and difficulties we have and expect to continue to encounter include, but are certainly not limited to, our ability to:

 
·
Raise the necessary capital to finance our business until we can introduce revenue-generating products on a full-scale basis;
 
 
·
Maintain effective control over the cost of our research, development and product testing activities;
 
 
·
Develop cost effective manufacturing methods for essential components of our proposed products;
 
 
·
Improve the performance of our commercial prototype batteries;
 
 
·
Successfully transition from our laboratory research efforts to commercial manufacturing of our battery technologies;
 
 
·
Adapt and successfully execute our rapidly evolving and inherently unpredictable business plan;
 
 
·
Implement and improve operational, financial and management control systems and processes;
 
 
·
License complementary technologies and, if necessary, successfully defend our intellectual property rights against potential claims;
 
 
·
Respond effectively to competitive developments and changing market conditions;
 
 
·
Continue to attract, retain and motivate qualified personnel; and
 
 
·
Manage each of the other risks set forth below.
 
Because of our limited operating history and our relatively recent transition into the production of prototype PbC devices that we are relying on to become our core revenue generating products, we have limited insight into trends and conditions that may exist or might emerge and affect our business. There is no assurance that our business strategy will be successful or that we will successfully address the risks identified in this prospectus.

We have incurred net losses from inception and do not expect to introduce our first PbC commercial technology products for 12 to 18 months.

From our inception we have incurred net losses and expect to continue to incur substantial and possibly increasing losses for the foreseeable future as we increase our spending to finance the development of our PbC technology, our administrative activities, and the costs associated with being a public company. Our operating losses have had, and will continue to have, an adverse impact on our working capital, total assets and stockholders’ equity. For the year ended December 31, 2007, we had net losses of approximately $14.3 million, a net loss of $7.9 million for the year ended December 31, 2006 and cumulative losses from inception (September 18, 2003) to March 31, 2008 of $41.5 million. Our PbC technology has not reached a point where we can mass produce batteries based on the technology and we will not be in a position to commercialize such products until we complete the development and testing activities. We believe the development and testing process will require a minimum of an additional 12 to 18 months. There can be no assurance that our development and testing activities will be successful or that our proposed products will achieve market acceptance or be sold in sufficient quantities and at prices necessary to make them commercially viable. If we do not realize sufficient revenue to achieve profitability, our business could be harmed.
 
3
 

Our business will not succeed if we are not able to raise substantial additional capital.

Our management believes our current financial resources will support operations for the next 18 months. We will not be able to continue our operations at planned levels of effort beyond that time frame without increased revenues or additional financing. We cannot assure you that any additional capital will be available to us on favorable terms, or at all. If we are unable to  generate sufficient revenues or  obtain additional capital when needed, our research, development and testing activities will be materially and adversely affected and we may be unable to take advantage of future opportunities or respond to competitive pressures. Any inability to generate revenue or raise capital when we require it would seriously harm our business.

We are currently involved in litigation.

Although third parties have not asserted any infringement claims against us, there is no assurance that third parties will not assert such claims in the future. Although not a patent infringement suit, a collection of individuals and entities that describe themselves as the “Taylor Group” sued the Company and claimed an interest in some of our intellectual property. In orders dated February 11, 2008, the United States Bankruptcy Court for the District of Nevada held that the Taylor Group has no interest in or rights to the technology. As described in this prospectus, the Bankruptcy Court has entered summary judgment orders in favor of the Company, holding that the Taylor Group has no interest in the technology and that the Taylor litigation is barred by the permanent injunction of Mega-C Power Corp.’s confirmed Chapter 11 plan. The Taylor Group filed motions for relief from the Bankruptcy Court orders granting partial summary judgment in favor of the Company, which were heard on May 12, 2008.

The Taylor Group filed motions for relief from the order granting partial summary judgment in favor of the Company and other relief. In orders entered on June 9, 2008, the Bankruptcy Court denied the Taylor Group's motions. In addition, the Company filed a motion for partial summary judgment for an order to require dismissal of the Taylor Group litigation against the Company. In orders entered on June 9, 2008, the Bankruptcy Court granted the Company’s motion and mandated that the Taylor Group litigation against the Company be dismissed. On June 18, 2008, the Taylor Group filed a notice of appeal from these orders. The Taylors have signed a pleading consenting to dismiss the Company from the Taylor Group litigation in Canada.

We are in breach of certain registration rights unrelated to this offering.
 
We have outstanding obligations to register approximately 1,063,262 shares of common stock that may be issued upon conversion of our 8% Cumulative Convertible Senior Preferred Stock, 7,992,941 shares of common stock that may be issued upon conversion of our Series A Convertible Preferred Stock, approximately 539,611 shares of common stock and issued pursuant to a certain secured bridge loan arrangement and an additional 4,316,272 shares of common stock issuable upon the exercise of certain of our outstanding warrants. We are currently in breach of all of our obligations to register these shares. There are no liquidated damages stipulated for our failure to register such shares; however, the holders of these securities may still elect to pursue remedies against the Company for our failure to meet these registration obligations which may affect our business operations or our ability to raise additional capital in the future.
 
As we sell our products, we may become the subject of product liability claims.

Due to the hazardous nature of many of the key materials used in the manufacturing of batteries, the producers of such products may be exposed to a greater number of product liability claims, including possible environmental claims. We currently have product liability insurance up to $1,000,000 per occurrence and $5,000,000 in the aggregate to protect us against the risk that in the future a product liability claim or product recall could materially and adversely affect our business operations. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of our product. We cannot assure you that as we continue distribution of our products that we will be able to obtain or maintain adequate coverage on acceptable terms, or that such insurance will provide adequate coverage against all potential claims. Even if we maintain adequate insurance, any successful claim could materially and adversely affect our reputation and prospects, and divert management’s time and attention. If we are sued for any injury allegedly caused by our future products our liability could exceed our total assets and our ability to pay such liability.

Our products contain hazardous materials including lead.
 
Lead is a toxic material that is a primary raw material in our PbC. We also use, generate and discharge other toxic, volatile and hazardous chemicals and wastes in our research, development and manufacturing activities. We are required to comply with federal, state and local laws and regulations regarding pollution control and environmental protection. Under some statutes and regulations, a government agency, or other parties, may seek to recover response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for such release or otherwise at fault. In addition, more stringent laws and regulations may be adopted in the future, and the costs of complying with those laws and regulations could be substantial. If we fail to control the use of, or to adequately restrict the discharge of, hazardous substances, we could be subject to significant monetary damages and fines, or forced to suspend certain operations.
 
 
The growth we seek is rare and inherently problematic.

The realization of our business objectives will require substantial future growth. Growth of this magnitude in the battery industry is rare. Even in the event we are able to complete the development of our prototypes, introduce our products to the market and grow our business, we expect that rapid growth will place a significant strain on our managerial, operational and financial resources. We must manage our growth, if any, through appropriate systems and controls. We must also establish, train and manage a much larger work force. If we do not manage the growth of our business effectively, our potential could be materially and adversely affected.

Being a public company increases our administrative costs significantly.

As a public company, we incur significant legal, accounting and other expenses that would not be incurred by a comparable private company. Commission rules and regulations have made some activities more time consuming and expensive and required us to implement corporate governance and internal control procedures that are not typical for development stage companies. We also incur a variety of internal and external costs associated with the preparation, filing and distribution of the periodic public reports and proxy statements required by the Securities Exchange Act of 1934, as amended. During the year ended December 31, 2007, we spent approximately $528,246   for the legal and accounting fees and other costs associated with compliance. We expect Commission rules and regulations to continue to make it more difficult and expensive for us to attract and retain qualified directors and executive officers.

We depend on key personnel and our business may be severely disrupted if we lose the services of our key executives and employees.

Our business is dependent upon the knowledge and experience of our key scientists, engineers and executive officers. Given the competitive nature of our industry, there is risk that one or more of our key scientists or engineers will resign their positions, which could have a disruptive impact on our operations. If any of our key scientists, engineers or executive officers do not continue in their present positions, we may not be able to easily replace them and our business may be severely disrupted. If any of these individuals joins a competitor or forms a competing company, we could lose important know-how and experience and incur substantial expense to recruit and train suitable replacements.

Our certificate of incorporation and by-laws provide for indemnification and exculpation of our officers and directors.

Our certificate of incorporation provides for indemnification our officers, directors and employees to the fullest extent permitted by Delaware law. It also provides exculpation of our directors for monetary damages arising from breach of their fiduciary duties in cases that do not involve fraud or willful misconduct. The Commission has advised that it believes that indemnification for liabilities arising under the securities laws is against public policy as expressed in the securities laws and is therefore unenforceable.

We have limited manufacturing experience which may translate into substantial cost overruns in manufacturing and marketing our products.

As we transition into the commercial production of our prototype devices we may experience substantial cost overruns in manufacturing and marketing our PbC technology, and may not have sufficient capital in the future to successfully complete such tasks. In addition, we may not be able to manufacture or market our products because of industry conditions, general economic conditions, and/or competition from potential manufacturers and distributors. Either of these inabilities could cause us to abandon our current business plan and may cause our operations to eventually fail.
 
5

Risks related to our PbC technology

We need to improve the performance of our commercial prototypes.

Our commercial prototypes do not satisfy all our performance expectations and we need to continue to improve various aspects of our PbC technology as we move forward with larger scale production of our commercial prototypes. There is no assurance that we will be able to resolve the known technical issues. Future testing of our prototypes may reveal additional technical issues that are not currently recognized as obstacles. If we cannot improve the performance of our prototypes in a timely manner, we may be forced to redesign or delay the large scale production of commercial prototypes or possibly cause us to abandon our product development efforts altogether.

We cannot begin full-scale commercial production of our PbC technology for 12 to 18 months.

We will not be able to begin full commercial production of our PbC energy storage devices until we complete our current testing operations, our planned application evaluation and our planned product development. We believe our commercialization path will require a minimum of 12 to 18 months. Even if our prototype development operations are successful, there can be no assurance that we will be able to establish and maintain our facilities and relationships for the manufacturing, distribution and sale of our PbC batteries or that any future products will achieve market acceptance and be sold in sufficient quantities and at prices necessary to make them commercially successful. Even if our proposed products are commercially successful there can be no assurance that we will realize enough revenue and gross margin from the sale of products to achieve profitability.

We do not have any long term vendor contracts.

We currently purchase the raw materials for our carbon electrodes and a variety of other components from third parties. We then fabricate our carbon electrodes and build our prototypes in-house. We do not have any long-term contracts with suppliers of raw materials and components and our current suppliers may be unable to satisfy our future requirements on a timely basis. Moreover, the price of purchased raw materials and components could fluctuate significantly due to circumstances beyond our control. If our current suppliers are unable to satisfy our long-term requirements on a timely basis, we may be required to seek alternative sources for necessary materials and components, or redesign our proposed products to accommodate available substitutes.

We do not have extensive manufacturing experience.

We do not have extensive manufacturing experience with respect to manufacturing our commercial prototypes in quantities required to achieve our operational goals and there is no assurance that we will be able to retain a qualified manufacturing staff or effectively manage the manufacturing of our proposed products when we are ready to do so.

We will be a small player in an intensely competitive market and may be unable to compete.

The lead-acid battery industry is large, intensely competitive and resistant to technological change. If our product development efforts are successful, we will have to compete or enter into strategic relationships with well-established companies that are much larger and have greater financial capital and other resources than we do. We may be unable to convince end users that products based on our PbC technology are superior to available alternatives. Moreover, if competitors introduce similar products, they may have a greater ability to withstand price competition and finance their marketing programs. There is no assurance that we will be able to compete effectively.

To the extent we enter into strategic relationships, we will be dependent upon our partners.

Our products are not intended for direct sale to end users and our business strategy will likely require us to enter into strategic relationships with manufacturers of other power industry equipment that use batteries and other energy storage devices as important components of their finished products. The agreements governing any future strategic relationships are unlikely to provide us with control over the activities of any strategic relationship we negotiate and our future partners, if any, could retain the right to terminate the strategic relationship at their option. Our future partners will have significant discretion in determining the efforts and level of resources that they dedicate to our products and may be unwilling or unable to fulfill their obligations to us. In addition, our future partners may develop and commercialize, either alone or with others, products that are similar to or competitive with the products that we intend to produce.
 
6

Risks relating to our intellectual property

We rely on licenses of third-party technology for our specialty batteries and may rely on additional licenses for our PbC technology, which may affect our continued operations with respect to each .

Our revenues in 2006 and 2007 were primarily related to our sale of specialty batteries consisting of classic car, 16 volt racing car batteries, and uninterruptible power supply batteries. As we develop our PbC technology, we may need to license additional technologies to optimize the performance of our products. We may not be able to license these technologies on commercially reasonable terms or at all. In addition, we may fail to successfully integrate any licensed technology into our proposed products. Our inability to obtain any necessary licenses could delay our product development and testing until alternative technologies can be identified, licensed and integrated. The inability to obtain any necessary third-party licenses could cause us to abandon a particular development path, which could seriously harm our business, financial position and results of our operations .

We may be unable to enforce or defend our ownership of proprietary technology.

Our ability to compete effectively will depend in part on our ability to maintain the proprietary nature of our PbC technology. Our PbC technology is protected by six issued U.S. patents and we currently have seven U.S. patent applications pending. We plan to file additional patent applications in the future. However the degree of protection offered by our existing patents or the likelihood that our future applications will be granted is uncertain. Competitors in both the U.S. and foreign countries, many of which have substantially greater resources and have made substantial investment in competing technologies, may have, or may apply for and obtain patents that will limit or interfere with our ability to make and sell products based on our PbC technology. Competitors may also intentionally infringe on our patents. The defense and prosecution of patent litigation is both costly and time-consuming, even if the outcome is favorable to us. An adverse outcome in the defense of a patent infringement suit could subject us to significant liabilities to third parties. Although third parties have not asserted any infringement claims against us, there is no assurance that third parties will not assert such claims in the future.

New technology may lead to our competitors developing superior products which would reduce demand for our products.

Research into the electrochemical applications for carbon nanotechnology and other storage technologies is proceeding at a rapid pace and many private and public companies and research institutions are actively engaged in the development of new battery technologies based on carbon nanotubes, nanostructured carbon materials and other non-carbon materials. These new technologies may, if successfully developed, offer significant performance or price advantages when compared with our PbC technology. There is no assurance that our existing patents or our pending and proposed patent applications will offer meaningful protection if a competitor develops a novel product based on a new technology.

Risks relating to the offering and our common stock

The number of shares of common stock we are registering could depress our stock price.  

This prospectus relates to 2,782,837 shares of our common stock that have been registered for resale by the Selling Stockholders. These shares represent approximately 7.3% of our capitalization assuming the exercise of certain warrants and options and conversion of preferred stock. The potential sale of a significant number of these shares may cause the market price of our common stock to decline.

We have issued a large number of convertible securities, warrants and options that may increase, perhaps significantly, the number of common shares outstanding.

We had 25,868,884 shares of common stock outstanding on the date of this prospectus, and (a) our Series A Convertible Preferred Stock is presently convertible into 7,992,941 shares of common stock, (b) our shares of 8% Cumulative Convertible Senior Preferred Stock are presently convertible into 1,063,262 shares of common stock, (c) we have warrants outstanding that, if exercised, would generate proceeds of $42,112,803 and cause us to issue up to an additional 14,316,272 shares of common stock and (d) we have options to purchase common stock that, if exercised, would generate proceeds of $10,575,518 and result in the issuance of an additional 2,485,885 shares of common stock.

We have provided and intend to continue offering compensation packages to our management and employees that emphasize equity-based compensation.

As a key component of our growth strategy, we have provided and intend to continue offering compensation packages to our management and employees that emphasize equity-based compensation. In particular:

 
·
Our incentive stock plan authorized incentive awards for up to 2,000,000 shares of our common stock; we have issued incentive awards for an aggregate of 652,950 shares at the date of this prospectus; and we have the power to issue incentive awards for an additional 1,347,050 shares without stockholder approval;
 
7
 
 
·
Our independent directors’ stock option plan authorized options for up to 500,000 shares of our common stock; we have issued options for an aggregate of 169,600 shares at the date of this prospectus; and have the power to issue options for an additional 330,400 shares without stockholder approval;
 
 
·
We have issued contractual options for an aggregate of 1,968,000 shares of our common stock, of which 1,528,000 are currently outstanding, to executive officers under the terms of their employment agreements with us; and
 
 
·
We have issued contractual options for an aggregate of 965,200 shares of our common stock, of which 765,900 are currently outstanding, to certain attorneys and consultants under the terms of their agreements with us.
 
We believe our equity compensation policies will allow us to provide substantial incentives while minimizing our cash outflow. Nevertheless, we will be required to account for the fair market value of equity compensation awards as operating expenses. As our business matures and expands, we expect to incur increasing amounts of non-cash compensation expense, which may materially and adversely affect our future operating results.

We may issue stock to finance acquisitions.

We may wish to acquire complementary technologies, additional facilities and other assets. Whenever possible, we will try to use our stock as an acquisition currency in order to conserve our available cash for operations. Future acquisitions may give rise to substantial charges for the impairment of goodwill and other intangible assets that would materially and adversely affect our reported operating results. Any future acquisitions will involve numerous business and financial risks, including:

 
·
difficulties in integrating new operations, technologies, products and staff;
 
 
·
diversion of management attention from other business concerns; and
 
 
·
cost and availability of acquisition financing.
 
We will need to be able to successfully integrate any businesses we may acquire in the future, and the failure to do so could have a material adverse effect on our business, results of operations and financial condition.

Because of factors unique to us, the market price of our common stock is likely to be volatile.

Because of the relatively small number of shares currently available for resale, the large number of shares that we are registering on behalf of the Selling Stockholders pursuant to this prospectus, the transitional stage of our business and numerous other factors, the trading price of our common stock has been and is likely to continue to be highly volatile. In addition, actual or anticipated variations in our quarterly operating results; the introduction of new products by competitors; changes in competitive conditions or trends in the battery industry; changes in governmental regulation and changes in securities analysts’ estimates of our future performance or that of our competitors or our industry in general, could adversely affect our future stock price. Investors should not purchase our shares if they are unable to suffer a complete loss of their investment.

Our current “bid” and “asked” prices may not stabilize at current levels

Our stock is quoted on the OTCBB. Since trading in our common stock began in January 2004, trading has been sporadic, trading volumes have been low and the market price has been volatile. The closing bid and asked prices were $1.51 and $1.70   per share, respectively, on June 30, 2008. The current quotations are not necessarily a reliable indicator of value and there is no assurance that the market price of our stock will stabilize at or near current levels.

Our common stock is subject to the “penny stock” rules.

Rule 3a51-1 promulgated under the Securities Exchange Act of 1934, as amended, defines a “penny stock” as any equity security that is not listed on a national securities exchange or the Nasdaq system and has a bid price of less than $5 per share. We presently are subject to the penny stock rules. Our market price has been highly volatile since trading in our common stock began in January 2004 and there is no assurance that the penny stock rules will not continue to apply to our shares for an indefinite period of time. Before effecting a transaction that is subject to the penny stock rules, a broker-dealer must make a decision respecting the suitability of the purchaser; deliver certain disclosure materials to the purchaser and receive the purchaser’s written approval of the transaction. Because of these restrictions, most broker-dealers refrain from effecting transactions in penny stocks and many actively discourage their clients from purchasing penny stocks. Therefore, both the ability of broker-dealers to recommend our common stock and the ability of our stockholders to sell their shares in the secondary market could be adversely affected by the penny stock rules.
 
8
 
USE OF PROCEEDS
 
We are not selling any of the shares of common stock being offered by this prospectus and will receive no proceeds from the sale of the shares by the Selling Stockholders. All of the proceeds from the sale of common stock offered by this prospectus will go to the Selling Stockholders at the time it offers and sells such shares.
 
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
Market Information
 
At the start of the year ended December 31, 2006, our stock was quoted on the OTCBB, until we became delinquent in our Commission reporting obligations in August 2006. As a result, our stock was temporarily removed from the OTCBB and began trading on the OTC Pink Sheets under the symbol AWPW.PK until July 3, 2008, when our common stock resumed trading on the OTCBB under the symbol AXPW.OB. Trading in our stock has historically been sporadic, trading volumes have been low, and the market price has been volatile.
 
The following table shows the range of high and low bid prices for our common stock as reported by the OTC Pink Sheets and the OTCBB, as the case may be, for each quarter since the beginning of 2006. The quotations reflect inter-dealer prices, without retail markup, markdown or commission and may not represent actual transactions.
           
Period
 
High
 
Low
 
 
 
 
 
 
 
Second Quarter 2006
 
$
4.10
 
$
1.75
 
 
         
Third Quarter 2006
 
$
3.50
 
$
1.60
 
 
         
Fourth Quarter 2006
 
$
4.00
 
$
1.10
 
 
         
First Quarter 2007
 
$
4.05
 
$
2.25
 
 
         
Second Quarter 2007
 
$
3.15
 
$
2.50
 
 
         
Third Quarter 2007
 
$
3.10
 
$
2.20
 
 
         
Fourth Quarter 2007
 
$
2.50
 
$
2.00
 
               
First Quarter 2008
 
$
2.74
 
$
1.85
 
 
On July 2, 2008, the closing price for our common stock as reported on the OTC Pink Sheets was $1.80 per share.
 
Securities Outstanding and Holders of Record
 
On June 30, 2008 there were approximately 386 record holders of our common stock, 11 holders of our 8% Cumulative Convertible Senior Preferred Stock (the “Senior Preferred Stock”) and 15 holders of our Series A Convertible Preferred Stock (the “Series A Preferred Stock”).
 
Dividend Policy
 
We have not paid and do not expect to pay dividends on our common stock. Any future decision to pay dividends on our common stock will be at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions.
 
9
 
Shares Eligible for Future Sale
 
Quercus is offering the common stock issued pursuant to the Securities Purchase Agreement, dated January 14, 2008 (the “Securities Purchase Agreement”) as of the date of this prospectus. Further, the Mega-C Trust is offering common stock issued in 2003 and 2005 which we are obligated to register pursuant to the Settlement Agreement, dated December 12, 2005 (the “Settlement Agreement”). In addition to the shares offered by this prospectus, we are obligated to register (1) approximately 4,700,000   shares of common stock issued to the Mega-C Trust upon demand by the Trustee of the Mega-C Trust, (2) 1,063,262 shares of common stock that may be issued upon conversion of our Senior Preferred Stock, (3) 7,992,941 shares of common stock that may be issued upon conversion of our Series A Preferred Stock, (4) approximately 539,611 shares of common stock and common stock underlying warrants issued pursuant to a certain secured bridge loan arrangement and (5) an additional 4,316,272 shares of common stock issuable upon the exercise of certain of our outstanding warrants.
 
An additional 14,729,177 outstanding shares and security ownership in 17,744,824 other beneficial rights not offered by this prospectus are held by affiliates of ours. These shares may only be sold pursuant to the time, manner and volume restrictions set forth in Rule 144 under the Securities Act. In general under Rule 144 as currently in effect, a person (or persons whose shares are aggregated), who may be deemed to be an “affiliate” of the Company as that term is defined under the Securities Act, is entitled to sell within any three-month period a number of shares beneficially owned for at least six months that does not exceed the greater of (i) 1% of the then outstanding shares of common stock or (ii) the average weekly trading volume of the outstanding shares of common stock during the four calendar weeks preceding such sale. Sales under Rule 144 are also subject to certain requirements as to the manner of sale, notice and the availability of current public information about us. A person (or persons whose shares are aggregated) who is not an “affiliate” of the Company during the 90 days immediately preceding a proposed sale by such person and who has beneficially owned “restricted securities” for at least one year is entitled to sell such shares under Rule 144(b) without regard to the volume, manner of sale, public information or notice requirements. As defined in Rule 144, an “affiliate” of an issuer is a person that directly or indirectly controls, or is controlled by, or is under common control with such issuer. In general, under Rule 701 under the Securities Act as currently in effect, any employee, consultant or advisor of the Company who purchases shares from the Company in connection with a compensatory stock or option plan or other written agreement related to compensation is eligible to resell such shares 90 days after the effective date of the offering in reliance on Rule 144, but without compliance with certain restrictions contained in Rule 144.
 
The volume of trading in our common stock has been low and executed trades over the OTC Pink Sheets and the OTCBB have been sporadic, which has resulted in an inconsistent trading market for our shares and no predictions can be made of the effect, if any, that future sales of shares of common stock described above, or the availability of shares for future sale, will have on the market price prevailing from time to time. Sales of substantial amounts of common stock in the public market, or the perception that such sales could occur, could adversely affect prevailing market prices of our common stock.
 
As of June 30, 2008, a total of 8,356,870  of our issued and outstanding shares were held by persons who are not affiliates of ours.
 
10
 
 
Stock Option Plans
 
The following table provides summary information on our equity compensation plans as of December 31, 2007.
 
   
Number of shares
issuable on exercise of
outstanding options
 
Weighted average
exercise price of
outstanding options
 
Number of shares
available for future
issuance under equity
compensation plans
 
Plan category:
             
Equity compensation plans approved by stockholders
             
               
2004 Incentive Stock Plan
   
51,950
 
 
$3.48
   
1,347,050
 
                     
2004 Directors’ Option Plan
   
140,035
 
 
$2.83
   
330,400
 
                     
Equity compensation plans not approved by stockholders
                   
                     
Contract options held by officers
   
905,000
 
 
$4.86
       
                     
Contract options held by consultants
   
753,900
 
 
$5.22
       
                     
Total equity awards
   
1,850,885
 
 
$4.81
       
 
The Company has two stockholder approved equity compensation plans and occasionally enters into employment and other contracts that provide for equity compensation arrangements other than those contemplated by the stockholder approved plans. The following sections summarize the Company’s equity compensation arrangements.
 
Incentive Stock Plan Approved by Stockholders  
 
Our stockholders have adopted an incentive stock plan for the benefit of our employees, consultants and advisors. Under the terms of the original plan, we were authorized to grant incentive awards for up to 1,000,000 shares of common stock. At our 2005 annual meeting, our stockholders increased the authorization under the incentive stock plan to 2,000,000 shares.
 
The incentive stock plan authorizes a variety of awards, including incentive stock options, non-qualified stock options, shares of restricted stock, shares of phantom stock and stock bonuses. In addition, the plan authorizes the payment of cash bonuses when a participant is required to recognize income for federal income tax purposes because of the vesting of shares of restricted stock or the grant of a stock bonus.
 
The plan authorizes the grant of incentive awards to our full-time employees who are not eligible to receive awards under the terms of their employment contract or another specialty plan. The plan also authorizes the grant of incentive awards to directors who are not eligible to participate in outside directors’ stock option plan, independent agents, consultants and advisors who have contributed to success.
 
The compensation committee administers the plan. The committee has absolute discretion to decide which employees, consultants and advisors will receive incentive awards, the type of award to be granted and the number of shares covered by the award. The compensation committee also determines the exercise prices, expiration dates and other features of awards.
 
The exercise price of incentive stock options must be equal to the fair market value of such shares on the date of the grant or, in the case of incentive stock options granted to the holder of more than 10% of the Company’s common stock, at least 110% of the fair market value of such shares on the date of the grant. The maximum exercise period for incentive stock options is ten years from the date of grant, or five years in the case of an individual who owns more than 10% of our common stock. The aggregate fair market value determined at the date of the option grant, of shares with respect to which incentive stock options are exercisable for the first time by the holder of the option during any calendar year, shall not exceed $100,000.
 
Outside Directors' Stock Option Plan Approved by Stockholders
 
Our stockholders have adopted an outside directors' stock option plan for the benefit of our non-employee directors in order to encourage their continued service as directors. Under the terms of the original plan, we were authorized to grant incentive awards for up to 125,000 shares of common stock. At the 2005 annual meeting, our stockholders increased the authorization under the directors’ plan to 500,000 shares.
 
11
 
Each eligible director who is, on or after the effective date of the plan, appointed to fill a vacancy on the board of directors or elected to serve as a member of the board of directors may participate in the plan. Each eligible director is automatically granted an option to purchase the maximum number of shares having an aggregate fair market value on the date of grant of $20,000. The option price of the stock subject to each option is required to be the fair market value of the stock on its date of grant. Options generally expire on the fifth anniversary of the date of grant. Any option granted under the plan shall become exercisable in full on the first anniversary of the date of grant, provided that the eligible director has not voluntarily resigned or been removed "for cause" as a member of the board of directors on or prior to the first anniversary of the date of grant (each a “qualified option”). Any qualified option shall remain exercisable after its first anniversary regardless of whether the optionee continues to serve as a member of the board of directors.
 
Equity Incentive Plans Not Approved by Stockholders
 
We have issued 300,000, 629,300, and 228,000 stock purchase options in the fiscal years ended December 31, 2005, 2006 and 2007, respectively, to officers, employees, attorneys and consultants in connection with contractual agreements that do not reduce the shares available under the stockholder’s approved plans. The following paragraphs summarize these contractual stock options.
 
In January 2004, members of the law firm of Fefer, Petersen & Cie, our general corporate counsel at the time (of which one member was a director of our company at the time) were granted two-year contractual options to purchase 189,300 shares of common stock at a price of $2.00 per share as partial compensation for services rendered, valued at $68,296. These members also received 116,700 warrants as consideration of pre-merger Tamboril debt. In August 2004, $1.00 of the exercise price of the total 306,000 options and warrants owned by these members was considered paid in advance in consideration of unbilled legal services provided by the firm. We recorded $306,000 related to this reduction. All of the warrants and options were exercised in the fourth quarter of 2005; however, $306,000 of the amount was included in stock subscription receivable as of December 31, 2005 and was received in 2006.
 
In July 2004, our former President and Chief Operating Officer, Charles Mazzacato, was granted a contractual option to purchase 240,000 shares of common stock at a price of $4.00 per share. This option vested on a monthly basis at the rate of 60,000 shares per year commenced July 31, 2005 and was exercisable for five years after each vesting date. The market value of our stock at the date of grant was greater than the exercise price, which resulted in a total intrinsic value of $180,000. In accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), we expensed the intrinsic value over the vesting period which resulted in expense of $18,750 and $45,000 during the years ended December 31, 2004 and 2005, respectively. On January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “ Share-Based Payment” (SFAS 123R), and recorded compensation of $124,364 during the year ended December 31, 2006. During the year ended December 31, 2006 the options were forfeited as a result of his termination of employment in 2006.
 
In July 2004, our former Chief Financial Officer, Peter Roston, was granted a contractual option to purchase 200,000 shares of common stock at a price of $4.00 per share. This option vested on a monthly basis at the rate of 50,000 shares per year commencing July 31, 2005 and was exercisable for five years after each vesting date. The market value of our stock at the date of grant was greater than the exercise price, which resulted in a total intrinsic value of $150,000. In accordance with APB 25, we expensed the intrinsic value over the vesting period which resulted in expense of $15,625 and $37,500 during the years ended December 31, 2004 and 2005, respectively. On January 1, 2006, we adopted the provisions of SFAS 123R, and recorded compensation of $138,182 during the year ended December 31, 2006. During the year ended December 31, 2006 the options were forfeited as a result of his termination of employment in 2006.
 
In April 2005, our Chief Executive Officer of the Company, Thomas Granville, was granted a contractual option to purchase 180,000 shares of common stock at a price of $2.50 per share. This option vests at the rate of 7,500 shares per month commencing May 1, 2005 and is exercisable for five years after each vesting date. The market value of our stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. On January 1, 2006, we adopted the provisions of SFAS 123R, and recorded compensation of $112,500 during the year ended December 31, 2006.
 
In April 2005, a European financial advisor was granted a contractual option to purchase 30,000 shares of common stock at a price of $2.50 per share. Options for an aggregate of 20,000 shares vested during the year ended December 31, 2005 and were exercisable for two years. On December 31, 2005, a total of 10,000 unvested options were forfeited when the advisory agreement was terminated. The options were valued at $35,998 using the Black-Scholes-Merton option pricing model and were included as an expense in 2005.
 
In September 2005, our Chief Technical Officer, Edward Buiel, was granted a contractual option to purchase 90,000 shares of common stock at a price of $4.00 per share. This option vests at the rate of 2,500 shares per month commencing October 2005 and is exercisable for five years after each vesting date. The market value of our stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. On January 1, 2006, we adopted the provisions of SFAS 123R, and recorded compensation of $68,100 during the year ended December 31, 2006.
 
12
 
In February 2006, our Chief Executive Officer, Thomas Granville, was granted an option to purchase 500,000 shares of common stock at an exercise price of $6.00. Of this total, 300,000 options vested immediately and the balance is expected to vest, subject to the attainment of certain specified objectives, over the next year. These 3 year options expire in February of 2009. The options are valued at $300,187 utilizing the Black-Scholes-Merton option pricing model with $259,027 of compensation recorded in 2006.
 
In February 2006, our Chief Technical Officer, Edward Buiel, was granted an option to purchase 35,000 shares of common stock at an exercise price of $6.00. Of this total, 10,000 options vested immediately and the balance is expected to vest, subject to the attainment of certain specified objectives, over the next year. These options are valued at $20,994 utilizing the Black-Scholes-Merton option pricing model with $13,330 of compensation recorded in 2006.
 
In February 2006, members and affiliates of the law firm of Fefer, Petersen & Cie, our general corporate counsel at the time (of which one member was a director of our company at the time) were granted an option to purchase 360,000 shares of common stock at an exercise price of $6.00. Of this total 240,000 options vested immediately and the balance will vest at the rate of 10,000 shares per month during the year ended December 31, 2006. These 3 year options expire in February of 2009. The options are valued at $193,449 utilizing the Black-Scholes-Merton option pricing model and were recorded as legal expense in 2006.
 
In February 2006, the external bankruptcy counsel of our company, Cecilia Rosenauer, was granted an option to purchase 15,000 shares of common stock at an exercise price of $6.00. The options vested on the effective date of Mega-C’s Chapter 11 plan of reorganization, which took place in November 2006. These options are valued at $2,483 utilizing the Black-Scholes-Merton option pricing model and were recorded as legal expense in 2006.
 
In March 2006, two employees were granted options to purchase a total of 24,000 shares of common stock at an exercise price of $4.00 and $6.00. The options vest at a rate of 2,500 per month over the first six months and 1,500 per month thereafter. These options are valued at $28,257 utilizing the Black-Scholes-Merton option pricing model with $24,408 of compensation recorded in 2006.
 
In December 2006, our Chief Technical Officer, Edward Buiel, was granted a contractual option to purchase an additional 100,000 shares of our common stock at a price of $3.75 per share. A total of 50,000 options will vest on December 29, 2009 and the remaining 50,000 will vest on December 29, 2010. The options will be exercisable for a period of six years from the vesting date. These options are valued at $267,372, utilizing the Black-Scholes-Merton option pricing model with $6,481 of compensation recorded in 2006.
 
In February 2006, a consultant, Trey Fecteau, was granted an option to purchase 97,000 shares of common stock at an exercise price of $4.00. The options vested upon completion of contractual services in December 2006. These options are valued at $150,702 utilizing the Black-Scholes-Merton option pricing model. The proceeds of the Series A Preferred Stock offering in 2006 were reduced by this amount to account for this expense.
 
In January 2007, Walker Wainwright, a director of our company, was granted an option to purchase 40,000 shares of common stock at an exercise price of $5.00 as compensation for services related to due diligence, negotiation and sale related to our 2006 Series A Preferred Stock offering. These three-year options vested immediately on the date of grant, and are valued at $52,230 utilizing the Black-Scholes-Merton option pricing model and were recorded as offering costs in 2007.
 
In August 2007, our former Chief Financial Officer, Andrew Carr Conway, Jr., was granted a contractual option to purchase 80,000 shares of common stock at an exercise price of $4.50. 20,000 options vested immediately upon contract inception and the remainder vested at a rate of 10,000 per month over the life of his six-month employment contract originally set to end in February 2008. This contract has been extended on a month-to month basis. These two-year options are valued at $37,356 utilizing the Black-Scholes-Merton option pricing model with $24,904 recorded as compensation in 2007.
 
In December 2007, our Vice-President of Manufacturing Engineering, Robert Nelson, was granted a contractual option to purchase 108,000 shares of common stock at an exercise price of $5.00. The options vest at a rate of 3,000 per month over a three year period, but are being amortized over the term of his two year employment contract. These five-year options are valued at $108,504 utilizing the Black-Scholes-Merton option pricing model with $4,521 recorded as compensation in 2007.
 
In March 2008 and June 2008 former Chief Financial Officer, Andrew Carr Conway, Jr., was granted additional contractual options under the same terms as his 2007 employment contract, to purchase 40,000 shares of common stock at an exercise price of $4.50 per share. The shares were granted based on the extension of his 2007 contract through June 2008. These two-year options are valued at $20,625 utilizing the Black-Scholes-Merton option pricing model with the full amount recorded as compensation in 2008.

In June 2008, Equity Awards were issued as part of a restructuring of all key employee contracts designed to provide for the long term stability of the Company:

Our Chief Executive Officer, Thomas Granville, was granted a contractual option to purchase an additional 90,000 shares of our common stock at a price of $2.50 per share. The options vest prorated over the 24-month term of his contract, and are exercisable for a period of five years from the vesting date. These options are valued at $79,872, utilizing the Black-Scholes-Merton option pricing model with $23,296 of compensation expected to be recorded in 2008.

Our Chief Technical Officer, Edward Buiel, was granted a contractual option to purchase an additional 100,000 shares of our common stock at a price of $2.50 per share. The options cliff vest on May 31, 2011, and are exercisable for a period of five years from the vesting date. These options are valued at $95,436, utilizing the Black-Scholes-Merton option pricing model with $18,557 of compensation expected to be recorded in 2008.

Our Chief Financial Officer, Donald Hillier, was granted an option to purchase 180,000 shares of our common stock. The exercise price of the option is $2.50 per share and the option vests at the rate of 5,000 shares per month through the term of the Employment Agreement. These options are valued at $179,244, utilizing the Black-Scholes-Merton option pricing model with $34,853 of compensation expected to be recorded in 2008.

Our Vice President of Manufacturing Engineering, Robert Nelson, was granted a contractual option to purchase an additional 25,000 shares of our common stock at a price of $2.50 per share. The options cliff vest on November 30, 2010, and are exercisable for a period of five years from the vesting date. These options are valued at $23,954, utilizing the Black-Scholes-Merton option pricing model with $5,782 of compensation expected to be recorded in 2008.
 
Three employees were granted contractual options to purchase an additional 200,000 shares of our common stock at a price of $2.50 per share. 5,000 of these options vested in June upon execution of the employment contracts, with the balance cliff vesting on June 15, 2011, and are exercisable for a period of three years from the vesting date. These options are valued at $165,041, utilizing the Black-Scholes-Merton option pricing model with $34,222 of compensation expected to be recorded in 2008.
 
13
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with the consolidated financial statements and the related notes that are set forth in our financial statements elsewhere in this prospectus.
 
Overview
 
We are a development stage company that was formed in September of 2003 to acquire and develop certain innovative battery technology. Since inception, APC has been engaged in R&D of the new technology for the production of lead-acid-carbon energy storage devices that we refer to as our proprietary lead/carbon (“PbC”) devices. As of December 31, 2003, APC engaged in a reverse acquisition with Tamboril, a public shell company. Tamboril was originally incorporated in Delaware in January 1997, operated a wholesale cigar business until December 1998 and was an inactive public shell thereafter until December 2003. The information presented herein relates to the operations of APC, the accounting acquirer. Tamboril, the legal acquirer, changed its name to Axion Power International, Inc. We formed a new corporation, Axion Power Battery Manufacturing Inc., which purchased the foreclosed assets of the failed battery manufacturing plant and now conducts our manufacture of specialty batteries.
 
Key Performance Indicators
 
Because of our early stage of development the usual financial measures are not particularly relevant or helpful in the assessment of company operations.
14
 
We do not use non-financial measures to evaluate our performance other than the degree of success of our R&D and demonstration projects. Our demonstration projects entail extended periods of time to assess our energy devices over multiple charge and deep discharge cycles. Further, the results of our demonstration projects do not lend themselves to simple measurement and presentation.
 
Material Trends and Uncertainties
 
We will continue to require substantial funds for R&D. Even with adequate funding there is no assurance our new technology can be successfully commercialized. While we intend to continue to manufacture specialty batteries and commence contract manufacturing there is no assurance of profits or whether those profits will be sufficient to sustain us as we continue to develop our new technology.
 
15
 
Recent Financing Activities
 
Bridge Loan Financing  In November of 2007 we structured short term secured bridge loan arrangements in increments of $100,000, the "Bridge Loans" with certain of our directors, officers and significant directors, such loans to bear interest at the rate of 14% and were secured by all of our assets, including our intellectual property and all of the equipment and inventory assets of our wholly-owned subsidiary, Axion Power Battery Manufacturing Inc. Total funding received under the Bridge Loans was approximately $2,640,000.

The Bridge Loans had an original maturity date of March 31, 2008, with three extensions of the maturity date at the option of the Company, with higher interest rates to apply to each such extension. On March 31, 2008, we sent notice to the investors of our intention to extend the loan until April 30, 2008. In accordance with the option terms contained in the loan agreement, three of the investors chose to convert a total of $328,984 into equity under the same terms offered to Quercus. The extension entitled the remaining investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 15%. On April 29, 2008, we sent notice to the investors of our intention to extend the loan until May 31, 2008. The extension entitles investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 16%.  On May 29, 2008, a related party converted $4,200 of his Bridge Loan into equity under the same terms offered to Quercus, with the balance repaid under the terms of the note for the Bridge Loan. On May 30, 2008, we sent notice to the remaining investors of our intentions to extend the loan until June 30, 2008. The interest rate during the extension period increased to 18% with an extension fee equal to 2% of the original loan and an extension fee of 2% of the original loan was paid to the holders of the Bridge Loans. A loan origination fee was paid equal to 8% of the original loan. The origination fee decreased by one-half percent each week after December 15, 2007 until the loan closed on January 7, 2008. Warrants exercisable at $2.35 until December 31, 2012 are included. For each $100,000 increment of the Bridge Loan, the investor were issued warrants as follows 3,405 warrants upon occurrence of the secured bridge loan, 851 additional warrants upon the extension of the loan to April 30, 2008, 1,276 additional warrants upon extension of the loan to May 31, 2008 and 2,128 additional warrants upon extension to June 30, 2008, Typical anti-dilution provisions apply to the warrants as well as registration rights.

On June 30, 2008, one of our directors converted $800,000 of indebtedness under the Bridge Loans into 380,952 shares of common stock and warrants to purchase 380,952 shares of common stock at an exercise price of $2.60 per share, such warrants to expire on June 29, 2013. The remaining $2,640,000 of indebtedness under the Bridge Loans was repaid on June 30, 2008 with a portion of the proceeds from the Final Quercus Investment (as described below). Upon the conversion and repayment occuring on June 30, 2008, the Bridge Loans have been fully repaid or converted, and there is no remaining indebtedness under these instruments.

The Quercus Investment On January 14, 2008, we entered into the Securities Purchase Agreement with Quercus, pursuant to which we agreed to issue to Quercus up to 8,571,429 shares of our common stock, together with common stock purchase warrants that will entitle the holder to purchase up to 10,000,000 additional shares of our common stock.
 
At the initial closing on January 14, 2008, Quercus invested $4.0 million in exchange for 1,904,762 shares and warrants to purchase an additional 2,857,143 shares at an exercise price of $2.60 per share. At the second closing on April 17, 2008, Quercus invested an additional $4.0 million in exchange for 1,904,762 shares of our common stock and warrants to purchase an additional 2,380,953 shares of at an exercise price of $2.60 per share.

On June 30, 2008, the Company completed the third and final tranche of the Quercus investment, whereby Quercus invested $10.0 million in exchange for 4,761,905 shares of our common stock and warrants to purchase an additional 4,761,905 shares of stock at an exercise price of $2.60 per share. All of the warrants issued to Quercus expire by June 29, 2013. A portion of the proceeds of the June 30, 2008, financing were used to retire the remainder of the $2,640,000 of the December 2007 Bridge Loans that the Company had previously entered into. Prior to June 30, certain of the bridge lenders had converted $335,000 into 158,659 shares of common stock and warrants to purchase 237,488 shares of common stock at an exercise price of $2.60 per share. On June 30, 2008, one of the Company’s directors converted $800,000 of indebtedness into 380,952 shares of common stock and warrants to purchase 380,952 shares at an exercise price of $2.60 per share. These warrants expire on June 29, 2013 as well. Upon this conversion, the December 2007 Bridge Loans have been repaid or converted in full, and there is no remaining indebtedness under those instruments.

The issuance of our common stock and warrants to Quercus and certain of our bridge lenders was pursuant to the private placement exemption available under Section 4(2) of the Securities Act of 1933.  
 
16
 
Taking into account the $18.0 million we have received from Quercus over the past six months, we believe that our available cash will provide sufficient cash resources to finance our operations and expected capital expenditures over the next 18 months.

Registration Obligations
 
In the Securities Purchase Agreement, we agreed to file one or more registration statements under the Securities Act covering the resale by Quercus of the shares of our common stock issued pursuant to the Securities Purchase Agreement and the shares of our common stock issued upon exercise of the warrants with this prospectus and the related registration statement being the first of such registrations. The registration rights provisions of the Securities Purchase Agreement contain conventional terms including indemnification and contribution undertakings and a provision for liquidated damages in the event any of the following occurs:
 
 
·
any post-effective amendment is not filed on or prior to the seventh business day after the registration statement ceases to be effective pursuant to applicable securities laws due to the passage of time or the occurrence of an event requiring us to file a post-effective amendment (the “Post-Effective Amendment Filing Deadline”);
 
 
·
we fail to file with the Commission a request for acceleration of effectiveness within five business days after the date that we are notified by the Commission;
 
 
·
we fail to respond to any comments made by the Commission within 15 business days after the receipt of such comments;
 
 
·
the registration statement is not declared effective by the Commission on or before October 19, 2008; 
 
 
·
a post-effective amendment is not declared effective on or prior to the 15th business day following the Post-Effective Amendment Filing Deadline;
 
 
·
after a registration statement is filed with and declared effective by the Commission, such registration statement ceases to be effective as to all securities registrable pursuant to the Securities Purchase Agreement (“Registrable Securities”) to which it is required to relate at any time until the earlier of (1) the fifth anniversary of the effective date; (2) the date when all Registrable Securities covered by such Registration Statement have been sold publicly; or (3) the date on which the Registrable Securities are eligible for sale without volume limitation pursuant to Rule 144 of the Securities Act for a period of more than 60 days in any twelve month period without being succeeded by an amendment to such registration statement or by a subsequent registration statement filed with and declared effective by the Commission; or
 
 
·
an amendment to a registration statement is not filed with the Commission within 15 business days after the Commission having notified us that such amendment is required in order for such Registration Statement to be declared effective (any such failure or breach being referred to as an “Registration Failure Event”).
 
17
 
In case any Registration Failure Event occurs, we would be obligated to pay liquidated damages to Quercus in an amount equal to 1% of the aggregate purchase price paid by Quercus pursuant to the Securities Purchase Agreement for any of our securities that were required to be registered but were not covered under an effective registration statement (the “Monthly Liquidated Damages”) for the first month and each successive month thereafter until the Registration Failure Event shall have been cured. Failure to make payments of the Monthly Liquidated Damages shall result in our being obligated to pay interest on any unpaid Monthly Liquidated Damages at a rate of 18% per year.
 
The Securities Purchase Agreement also grants to Quercus a right of first refusal to participate in any subsequent financing we undertake prior to the second anniversary of the second closing (subject to certain conventional exceptions) in order to permit Quercus to maintain its fully-diluted ownership interest in our common stock.
 
As an inducement to Quercus to enter into the Securities Purchase Agreement and to purchase the shares of our common stock and the warrants issuable under the Securities Purchase Agreement, certain directors, officers and principal holders of our issued and outstanding convertible securities, warrants and stock options agreed to refrain from converting any of their convertible securities or exercising any of their stock purchase rights until the board of directors proposes and our stockholders approve a charter amendment that will increase the number of authorized common shares from the current limit of 50 million shares of common stock to a proposed limit of not less than 75 million shares of common stock. Concurrently, we agreed to extend the expiration date of the warrants and options that are subject to forbearance agreements for a period of time equal to the forbearance period. In accordance with the forbearance agreements, we will propose stockholder approval of this share increase of authorized common shares.
 
C&T and Senior Preferred Warrants
 
In January of 2004 we issued warrants (the “C&T Warrants”) to the stockholders (the “C&T Warrant Holders”) of C and T Co., Inc. (“C&T”) in exchange for the acquisition of certain intellectual property rights associated with the lead/carbon hybrid supercapacitor formerly referred to as the E3 Supercell. In February of 2005 we issued shares of our Senior Preferred Stock to a group of investors (the “Senior Preferred Holders”), and in recognition of certain concessions, we issued warrants to the Senior Preferred Holders (the “Senior Preferred Warrants”). Both the C&T Warrants and the Senior Preferred Warrants expired during the period of time in which we were not current in our Exchange Act reporting obligations. In recognition of this, our board of directors has authorized management to commence discussions and potential negotiations with the C&T Warrant Holders and the Senior Preferred Holders in an effort to recognize that the economic benefits that these parties and we expected at the time these warrants were issued was frustrated by the length of the time we were out of compliance with our Exchange Act reporting obligations and to provide some form of tangible value to the C&T Warrant Holders and the Senior Preferred Holders.
 
Results of Operations
 
The comparative data below presents our results of operations for the three-month periods ended March 31, 2007 and 2008 and for the fiscal years ended December 31, 2006 and 2007. While certain of the data is not strictly comparable because some line items are positive and some negative, the percentages calculated demonstrate the relative significance of the various line items and the line items where there were significant changes from year to year:
 
Quarterly Comparisons
 
 
1.
The cost of tangible products sold in the three month period ended March 31, 2008 increased $0.165 million over the same period in 2007. The increase substantially relates to an increase in material costs related to volume and the expansion of our manufacturing management development team that focused on readying the facility for commercialization of our PbC battery technology.
 
 
2.
Selling, General and Administrative (“SG&A”) expenses increased substantially during the first quarter of 2008. While there were a number of contributing factors, the increase is primarily due to higher legal expenses and duplicated public accounting and auditing services related to the selection and retention of our current auditors.
 
 
3.
R&D expenses increased $0.062 million over the amounts recorded during the first quarter of 2007 due to higher personnel costs.
 
18
 
 
4.
There were non-cash preferred stock dividends and beneficial conversion features of $ 5.3 million in 2007 with a comparable amount of $0.3 million in the first quarter of 2008. This non-cash beneficial conversion item is not expected to recur in 2008 in as substantial an amount as it did in 2007.
 
 
5.
Interest expenses for the first quarter of 2008 was higher than during the similar period of 2007 due to the bridge loan financing offered during the fourth quarter of 2007, whereas the capital needs for the early part of 2007 were satisfied through a preferred stock offering.
 
 
6.
The Pennsylvania capital stock tax was accrued during the fourth quarter of 2007, and was accounted for as income taxes. This item is not provided for during the first quarter of 2008.
 
Annual Comparisons
 
 
1.
SG&A expenses declined substantially from 2006 to 2007. While there were a number of factors that contributed, the decline reflects a decrease in legal expenses, as well as the consolidation of our total operations in New Castle, Pennsylvania.
 
 
2.
R&D expenses declined from 2006 to 2007. This was the result of the closing of our Toronto facility and the gradual transition from a full R&D company to the present entity that has both manufacturing and R&D components.
 
 
3.
There was a $1.1 million credit to total expenses in 2006, as a result of the return of the Mega-C Trust Augmentation Shares (see “Mega-C Trust Share Augmentation (Return)” below), which is not expected to recur. This line item reduced total expenses by $1.1 million in 2006 compared to 2007.
 
 
4.
There were non-cash preferred stock dividends and beneficial conversion features of $8.4 million in 2007 with a comparable amount of $0.8 million in 2006. This non-cash item is not expected to recur in as significant an amount in 2007.
 
 
5.
The non-cash preferred stock dividends and beneficial conversion feature were the primary reason for the approximately $6 million increase in net loss attributable to common stockholders in 2007.
 
 
6.
The Pennsylvania capital stock tax was accrued to cover and was recorded as income tax for 2007.
 

   
Three-Month Period Ended March 31,
 
Year Ended December 31,
 
Statements of Operation
 
2008
 
Percent of line
item to net loss
applicable to
common
stockholders
 
2007
 
Percent of line
item to net loss
applicable to
common
stockholders
 
2007
 
Percent of line
item to net loss
applicable to
common
stockholders
 
2006
 
Percent of line
item to net loss
applicable to
common
stockholders
 
Revenues
 
$
215,727
   
-7.3
%
$
164,513
   
-2.5
%
$
533,911
   
3.7
%
$
275,377
   
3.5
%
Cost of tangible products sold
   
394,236
   
13.3
%
 
228,890
   
3.5
%
 
1,130,855
   
7.9
%
 
557,983
   
7.1
%
Gross profit (loss)
   
(178,509
)
 
6.0
%
 
(64,377
)
 
1.0
%
 
(596,974
)
 
4.2
%
 
(282,606
)
 
3.6
%
Expenses
                                                 
Selling, general & administrative
   
1,713,165
   
57.7
%
 
879,462
   
13.4
%
 
3,720,632
   
26.0
%
 
4,788,986
   
60.9
%
Research & development
   
382,017
   
12.9
%
 
320,374
   
4.9
%
 
1,308,345
   
9.2
%
 
2,001,506
   
25.5
%
Impairment of assets
                                       
6,581
   
0.1
%
Interest expense - related party
   
419,673
   
14.1
%
 
17,202
   
0.3
%
 
276,651
   
1.9
%
 
713,048
   
9.1
%
Derivative revaluation
   
(2,844
)
 
-0.1
%
 
7,108
   
0.1
%
 
(72,236
)
 
0.5
%
 
437,588
   
5.6
%
Mega-C Trust Share Augmentation (Return)
                                       
(1,125,000
)
 
14.3
%
Other, net
   
(11,328
)
 
-0.4
%
 
(22,543
)
 
0.3
%
 
(47,708
)
 
0.3
%
 
(77,352
)
 
1.0
%
Net loss before income taxes
   
(2,679,192
)
 
90.3
%
 
(1,265,980
)
 
19.3
%
 
(5,782,658
)
 
40.5
%
 
(7,027,963
)
 
89.4
%
Income Taxes
   
-
   
0
%
 
-
   
0
%
 
83,469
         
_
       
Deficit accumulated during development stage
   
(2,679,192
)
 
90.3
%
 
(1,265,980
)
 
19.3
%
 
(5,866,127
)
 
41.1
%
 
(7,027,963
)
 
89.4
%
Less preferred stock dividends & beneficial conversion feature
   
(287,415
)
 
9.7
%
 
(5,283,092
)
 
80.7
%
 
(8,417,955
)
 
58.9
%
 
(835,529
)
 
10.6
%
Net loss applicable to common stockholders
 
$
(2,966,607
)
 
100.0
%
$
(6,549,072
)
 
100.0
%
 
(14,284,082
)
 
100.0
%
 
(7,863,492
)
 
100.0
%
Basic and diluted net loss per share
 
$
(0.17
)
     
$
(0.40
)
       
(0.88
)
       
(0.47
)
     
Weighted average common shares outstanding
   
17,861,987
         
16,247,299
         
16,247,299
         
16,628,290
       
 
19
 
Summary of Consolidated Results for the Three-Month Period Ended March 31, 2008 compared with the Three-Month Ended March 31, 2007
 
Revenue
 
Our revenues were approximately $215,727 for the quarter ended March 31, 2008 compared to revenues of approximately $164,513 for the quarter ended March 31, 2007. The approximate 31% increase in revenue was primarily due to another year of market exposure, especially in the race car and classic car industries and the sale of uninterruptible power supply batteries to one of our customers. These revenues will be dependent upon the number of enthusiasts for classic cars, auto racing and the amount of penetration we can achieve into the uninterruptible power supply market. We have two customers that together accounted for more than 31% (18.2% and 12.95%, respectively) of this revenue in the first quarter of 2008.
 
Cost of Tangible Products Sold and Gross Profit (Loss)
 
The cost of tangible products sold (“COTPS”) includes several raw materials with lead being the most prominent and costly. We also use other components such as plastic battery cases and covers, acid and separators. Our PbC batteries use specialty activated carbon for the negative electrode component of the battery. Lead, in particular, has increased substantially in price in the last two years as quantities available have shrunk. In manufacturing batteries we also incur labor and overhead expense as well as normal costs of packaging and shipping. COTPS increased by approximately $0.17 million, or 72%, to $0.39 million for the quarter ended March 31, 2008 compared with approximately $0.22 million for the quarter ended March 31, 2007. The increase in COTPS in the first quarter of 2007 compared to 2008 was primarily attributable to:
 
 
1.
sales increase of over 31%;
 
 
2.
preparing the manufacturing facility for the projected increase in sales and the additions to staff required for this increase in sales; and
 
 
3.
increased advertising with respect to a wider variety of products.
 
Gross loss (margin on sales) increased from approximately ($0.063) million, in the first quarter 2007 to $0.179 million, in the first quarter of 2008. The increased loss on gross margin was primarily attributable to the buildup associated with the transition to increased production and the continued operation of the plant at a low level of production. We believe we will produce profitable gross margins on sales as we ramp up production but there is no assurance of profits.
 
Selling, General & Administrative Expenses
 
SG&A expenses include salaries and services, non-cash compensation, sales and marketing expenses as well as public company costs which include financing, fund raising, investor relations, directors’ compensation, legal and audit fees. Total SG&A expenses increased $0.83 million, or 95%, to $1.7 million for the quarter ended March 31, 2008 compared with the quarter ended March 31, 2007 expenses of approximately $0.87 million. As a comparison of revenues to SG&A, SG&A expenses were eight times revenues for the first quarter 2008 compared to 5.4 times revenues for the same quarter in 2007. The increase in SG&A was primarily attributable to the increase in legal and accounting fees and investor relations expenses.
 
Research & Development Expenses
 
R&D expenses include salaries for our scientists as well as test equipment and general overhead.   Total R&D expenses increased $0.062 million or 19% to $0.382 million for the quarter ended March 31, 2008 compared with the quarter ended March 31, 2007 expenses of $.320 million. As a percentage of revenues, R&D expenses were 178% for the first quarter of 2008 and 194% for the same quarter in 2007. The increase in product development expenses were primarily due to increased personnel costs associated with additional R&D efforts.
 
20
 
Interest Expense – Related Party
 
Related party interest expenses include the coupon value of interest on debt, as well as the debt discount on detachable warrants and origination fees. For the period ended March 31, 2007 related party interest expenses were approximately $0.017 compared with $0.420 million in the period ended March 31, 2008. The disparity results from the method that the Company used in funding its capital needs. During the fourth quarter of 2006, the Company funded its capital needs through a preferred stock offering, whereas during the fourth quarter of 2007, the Company met its capital needs through a secured bridge loan financing program. The 2007 loans are convertible into the Company’s common stock.
 
Derivative Revaluation
 
Derivative revaluations are recognized whenever the Company incurs a liability to issue an equity instrument. The instrument is revalued quarterly until the point in time that the liability is settled. Derivative revaluation expenses for the period ended March 31, 2007 resulted in a credit of $0.007 million compared with a charge of $(0.003) million in the period ended March 31, 2008. During 2007, the Company funded its capital needs with debt that offered detachable warrants. These warrants were not settled until March 2008, at which point the Company’s stock values were lower, giving rise to the nominal credit in 2008. Whereas 400,000 warrants were subject to revaluation during 2007, only 20,000 were outstanding as of March 31, 2008.
 
21
 
Capital Expenditure Commitments
 
We plan the following capital expenditures:
 
1.   new equipment for negative electrode production;
 
2.   new equipment for carbon sheeting production;
 
3.   new equipment for standard lead-acid battery production; and
 
4.   renovate and install already purchased lead-acid battery production equipment.
 
Summary of Consolidated Results for the Year Ended December 31, 2007 compared with Year Ended December 31, 2006
 
Revenue
 
Our revenues nearly doubled to approximately $534,000 for the fiscal year ended December 31, 2007 compared to revenues of approximately $275,000 for the fiscal year ended December 31, 2006. The increase in revenue was primarily due to 12 months of operation at the New Castle plant as opposed to nine months in 2006. In 2007 we had a better plant facility with more licensed products to produce than we had in 2006. Our purchase of the assets of a battery manufacturing plant in early 2006 enabled us to realize the revenues to date primarily from the sale of specialty batteries (classic car and 16 volt racing car batteries). These revenues will be dependent upon the number of enthusiasts for classic cars and for auto racing. We have one customer that accounted for 11.4% of revenues in 2007.
 
22
 
Cost of Tangible Products Sold and Gross Profit (Loss)
 
COTPS include several raw materials with lead being the most prominent and costly. We also use other components such as plastic battery cases and covers, acid and separators. Our PbC batteries use specialty activated carbon for the negative electrode component of the battery. Lead in particular has increased substantially in price in the last two years as available quantities have shrunk. In manufacturing batteries we also incur labor and overhead expense as well as normal costs of packaging and shipping. COTPS increased by approximately $0.57 million, or 102%, to $1.13 million for the fiscal year ended December 31, 2007 compared with approximately $0.56 million for the fiscal year ended December 31, 2006. The increase in COTPS from fiscal 2006 to fiscal 2007 was primarily attributable to the following:
 
 
1.
Sales revenues very nearly doubled;
 
 
2.
2007 was the first full year for the sale of our specialty batteries after the New Castle battery plant remained dormant for nine months from June of 2005 into March of 2006;
 
 
3.
In 2007 the Company had a history of one year in production to meet customers’ needs; and
 
 
4.
We were able to do more advertising for the 2007 sales season.
 
Gross loss (margin on sales) increased from approximately ($0.3) million, or in fiscal year 2006 to ($0.6) million, in fiscal year 2007. The increased loss on gross margin was attributable to continued operations of the plant at a very low level or production. We believe we will produce profitable gross margins on sales as we ramp up production but there is no assurance of profits.
 
Selling, General & Administrative Expenses
 
SG&A expenses include salaries and services, non-cash compensation, sales and marketing expenses as well as public company costs which include fund raising, investor relations, directors’ compensation, legal and audit fees. Total SG&A expenses decreased $1.1 million, or 22%, to $3.7 million for the fiscal year ended December 31, 2007 compared with the fiscal year ended December 31, 2006 expenses of approximately $4.8 million. As a comparison of revenues to SG&A, SG&A expenses were 7 times revenues for fiscal 2007 compared to 17.4 times revenues for fiscal 2006. The decrease in marketing and selling expenses from fiscal 2006 to fiscal 2007 was primarily attributable to a decrease in legal fees and the consolidation of operations into a single facility at New Castle.
 
Research & Development Expenses
 
R&D expenses include salaries for our scientists as well as test equipment and general overhead. Total research and product development expenses decreased $0.7 million or 35% to $1.3 million for the fiscal year ended December 31, 2007 compared with the fiscal year ended December 31, 2006 expenses of $2.0 million. As a percentage of revenues, R&D expenses were 245% for fiscal 2007 and 727% for fiscal 2006. The decrease in product development expenses from the levels for fiscal 2006 to the levels for fiscal 2007 was due to reduced salaries resulting from the closure of the operations in Canada and lower legal fees related to our intellectual property.
 
Interest Expense - Related Party
 
Interest expense - related party includes the coupon value of interest on debt, debt discount on detachable warrants, and the beneficial conversion opportunities inherent to the debt itself. Interest expense - related party for the fiscal year ended December 31, 2007 was approximately $0.3 million compared with $0.7 million in the fiscal year ended December 31, 2006, representing a decrease of approximately $0.4 million. As the Company funded its capital needs in 2006 though loan instruments, the bulk of these loans were converted to equity during the fourth quarter of 2007. Unlike 2006, the 2007 loans were not convertible and warrant modifications involved preferred dividends and not interest as in 2006.
 
Derivative Revaluation
 
Derivative revaluations are recognized whenever the Company incurs a liability to issue an equity instrument. The instrument is revalued quarterly until the point in time that the liability is settled. Derivative revaluation expenses for the fiscal year ended December 31, 2007 was approximately a credit of ($0.072) million compared with a charge of $0.43 million in the fiscal year ended December 31, 2006, representing a decrease of approximately $0.5 million. Throughout 2006, we funded our capital needs with debt that offered detachable warrants. These warrants were not settled until December 2006 at which point the Company’s stock values were at their peak. Whereas 600,000 warrants were subject to revaluation during 2006, only 400,000 were subject to revaluation during 2007.
 
23
 
Mega-C Trust Share Augmentation (Return)
 
Mega-C Trust share augmentation (return) includes the valuation of 500,000 shares of our common stock as described in the financial statement footnote titled “ Mega-C Power Corp (Mega-C), Mega-C Trust (the Trust), The Taylor Litigation.” This type of transaction is not expected to recur after the transaction in 2006.
 
For the fiscal year ended December 31, 2007, our net loss before income taxes decreased $1.2 million, or 18%, to $5.8 million on revenue of $0.5 million, from an operating loss of approximately ($7.0 million) on revenue of $0.3 million for the fiscal year ended December 31, 2006. As discussed above, the factors primarily affecting this decrease in operating loss were a decrease in legal expenses, the absence of a $1.1 million dollar credit as occurred in 2006 and a decrease in expenses from the closure of our Canadian facilities.
 
Included in the net loss applicable to common stockholders are non-cash compensation expense related to preferred stock dividends and beneficial conversion feature of $8.4 million in 2007 compared with $0.8 million in 2006.
 
Our revenues and expenses do not include any items that do not arise from continuing operations. However, our operational costs have included significant legal costs that we believe will decline based on the status of the litigation described in the litigation section herein.
 
Our net loss attributable to common stockholders in 2007 of $14.0 million included $8.4 million dollars of preferred stock dividends and charges related to a beneficial conversion feature. We do not anticipate that these levels of non-cash charges will recur.
 
The year 2006 reflects a line item captioned “Mega-C Trust Share Augmentation (Return)” with a credit of $1,125,000. This credit reduced our overall loss by $1.1 million dollars and is not expected to recur.
 
There are limited seasonal aspects to our specialty battery business. Sales for batteries for race cars and classic cars typically peak in the spring with another smaller peak in the fall.
 
Liquidity and Capital Resources
 
Our primary source of liquidity has historically been cash generated from sales of our equity or debt securities. From inception until the fiscal year ended December 31, 2005, we generated no revenue from operations. We believe we have sufficient funds taking into account the final investment by the Quercus Trust on June 30, 2008 to conduct our operations for the next 18 months. If we do not significantly increase our revenues over the next 18 months will likely be unable to implement our business plan, fund our liquidity needs or even continue our operations after this period. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, most likely will result in dilution to our stockholders.
 
As of June 30, 2008, we had approximately $12.5 million of cash and cash equivalents, and approximately $9 million in working capital.
 
Cash, Cash Equivalents and Working Capital
 
At December 31, 2007, we had approximately $0.67 million of cash and cash equivalents compared to approximately $3.6 million at December 31, 2006. At December 31, 2007 working capital deficit was $2.9 million compared to $2.1 million at December 31, 2006.
 
Cash Flows from Operating Activities
 
Net cash used in operations for the year ended December 31, 2007 was $3.7 million, primarily due to ongoing R&D, accounting and legal fees, and normal costs of operations. This was partially offset by the following sources of cash and non-cash items governmental grants, equity instruments and loans from related parties. Cash used in operations for the year ended December 31, 2006 was approximately $4.6 million, primarily due to a deficit accumulated during development stage of approximately $7.0 million and the following uses of cash inventory and other prepaid expenses. This was partially offset by cash and non-cash items by sale of equity instruments and related party debt. Future fluctuations in inventory balances, accounts receivable and accounts payable will be dependent upon several factors, including, but not limited to, quarterly sales, our strategy in building inventory in advance of receiving orders from customers, and the accuracy of our forecasts of product demand and component requirements.
 
Cash Flows from Investing Activities
 
Net cash used in investing activities for the fiscal year ended December 31, 2007 was $1.2 million compared to $0.8 million for the fiscal year ended December 31, 2006. The cash used by investing activities included the purchase of equipment for both production and R&D.
 
24
 
Cash Flows from Financing Activities
 
Net cash provided by financing activities in the fiscal year ended December 31, 2007 was approximately $2.0 million compared to $8.4 million for the fiscal year ended December 31, 2006, primarily due to the proceeds from related party debt received in 2007 compared to 2006.
.
Critical Accounting Policies, Judgments and Estimates
 
The “Management’s Discussion and Analysis of Financial Condition or Plan of Operation” section of this prospectus discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). To prepare these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities. These estimates also affect our reported revenues and expenses. On an ongoing basis, management evaluates its estimates and judgment, including those related to revenue recognition, accrued expenses, financing operations and contingencies and litigation. Management bases its estimates and judgment on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.
 
25
 
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statement and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates.
 
Principles of Consolidation: The consolidated financial statements include the accounts of the Company, and its wholly owned subsidiaries, Axion Power Battery Manufacturing, Inc., APC and C&T. All significant inter-company balances and transactions have been eliminated in consolidation.
 
Revenue Recognition: The Company recognizes revenue upon transfer of title at the time of shipment (F.O.B. shipping point), when all significant contractual obligations have been satisfied, the price is fixed or determinable and collection is reasonably assured.
 
Stock-Based Compensation: Prior to January 1, 2006, the Company accounted for stock option awards in accordance with the recognition and measurement provisions of APB 25 and related interpretations, as permitted by Statement of Financial Accounting Standard No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”). Under APB 25, compensation cost for stock options issued to employees was measured as the excess, if any, of the fair value of the Company’s stock at the date of grant over the exercise price of the option granted. Compensation cost was recognized for stock options, if any, ratably over the vesting period. As permitted by SFAS 123, the Company reported pro-forma disclosures presenting results and earnings as if the Company had used the fair value recognition provisions of SFAS 123 in the Notes to the Consolidated Financial Statements.
 
Effective January 1, 2006, the Company adopted SFAS 123R using the modified prospective transition method. See footnote captioned “Equity Compensation” for further detail on the impact of SFAS 123R to the Company’s consolidated financial statements.
 
Stock-based compensation related to non-employees is recognized as compensation expense in the accompanying consolidated statements of operations and is based on the fair value of the services received or the fair value of the equity instruments issued, whichever is more readily determinable. The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of EITF 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and EITF 00-18, “Accounting Recognition for Certain Transactions Involving Equity Instruments granted to Other Than Employees.” The measurement date for the fair value of the equity instruments issued is determined at the earlier of (1) the date at which a commitment for performance by the consultant or vendor is reached or (2) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
 
Research and Development: R&D costs are recorded in accordance with FASB No. 2, “Accounting for Research and Development Costs,” which requires that costs incurred in R&D activities covering basic scientific research and the application of scientific advances to the development of new and improved products and their uses be expensed as incurred. The policy of expensing the costs of R&D activities relate to (1) in-house work conducted by the Company, (2) costs incurred in connection with contracts that outsource R&D to third party developers and (3) costs incurred in connection with the acquisition of intellectual property that is properly classified as in-process R&D. All R&D costs have been expensed.
 
Off Balance Sheet Arrangements. We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, an effect on our financial condition, financial statements, revenues or expenses.
 
BUSINESS
 
Our Corporate History
 
APC was formed in September of 2003 to acquire and develop certain innovative battery technology. Since inception APC has been engaged in R&D of the new technology for the production of PbC batteries. As of December 31, 2003, APC engaged in a reverse acquisition with Tamboril, a public shell company whereby APC became a wholly-owned subsidiary of Tamboril. Tamboril was originally incorporated in Delaware in January 1997, operated a wholesale cigar business until December 1998 and was an inactive public shell thereafter until December 2003. Tamboril changed its name to Axion Power International, Inc. immediately following the reverse acquisition.
 
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Since inception, our operations have been financed by a small group of individuals with minimal revenue generated. As a result, trading in our common stock has been sporadic, volumes have been low, and the market price has been volatile. We believe that a successful transition from R&D to manufacturing will improve our cash balances and market profile and may result in a more active trading market for our stock. However, we can provide no guarantees that our transition efforts will be successful.
 
The Battery Industry
 
There are two principal types of lead acid batteries; flooded batteries and valve regulated lead acid (“VRLA”). The choice of battery depends mainly on the specific application that the battery serves. Typical standby or stationary applications use VRLA batteries due to their inherent advantages including spill proof design, low maintenance, compact form, low self-discharge and high performance. On the other hand, applications like industrial equipment, traction and/railroad applications prefer the flooded lead acid battery types due to their superior performance in continuous deep discharge applications and at high operating temperatures, among other features.
 
Technology within the lead-acid battery industry has remained relatively stable for the last 30 years and an industry-wide lack of innovation has generally restrained growth into new applications and emerging markets.
 
Alternative energy applications like wind and solar power require an energy storage solution that combines low cost and long life cycles. Lead-acid batteries are currently one of the gold standards in large-scale power storage applications, but the short cycle-life of lead acid chemistry at deep discharge levels is a primary inhibitor to growth. Due primarily to the cycle-life limitations of lead acid batteries, a number of battery manufacturers are experimenting with alternative battery technologies that are far more expensive to implement, but offer substantial cycle-life advantages.
 
For the last ten years, Asian battery manufacturers have been vigorous competitors in the North American market. However, lead acid batteries suffer irreparable damage if they are packed in shipping containers for lengthy maritime transport or held in inventory for extended periods. Due to performance issues and warranty problems in North America, increased domestic demand in their home markets, and significant changes in their home countries’ import-export regulations and tariffs, many of the large Asian manufacturers have significantly reduced their battery exports to Europe or the Americas. Domestic battery manufacturing plants have closed and, since the closed plants were often sold at auction to foreign buyers or scrapped, the net result was a substantial decline in domestic capacity. The resulting unavailability of imports coupled with the reduction in domestic plant capacity has left the North American industry in a position where it cannot currently produce batteries in sufficient numbers to meet growing market demands. The major participants in the industry are responding with plans to construct several million square feet of new manufacturing facilities, but those new plants are not expected to be fully operational for 12 to 18 months.
 
The North American lead acid battery industry is mature with a few leading vendors that have a global presence and a larger number of smaller regional and local vendors that cater to the needs of the North American market. The first tier companies that have a global presence include EnerSys, Exide Technologies, Johnson Controls and FIAMM. The second tier companies that cater mainly to the North American Markets include, among others, C&D Technologies, GS Batteries, Crown Batteries, Trojan Battery, Eagle Picher Technologies and East Penn Manufacturing. The user segments that rely on lead acid batteries include automotive applications, standby applications ranging from uninterruptible power supplies to telecommunication applications, power storage for wind and solar systems and motive power for heavy-duty equipment and railroad applications.
 
Our Business
 
We are a development stage company that has invested four years and approximately $9.5 million in R&D expense to develop a patented energy storage device that uses carbon electrode assemblies to replace the lead-based negative electrodes found in conventional lead-acid batteries. The end result is the PbC battery prototype, a battery-supercapacitor hybrid that combines the simplicity of lead-acid batteries and the faster recharge rates and longer cycle lives of supercapacitors in a low-cost device that can be designed to deliver maximum power for fast discharge applications; maximum energy for slow discharge applications; or a range of balances between the two.
 
Our PbC technology, which is protected by six issued U.S. patents, seven pending U.S. patent applications, other proprietary features and structures, is technically sophisticated yet simple. The carbon electrode assemblies are fabricated from readily available raw materials using, for the most part, standard industrial processes and techniques. The electrodes are then assembled into PbC batteries that use the same cases, covers, positive electrodes, separators and electrolyte as conventional lead-acid batteries and they are assembled with the same equipment and manufacturing methods that we, and the majority of the lead-acid battery industry, uses for manufacturing lead-acid batteries. PbC batteries use up to 40% less lead than comparable sized lead-acid batteries, and the lead, plastics and acid employed are fully recyclable at existing facilities, which makes the PbC battery a more environmentally-friendly product.
 
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In February 2007, our PbC technology received the prestigious Frost & Sullivan Technology Innovation Award for the best development in the field of lead acid batteries for 2006.
 
We believe that for large-scale deep-discharge energy storage systems (10 kWh or greater), our commercial prototype PbC batteries offer one of the lowest total cost of ownership per charge-discharge cycle in the battery industry. As ongoing development work on our PbC technology progresses, we believe additional cost reductions and efficiency gains are likely.
 
We believe our PbC technology will be uniquely situated to exploit the current problems facing the North American lead-acid battery industry. While we may exploit our PbC technology in a number of ways, our recent acquisition of a battery manufacturing plant gives us the ability to produce energy storage devices using our new technology. The plant acquisition allows us to exploit our technology by manufacturing our new energy storage devices for demonstration projects, for sale to end-users (once we are satisfied with the technology) or to manufacture the component parts other battery manufacturers could insert into their own batteries. The facility leased in New Castle, Pennsylvania beginning in 2006 has a permitted manufacturing capacity of 3,000 batteries per day and has operational production lines for both sealed and flooded lead-acid batteries. The ability to produce both types of batteries in a variety of sizes enables us to target our excess capacity at high-margin products that are required in relatively small volumes, such as deep cycle industrial batteries and other specialty products. Over the next 18 to 24 months, we plan to exploit the manufacturing capacity deficit in the lead-acid battery industry by producing high margin lead-acid products while we complete development of our PbC technology. As additional capacity comes on-line in the broader industry, we plan to transition our manufacturing focus from lead-acid products to our reduced-lead, enhanced-performance lead-carbon PbC products.
 
As we continue the transition from laboratory research to commercial prototype manufacturing, we will need to:
 
 
·
refine our planned fabrication methods for carbon electrode assemblies;
 
 
·
demonstrate the feasibility of manufacturing our PbC device using standard techniques and equipment;
 
 
·
demonstrate and document the performance of our PbC device in key applications; and
 
 
·
respond appropriately to anticipated and unanticipated technical and manufacturing challenges.
 
We plan to develop our PbC device for use in a variety of applications including:
 
 
·
motive power applications;
 
 
·
stationary power applications;
 
 
·
hybrid electric vehicle applications; and
 
 
·
military applications.
 
We believe demand for cost-effective energy storage systems will grow rapidly. We also believe we can become a leader in the high performance battery market. We believe our competitive advantages will include:
 
 
·
Ease of integration: Our planned electrode assemblies will be designed to replace the standard grid and paste negative electrodes in conventional lead-acid batteries. In some applications that require fixed voltage operations, voltage conversion may be needed;
 
 
·
Superior flexibility: By changing the number, geometry and arrangement of the electrode assemblies, we expect to be able to configure our technology to favor either energy storage or power delivery; and
 
 
·
Reduced lead content : Depending on the energy, power and cycling requirements of a particular application, our PbC device will use up to 40% less lead than conventional lead acid batteries.
 
We anticipate our ability to establish and maintain a competitive position will be dependent on several factors, including:
 
 
·
the availability of raw materials and key components;
 
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·
our ability to design and manufacture commercial prototype PbC carbon electrode assemblies;
 
 
·
our ability to establish and operate facilities that can fabricate electrode assemblies and commercially manufacture our PbC device with consistent quality at a predictable cost;
 
 
·
our ability to establish and expand a customer base;
 
 
·
our ability to compete against established and emerging battery and other storage technologies;
 
 
·
the market for batteries in general; and
 
 
·
our ability to retain key personnel.
 
Our objective is to become an industry leader in low cost, high performance energy storage systems. We plan to achieve this objective by pursuing the following core strategies:
 
 
·
Platform technology business model. We plan to implement a platform technology business model where we will focus on developing and manufacturing carbon electrode assemblies that we can offer for sale to established battery manufacturers who want to use our PbC device products in their batteries.
 
 
·
Leverage relationships with thought leaders. We are engaged in discussions with industry consortia, research institutions and other thought leaders in the fields of utility applications, hybrid electric vehicles and automotive fuel cell technology. As we develop our relationships in the field of energy research, we believe the opportunities for government funding and consortia participation will expand rapidly, and improve our access to potential suppliers and customers.
 
 
·
Leverage relationships with battery manufacturers . Our business model is based on the premise that we can most effectively address the needs of the market by selling electrode assemblies to established battery manufacturers who want to expand their existing product lines. This business model should allow us to leverage the business abilities, manufacturing facilities and distribution networks of established manufacturers, in order to reduce our time to market and increase our potential market penetration.
 
 
·
Build a recognized brand. We believe strong brand name recognition is important to increase product awareness and to effectively penetrate the mass market. We intend to differentiate our brand by emphasizing our combination of high performance and low total cost of ownership per storage cycle.
 
 
·
Secondary focus on emerging markets . Emerging markets for fuel cell power systems, hybrid electric vehicles and conventional utility applications are becoming increasingly attractive. We are actively evaluating the potential for using our PbC device products in these emerging markets.
 
 
·
Maintain our technical advantage and reduce manufacturing costs . We intend to maintain our technical advantage by continuing to invest in R&D to improve the performance of our PbC devices and lower our manufacturing costs.
 
The battery industry is mature, capital intensive, heavily regulated, highly competitive and averse to product performance risks associated with radical departures from established technology. Due to the nature of the industry, we do not believe we will be able to make a credible entry into the battery market until we have proven the advantages of our PbC device technology in demonstration projects with end users. Therefore, our business plan contemplates two discrete phases: the Development Phase (including prototype and demonstration) and the Commercialization Phase.
 
Development Phase. During the Development Phase, we will focus on producing small quantities of commercial prototypes in our own manufacturing facilities. These commercial prototypes will serve as the foundation for a series of paid demonstration projects with established end users. If the demonstration projects are successful and end user testing validates the advantages of our PbC device technology under real-world operating conditions, we can proceed to the full commercialization phase. In general, our development path in each identified target market will include the following:
 
 
·
Prototype manufacturing. We are finalizing design work and manufacturing plans for our commercial prototype PbC devices. We intend to purchase raw materials and components from established manufacturers and then fabricate electrode assemblies and assemble our commercial prototype PbC devices in company-owned facilities at a higher rate than we can manufacture today.
 
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·
Demonstration projects . When we have developed and tested our commercial prototype PbC devices for a particular target market, we will need to negotiate demonstration projects with industry participants, some of whom we already have contracts with, manufacture the required PbC devices and document the performance of our products in real-world conditions.
 
 
·
Commercial production . When we have developed sufficient data to support a decision to commence full scale production of a product or product line, we intend to use our New Castle Pennsylvania facility until we fill our permitted capacity, after which we plan to pursue strategic relationships with one or more battery manufacturers that are willing to manufacture co-branded commercial PbC products.
 
Our planned demonstration projects are not expected to generate sufficient gross profit to offset our expected operating costs. Accordingly, we do not expect to attain profitability during the demonstration phase. If we enter into a commercialization relationship for a specific product or product line, we believe our margins are likely to improve. However, there is no assurance that the commercialization of products for one or more market segments will generate sufficient revenue to offset our anticipated operating expenses and yield a profit.
 
Commercialization phase. During the commercialization phase, we intend to implement a platform technology business model where we will develop and manufacture the carbon electrode assemblies that are unique to our PbC device and then sell those assemblies to established battery manufacturers who want to make their batteries better. We believe a platform technology business model can reduce our time to market, allow us to rely on the established business abilities of existing manufacturers and forge a strong brand identity for our PbC device, while allowing us to focus on a narrow band of value-added activities that appear likely to minimize our investment and maximize our profitability.
 
We will not be in a preferred position to negotiate manufacturing relationships with established battery manufacturers until we complete our planned demonstration projects. Even if our planned demonstration projects are successful, we may be unable to negotiate manufacturing relationships on terms acceptable to us. If we decide to manufacture and distribute a line of commercial battery products ourselves, rather than sell carbon electrode assemblies to established battery manufacturers, our time to market and our anticipated capital costs may increase dramatically.
 
We plan to initially focus on high-value market segments. We believe our commercial PbC device will be most appealing in high-value market segments where longer life, high performance, and low maintenance costs are more important than initial purchase price.
 
Acquisition of Our PbC Device Technology
 
We incorporated APC in September 2003, for the purpose of acquiring rights to our PbC technology from C&T, the original owner of the patents. The founders of APC were stockholders of Mega-C Power Corp. (“Mega-C”), which from 2001 until mid 2003 held a limited, nonexclusive license to market products utilizing the PbC device technology that we currently own. In February 2003, the Ontario Securities Commission began an investigation into Mega-C’s stock sales that terminated Mega-C’s ability to finance its operations and continue in business. The founders of APC had collectively invested approximately $3.9 million in Mega-C and were facing a total loss of this investment when Mega-C was unable to continue in business. In connection with the organization of APC, the founders invested approximately $1.4 million dollars.
 
In late December 2003, Tamboril had 1,875,000 shares outstanding. After evaluating the PbC device technology and APC, Tamboril’s management negotiated a series of related transactions that included:
 
 
·
a reverse acquisition between Tamboril and APC;
 
 
·
the establishment of the Mega-C Trust for the stated purpose of preserving the potential equitable rights of Mega-C’s creditors and stockholders while potentially insulating us from the litigation risks associated with the activities of Mega-C and its promoters; and
 
 
·
a purchase of the PbC device technology from C&T.
 
The reverse acquisition, trust establishment and technology acquisition transactions closed in December 2003 and January 2004. In connection with the closings:
 
 
·
in the reverse acquisition we issued 10,739,500 common shares and 608,600 warrants for the outstanding securities of APC (which resulted in APC becoming a wholly owned subsidiary of Tamboril);
 
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·
we issued 233,400 warrants to purchase stock in the post-acquisition company to Tamboril’s management in satisfaction of related-party debt;
 
 
·
C&T purchased 1,250,000 previously outstanding common shares from Tamboril’s management;
 
 
·
we purchased all of C&T’s interest in the PbC device technology for 1,562,900 warrants; and
 
 
·
we assumed and satisfied APC’s obligations of $1,794,000 under the November 2003 Development and License Agreement originally entered into by APC and C&T to develop the PbC technology through the issuance of $1,000,000 of Senior Preferred Stock and the payment of $794,000 in cash through March 31, 2005.
 
We acquired full ownership of C&T, including its capital stock, in March 2005 upon final satisfaction of the payments noted above and extinguished all rights to future payments under the November 2003 development and license agreement. C&T’s assets other than the intellectual property were insignificant. We purchased $84,000 in equipment from an affiliate of C&T.
 
Of the 10,739,500 common shares that Tamboril issued for the outstanding securities of APC, 7,327,500 shares, or approximately 58% of our post-transaction capitalization, were deposited in the Mega-C Trust. The remaining 3,412,000 shares were distributed among APC’s stockholders. After the closing, APC’s stockholders, C&T’s stockholders and the Mega-C Trust owned 95% of our stock. For financial reporting purposes, APC was deemed to be the accounting acquirer of Tamboril, followed by a recapitalization.
 
Since February 2004, we have been involved in litigation with certain promoters of Mega-C who are asserting a variety of claims arising from APC’s alleged interference in Mega-C’s affairs and our purchase of the PbC device technology. We filed an involuntary bankruptcy petition against Mega-C in April 2004 and contributed 500,000 additional shares to the Mega-C Trust in February 2005 for the purpose of augmenting the trust corpus and offsetting the additional administrative and operating costs associated with the bankruptcy. In July 2005, we initiated litigation with Mega-C’s Chapter 11 Trustee that focused primarily on whether the stock in the Mega-C Trust was property of the bankruptcy estate or should remain in the Mega-C Trust. On December 12, 2005, we entered into the Settlement Agreement with Mega-C’s Chapter 11 Trustee, the Mega-C Trust and others that will resolve all disputes, including disputes arising from our purchase of the original patents for the technology from C&T and derivative claims of Mega-C’s stockholders.
 
The Settlement Agreement resulted in the return of 1,500,000 of our shares for cancellation, of which 500,000 represented a return of the 500,000 augmentation shares issued to the Mega-C Trust and the remaining 1,000,000 were accounted for as a retroactive adjustment to the 10,739,500 shares issued as consideration in the reverse acquisition. This settlement is discussed in detail in Note 14 to our Audited Consolidated Financial Statements on page F-37.
 
Although third parties have not asserted any infringement claims against us, there is no assurance that third parties will not assert such claims in the future. Although not a patent infringement suit, a collection of individuals and entities that describe themselves as the “Taylor Group” sued the Company and claimed an interest in some of our intellectual property. In orders dated February 11, 2008, the United States Bankruptcy Court for the District of Nevada held that the Taylor Group has no interest in or rights to the technology. As described in this prospectus, the Bankruptcy Court has entered summary judgment orders in favor of the Company, holding that the Taylor Group has no interest in the Technology and that the Taylor litigation is barred by the permanent injunction of Mega-C Power Corp.’s confirmed Chapter 11 plan. The Taylor Group filed motions for relief from the Bankruptcy Court orders granting partial summary judgment in favor of the Company, which were heard on May 12, 2008. The Taylor Group filed motions for relief from the order granting partial summary judgment in favor of the Company and other relief. In orders entered on June 9, 2008, the Bankruptcy Court denied the Taylor Group's motions. In addition, the Company filed a motion for partial summary judgment for an order require to require dismissal of the Taylor Group litigation against the Company. In orders entered on June 9, 2008, the Bankruptcy Court granted the Company's motion and mandated that the Taylor Group litigation against the Company be dismissed. On June 18, 2008, the Taylors Group filed a notice of appeal from these orders. The Taylors have signed a pleading to dismiss the Company from the Taylor Group litigation in Canada.
 
Our Patents and Intellectual Property
 
We own six issued U.S. patents and have seven patent applications pending at the date of this report covering various aspects of our PbC device technology. There is no assurance that any of the pending patent applications will ultimately be granted. Our issued patents are:
 
 
·
U.S. Patent No. 6,466,429 (expires May 2021) - Electric double layer capacitor;
 
 
·
U.S. Patent No. 6,628,504 (expires May 2021) - Electric double layer capacitor;
 
 
·
U.S. Patent No. 6,706,079 (expires May 2022) - Method of formation and charge of the negative polarizable carbon electrode in an electric double layer capacitor;
 
 
·
U.S. Patent No. 7,006,346 (expires April 2024) - Positive Electrode of an electric double layer capacitor;
 
 
·
U.S. Patent No. 7,110,242 (expires February 2021) - Electrode for electric double layer capacitor and method of fabrication thereof; and
 
 
·
U.S. Patent No. 7,119,047 (expires February 2021) - Modified activated carbon for carbon for capacitor electrodes and method of fabrication thereof.
 
Patents generally expire 17 years from date of issue.
 
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We have no duty to pay any royalties or license fees with respect to the commercialization of our PbC device technology and we are not subject to any field of use restrictions. We believe our patents and patent applications, along with our trade secrets, know-how and other intellectual property will be critical to our success.
 
Our ability to compete effectively with other companies will depend on our ability to maintain the PbC device technology. We plan to file additional patent applications in the future. However, the degree of protection offered by our existing patents or the likelihood that our future applications will be granted is uncertain. Competitors in both the United States and foreign countries, many of which have substantially greater resources and have made substantial investment in competing technologies, may have, or may apply for and obtain patents that will prevent, limit or interfere with our ability to make and sell products based on our PbC device technology. Competitors may also intentionally infringe on our patents. The prosecution and defense of patent litigation is both costly and time-consuming, even if the outcome is favorable to us. An adverse outcome in the defense of a patent infringement suit could subject us to significant liabilities to third parties. Although third parties have not asserted any infringement claims against us, there is no assurance that third parties will not assert such claims in the future, or claims similar to those of the Taylor Group discussed above. 
 
We also rely on trade secrets, know-how and other unpatented technology and there is no assurance that others will not independently develop the same or similar technology or obtain unauthorized access to our trade secrets, know-how and other unpatented technology. To protect our rights in these areas, we require all employees, consultants, advisors and collaborators to enter into confidentiality agreements. These agreements may not provide meaningful protection for our unpatented technology in the event of an unauthorized use, misappropriation or disclosure. While we have attempted to protect the unpatented proprietary technology that we develop or acquire and will continue to attempt to protect future proprietary technology through patents, copyrights and trade secrets, we believe that our success will depend upon further innovation and technological expertise.
 
We may license technology from third parties. Our proposed products are still in the development stage and we may need to license additional technologies to optimize the performance of our products. We may not be able to license these technologies on commercially reasonable terms or at all. In addition, we may fail to successfully integrate any licensed technology into our proposed products. Our inability to obtain any necessary licenses could delay our product development and testing until alternative technologies can be identified, licensed and integrated.
 
In general, the level of protection afforded by a patent is directly proportional to the ability of the patent owner to protect and enforce his rights through legal action. Since our financial resources are limited, and patent litigation can be both expensive and time consuming, there can be no assurance that we will be able to successfully prosecute an infringement claim in the event that a competitor develops a technology or introduces a product that infringes on one or more of our patents or patent applications. There can be no assurance that our competitors will not independently develop other technologies that render our proposed products obsolete. In general, we believe the best protection of our proprietary technology will come from market position, technical innovation, speed-to-market and product performance. There is no assurance that we will realize any benefit from our intellectual property rights.
 
Our Competition
 
We plan to compete with a number of established competitors in the battery and supercapacitor industry, including:
 
·      Maxwell
 
·      Enersys
 
·      Energy Conversion Devices
 
·      Exide
 
·      Panasonic
·      Japan Storage Battery
 
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·      Nippon-Chemicon
 
·      Ness
In addition, many universities, research institutions and other companies are developing advanced energy storage technologies including:
 
 
·
symmetric supercapacitors;
 
 
·
asymmetric supercapacitors with organic electrolytes;
 
 
·
nickel metal hydride batteries;
 
 
·
lithium ion batteries; and
 
 
·
advanced lead-acid and flow batteries.
 
Other business entities are developing advanced energy production technologies like fuel cells, solar cells and windmills which may use our products, or, in some cases, compete with our products.
 
Since some of our competitors are developing technologies that may ultimately have costs similar to, or lower than, our projected costs, there can be no assurance we will be able to compete effectively.
 
Most of our potential competitors have longer operating histories, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than us. As a result, they may be able to respond more quickly to changing customer demands or to devote greater resources to the development, promotion and sales of their products than we may be able to.
 
Our competitors with more diversified product offerings may be better positioned to withstand changing market conditions. Some of our competitors own, partner with, have longer term or stronger relationships with suppliers of raw materials and components, which could result in them being able to obtain raw materials on a more favorable basis than us. It is possible that new competitors or alliances among existing competitors could emerge and rapidly acquire significant market share, which would harm our business.
 
We expect to compete on the basis of design flexibility, performance, reliability and total cost of ownership per storage cycle. If we fail to compete successfully, our business would suffer and we may lose or be unable to gain market share. In addition, the energy storage device market in general competes with other sources of renewable energy and conventional power generation. If prices for conventional and other renewable energy resources decline, or if these resources enjoy greater policy support than solar power, the energy storage device market could suffer.
 
The development of technology, equipment and manufacturing techniques and the operation of a facility for the automated production of rechargeable batteries require large capital expenditures. In order to minimize our capital investment in manufacturing facilities and establish strong brand name recognition for our products, our overall strategy is to negotiate strategic alliances and other production agreements with established battery manufacturers that want to include a high-performance co-branded product in their existing product lines. There can be no assurance, however, that our platform technology business model will succeed in the battery industry.
 
Raw Materials
 
During the research stage, we used readily available raw materials, off-the-shelf components manufactured by others and hand-made components fabricated by our staff. As we begin manufacturing in commercial quantities, we will need to establish reliable supply channels for commercial quantities of raw materials and components. We believe established suppliers of raw materials and components will be able to satisfy our requirements on a timely basis. However we do not have any long-term supply contracts and the unavailability of necessary raw materials or components could delay the production of our products and adversely impact our results of operations.
 
Lead is the primary raw material in lead-acid batteries and currently accounts for approximately 80% of our raw material and component costs in the specialty batteries we build now. Lead prices have increased dramatically over the last two years. Our new PbC device technology will require up to 40% less lead than conventional batteries. This makes the reduced lead content in our batteries a distinct competitive advantage.
 
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Environmental Protection
 
Lead is a toxic material that is a primary raw material in our PbC. We also use, generate and discharge other toxic, volatile and hazardous chemicals and wastes in our research, development and manufacturing activities. We will be required to comply with federal, state and local laws and regulations regarding pollution control and environmental protection. Under some statutes and regulations, a government agency, or other parties, may seek to recover response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for such release or otherwise at fault. In addition, more stringent laws and regulations may be adopted in the future, and the costs of complying with those laws and regulations could be substantial. If we fail to control the use of, or to adequately restrict the discharge of, hazardous substances, we could be subject to significant monetary damages and fines, or forced to suspend certain operations.
 
Our Research and Development
 
We engage in extensive R&D to improve our PbC device technology and our proposed products. Our goal is to increase efficiency and reduce costs in order to maximize our competitive advantage. Our R&D organization works closely with our engineering team, our suppliers and potential customers to improve our product design and lower manufacturing costs. During the years ended December 31, 2006 and 2007, we spent $2.1 million and $1.3 million respectively on R&D, and $9.5 million since inception. While our limited financial resources and short operating history makes it difficult for us to estimate our future expenditures, we expect to incur R&D expenditures of consistent magnitude for the foreseeable future.
 
Our Employees
 
New Castle, Pennsylvania: We presently employ a staff of 31, including a six-member scientific and engineering team, and 15 people who are involved principally in manufacturing. We are not subject to any collective bargaining agreements and believe our relations with our employees are good.
 
Description of Properties
 
In April of 2008 we signed a new lease that added to our existing space at our manufacturing plant in New Castle, Pennsylvania. The new lease calls for a monthly payment of $16,142 with an initial term of two years beginning April 2008. The lease includes two successive five-year renewal options, with future rent to be negotiated at a commercially reasonable rate. The battery manufacturing facility includes approximately 70,438 square feet of floor space, including 7,859 square feet of office, locker, lab and lunch area, 46,931 square feet of manufacturing space, 1,488 square feet of dedicated lab space, 9,200 square feet of storage buildings and 5,000 square feet of basement area. In addition to the monthly rental, we are obligated to pay all required maintenance costs, taxes and special assessments, maintain public liability insurance, and maintain fire and casualty insurance for an amount equal to 100% of the replacement value of the leased premises. Our battery manufacturing operations at this facility are conducted through a wholly owned subsidiary named Axion Power Battery Manufacturing, Inc. Management believes our property is in good condition.
 
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LEGAL PROCEEDINGS
 
Taylor Litigation
 
On February 10, 2004, Lewis “Chip” Taylor, Chip Taylor in Trust, Jared Taylor, Elgin Investments, Inc. and Mega-C Technologies, Inc. (collectively the “Taylor Group”) filed a lawsuit in the Ontario Superior Court of Justice Commercial List (Case No. 04-CL-5317) that named Tamboril, APC, Rene Pardo, Marvin Winick, Kirk Tierney, Joseph Piccirilli, Ronald Bibace, Robert Averill, James Smith, James Eagan, Thomas Granville, Joseph Souccar, Glenn W. Patterson, Canadian Consultants Bureau Inc., Robert Appel, Harold Rosen, Igor Filipenko, Valeri Shtemberg, Yuri Volfkovich, Pavel Shmatko, Michael Kishinevsky, Mega-C Power Corporation (Nevada), Mega-C Power Corporation (Ontario), C&T, Turitella Corporation, Gary Bouchard, Fogler Rubinoff LLP, Netprofitetc Inc., 503124 Ontario Ltd., HAP Investments LLC, Infinity Group LLC, James Keim, Benjamin Rubin and John Doe Corporation as defendants (the “Taylor Litigation”). As discussed more fully below, by virtue of an order entered on February 11, 2008 by the Bankruptcy Court in the Mega-C bankruptcy case, this action against the Company, Mega-C Power Corporation (Nevada), Robert Averill, Glenn Patterson, Igor Filipenko, Thomas Granville and HAP Investments is subject to the permanent injunction of the confirmed Chapter 11 Plan of Mega-C. This ruling confirmed management’s prior assessment of this lawsuit, which management believed had remote possibility of an adverse decision. No amounts have been provided for in the accompanying financial statements pursuant to the requirements of Statement of Financial Accounting Standards No. 5, “ Accounting for Contingencies.” We have offered to provide a coordinated legal defense for all individual defendants who agree to be represented by counsel for the Company in Canada. Any named defendant will be free to retain independent legal counsel, but we are not responsible for the costs of separate legal counsel. We have not agreed to indemnify any party against damage awards rendered against them or amounts paid in settlement of claims.
 
In February 2005, the Bankruptcy Court stayed the Taylor Litigation pending resolution of Mega-C’s Chapter 11 bankruptcy case. On December 12, 2005, we entered into a settlement agreement with Mega-C, through its Chapter 11 Trustee, and various others that was approved by an order entered in the bankruptcy case on February 1, 2006 and which became fully effective when the Court confirmed Mega-C’s Chapter 11 Plan of Reorganization in an order entered on November 8, 2006. The details of the settlement agreement and the current state of the Taylor Group's litigation are discussed below.
 
Bankruptcy Court Litigation
 
In April 2004, we filed an involuntary Chapter 11 petition against Mega-C in the U.S. Bankruptcy Court for the District of Nevada (Case No. 04-50962-gwz). In March 2005, the Bankruptcy Court appointed William M. Noall (“Noall”) to serve as Chapter 11 Trustee for the Mega-C case. On June 7, 2005, the Chapter 11 Trustee commenced an adversary proceeding against Sally Fonner (“Fonner”), the trustee of the Mega-C Trust (Adversary Proceeding No. 05-05042-gwz), demanding, among other things, the turnover of at least 7,327,500 shares held by the Mega-C Trust as property of the bankruptcy estate. On July 27, 2005, we commenced an adversary proceeding against Noall and Fonner (Adversary Proceeding No. 05-05082-gwz) for the purpose of obtaining a judicial determination that:
 
 
·
Mega-C does not have any interest in the three patents and other intellectual property the Company purchased directly from C&T;
 
 
·
Mega-C did not transfer any property to our Company with the intent to damage or defraud any entity;
 
 
·
Mega-C did not transfer any property to our Company for less than reasonably equivalent value; and
 
 
·
if the court ultimately decides that the stock in the Mega-C Trust is property of the bankruptcy estate, the stock must be held in a resulting trust for our benefit.
 
Settlement Agreement
 
On December 12, 2005, we entered into the Settlement Agreement with Mega-C, represented by Chapter 11 Trustee Noall, and the Mega-C Trust, represented by its trustee Fonner. Additional signatories to the Settlement Agreement include: (1) the Company’s subsidiaries APC and C&T, (2) Fonner in both her capacity as Mega-C’s sole officer and director and as trustee of the Mega-C Trust, (3) certain former stockholders of APC including Robert Averill, Joe Piccirilli, Canadian Consultants Bureau Inc., James Smith, James Eagan, Tom Granville, Joe Souccar, HAP Investments, LLC, Glenn Patterson, Igor Filipenko, Ron Bibace, Kirk Tierney, Infinity Group, LLC, James Keim and Turitella Corporation, (4) Paul Bancroft and (5) certain former stockholders of C&T, including Yuri Volkovich, Pavel Shmatko, Albert Shtemberg, Edward Shtemberg, C&T Co., Inc. in Trust, Oksana Fylypenko, Andriy Malitskiy, Valeri Shtemberg, Yuri Shtemberg, Victor Eshkenazi, Miraslav E. Royz, and Rimma Shtemberg.
 
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The Settlement Agreement was approved by the Bankruptcy Court after a hearing in an order dated February 1, 2006. Certain terms were subject to confirmation and effectiveness of Mega-C’s Chapter 11 plan of reorganization. On November 8, 2006, the Bankruptcy Court entered an order confirming the Chapter 11 plan. The confirmed Chapter 11 plan was subsequently substantially consummated on November 21, 2006. The Settlement Agreement was fully incorporated in the confirmed Chapter 11 plan. At the date of these financial statements, the plan is fully effective and substantially consummated. Accordingly, all pending and potential disputes between the parties have been resolved. By way of summary of the Chapter 11 plan, the following steps have been accomplished:
 
 
·
we have compromised and withdrawn our notes receivable from Mega-C to an allowed unsecured claim of $100;
 
 
·
Mega-C has assigned all of right, title and interest, if any, in the technology and any and all tangible and intangible personal property in our possession to us;
 
 
·
the Mega-C Trust has been restated as the Second Amended Stockholders Trust of Mega-C Power Corporation and retained title to 4,700,000 shares that will be sold to pay creditor claims that remain unsatisfied from the Liquidation Trust described below, with the balance to be proportionately distributed to the holders of allowed equity interests in Mega-C. The Second Amended Stockholders Trust also has title to certificates for 685,002 shares of our common stock, which serve as collateral for loans in the amount of $2,055,000 paid to the newly created Liquidation Trust to fund the confirmed Chapter 11 plan;
 
 
·
a newly created liquidation trust (the “Liquidation Trust”) received the proceeds of loans in the amount of $2,055,000, secured by 685,002 shares, and legal title to 314,998 shares that will be sold to pay creditor claims and expenses;
 
 
·
the former trustee of the Mega-C Trust has received 627,500 shares as compensation by the Mega-C Trust through the effective date of the Chapter 11 plan; and
 
 
·
the Mega-C Trust surrendered 1,500,000 shares to us which were promptly cancelled.
 
The litigation settlement and releases provided by the Chapter 11 plan, which are as broad as the law allows, are now binding on Mega-C, the Chapter 11 trustee, the Taylor Group and all other parties described in the plan of reorganization. In an order entered on February 11, 2008, the Bankruptcy Court granted our motion for partial summary judgment, holding that the alleged "oral" agreement creating rights or interests in the Technology in favor of the Taylor Group never existed and, even if it had, the Taylor Group transferred any such rights to the Debtor which were then transferred to the Company by the confirmed Chapter 11 plan. The Bankruptcy Court held that the Taylor Group has no interest in or rights to the Technology. The Bankruptcy Court held that the only rights the Taylor Group has are as putative creditors or stockholders of Mega-C and that any attempts to claim an interest in or contest the Company's title to the technology are contrary to the permanent injunction of the Chapter 11 plan. The Bankruptcy Court held that the Taylor Litigation against the Company is barred by the permanent injunction of the confirmed Chapter 11 plan.
 
The Taylor Group filed motions for relief from the order granting partial summary judgment in favor of the Company and other relief. In orders entered on June 9, 2008, the Bankruptcy Court denied the Taylor Group's motions. In addition, the Company filed a motion for partial summary judgment for an order require to require dismissal of the Taylor Group litigation against the Company. In orders entered on June 9, 2008, the Bankruptcy Court granted the Company's motion and mandated that the Taylor Group litigation against the Company be dismissed. On June 18, 2008, the Taylor Group filed a notice of appeal from these orders. The Taylor Group signed a pleading consenting to dismiss the Company from the Taylor Group litigation in Canada.
 
While certain aspects of the bankruptcy litigation discussed above relating to the confirmation of the Chapter 11 plan and the settlement agreement are on appeal to the Ninth Circuit Court of Appeals and to the United States District Court for the District of Nevada, we believe the possibility of any adverse decision to the Company to be remote.
 
We recorded a recovery of notes receivable previously written off in November of 2006 in the amount of $100 as well as other assets received from Mega-C. The other assets received, primarily miscellaneous fixed assets, have been determined to be negligible in value and no attempt has been made to secure an appraisal or record any amounts for these assets. By virtue of the confirmed Chapter 11 plan, all of the Mega-C’s right, title and interest, if any, in the technology was transferred to the Company. By virtue of the February 11, 2008 orders of the Bankruptcy Court, the Taylor Group has no interest in or rights to the technology.
 
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Contingent Shares
 
We agreed to sell 1,000,000 shares of common stock to a foreign partnership, Mercatus & Partners Limited, a private limited company formed under the laws of the United Kingdom with an executive office at Via S. Roberto Bellarmino 4, 00142 Roma, Italy, December 12, 2005, at a price of $2.50 per share as part of a group of comparable transactions where the purchaser planned to contribute a portfolio of small public company securities to a pair of offshore funds in exchange for fund units, and then use the fund units as security for bank financing that would be used to pay for the underlying securities. Contrary to the terms and conditions of the Company’s agreement, the foreign partnership was in possession of a stock certificate representing these 1,000,000 shares; however, completion of the transaction was contingent upon receipt of the proceeds from the foreign partnership, which were not received. The 1,000,000 shares were recovered December 4, 2007 and forwarded to Continental Stock Transfer Agency for cancellation, which took place that same month.
 
In connection with the offering described above, four holders of warrants to purchase shares of our common stock agreed to exercise their warrants to purchase, in the aggregate, 301,700 shares of common stock (the “Incompletely Exercised Warrant Shares”) for the purpose of selling them to the foreign partnership in a transaction that was substantially similar to the one the Company entered into with the same foreign partnership. These shares were to be issued to the foreign partnership upon receipt of payment, which was in turn contingent upon the foreign partnership tendering the payment of the purchase price for these shares. Contrary to the terms and conditions of their agreements, we believe the foreign partnership is in possession of a stock certificate representing these shares without tendering the purchase price to either us or to the warrantholders. As such, the Incompletely Exercised Warrant Shares have not been duly issued and have been excluded from all calculations of the issued and outstanding shares of common stock in these financial statements. We have included the Incompletely Exercised Warrant Shares as outstanding warrants, pending receipt of the exercise price from the four warrantholders. We have not yet located the Incompletely Exercised Warrant Shares. We retained counsel to cause the parties who have possession of the Incompletely Exercised Warrant shares to return the shares absent payment. Counsel was retained October 6, 2007.
 
Peter Roston Litigation
 
A prior Chief Financial Officer, Mr. Peter Roston, filed a lawsuit to recover the full amount of compensation and benefits that would have been paid to him through the initial term of his employment for breaches in his employment agreement after he was discharged for cause by the Company in December 2006. Arbitration proceedings for this matter began in April 2008 and are scheduled to reconvene in July 2008. We determined the range of potential loss to be CAD $250,000 to CAD $275,000, however the risk of loss as a result of this lawsuit is considered by the Company to be “remote” as that term is used in Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.” No amount was recorded for this contingency.
 
Cypress Avenue Partners, LLC .
 
On May 8, 2008, Cypress Avenue Partners, LLC (“Cypress”), filed a complaint against the Company and several others in the United States District Court for the Northern District of California. The complaint alleges, among other things, that Cypress entered into a contract with the Company under which Cypress was to act as a finder and was entitled to certain remuneration which it was not paid. Cypress claims it is entitled to purchase 200,000 shares of common stock of the Company and is owed $900,000, representing a five percent placement fee on the amount of $18 million which reflects the closing of all rounds of Quercus financing. We have denied any obligation to pay this placement fee to Cypress under the terms of an October 2006 letter agreement between us and Cypress. We filed a Motion to Dismiss the Complaint on June 30, 2008. The argument is scheduled for August 7, 2008.
 
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MANAGEMENT
 
Our board of directors directs the management of the business and affairs of our company as provided in our certificate of incorporation, our by-laws and the General Corporation Law of Delaware. Members of our board of directors keep informed about our business through discussions with senior management, by reviewing analyses and reports sent to them, and by participating in board and committee meetings.
 
Our board of directors is divided into three classes of directors that serve for staggered three-year terms. Three of our current board members have been elected to serve for terms that expire on the date of our 2008 annual meeting; two have been elected to serve for terms that expire on the date of our 2008 annual meeting; and three have been elected to serve for terms that expire on the date of our 2009 annual meeting. Because we did not hold an annual meeting in 2007, the directors whose terms expired continue to serve until our next annual meeting, which we anticipate will be held sometime during 2008. At the 2008 annual meeting, we expect to nominate six directors for election, three to serve until the annual meeting in 2010 and three to serve until the annual meeting in 2011. The following table identifies our directors; and specifies their respective ages and positions with our company.
 
Name
 
Age
 
Position
 
           
Thomas Granville
 
64
 
Chief Executive Officer, Director
 
Dr. Howard K. Schmidt
 
49
 
Director
 
Michael Kishinevsky
 
42
 
Director
 
Glenn Patterson
 
55
 
Director
 
Stanley A. Hirschman
 
61
 
Director
 
Dr. Igor Filipenko
 
43
 
Director
 
Robert G. Averill
 
68
 
Director
 
D. Walker Wainwright
 
57
 
Director
 
 
Executive officers.
 
The following table identifies our non-director executive officers and specifies their respective ages and positions with the Company.
 
Name
 
Age
 
Position
 
           
Andrew Carr Conway Jr.
 
64
 
Former Chief Financial Officer
 
Dr. Edward Buiel
 
36
 
Vice President and Chief Technology Officer
 
Dr. Robert F. Nelson
 
68
 
Vice President, Manufacturing and Engineering
 
Donald T.  Hillier  
47
  Chief Financial Officer  
 
The following paragraphs provide summary biographical information furnished by our directors and non-director executive officers.
 
Directors
 
Dr. Igor Filipenko, M.D. was appointed to our board of directors in February 2004 and reelected at our 2004 annual meeting for a term that will expire on the date of our 2008 annual meeting. Dr. Filipenko was a founder of C&T, the original developer of the e3 Supercell technology (which we now refer to as PbC technology). In addition to his duties as president of C&T, Dr. Filipenko a principal stockholder in a number of other enterprises, including Oledo Associated S.A., VIK Oil and Vostok Energiya, a group of Ukrainian companies that are engaged in petroleum refining and the import, export and trading of petroleum products, and Laser Plus, an ophthalmologic clinic located in Donetsk, Ukraine. Dr. Filipenko is a 1986 graduate of Donetsk Medical University, Ukraine.
 
Robert G. Averill is an independent director who was appointed to our board of directors in February 2004 and reelected at our 2004 annual meeting for a term that will expire on the date of our 2008 annual meeting. Mr. Averill is retired and principally involved in personal investments. He served as a director of Implex Corp., a New Jersey based developer and manufacturer of orthopedic implants that he co-founded in 1991 and then sold to Zimmer Holdings, Inc. From 1978 to 1991 Mr. Averill held a variety of executive positions with Osteonics Corp., a developer and manufacturer of orthopedic implants that he co-founded in 1978 and then sold to Stryker Corporation. From 1971 to 1977, Mr. Averill served as a director and held a variety of executive positions with Meditech Inc., a developer and manufacturer of orthopedic implants that he co-founded in 1971 and sold to 3M Corporation in 1975. Mr. Averill holds 28 patents on a variety of orthopedic devices and materials and he is the co-author of several publications in the field of orthopedics. Mr. Averill holds two degrees from the Newark College of Engineering (BS-mechanical engineering, 1962 and MS-engineering management, 1966).
 
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Thomas Granville was appointed to our board of directors in February 2004 and reelected at our 2005 annual meeting for a term that will expire on the date of our 2008 annual meeting. Mr. Granville served as the chairman of our board of directors from February 2004 through April 2005 when he agreed to accept full-time employment as our chief executive officer. Mr. Granville has served as the president of Gallagher Elevator Company, a New York company (“Gallagher”) that specializes in the installation and maintenance of elevators, escalators, moving walkways and other building transportation products. Mr. Granville also served 15 years as treasurer, ten years as the president of the National Elevator Industry Inc., a trade association that represents elevator manufacturers and contractors where his duties included labor negotiations for national contracts and oversight duties to a $2.3 billion national pension fund. Mr. Granville has also been a partner, or the general partner of a number of real estate partnerships that owned multi-family housing, commercial real estate and a cable television company. Mr. Granville is a 1967 graduate of Canisus College. (BA-Business Administration).
 
Michael Kishinevsky is an independent director who was elected at our 2005 annual meeting for a term that will expire on the date of our 2008 annual meeting. Mr. Kishinevsky is a Canadian lawyer who principally engaged in the practice of corporate and commercial law for ten years, with a particular emphasis on the needs of Toronto’s Russian speaking population. For five years Mr. Kishinevsky served as general legal counsel for C&T. Mr. Kishinevsky currently serves as a Director of Sunrock Consulting Ltd., a company he co-founded in 1995 that specializes in the import and distribution of carbon black and synthetic rubber. He is also the President and Director of SunBoss Chemicals Corp., a corporation specializing in chemical additives for the custom rubber mixing industry. Mr. Kishinevsky is a 1989 graduate of the University of Calgary (B.Sc. in Cellular, Molecular and Microbial Biology and B.Sc. in Psychology) and a 1993 graduate of the University of Ottawa School of Law. Mr. Kishinevsky was called to the bar in the Ontario courts in 1995 and is a member of the Law Society of Upper Canada.
 
Dr. Howard K. Schmidt, Ph.D.   is an independent director who was appointed to our board of directors in April 2005 and reelected at our 2005 Annual Meeting for a term that will expire on the date of our 2008 annual meeting. Dr. Schmidt is employed as a Senior Research Fellow in the Department of Chemical and Biomolecular Engineering at Rice University in Houston, Texas. Between September, 2003 and March, 2008, he was previously the Executive Director of the Carbon Nanotechnologies Laboratory (the “CNL”) at Rice University in Houston, Texas. Dr. Schmidt is an expert in the field of carbon nanotechnology and single-wall carbon nanotubes. Dr. Schmidt is responsible for developing and managing key federal and industrial relationships to drive emerging applications for carbon nanotubes. Before joining the CNL, Dr. Schmidt operated Stump Partners, a Houston-based consultancy firm and was involved in two Internet ventures. In 1989, Dr. Schmidt founded SI Diamond Technologies, Inc., a company that received the prestigious R&D 100 Award from Research and Development Magazine in 1989; went public in 1993; and recently changed its name to Nano-Proprietary, Inc. Dr. Schmidt holds two degrees from Rice University (BS-Electrical Engineering, 1980 and Ph.D.-Chemistry, 1986).
 
Glenn Patterson is an independent director who was appointed to our board of directors in February 2003 and is currently elected to serve until our 2009 annual meeting. He is President of HAP International Inc., an investment research and analyst company. Until November 2004, Mr. Patterson served as president of Oregon Electric Group, an industrial, commercial, power (including distribution systems) and technology services contractor based in Portland, Oregon. During Mr. Patterson’s tenure as president, Oregon Electric grew from $16 million in sales in 1994 to $127 million in sales in 2000. In September 2001, Oregon Electric was sold to Montana-Dakota Resources, whose major subsidiaries includes major electrical power generating, utility and distribution companies with operations in 40 states. Mr. Patterson graduated summa cum laude from Willamette University (BS-Economics) in 1975.
 
Stanley A. Hirschman was elected to our board of directors as an independent director at our 2006 annual meeting serving for a three-year term that will end on the date of our 2009 annual meeting. He is President of CPointe Associates, Inc., a Plano, Texas executive management and retail operations consulting firm. He is an investment due diligence specialist and works regularly with public companies dealing with the difficulties of the balance between increased regulatory requirements and reasonable corporate governance. He has served on boards of several public companies and is currently a director of South Texas Oil Co. and former chairman of Mustang Software, Inc. Mr. Hirschman’s client list has included GameStop, Nortel, Dalrada Financial Corp, The Longview Funds, Earthlink, Aiirmesh Communications, Bravo Foods International and Retail Highway. Prior to establishing CPointe Associates, Mr. Hirschman was Vice President Operations, Software Etc., Inc., a 396 retail store software chain, from 1989 until 1996. Mr. Hirschman also held senior executive management positions with T.J. Maxx, Gap Stores and Banana Republic. Mr. Hirschman is a member of the National Association of Corporate Directors, the KMPG Audit Committee Institute and is a graduate of the Harvard Business School Audit Committees in the New Era of Governance. He is active in community affairs and serves on the Advisory Board of the Salvation Army Adult Rehabilitation Centers.
 
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D. Walker Wainwright is an independent director who was appointed to our board of directors on January 15, 2007. Mr. Wainwright was elected to fill a vacancy on our board of directors created by the concurrent resignation of John Petersen, who continued to serve as corporate counsel. He is the founder and chief executive of Wainwright & Co. LLC, an independent financial advisory firm and investment manager. The firm’s activities include the identification and assessment of hedge fund investments, the monitoring of these investments and the creation of proprietary hedge fund portfolios. In this respect, the firm works with investment management firms, not-for-profit organizations and family offices as an independent consultant to create client-specific solutions. Wainwright & Co. also researches and reviews private investments, including private equity funds, to assist in determining their suitability for specific accounts or portfolios. Hedge fund portfolios for which Mr. Wainwright serves as manager or advisor currently have an aggregate value of $200 million. The firm also provides corporate finance advice on a selective basis to individuals or corporate entities. Formerly a Managing Director in investment banking at Smith Barney, Inc. and at Kidder, Peabody & Co., Mr. Wainwright has over 30 years’ consulting, banking and investment banking experience. Having directed Kidder’s investment banking efforts in the Asia Pacific Region, he has extensive international experience and has lived in Australia and Lebanon. Mr. Wainwright began his career at Chemical Bank and, subsequently, Schroders. He is a graduate of Stanford University (A.B. – 1972) and of Columbia University (M.B.A. – 1976).
 
Executive Officers
 
  Andrew Carr Conway, Jr . was appointed Chief Financial Officer on September 27, 2007 and served until June 18, 2008. Mr. Conway is a Certified Public Accountant, Forensic Certified Public Accountant, Certified Fraud Examiner, and Certified Financial Investigator. For the last ten years Mr. Conway has been in private practice examining violations of GAAP and investigating misappropriations of corporate assets. Mr. Conway retired from the Commission December 30, 1997 where he worked both in the Division of Corporation Finance and the Division of Enforcement, as those functions are conducted in the Commission’s regional offices. Prior to Mr. Conway’s service with the Commission, he served in a wide variety of different functions for the Internal Revenue Service until transferring to the Commission January 7, 1984. Mr. Conway has a total of over 40 years of investigative and examination experience including service as an expert witness by deposition and appearance at trial. Mr. Conway graduated from Abilene Christian University in 1967 with a degree in accounting.
 
Donald T. Hillier was appointed our Chief Financial Officer on June 18, 2008. Mr. Hillier, is a Certified Public Accountant (inactive status) with 24 years experience that encompasses “Big Four” accounting firms in Atlanta and Pittsburgh, as an entrepreneur providing financial consulting to enterprises ranging from early stage start up to Fortune 100 companies, and a chief financial officer and director of international operations for two companies prior to the Company. Mr. Hillier’s experience includes broad-based corporate finance including SEC reporting, mergers and acquisitions, capital formation and corporate taxation as well as starting and managing an international subsidiary in Sao Paulo, Brazil. Mr. Hillier has been a guest speaker in a variety of panel discussions. He earned his M.B.A. in corporate finance and international operations from Duquesne University in Pittsburgh, Pennsylvania in 2000 where he graduated with high honors. Before joining the Company, Mr. Hillier served through Resources Global Professionals, from 2003-2007, as an executive financial consultant to various companies including Belden, Inc., Curtiss Wright, Sony Corporation, Knova Software, HJ Heinz Company and Michael Baker Corporation providing leadership and consulting for merger transactions, Sarbanes-Oxley Act implementations, SEC reporting matters and international operations. During this time Mr. Hillier also provided Chief Financial Officer services to various small companies assisting with capital formation, strategic planning and operations management. From 2007 until May 2008, Mr. Hillier served as the Chief Financial Officer for The Continuous Learning Group, an international strategy and management consulting firm where he lead the finance department and provided strategic direction.
 
Dr. Edward Buiel, Ph.D. was appointed chief of R&D in September 2005. Before joining our company, Dr. Buiel served for 3-1/2 years as project leader for the Energy Storage Group of Meadwestvaco Corporation, one of the largest producers of activated carbon in the world. In this position Dr. Buiel’s team focused on developing activated carbon materials for electrochemical applications including Lithiumion batteries, organic ultracapacitors, and asymmetric lead-carbon capacitors. His responsibilities included managing a USCAR-Advanced Battery Consortium project to develop activated carbon materials for hybrid electric vehicle energy storage systems and managing a joint program with Sandia National Laboratories to develop lead-carbon capacitors for grid-connected energy storage systems. Previously, Dr. Buiel worked for nine months as a senior software engineer for Vasocor, Inc. and for 2-1/2 years as a Senior Research Engineer for the Automotive Carbon Group of Meadwestvaco Corporation. Dr. Buiel is a 1994 graduate of Queen’s University, Kingston, Ontario, where he earned a Bachelor of Science in Engineering and Physics, and a 1998 graduate of Dalhousie University, Halifax, Nova Scotia, where he earned a Ph.D. in Physics and wrote his doctoral thesis on “The Development of Disordered Carbon Materials as Anode Materials for Li-ion Battery Applications.”
 
Dr. Robert F. Nelson, Ph.D. joined the Company as Vice President of Manufacturing Engineering in December 2007. Before joining Axion, Dr. Nelson worked for Firefly Energy, Inc. as a Technical Advisor and Senior Vice President of Engineering for 4-1/2 years. His primary function at Firefly was to implement the development and testing of VRLA cells and batteries. Before Firefly, Dr. Nelson was an independent consultant for six years, working with some 45 companies on materials and designs of VRLA batteries. Previous positions include three years at Bolder Technologies (1994-1997), three years at the International Lead Zinc Research Organization (where he organized and managed the Advanced Lead-Acid Research Organization, ALABC, from 1991 to 1994), one year at Portable Energy Products (a lead-acid startup company) and 13 years with Gates Energy Products, the innovator of VRLA technology. Over these 30 years, Dr. Nelson has five patents, has given invited presentations at some 35 international conferences and published 38 research papers in refereed journals. Before this, he spent 11 years in teaching and research, lastly at the University of Georgia (1972-1977). Dr. Nelson is a 1963 graduate of Northwestern University with a B.A. in Chemistry (cum laude) and a 1967 graduate of the University of Kansas with a Ph.D. in Analytical Chemistry. During his academic career he gave presentations at over 30 international conferences and published more than 35 refereed papers dealing with organic electrochemistry.
 
Presiding Director
 
Our Chief Executive Officer, Thomas Granville, acts as the presiding director at meetings of our board of directors. In the event that Mr. Granville is unavailable to serve at a particular meeting, responsibility for the presiding director function will rotate among the chairmen of each of the committees of our board of directors.
 
 
Corporate Governance
 
Our board of directors believes that sound governance practices and policies provide an important framework to assist them in fulfilling their duty to stockholders. Our board of directors is working to adopt and implement many “best practices” in the area of corporate governance, including separate committees for the areas of audit and compensation, careful annual review of the independence of our Audit and Compensation Committee members, maintenance of a majority of independent directors, and written expectations of management and directors, among other things.
 
Code of Business Conduct and Ethics
 
Our board of directors has adopted a Code of Business Conduct and Ethics, which has been distributed to all directors, officers, and employees and will be given to new employees at the time of hire. The Code of Business Conduct and Ethics contains a number of provisions that apply principally to our President, Chief Financial Officer and other key accounting and financial personnel. A copy of our Code of Business Conduct and Ethics can be found under the “Investor Information” section of our website at www.axionpower.com. We intend to disclose any amendments or waivers of our Code of Business Conduct and Ethics on our website at www.axionpower.com.
 
Communications with the Board of Directors
 
Stockholders and other parties who are interested in communicating with members of our board of directors, either individually or as a group may do so by writing to Thomas Granville, c/o Axion Power International, Inc, 3601 Clover Lane, New Castle, Pennsylvania, 16105. Mr. Granville will review all correspondence and forward to the appropriate members of the board of directors copies of all correspondence that, in the opinion of Mr. Granville, deals with the functions of the board of directors or its committees or that he otherwise determines requires their attention. Concerns relating to accounting, internal controls or auditing matters should be immediately brought to the attention of our Audit Committee and will be handled in accordance with procedures established by that committee.
 
Director Independence
 
Our board of directors has determined that six of our directors would meet the independence requirements of the American Stock Exchange if such standards applied to the Company. In the judgment of the board of directors, Dr. Filipenko, and Mr. Granville do not meet such independence standards. In reaching its conclusions, the board of directors considered all relevant facts and circumstances with respect to any direct or indirect relationships between the Company and each of the directors, including those discussed under the caption “Certain Relationships and Related Transactions.” Our board of directors determined that any relationships that exist or existed in the past between the Company and each of the independent directors were immaterial on the basis of the information set forth in the above-referenced sections.
 
Board Committees
 
Audit Committee   – Our board of directors has created an audit committee that presently consists of Mr. Patterson, Mr. Hirschman and Dr. Schmidt. Mr. Patterson serves as chairman of the audit committee. All members have a basic understanding of finance and accounting, and are able to read and understand fundamental financial statements. The board of directors has determined that all members of the audit committee would meet the independence requirements of the American Stock Exchange if such standards applied to our company. Our board of directors has also determined that based on education and work history, Messrs. Patterson and Hirschman meet the definition of an “Audit Committee Financial Expert” as established by the Commission. The audit committee has the sole authority to appoint, review and discharge our independent auditors. The audit committee reviews the results and scope of the audit and other services provided by our independent auditors, as well as our accounting principles and its system of internal controls, reports the results of their review to the full board of directors and to management and recommends to the full board of directors that the our audited consolidated financial statements be included in our Annual Report on Form 10-KSB.
 
Compensation Committee   – Our board of directors has created a compensation committee that presently consists of Messrs Averill, Patterson, Kishinevsky and Wainwright. Mr. Averill serves as chairman of the compensation committee. The compensation committee exercises our board of director’s authority concerning compensation of the executive management team, non-employee directors and the administration of our stock-based incentive compensation plans. The compensation committee typically meets in separate sessions independently of board meetings. The compensation committee typically schedules telephone meetings as necessary to fulfill its duties. The chairman establishes meeting agendas after consultation with other committee members and Mr. Thomas Granville, our CEO. Subject to supervision by the full board of directors, the compensation committee administers our 2004 Incentive Stock Plan. Our CEO and other members of management regularly discuss our compensation issues with compensation committee members. Subject to compensation committee review, modification and approval, Mr. Granville typically makes recommendations respecting bonuses and equity incentive awards for the other members of the executive management team. The compensation committee establishes all bonus and equity incentive awards for Mr. Granville in consultation with other members of the management team. Our board of directors has determined all members of the compensation committee would meet the independence requirements of the Amex if such standards are applied to us.
 
41
 
Technology Committee   – Our board of directors has created a technology committee that consists of Dr. Schmidt and Messrs. Averill and Granville. Dr. Schmidt serves as chairman of the technology committee. The technology committee provides board-level oversight, guidance and direction to our R&D staff, supervises the activities of our Technical Advisory Board, evaluates and makes recommendations with respect to the acquisition and licensing of complementary and competitive technologies and supervises the activities of our intellectual property lawyers.
 
Nominating Committee   – Given the relatively small size of our board of directors and wanting to involve the entire board of directors in nominating decisions, we have elected not to have a separate nominating committee, and the entire board of directors currently serves that function. With respect to director nominees, our board of directors will consider nominees recommended by stockholders that are submitted in accordance with our By-Laws. The process for receiving and evaluating director nominations from stockholders is described below.
 
42
 
EXECUTIVE COMPENSATION
 
Summary Compensation Table
 
The following table sets forth the compensation earned by or paid to our Named Executive Officers with respect to the years ended December 31, 2006 and 2007.  The Named Executive Officers are as shown. We did not have any non-equity incentive plans, pension plans or deferred compensation plans during the years, ended December 31, 2006, and 2007.

Name and
Principal Position
 
 
Year
 
Salary
($) (1)
 
Bonus
($) (2)
 
Stock
Awards($) (3)
 
Option Awards
($) (3)
 
All Other
Compensation
($) (6)
 
Total
Compensation
($)
 
Thomas Granville (4)
CEO and Director
   
2007
2006
   
252,000
252,000
    356,700     200,000     412,687    
25,312
174,184
   
277,312
1,395,571
 
Charles Mazzacato
Former CEO and Director
    2006     125,000           -     124,364     -     249,364  
Edward Buiel
Vice President and CTO
   
2007
2006
   
168,000
132,000
          937,500     288,366    
22,312
28,039
   
190,312
1,385,905
 
Andrew C. Conway, Jr (5)
Consultant
   
2007
   
163,878
                           
163,878
 
Andrew C. Conway, Jr (5)
Former CFO  
   
2007
   
66 , 450
               
37 , 356
         
103 , 806
 
Peter Roston
Former CFO
    2006     122,570                 138,182           260,752  
Michael Courtade
Former CFO
    2006     18,000                     604     18,604  
Robert Nelson
Vice President
   
2007
   
11,423
         
82,800
   
108,504
         
202,727
 
 
1.
Salaries are presented as the contractual amount earned for the year, regardless of date of payment.
 
2.
Discretionary bonuses are not made pursuant to any specific bonus plan. In December 2006, Mr. Granville was awarded a cash bonus of $300,000. $225,000 was paid during the first quarter of 2007 and the remainder on May 19, 2007. These amounts were reported in Form 10-KSB for the period ended December 31, 2006 and are accordingly not included in 2007 above.
 
3.
Mr. Conway received stock options valued at the amount cited. Mr. Nelson received both a stock grant and an option grant which is valued at the amount cited.
 
4.
With the exception of equity compensation and related gross-ups compensation related to Mr. Granville’s employment were remitted to Gallagher under an agreement whereby Mr. Granville’s services are provided to us through Gallagher.
 
5.
Andrew Conway performed consulting services for the Company before he accepted a position as CFO in 2007. For the amounts reflected above as consulting fees, Andrew Conway received less than half of the amounts disclosed with the firm he was employed by receiving the balance of the consulting fees. With respect to the total compensation for Andrew Conway as CFO, the total does not include travel and living expenses while Mr. Conway was in New Castle for Company business reasons.
 
6.
Amounts in the other compensation column for 2007 represent perquisites paid to the employees.
 
Employment Agreements
 
We have entered into executive employment agreements with Thomas Granville, Edward Buiel, Andrew Carr Conway, Jr., Robert Nelson and Donald T. Hillier. These agreements generally require each executive to devote substantially all of his business time to our affairs, establish standards of conduct, prohibit competition with our company during their term, affirm our rights respecting the ownership and disclosure of patents, trade secrets and other confidential information, provide for the acts and events that would give rise to termination of such agreements and provide express remedies for a breach of the agreement. Each of our executives will participate, without cost, in our standard employee benefit programs, including medical/hospitalization insurance and group life insurance, as in effect from time to time. Each of the covered executives will generally receive an automobile allowance and reimbursement for all reasonable business expenses incurred by him on behalf of the Company in the performance of his duties. The provisions of the individual agreements are summarized below:
 
1.
Thomas Granville . On June 23, 2008, we entered into an Executive Employment Agreement with Thomas Granville as Chief Executive Officer. Pursuant to this agreement, Mr. Granville will receive a monthly base salary of $27,000 for the period commencing June 1, 2008, and terminating May 31, 2010. Mr. Granville’s base salary is subject to annual review, and such salary is subject to renegotiation on the basis of Mr. Granville’s and the Company’s performance. In addition, Mr. Granville will receive a signing bonus of $250,000, to be paid 50% within ten (10) days of the execution of the agreement and 50% upon receipt of the final $10,000,000 investment from the Quercus Trust. The Company also granted Mr. Granville an option to purchase 90,000 shares of our common stock at a price of $2.50 per share at a vesting rate of 3,750 shares per month through the term of the agreement. Mr. Granville is eligible to participate in any executive compensation plans adopted by the shareholders of the Company and the Company's standard employee benefit programs.
 
43
 
2.
Donald T.  Hillier .  On June 18, 2008, we entered into an Executive Employment Agreement with Donald T. Hillier as Chief Financial Officer.  Pursuant to this agreement, Mr. Hillier will receive a monthly base salary of $12,500 for the period commencing June 16, 2008, and terminating June 15, 2011.  Mr. Hillier's base salary is subject to review after six (6) months and then on an annual basis thereafter, and such salary is subject to renegotiation on the basis of Mr. Hillier's and the Company's performance.  The Company also granted to Mr. Hillier 90,000 shares of common stock which will vest in equal 30,000 share amounts on June 16 of each of 2009, 2010 and 2011.  In addition, Mr. Hillier was granted an option to purchase 180,000 shares of common stock at a price of $2.50 per share at a vesting rate of 5,000 shares per month through the term of the agreement.  Mr. Hillier is eligible to participate in any executive compensation plans adopted by the shareholders of the Company and the Company's standard employee benefit programs.
 
3.
Edward Buiel, Ph.D. On June 23, 2008, we entered into an Executive Employment Agreement with Dr. Edward Buiel as Vice President and Chief Technology Officer. Pursuant to this agreement, Dr. Buiel will receive a monthly salary of $15,000 for the period commencing June 1, 2008 and terminating May 31, 2010. Dr. Buiel’s base salary is subject to annual review, and such salary is subject to renegotiation on the basis of Mr. Dr. Buiel’s and the Company’s performance. In addition, Dr. Buiel will receive a signing bonus of $110,000, to be paid 90% within ten (10) days of the execution of the agreement and 10% upon the earlier of (i) the receipt of the final $10,000,000 investment from the Quercus Trust or (ii) August 31, 2008. Also, if Dr. Buiel is still employed with the Company on June 1, 2011, he will receive a bonus of $50,000, notwithstanding any other bonus arrangement. The Company also granted Dr. Buiel an option to purchase 100,000 shares of our common stock, which had been previously been granted in his prior Executive Employment Agreement dated December 29, 2006. These options are exercisable at a price of $3.75 per share and shall vest 50% on December 29, 2009 and 50% on December 29, 2010. In addition, Dr. Buiel was granted an option to purchase 100,000 shares of our common stock in recognition for the opportunity cost associated with the longer term of his new Executive Employment Agreement. These options are exercisable at a price of $2.50 per share and shall vest on May 31, 2011. Dr. Buiel is eligible to participate in any executive compensation plans adopted by the shareholders of the Company and the Company's standard employee benefit programs. Certain of these equity awards were awarded under Dr. Buiel’s 2006 employment agreement and the terms of such awards have been incorporated into his new Executive Employment Agreement.
 
4.
Andrew C. Conway, Jr.  Under the terms of his employment agreement effective August 2007, which had an original term of six months, Mr. Conway receives an annualized salary of $180,000, bonuses as determined by the compensation committee and an option to purchase 80,000 shares of our common stock at a price of $4.50 per share. 30,000 options vested with the execution of the contract, and the balance vest periodically over the remainder of the contract. The contract automatically renewed for an additional six month term ending August 31, 2008.
 
5.
Dr. Robert F. Nelson. Under the terms of his employment agreement effective December 2007, which has a term of two years, Dr. Nelson receives an annual salary of $132,000 and bonuses as determined by the compensation committee. In addition, Dr. Nelson receives an option to purchase 108,000 shares of our common stock at a price of $5.00 per share and 36,000 shares of restricted common stock, each that vest over three years from the effective date of his employment agreement.
 
We have no retirement plans or other similar arrangements for any directors, executive officers or employees.
 
44
 
Outstanding Equity Awards At Fiscal Year-End Table

   
Option Awards
 
Stock Awards
     
                               
Equity Incentive Plan Awards
     
   
Non-Plan
         
Equity
Incentive
Plan
Awards
                         
   
Number of shares underlying unexercised options
     
Number
 
Market
Value
 
# Shares
 
Market
Value
     
Name
 
#
Exercisable
 
#
UnExercisable
 
Unearned
 
Exercise
Price
 
Expiration Date
 
Shares or units of
stock that have not
vested
 
Unearned shares,
units, or other rights
that have not vested
 
 Footnotes
 
(a)
 
(b)
 
(c)
 
(d)
 
(e)
 
(f)
 
(g)
 
(h)
 
(i)
 
(j)
     
Granville, Tom
         
0
   
2,200
 
$
5.60
   
2/2/2009
                           
Director's plan award - Fully vested
 
 
                                                             
Granville, Tom
   
180,000
   
0
       
$
2.50
   
varies through 4/30/12
                           
Issued pursuant to April 2005 Executive Employment Agreement. Options Expire 5 years after monthly vest date
 
 
                                                             
Granville, Tom
   
400,000
   
100,000
       
$
6.00
   
2/10/2009
                           
Non-Plan Performance-based award granted by the Compensation Committee Feb 2006 - Vesting is contingent upon future events
 
 
                                                             
Buiel, Edward
   
70,000
   
20,000
       
$
4.00
   
varies through 8/31/13
                           
Issued pursuant to Sept 2005 Executive Employment Agreement. Options expire 5 years after monthly vest date
 
 
                                                         
 
 
Buiel, Edward
                                             
250,000
 
$
937,500
   
Restricted Stock Grant issued pursuant to Dec 2006 Executive Employment Agreement - Lump sum Vesting Date 12/29/2009
 
 
                                                             
Buiel, Edward
   
15,000
   
20,000
       
$
6.00
   
2/10/2009
                           
Non-Plan Performance-based award granted by the Compensation Committee Feb 2006 - Vesting is contingent upon future events
 
 
                                                             
Buiel, Edward
   
0
   
50,000
       
$
3.75
   
12/29/2015
                           
Options issued pursuant to Dec 2006 Executive Employment Agreement. Lump sum vesting date - 12/29/2009
 
 
                                                             
Buiel, Edward
   
0
   
50,000
       
$
3.75
   
12/29/2016
                           
Options issued pursuant to Dec 2006 Executive Employment Agreement. Lump sum vesting date - 12/29/2010
 
 
                                                             
Conway, Andrew Carr Jr.
   
60,000
   
20,000
       
$
4.50
   
varies through 2/28/2010
                           
Options issued pursuant to Aug 2007 Executive Employment Agreement. Vesting monthly through Feb 29, 2008
 
 
                                                             
Nelson, Robert
   
3,000
   
105,000
       
$
5.00
   
varies through 12/01/2015
                           
Options issued pursuant to Dec 2007 Executive Employment Agreement. Vesting monthly through Dec 1, 2010
 
 
                                                             
Nelson, Robert
                                             
35,000
 
$
79,350
   
Restricted Stock Grant issued pursuant to Dec 2007 Executive Employment Agreement - Vest monthly through Dec 2010
 
 
Nonqualified deferred compensation
 
We had no non-qualified deferred compensation plans during 2007.
 
Post-Termination Compensation
 
We have not entered into change in control agreements with any of our Named Executive Officers or other members of the executive management team. No awards of equity incentives under our 2004 Incentive Stock Plan or awards of options under our 2004 Outside Directors Stock Option Plan provide for immediate vesting upon a change in control other than a restricted stock grant of 36,000 shares issued to Robert Nelson. However, the compensation committee has the full and exclusive power to interpret the plans, including the power to accelerate the vesting of outstanding, unvested awards.  A “change in control” is generally defined as (1) the acquisition by any person of 30% or more of the combined voting power of the Company’s outstanding securities or (2) the occurrence of a transaction requiring stockholder approval and involving the sale of all or substantially all of the Company’s assets or the merger of the Company with or into another corporation.
 
Director   Compensation
 
The members of our board of directors are actively involved in various aspects of our business ranging from relatively narrow board oversight functions to providing hands-on guidance to our executives and scientific staff with respect to matters within their personal experience and expertise. We believe that the active involvement of all directors in our principal business and policy decisions increases our board of directors’ understanding of our needs and improves the overall quality of our management decisions. In recognition of the substantial time and personal effort that we require from our directors, we have adopted director compensation policies that provide for higher director compensation than is typically found in companies at our early stage of development.
 
45
 
Only independent directors are compensated separately for service as members of our board of directors. Each of our independent directors received the following compensation for the period January 1, 2007 through December 31, 2007:
 
 
·
A basic annual retainer of $25,000 for service as a director;
 
 
·
A supplemental retainer of $6,000 for service as chairman of audit committee or technology committee, and supplemental annual retainer $4,000 for service as chairman of any other board committee;
 
 
·
A supplemental annual retainer of $3,000 for service as a committee member;
 
 
·
A meeting fee of $1,500 per day for each board or committee meeting attended in person or $500 for each board or committee meeting attended by telephone; and
 
 
·
Reimbursement for all reasonable travel, meals and lodging costs incurred on our behalf.
 
At our 2004 annual meeting, our stockholders ratified a stock option plan for independent directors that authorized the issuance of options to purchase $20,000 of our common stock for each year of service as a director of our company. At our 2005 annual meeting, the number of shares reserved for issuance under the outside directors’ stock option plan was increased to 500,000.
 
For the years ended December 31, 2007, 2006, 2005 and 2004, we issued, 0, 60,000, 70,000 and 54,000, respectively of options pursuant to our directors’ stock option plan. Of this total, no options were exercised during the year ended December 31, 2007, 90,035 options are currently vested and exercisable at a weighted average price of $2.83 per share and 50,000 options are unvested and will be exercisable at a weighted average price of $2.40 per share.
 
46
 
Director Compensation Table
 
The following table provides information regarding compensation paid to non-employee directors for services rendered during the year ended December 31, 2007.
 

Name
 
Fees Earned
or Paid in
Cash ($)
 
Stock
Awards
($)
 
Option
  Awards  
($)
 
Non-Equity
Incentive Plan
Compensation
($)
 
Nonqualified 
Deferred 
Compensation 
Earnings
 
All Other 
Compensation
($)
 
Total ($)
 
Thomas Granville (1)
   
0
                                     
John Petersen
   
0
                                     
Fefer, Petersen & Cie, Attorneys (2)
   
0
                                     
Dr. Igor Filipenko
   
0
                                     
Robert G. Averill
   
39,000
                                 
39,000
 
Dr. Howard K. Schmidt
   
51,600
                                 
51,600
 
Michael Kishinevsky
   
33,000
                                 
33,000
 
Glenn Patterson
   
51,000
                                 
51,000
 
Stanley A. Hirschman
   
43,000
                                 
43,000
 
Walker Wainwright
   
31,500
         
(3) 53,230
                     
84,730
 
 
(1)
See Executive Compensation Table
 
(2)
John Petersen, the Company’s legal counsel, served as a member of our board of directors through January 15, 2007. Mr. Petersen did not receive payment for serving as a member of the board of directors.
 
(3)
In January 2007, Walker Wainwright was granted an option to purchase 40,000 shares of common stock at an exercise price of $5.00 as compensation for services related to due diligence, negotiation and sale of the 2006 Series A Preferred Stock offering. 
 
47

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
On June 30, 2008, we had 25,868,884 shares of common stock, 137,500 shares of Senior Preferred Stock and 772,997 shares of Series A Preferred Stock outstanding on the date of this report. The following table sets forth certain information with respect to the beneficial ownership of our securities as of June 30, 2008, for (i) each of our directors and executive officers; (ii) all of our directors and executive officers as a group; and (iii) each person who we know beneficially owns more than 5% of our common stock.
 
Beneficial ownership data in the table has been calculated based on Commission rules that require us to identify all securities that are exercisable for or convertible into shares of our common stock within 60 days of June 30, 2008 and treat the underlying stock as outstanding for the purpose of computing the percentage of ownership of the holder.
 
Except as indicated by the footnotes following the table, and subject to applicable community property laws, each person identified in the table possesses sole voting and investment power with respect to all capital stock held by that person. The address of each named executive officer and director, unless indicated otherwise by footnote, is c/o Axion Power International, Inc. 3601 Clover Lane, New Castle PA 16105.

   
Common Stock
 
Preferred Conversion
(1)
 
Warrant &  Options
(2) 
 
Combined Ownership
 
Percentage
 
Quercus Trust (5) 1835 Newport Blvd
A109 - PMB 467
Cosa Mesa, CA 92627
   
8,571,429
   
-
   
10,000,000
   
18,571,429
   
51.8
%
                                 
Trust for the Benefit of the Shareholders of Mega-C Power Corp (6)
c/o Cecilia L Rosenauer Ltd
510 W Plumb Lane Suite A
Reno NV 89509
   
5,385,002
   
-
   
-
   
5,385,002
   
20.8
%
                                 
Fursa Master Global Event Driven Fund LP
200 Park Avenue, 54th Floor (7)
New York, New York 10166
William F. Harley III
   
-
   
2,045,505
   
-
   
2,045,505
   
7.3
%
                                 
Merriman Curhan Ford 600 California St, 9th Floor San Francisco CA 94108
   
-
   
-
   
1,485,714
   
1,485,714
   
5.4
%
                                 
Directors and Named Executive Officers:
                               
                                 
Averill, Robert
   
1,173,853
   
1,632,686
   
1,247,006
   
4,053,545
   
14.1
%
                                 
Glenn Patterson
   
917,030
   
1,257,308
   
582,015
   
2,756,353
   
10.0
%
                                 
Peterson, John (4)
   
217,500
   
1,060,259
   
369,900
   
1,647,659
   
6.0
%
                                 
Granville, Tom
   
421,300
   
204,551
   
593,450
   
1,219,301
   
4.6
%
                                 
Filipenko, Igor (3)
   
785,900
   
329,690
   
83,459
   
1,199,049
   
4.6
%
                                 
Buiel, Edward
   
31,000
   
-
   
135,000
   
166,000
   
*
 
                                 
Hillier, Donald T.
   
-
   
-
   
10,000
   
10,000
   
*
 
                                 
Conway, Andrew C., Jr
   
-
   
-
   
120,000
   
120,000
   
*
 
                                 
Wainwright, Walker
   
-
   
-
   
40,000
   
40,000
   
*
 
                                 
Schmidt, Howard
   
-
   
-
   
23,000
   
23,000
   
*
 
                                 
Hirschman, Stan
   
-
   
-
   
10,000
   
10,000
   
*
 
                                 
Nelson , Robert
   
9,000
   
-
   
31,500
   
40,500
   
*
 
                                 
Kishinevsky, Michael
   
-
   
-
   
15,000
   
15,000
   
*
 
                                 
Directors and officers as a group   (13 persons)
                               
                                 
* Less than 1%
   
3,555,583
   
4,484,494
   
3,260,330
   
11,300,407
   
33.6
%
 
(1) Represents shares of common stock issuable upon conversion of preferred stock held by the stockholder.

(2) Represents shares of common stock issuable upon exercise of warrants and options held by the stockholder that are presently exercisable or
will become exercisable within 60 days.

(3) Includes 976,877 shares held by Dr. Igor Filipenko and 222,172 shares held by his wife, including 175,000 shares of common stock and 47,172 shares issuable upon the conversion of 6,100 shares of preferred stock.

(4) Includes 13,000 shares of common stock held by Mr. Petersen, 4,500 shares of common stock held by Mr. Petersen’s wife, and 200,000 shares of common stock deposited in a segregated account at Credit Suisse as collateral security for a second mortgage on Mr. Petersen’s principal residence.

(5) The trustees of The Quercus Trust are Mr. David Gelbaum and Ms. Monica Chavez Gelbaum, each with shared voting and dispositive power over the shares held by this trust.

(6) Mr. Jeff Hartman is the current trustee of the Trust for the Benefit of the Shareholders of Mega-C Power Corporation with sole voting and dispositive power over the shares held by this trust.

(7) Mr. William F. Harley, III is the Chief Investment Manager for Fursa Global Event Driven Fund, and in this capacity, he has sole voting and dispositive  power over the shares held by Fursa.
 
For purposes of this table, a person is deemed to have beneficial ownership of the number of shares of common stock that such person has the right to acquire within 60 days of June30, 2008. The percentage of beneficial ownership before the offering has been based on us having 25,868,884 shares of common stock issued and outstanding as of June 30, 2008.
 
48
 
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
 
Transactions with directors
 
Dr. Igor Filipenko—financing transactions. During 2007 Dr. Filipenko advanced monies to the Company in the amount of $207,000. From the 2007 loan agreements, Dr. Filipenko earned 31,750 three-year warrants at an exercise price of $6.00 per share, and 7,661 five-year warrants at an exercise price of $2.35 per share. His August loan in the amount of $115,000 by conversion into a $225,000 private placement secured bridge loan on December 17, 2007. This short term bridge loan earns interest at a rate of 14%, origination fees of $18,000 over a 3 month period, and the 7,661 warrants as referenced above. The $225,000 loan had an initial maturity date of March 2008.  On March 31, 2008 and then again on April 30, 2008, the Company sent notice to Mr. Filipenko of its intention to extend the loan until April 30, 2008, and May 31, 2008 respectively. The extension entitles Mr. Filipenko to earn an extension fee of 1% of the original loan on each extension date. With the March 31, 2008 extension, Mr. Filipenko will earn interest on principal plus interest accrued through the extension date, at an annual rate of 15%. The April extension increased the annual interest rate to 16%. 4,573 warrants exercisable at $2.35 until December 31, 2012 are included with these two extensions. Under this loan agreement, during 2008 Dr. Filipenko earned an additional 9,148 five-year warrants at an exercise price of $2.35 per share. On June 30, 2008 we paid Dr .Filipenko the $252,769 balance due from our indebtedness under this Bridge Loan.
 
 
Robert Averill—financing transactions-2006. Mr. Averill was one of the original founders of APC. During the first quarter of 2006, Mr. Averill loaned us $1,000,000 under the terms of a one-year promissory note that bore interest at the rate of 10% per annum, requires monthly payments of accrued interest, and was secured by a lien on all of our property. Over the course of 2006, Mr. Averill continued to advance monies to the Company, increasing the loaned amount to $1,955,000, with interest rates ranging from 10-12%. The interest rate varied because of different loans and interest rate escalators under certain circumstances. Accrued interest from these loans amounted to $127,260 during 2006. By the terms of these loans, he received 345,000 common stock purchase warrants with a debt discount valued at $127,243 in 2006. Mr. Averill was eligible to receive an additional 230,000 three-year warrants at an exercise price of $6.00 per share from these loans through the date of extinguishment in November 2007. Some of his loans were convertible into offering units at a price of $2.50 per unit (each unit consisting of one share of common stock and one five year warrant to purchase one share of common stock at a price of $4.00 per share.) Mr. Averill elected not to exercise this feature; instead, he converted $1,645,000 of his loans plus interest into Series A Preferred Stock during the fourth quarter of 2006, and carried over $428,675 of principle plus $8,585 of interest into 2007. During 2007, Mr. Averill earned an additional 366,000 three-year warrants from these loans at an exercise price of $6.00 per share. 
 
Robert Averill—financing transactions- 2007 -During 2007, Mr. Averill continued to advance monies to the company in the amount of $1,267,751. From the 2007 loan agreements, Mr. Averill earned 136,000 3-year warrants at an exercise price of $6.00 per share, and 61,290 five-year warrants at an exercise price of $2.35 per share. $115,000 of these loans were repaid in September 2007 and the balance of these loans, including the 2006 carryover, was extinguished along with $70,335 in interest by conversion into a $1,800,000 private placement secured bridge loan on November 27, 2007. This short term bridge loan earns interest at a rate of 14%, origination fees of $8,000 (on each $100,000) over a 4 month period, and the 61,290 warrants as referenced above. The $1.8 million loan had an initial maturity date of March 2008. On March 31, 2008 and then again on April 30, 2008, the Company sent notice to Mr. Averill of its intention to extend the loan until April 30, 2008, and May 31, 2008 respectively. The extension entitles Mr. Averill to earn an extension fee of 1% of the original loan on each extension date. With the March 31, 2008 extension, Mr. Averill will earn interest on principal plus interest accrued through the extension date, at an annual rate of 15%. The April extension increased the annual interest rate to 16%. 38,286 warrants exercisable at $2.35 until December 31, 2012 are included with these two extensions. Under this loan agreement, during 2008 Mr. Averill earned an additional 457,542 five-year warrants at an exercise price of $2.35 per share. On June 30, 2008, we repaid the $1,235,028 balance due under this Bridge Loan after Mr. Averill converted $800,000 of this Bridge Loan into 380,952 shares of our common stock pursuant to the terms of the Bridge Loan agreement.
 
 
Glenn Patterson—financing transactions. In April 2006, Mr. Patterson loaned us $100,000 on a short-term note. Over the year 2006, Mr. Patterson continued to advance monies to the company, increasing the loaned amount to $1,105,000, with interest rates ranging from 10-12%. The interest rate varied because of different loans and interest rate escalators under certain circumstances. Accrued interest from these loans amounted to $43,577 during 2006. By the terms of these loans, he received 353,113 common stock purchase warrants with a debt discount valued at $93,334. Some of his loans were convertible into offering units at a price of $2.50 per unit (each unit consisting of one share of common stock and one five year warrant to purchase one share of common stock at a price of $4.00 per share). Mr. Patterson elected not to exercise this feature; instead, he converted $1,080,000 of his loans plus interest into Series A Preferred Stock during the fourth quarter of 2006. $72,124 principle and $2,114 interest carried over into 2007 and was paid on January 25, 2007 prior to the maturity date of his loans. In December 2007, Mr. Patterson loaned the Company $92,000 pursuant to the Company’s private placement secured bridge loan offering, earning interest at 14% per annum, origination fees of $8,000 over 3 ½ months, and 3,405 five-year warrants at an exercise price of $2.35 per share. This short term bridge loan had an initial maturity date of March 2008. On March 31, 2008 and then again on April 30, 2008, the Company sent notice to Mr. Patterson of its intention to extend the loan until April 30, 2008, and May 31, 2008 respectively. The extension entitles Mr. Patterson to earn an extension fee of 1% of the original loan on each extension date. With the March 31, 2008 extension, Mr. Patterson will earn interest on principal plus interest accrued through the extension date, at an annual rate of 15%. The April extension increased the annual interest rate to 16%. 2,127 warrants exercisable at $2.35 until December 31, 2012 are included with these two extensions. Under this loan agreement, during 2008 Mr. Patterson earned an additional 4,627 five-year warrants at an exercise price of $2.35 per share. On May 29, 2008, we repaid the $104,770 balance due under this Bridge Loan after Mr.Patterson converted $4,200 of this Bridge Loan into 2,000 shares of our common stock pursuant to the terms of the Bridge Loan agreement.
 
49
 
John Petersen— compensatory transactions. John Petersen was a director of our company until January 15, 2007 and a partner in the law firm of Fefer, Petersen & Cie, which serves as our legal counsel. During 2007, we paid Fefer, Petersen & Cie $180,000 in cash.
 
Transactions with Executive Management
 
See “Executive Compensation” above for a discussion of the material elements of compensation awarded to, earned by or paid to our Named Executive Officers. 
 
50
 
THE SELLING STOCKHOLDERS AND PLAN OF DISTRIBUTION
 
We are registering 2,782,837 shares of common stock held by the Selling Stockholders pursuant to the registration obligations of the Securities Purchase Agreement and the Settlement Agreement to permit the resale of these shares of common stock by the Selling Stockholders from time to time after the date of this prospectus. After completion of the offering, Quercus will hold 16,473,594 shares of our common stock, either out right or upon the exercise of its warrants and the Mega-C Trust will hold 4,700,000 shares of our common stock. We will not receive any of the proceeds from the sale by the Selling Stockholders of the shares of common stock covered by this prospectus. We will bear all fees and expenses incident to our obligation to register the shares of common stock.
 
Name of Selling Stockholder
 
Amount benefically 
owned by Selling 
Stockholder
 
Amount to be 
offered  to 
Selling 
Stockholder’s 
Account
 
Amount to be 
benefically owned 
following 
completion 
of offering
 
Percent to be beneficially owned following completion of the offering
 
The Quercus Trust(1)
   
18,571,429
   
2,097,835
   
16,473,594
   
45.9
%
Second Amended Stockholders Trust of Mega-C Corporation(2)
   
5,385,002
   
685,002
   
4,700,000
   
18.2
%
 
(1)
David Gelbaum and Monica Chavez Gelbaum are the trustees of The Quercus Trust, each with shared voting power over the shares held by this trust.
(2)
Jeff Hartman is the current trustee of the Mega-C Trust with sole voting power over the shares held by this trust.
 
The Selling Stockholders may sell all or a portion of the shares of common stock beneficially owned by it and offered hereby from time to time directly or through one or more underwriters, broker-dealers or agents. The shares of common stock may be sold in one or more transactions at fixed prices, at prevailing market prices at the time of the sale, at varying prices determined at the time of sale, or at negotiated prices. These sales may be effected in transactions, which may involve crosses or block transactions:
     
 
·
to purchasers directly;
 
 
·
in ordinary brokerage transactions and transactions in which the broker solicits purchasers;
 
 
·
through underwriters or dealers who may receive compensation in the form of underwriting discounts, concessions or commissions from such stockholders or from the purchasers of the securities for whom they may act as agent;
 
 
·
by the pledge of the shares as security for any loan or obligation, including pledges to brokers or dealers who may effect distribution of the shares or interests in such securities;
 
 
·
to purchasers by a broker or dealer as principal and resale by such broker or dealer for its own account pursuant to this prospectus;
 
 
·
in a block trade in which the broker or dealer so engaged will attempt to sell the securities as agent but may position and resell a portion of the block as principal to facilitate a transaction;
 
 
·
through an exchange distribution in accordance with the rules of the exchange or in transactions in the over-the-counter market;
 
 
·
pursuant to Rule 144; or
 
 
·
in any other manner not proscribed by law.
 
If the Selling Stockholders effect such transactions by selling shares of common stock to or through underwriters, broker-dealers or agents, such underwriters, broker-dealers or agents may receive commissions in the form of discounts, concessions or commissions from the Selling Stockholders or commissions from purchasers of the shares of common stock for whom they may act as agent or to whom they may sell as principal (which discounts, concessions or commissions as to particular underwriters, broker-dealers or agents may be in excess of those customary in the types of transactions involved). In connection with sales of the shares of common stock or otherwise, the Selling Stockholders may enter into hedging transactions with broker-dealers, which may in turn engage in short sales of the shares of common stock in the course of hedging in positions they assume. If the Selling Stockholders enter into an agreement to sell its shares to a broker-dealer and such broker-dealer is acting as an underwriter, we will file a post-effective amendment to the registration statement of which this prospectus forms a part for the purpose of updating this disclosure with respect to such broker-dealer and its related plan of distribution. The Selling Stockholders may also sell shares of common stock short and deliver shares of common stock covered by this prospectus to close out short positions. The Selling Stockholders may also loan or pledge shares of common stock to broker-dealers that in turn may sell such shares.
 
The Selling Stockholders and any broker-dealer participating in the distribution of the shares of common stock may be deemed to be “underwriters” within the meaning of the Securities Act, and any commission paid, or any discounts or concessions allowed to, any such broker-dealer may be deemed to be underwriting commissions or discounts under the Securities Act.
 
51
 
 
We have advised the Selling Stockholders that under current interpretations they may not use shares registered on this registration statement to cover short sales of our common stock made prior to the date on which this registration statement shall have been declared effective by the Commission. If the Selling Stockholders use this prospectus for any sale of our common stock, it will be subject to the prospectus delivery requirements of the Securities Act.
 
The Selling Stockholders and any other person participating in such distribution will be subject to applicable provisions of the Exchange Act and the rules and regulations thereunder, including, without limitation, Regulation M of the Exchange Act, which may limit the timing of purchases and sales of any of the shares of common stock by the Selling Stockholders and any other participating person. Regulation M may also restrict the ability of any person engaged in the distribution of the shares of common stock to engage in market-making activities with respect to the shares of common stock. All of the foregoing may affect the marketability of the shares of common stock and the ability of any person or entity to engage in market-making activities with respect to the shares of common stock.
 
We have also agreed to indemnify Quercus against liabilities, including some liabilities under the Securities Act. In accordance with the Securities Purchase Agreement, Quercus will be entitled to contribution. We may be indemnified by Quercus against civil liabilities, including liabilities under the Securities Act, which may arise from any written information furnished to us by Quercus specifically for use in this prospectus, in accordance with the related registration rights agreements, or we may be entitled to contribution.
 
Once sold under the registration statement, of which this prospectus forms a part, the shares of common stock will be freely tradable in the hands of persons other than our affiliates.
 
There can be no assurance that the Selling Stockholders will sell any or all of the shares of common stock registered pursuant to the registration statement, of which this prospectus forms a part.
 
Our common stock is quoted on the OTCBB.
 
DESCRIPTION OF SECURITIES
 
General
 
Our amended certificate of incorporation authorizes the issuance of 50,000,000 shares of common stock and 12,500,000 shares of preferred stock. We have designated 1,000,000 shares of our authorized preferred stock as Senior Preferred Stock, and 2,000,000 shares designated as Series A Preferred Stock. We have 25,868,884 common shares and 910,497 shares of preferred stock outstanding. Outstanding warrants, vested options, and convertible rights entitle the holders to purchase 24,958,110 additional shares of common stock.
 
Within the limits established by our certificate of incorporation, our board of directors has the power at any time and without stockholder approval to issue shares of our authorized common stock or preferred stock for cash, to acquire property or for any other purpose that the board of directors believes is in the best interests of our company. Our stockholders have no pre-emptive rights and any decision to issue additional shares of common stock or preferred stock will reduce the percentage ownership of our current stockholders and could dilute our net tangible book value.
 
Our board of directors has the power to establish the designation, rights and preferences of any preferred stock we issue in the future. Accordingly, our board of directors may, without stockholder approval, issue preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock. Subject to the directors’ duty to act in the best interest of our company, shares of preferred stock can be issued quickly with terms calculated to delay or prevent a change in control or make removal of management more difficult.
 
The following summary of our capital stock does not purport to be complete and is subject to and qualified in its entirety by, our amended and restated certificate of incorporation and our by-laws, each of which are included as exhibits to the registration statement of which this prospectus forms a part and by the provisions of applicable law.
 
Common Stock
 
Our common stockholders are entitled to one vote for each share held of record on all matters to be voted on by stockholders. There is no cumulative voting with respect to the election of directors, with the result that the holders of more than 50% of the shares voted for the election of directors can elect the entire board of directors. The holders of common stock are entitled to receive dividends when, as and if declared by our board of directors out of funds legally available. In the event of our liquidation, dissolution or winding up, our common stockholders are entitled to share ratably in all assets remaining available for distribution to them after payment of liabilities and after provision has been made for each class of stock, if any, having preference over the common stock. The holders of common stock have no preemptive or other subscription rights and there are no redemption provisions applicable to the common stock. All of our outstanding shares of common stock are fully paid and non-assessable.
 
52
 
The Mega-C Trust holds 5,385,002 shares of our common stock. Under the original trust agreement, the trustee of the Mega-C Trust was required to vote the trust shares proportionally with the votes cast by our other stockholders. Under the settlement agreement and the reorganization plan, the Mega-C Trust and a liquidation trust for Mega-C will have the right to vote the number of shares that is equal to the lesser of the number of shares held by them, or the number of shares held by APC’s founders and their spouses and dependents. At the date of this prospectus, the Mega-C Trust and the liquidation trust would be entitled to cast up to 5,385,002 votes at a meeting of stockholders and may have substantial influence over the outcome of any stockholder vote.
 
Senior Preferred Stock  
 
Our board of directors has designated 1,000,000 shares of our authorized preferred stock as Senior Preferred Stock and a total of 137,500 shares are outstanding at the date of this prospectus. We are not authorized to issue any additional shares of Senior Preferred Stock. So long as any Senior Preferred Stock is outstanding, we cannot (1) issue any series of stock having rights senior to or on parity with the Senior Preferred Stock (2) amend, alter or repeal any provision of our certificate of incorporation or by-laws to adversely affect the preferences, qualifications, limitations or restrictions of the Senior Preferred Stock or (3) effect a reclassification of the Senior Preferred Stock without the consent of the holders of a two-thirds majority of the outstanding shares of Senior Preferred Stock.
 
Holders of Senior Preferred Stock are entitled to receive dividends at the annual rate of 8%. Dividends are payable quarterly on the last day of March, June, September and December of each year. Dividends are cumulative from the date of issuance and payable to holders of record. In order to conserve our available resources, we will not pay cash dividends on the Senior Preferred Stock in any quarter where our company reports a net loss. Any accrued dividends that are not paid in cash will be added to the stated value of the Senior Preferred Stock.
 
The preferred stock had an initial stated value of $10.00 per share. Accrued dividends that are not paid in cash within ten days of a payment date will automatically be added to the stated value and the stated value, as adjusted, will be used for all future dividend and conversion calculations. The following table summarizes the stated value of our Senior Preferred Stock at the end of each quarter through June 30, 2008.
 
Quarter Ended
 
Adjusted Stated Value
 
Quarter Ended
 
Adjusted Stated Value
 
               
31-Mar-06
 
$
10.86
   
31-Mar-07
 
$
11.75
 
                     
30-Jun-06
 
$
11.07
   
30-Jun-07
 
$
11.99
 
                     
30-Sep-06
 
$
11.29
   
30-Sep-07
 
$
12.23
 
                     
31-Dec-06
 
$
11.52
   
31-Dec-07
 
$
12.47
                     
 
         
31-Mar-08
 
$
12.72
 
                     
           
30-Jun-08
 
$
12.97
 
 
Holders of Senior Preferred Stock have the right to convert their shares into common stock at any time. The adjusted conversion price is presently $1.68 per share. As a result, of the cumulative stated value and conversion price reductions, each share of senior preferred is presently convertible into 5.96   shares of common stock.
 
The conversion price of the Senior Preferred Stock will be subject to further adjustment for certain events, including: sales of common stock at a price that is less than the then current conversion price; share dividends on our common stock; subdivisions or combinations of our common stock; and the issuance of certain rights or warrants to holders of our common stock that permit them to subscribe for or purchase shares of our common stock at a price less than current market price. No adjustment in the conversion price will be required to be made until cumulative adjustments equal at least $0.05 per share of common stock; however, any adjustments that are not made will be carried forward. All conversion price adjustment calculations shall be made to the nearest cent.
 
53
 
In connection with the election of directors, the holders of Senior Preferred Stock will have the right to vote as a separate class to elect one member of our board of directors. With respect to all other matters submitted for a stockholder vote other than the election of directors and matters that specifically require class voting under Delaware law, the holders of Senior Preferred Stock will be entitled to cast the number of votes equal to the number of shares of common stock into which the Senior Preferred Stock could then be converted.
 
We may from time to time decrease the conversion price by any amount for any period of at least 20 days, in which case we will give each holder of Senior Preferred Stock at least 15 days notice of such decrease.
 
No fractional shares of common stock will be issued upon conversion of the Senior Preferred Stock, but in lieu thereof, an appropriate amount will be paid in cash by the company based on the reported last sale price for the shares of common stock on the business day prior to the date of conversion.
 
In connection with any optional conversion, all accrued and declared dividends through the end of the calendar quarter in which the conversion is effected will be added to the conversion value. If the Senior Preferred Stock is called for redemption, the conversion right shall terminate at the close of business on the redemption date.
 
If the market price of our common stock exceeds certain price thresholds for at least 30 trading days within any period of 45 consecutive trading days, we will have the right to redeem unconverted shares of Senior Preferred Stock for cash according to the following schedule:
 
 
·
if the market price exceeds $6.00 per share, we will be entitled to redeem 20% of the Senior Preferred Stock for the stated value unless the holders exercise their conversion rights;
 
 
·
if the market price exceeds $7.00 per share, we will be entitled to redeem another 20% of the Senior Preferred Stock for the stated value unless the holders exercise their conversion rights;
 
 
·
if the market price exceeds $8.00 per share, we will be entitled to redeem another 20% of the Senior Preferred Stock for the stated value unless the holders exercise their conversion rights;
 
 
·
if the market price exceeds $9.00 per share, we will be entitled to redeem another 20% of the Senior Preferred Stock for the stated value unless the holders exercise their conversion rights; and
 
 
·
if the market price exceeds $10.00 per share, we will be entitled to redeem the final 20% of the Senior Preferred Stock for cash unless the holders exercise their conversion rights.
 
In connection with any proposed redemption of Senior Preferred Stock, we will give each holder not less than 30 days notice of our intention to redeem a portion of his shares. The notice will state the redemption date, the number of shares of Senior Preferred Stock to be redeemed, the amount payable in connection with the redemption and the number of shares of common stock that will be issued to the holder if he chooses to exercise his conversion rights prior to the redemption date. After the redemption date, unless we fail to pay the redemption price, dividends will cease to accrue on the shares of Senior Preferred Stock called for redemption and all conversion rights of the holders of those shares will terminate, except the right to receive the redemption price without interest. There is no mandatory redemption or sinking fund obligation with respect to the Senior Preferred Stock.
 
In the event of any liquidation, dissolution or winding up of our company, holders of Senior Preferred Stock are entitled to a liquidation preference equal to the stated value of the Senior Preferred Stock on the payment date before any payment or distribution is made to the holders of common stock. The holders of such shares will not be entitled to any further participation in any distribution of assets by our company.
 
Series A Preferred Stock
 
Authorization . On October 18, 2006, our board of directors authorized a new series of preferred stock consisting of up to 2,000,000 shares to be designated Series A Preferred Stock. No more than 1,000,000 shares may be sold for cash and the remaining shares must be reserved for (i) issuance upon exercise of the conversion rights of holders of our secured and unsecured short-term debt, and (ii) to pay in-kind dividends on the Series A Preferred Stock. So long as any Series A Preferred Stock is outstanding, we are prohibited from issuing any series of stock having rights senior to or on parity with the Series A Preferred Stock without the approval of the holders of two-thirds of the outstanding Preferred Stock. The holders of Series A Preferred Stock have no preemptive rights with respect to any other securities of our company.
 
Stated Value . The Series A Preferred Stock has a stated value of $10.00 per share.
 
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Dividends . Holders of shares of Series A Preferred Stock will receive dividends at the annual rate of 10% of the stated value of the Series A Preferred Stock; provided that if we are delinquent in our Commission reports on any dividend payment date, the required dividend will be calculated at an annual rate of 20% for that dividend period only. Such dividends shall be payable in equal quarterly payments on the last day of March, June, September and December of each year commencing December 31, 2006, except that if any such date is a Saturday, Sunday or legal holiday, then such dividend shall be payable on the next day that is not a Saturday, Sunday or legal holiday. Dividends will accrue and be cumulative from the date of issuance of the Series A Preferred Stock until paid in full. When dividends are declared by the board of directors, each holder of Series A Preferred Stock will have the option, for a period of ten days from the dividend declaration date, to elect to receive his dividend in cash or in fully-paid shares of Preferred Stock which will be valued at $10 per share for dividend payment purposes.
 
Liquidation Rights . In the event of any liquidation, dissolution or winding up of our company, holders of shares of Series A Preferred Stock are entitled to receive the liquidation preference of $10 per share plus accrued dividends before any payment or distribution is made to the holders of common stock. After payment in full of the liquidation preference of the shares of the Series A Preferred Stock, the holders of such shares will not be entitled to any further participation in any distribution of assets by our company.
 
Voting Rights . With respect to all matters submitted for a stockholder vote other than matters that specifically require class voting under Delaware law, the holders of the Series A Preferred Stock will be entitled to cast the number of votes equal to the number of shares of common stock into which such shares of Series A Preferred Stock could be converted on the record date. So long as any Series A Preferred Stock is outstanding, we may not, without the affirmative vote of the holders of at least two-thirds of the outstanding shares, voting separately as a class, (1) amend, alter or repeal any provision of the certificate of incorporation or bylaws so as to adversely affect the relative rights, preferences, qualifications, limitations or restrictions of the Series A Preferred Stock, (2) authorize or issue, or increase the authorized amount of, any additional class or series of stock, or any security convertible into stock of such class or series, ranking senior to the Series A Preferred Stock as to dividends, redemption or upon liquidation, dissolution or winding up of the Company or (3) effect any reclassification of the Preferred Stock.
 
Optional Conversion . Holders of the Series A Preferred Stock have the right to convert shares of Series A Preferred Stock into shares of our common stock. The conversion price is $1.25 per share. The conversion price will be subject to adjustment for certain events, including: sales of common stock at a price that is less than the then current conversion price; share dividends on our common stock; subdivisions or combinations of our common stock; and the issuance of certain rights or warrants to holders of our common stock that permit them to subscribe for or purchase shares of our common stock at a price less than the conversion price of the Series A Preferred Stock then in effect. No adjustment in the conversion price will be required to be made until cumulative adjustments equal at least $.05 per share of common stock; however, any adjustments that are not made shall be carried forward. All conversion price adjustment calculations shall be made to the nearest cent.
 
We may from time to time decrease the conversion price by any amount for any period of at least 20 days, in which case we will give each holder of Series A Preferred Stock at least 15 days’ notice of such decrease.
 
No fractional shares of common stock will be issued upon conversion, but, in lieu thereof, an appropriate amount will be paid in cash by the Company based on the reported last sale price for the shares of common stock on the business day prior to the date of conversion.
 
In connection with any optional conversion, all accrued dividends through the end of the calendar quarter in which the conversion is effected will be added to the conversion value. If the Series A Preferred Stock is called for redemption, the conversion right shall terminate at the close of business on the redemption date.
 
Registration of Underlying Common Stock .   Under the Settlement Agreement, we are obligated to register approximately 4,700,000 shares of our common stock held by the Trustee for the Mega-C Trust and approximately 314,998 shares held by the trustee for the Liquidation Trust, upon a written request from either party (the “Demand Registration Shares”). In addition, we have outstanding obligations to register 1,063,262 shares of common stock underlying our Senior Preferred Stock, outstanding obligations to register 7,992,492 shares of common stock underlying our Series A Preferred Stock, outstanding obligations to register approximately 539,611 shares of common stock and common stock underlying certain warrants issued pursuant to a certain secured bridge loan arrangement, and outstanding obligations to register an additional 4,316,272 shares of common stock issuable upon the exercise of certain of our outstanding warrants (the “Contractual Registration Shares”). We are currently in breach of our obligations to register the Contractual Registration Shares, and we are not including any of Contractual Registration Shares in this offering. There are no liquidated damages stipulated for our failure to register the Contractual Registration Shares; however, the holders of the Contractual Registration Shares may still elect to pursue remedies against the Company for our failure to meet these registration obligations.
 
55
 
The underlying agreements generally require our company to pay the fees and expenses we incur in connection with the registration and to indemnify the holders of shares against losses, claims, damages, liabilities or expenses that arise out of or are based upon any untrue statement (or alleged untrue statement) of a material fact made by our company. Likewise, each holder whose securities are included in such registration will be required to indemnify our company against losses, claims, damages, liabilities or expenses that arise out of or are based upon any untrue statement (or alleged untrue statement) of a material fact that is made in reliance upon information provided by the holder.
 
A substantial increase in the supply of freely transferable shares may depress the market price of our stock. If the holders of our stock were to offer a substantial number of shares for sale at or about the same time, the price decline would probably be dramatic. The availability of a large supply of freely transferable shares might also make it more difficult for us to sell common stock in the future or reduce the price at which we could sell our shares.
 
Upon our registration of the shares of common stock underlying the shares of our Senior Preferred Stock and Series A Preferred Stock, we are further obligated to use all reasonable efforts to maintain the effectiveness of such registration statements for a period of eighteen months and twenty four months, respectively. If we decide to file a registration statement under the Securities Act for a proposed public offering of common stock by our company, then the holders of our Senior Preferred Stock and our Series A Preferred Stock, will be afforded a reasonable opportunity to participate in that public offering as selling stockholders. In connection with any such piggy-back registration, the holders of our Senior Preferred Stock and our Series A Preferred Stock shall, if requested in writing by the managing underwriter or underwriters in an underwritten offering, agree not to effect any other public sale or distribution of our common stock, including a sale pursuant to the Rule 144 (except as part of such underwritten registration), during the seven-day period prior to, and during the 90-day period following, the effective date of underwritten registration.
 
Redemption . After we have registered the common stock issuable upon conversion of the Series A Preferred Stock under the Securities Act, if the market price of our common stock exceeds certain price thresholds for at least 30 trading days within any period of 45 consecutive trading days, we will have the right to redeem unconverted shares of Series A Preferred Stock for cash according to the following schedule:
 
·       If the market price of our common stock exceeds $5.00 per share, we will be entitled to redeem 20% of the Series A Preferred Stock for the stated value unless the holders exercise their conversion rights;
 
·       If the market price of our common stock exceeds $7.50 per share, we will be entitled to redeem another 20% of the Series A Preferred Stock for the stated value unless the holders exercise their conversion rights;
 
·       If the market price of our common stock exceeds $10.00 per share, we will be entitled to redeem another 20% of the Series A Preferred Stock for the stated value unless the holders exercise their conversion rights;
 
·       If the market price of our common stock exceeds $12.50 per share, we will be entitled to redeem another 20% of the Series A Preferred Stock for the stated value unless the holders exercise their conversion rights; and
 
·       If the market price of our common stock exceeds $15.00 per share, we will be entitled to redeem the final 20% of the Series A Preferred Stock for cash unless the holders exercise their conversion rights.
 
In connection with any proposed redemption of Series A Preferred Stock, we will give each holder not less than 30 days notice of our intention to redeem a portion of his shares. The notice will state the redemption date, the number of shares of Series A Preferred Stock to be redeemed, the amount payable in connection with the redemption and the number of shares of common stock that will be issued to the holder if he chooses to exercise his conversion rights prior to the redemption date. If fewer than all of the outstanding shares of Series A Preferred Stock are to be redeemed, we will select those to be redeemed pro rata or by lot. After the redemption date, unless we fail to pay the redemption price, dividends will cease to accrue on the shares of Series A Preferred Stock called for redemption and all conversion rights of the holders of those shares will terminate, except the right to receive the redemption price without interest. There is no mandatory redemption or sinking fund obligation with respect to the Series A Preferred Stock.
 
Warrants
 
At the date of this prospectus, we have 14,316,212 outstanding warrants that represent potential future cash proceeds to our company of $42,112,803. The warrants are divided into four classes that are presently exercisable and expire at various times over the next 60 months. The following table summarizes the number of warrants in each class, the anticipated proceeds from the exercise of each class, and the expiration date of each class.
 
56

Warrant
 
Number of
 
Exercise
 
Anticipated
 
Expiration
 
Series
 
Warrants
 
Price
 
Proceeds
 
Date
 
Freestanding Warrants
   
9,000
 
$
6.00
 
$
54,000
   
December 31, 2009
 
Series V Warrants
   
680,000
 
$
4.00
 
$
2,720,000
   
May 7, 2009
 
Series VI Warrants
   
1,139,363
 
$
6.00
 
$
6,836,178
   
March 31, 2011
 
2007 Bridge Warrants
   
183,755
 
$
2.35
 
$
431,824
   
December 31, 2012
 
2008 Conversion-Warrants    
618,440
 
$
2.60
 
$
1,607,944
   
June 29, 2013
 
2008 Quercus
   
11,485,714
 
$
2.60
 
$
29,862,856
   
June 29, 2013
 
Freestanding Warrants
   
200,000
 
$
3.00
 
$
600,000
   
October 5, 2009
 
Totals
   
14,316,272
       
$
42,112,803
       
 
The holders of warrants are not required to exercise their rights at any time prior to the expiration date and we are unable to predict the amount and timing of any future warrant exercises. We reserve the right to temporarily reduce the exercise prices of our warrants from time to time in order to encourage the early exercise of the warrants.
 
Stock Options
 
At the date of this prospectus, we have 2,485,885 outstanding stock options that represent potential future cash proceeds to our company of $10,575,518. The outstanding options include 1,563,135 options that are currently vested and exercisable, or 1,573,135 that will become vested and exercisable within 60 days, and represent potential future cash proceeds to our company of $7,562,393 and $7,587,393 respectively. The remaining options will vest and become exercisable over the next four years. The following table provides summary information on our outstanding options.

 
 
Vested Option Grants
 
Unvested Option Grants
 
 
 
Shares
 
Price
 
Proceeds
 
Shares
 
Price
 
Proceeds
 
Incentive Plan options
   
51,950
 
$
3.48
 
$
180,960
   
0
 
$
0
 
$
0
 
Directors’ Plan options
   
100,035
 
$
3.16
   
315,738
   
40,000
 
$
2.00
   
80,000
 
Contract options to officers
   
840,250
 
$
4.78
   
4,016,875
   
687,750
 
$
3.56
   
2,445,625
 
Contract options to consultants and employee
   
570,900
 
$
5.34
   
3,048,820
   
195,000
 
$
2.50
   
487,500
 
Total
   
1,563,135
 
$
4.84
 
$
7,562,393
   
922,750
 
$
3.27
 
$
3,013,125
 
 
The holders of options are not required to exercise their rights at any time and we are unable to predict the amount and timing of any future option exercises. We reserve the right to temporarily reduce the exercise prices of our options from time to time in order to encourage the early exercise of the options.
 
Delaware Anti-takeover Statute
 
We are subject to the provisions of section 203 of the Delaware General Corporation Law regulating corporate takeovers. In general, those provisions prohibit a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder, unless:
 
 
·
the transaction is approved by the board of directors before the date the interested stockholder attained that status;
 
 
·
upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced; or
 
 
·
on or after the date the business combination is approved by the board of directors and authorized at a meeting of stockholders by at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder.
 
Section 203 defines “business combination” to include the following:
 
 
·
any merger or consolidation involving the corporation and the interested stockholder;
 
57
 
 
·
any sale, transfer, pledge or other disposition of 10% or more of the assets of the corporation involving the interested stockholder;
 
 
·
subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder;
 
 
·
any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or
 
 
·
the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation.
 
In general, Section 203 defines an interested stockholder as any entity or person beneficially owning 15% or more of the outstanding voting stock of the corporation and any entity or person affiliated with or controlling or controlled by any of these entities or persons.
 
A Delaware corporation may opt out of this provision either with an express provision in its certificate of incorporation or bylaws approved by its stockholders. However, we have not opted out, and do not currently intend to opt out, of this provision. The statute could prohibit or delay mergers or other takeover or change in control attempts and, accordingly, may discourage attempts to acquire us.
 
Certificate of Incorporation and By-laws
 
Our Certificate of Incorporation and by-laws include provisions that may have the effect of delaying or preventing a change of control or changes in our management. These provisions include:
 
 
·
the division of our board of directors into three classes of directors that serve for rotating three-year terms;
 
 
·
the right of the board of directors to elect a director to fill a vacancy created by the resignation of a director or the expansion of the board of directors;
 
 
·
the prohibition of cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates;
 
 
·
the requirement for advance notice for nominations of candidates for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;
 
 
·
the ability of the board of directors to issue, without stockholder approval, up to 12,355,000 shares of preferred stock with terms set by the board of directors, which rights could be senior to those of common stock; and
 
 
·
the right of our board of directors to alter our bylaws without stockholder approval.
 
Transfer Agent
 
Our transfer agent is Continental Stock Transfer & Trust, 17 Battery Place, New York, New York 10004.
 
58

LEGAL MATTERS
 
The legality of the shares of common stock offered by this prospectus will be passed upon for us by Andrews Kurth LLP of Dallas, Texas.
 
EXPERTS
 
The financial statements as December 31, 2007 and 2006 included in this prospectus have been so included in reliance on the report of Rotenberg & Co. LLP, an independent registered public accounting firm, given on the authority of said firm as experts in accounting and auditing.
 
WHERE YOU CAN FIND MORE INFORMATION
 
We have filed a registration statement on Form S-1/A with the Commission with respect to this offering. This prospectus, which is part of the registration statement, does not include all of the information contained in the registration statement. You should refer to the registration statement and its exhibits and schedules for additional information. Whenever we make reference in this prospectus to any of our contracts, agreements or other documents, the references are not necessarily complete and you should refer to the exhibits and schedules attached to the registration statement for copies of the actual contract, agreement or other document.
 
We also file annual, quarterly and current reports, proxy statements and other documents with the Commission under the Exchange Act. You may read and copy any materials that we may file without charge at the Commission’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may call the Commission at 1-800-Commission-0330 for further information on the operation of the Public Reference Room. You may obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the Commission at 100 F Street, N.E., Washington, D.C. 20549. The Commission also maintains an Internet site, http://www.sec.gov, which contains reports, proxy and information statements and other information regarding issuers that file electronically with the Commission. The other information we file with the Commission is not part of the registration statement of which this prospectus forms a part.
 
59
 
AXION POWER INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
Reports of Independent Registered Public Accounting Firms
 
F-2
     
Notes to Consolidated Financial Statements
 
F-7
     
Consolidated Balance Sheets as of December 31, 2007 and 2006
 
F-3
     
Consolidated Statements of Operations for years ended December 31, 2007 and 2006
  And for the period since inception (September 18, 2003) through December 31, 2007
 
F-4
     
Consolidated Statements of Stockholders’ Equity (Deficit) for the period since inception (September 18, 2003) through December 31, 2007
 
F-6
     
Consolidated Statements of Cash Flows for the years ended December 31, 2007 and 2006
  And for the period since inception (September 18, 2003) through December 31, 2007
 
F-5
     
 
F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
Axion Power International, Inc.
 
We have audited the accompanying consolidated balance sheets of Axion Power International, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, cash flows, and changes in stockholders’ equity and comprehensive income for the years then ended and for the period since inception (September 18, 2003) through December 31, 2007. Axion Power International Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Axion Power International, Inc. as of December 31, 2007 and 2006, and the results of its operations and its cash flows for the years then ended and for the period since inception (September 18, 2003) through December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
 

/s/ Rotenberg & Co., LLP

Rotenberg & Co., LLP
Rochester, New York
April 3, 2008 except for the restatement in notes 8 and 10 to the consolidated financial statements, as to which the date is May 12, 2008

F-2
AXION POWER INTERNATIONAL, INC
CONSOLIDATED BALANCE SHEETS
(A Development Stage Company)
 
     
  December 31, 2006
 
           
ASSETS
 
 
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
Cash & cash equivalents
 
$
671,244
 
$
3,610,280
 
Accounts receivable
   
133,646
   
45,007
 
Other receivables
   
341,801
   
429,035
 
Inventory
   
375,635
   
267,186
 
Prepaid expenses
   
82,102
   
92,579
 
Total current assets
   
1,604,428
   
4,444,087
 
 
         
Property & equipment, net
   
2,119,252
   
1,044,805
 
TOTAL ASSETS
 
$
3,723,680
 
$
5,488,892
 
 
         
LIABILITIES & STOCKHOLDERS' EQUITY
         
 
         
Current Liabilities:
         
Accounts payable
 
$
1,573,436
 
$
911,466
 
Other current liabilities
   
583,591
   
840,330
 
Notes payable to related parties
   
2,259,826
   
499,482
 
Liability to issue equity instrument
   
106,183
   
-
 
Total current liabilities
   
4,523,036
   
2,251,278
 
 
         
Deferred revenue
   
840,945
   
-
 
Total liabilities
   
5,363,981
   
2,251,278
 
 
         
Stockholders' Equity:
         
Convertible preferred stock-12,500,000 shares authorized
             
Senior preferred - 1,000,000 shares designated. 137,500 issued and outstanding (137,500 in 2006)
   
1,515,376
   
1,548,989
 
Series A preferred - 2,000,000 shares designated. 822,997 shares issued and outstanding (782,997 in 2006)
   
9,802,894
   
1,578,235
 
Common stock-50,000,000 shares authorized $0.0001 par value 16,248,298 issued & outstanding (16,247,298 in 2006)
   
1,625
   
1,625
 
Additional paid in capital
   
25,768,331
   
24,574,346
 
Deficit accumulated during development stage
   
(38,498,704
)
 
(24,214,622
)
Cumulative foreign currency translation adjustment
   
(229,823
)
 
(250,959
)
Total Stockholders' Equity
   
(1,640,301
)
 
3,237,614
 
 
         
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY
 
$
3,723,680
 
$
5,488,892
 
 
The Accompanying Notes are an Integral Part of the Financial Statements
 
F-3
AXION POWER INTERNATIONAL, INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(A Development Stage Company)
 
   
Years Ended
 
Inception
 
   
December 31,
 
(9/18/2003) to
 
   
2007
 
2006
 
December 31, 2007
 
 
 
 
 
 
 
 
 
Revenues
 
$
533,911
 
$
275,377
 
$
809,288
 
Cost of tangible products sold
   
1,130,885
   
557,983
   
1,688,868
 
Gross profit / (loss)
   
(596,974
)
 
(282,606
)
 
(879,580
)
 
             
Expenses
             
Selling, general & administrative
   
3,720,632
   
4,788,986
   
13,169,192
 
Research & development
   
1,308,345
   
2,001,506
   
9,143,233
 
Impairment of assets
   
-
   
6,581
   
1,391,485
 
Interest expense - related party
   
276,651
   
713,048
   
1,014,487
 
Derivative revaluation
   
(72,236
)
 
437,588
   
365,352
 
Mega-C Trust Share Augmentation (Return)
   
-
   
(1,125,000
)
 
400,000
 
Other, net
   
(47,708
)
 
(77,352
)
 
(476,928
)
Net loss before income taxes
   
(5,782,658
)
 
(7,027,963
)
 
(25,886,401
)
Income Taxes
   
83,469
   
-
   
83,469
 
Deficit accumulated during development stage
   
(5,866,127
)
 
(7,027,963
)
 
(25,969,870
)
 
             
Less preferred stock dividends and beneficial conversion feature
   
(8,417,955
)
 
(835,529
)
 
(12,528,835
)
Net loss applicable to common shareholders
 
$
(14,284,082
)
$
(7,863,492
)
$
(38,498,705
)
 
             
Basic and diluted net loss per share
 
$
(0.88
)
$
(0.47
)
$
(2.73
)
Weighted average common shares outstanding
   
16,247,299
   
16,628,290
   
14,080,181
 
 
The Accompanying Notes are an Integral Part of the Financial Statements
 
F-4

AXION POWER INTERNATIONAL, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(A Development Stage Company)
 
   
Years Ended
 
Inception
 
   
December 31,
 
(9/18/2003) to
 
   
2007
 
2006
 
12/31/2007
 
 
 
 
 
 
 
 
 
Cash Flows from Operating Activities:
 
 
 
 
 
 
 
Deficit accumulated during development stage
 
$
(5,866,127
)
$
(7,027,963
)
$
(25,969,870
)
Adjustments required to reconcile deficit
             
accumulated during development stage to cash flows
             
used by operating activities
             
Depreciation
   
176,196
   
96,249
   
353,482
 
Impairment of assets
   
-
   
6,582
   
1,391,486
 
Non-cash interest expense
   
224,536
   
713,048
   
962,372
 
Extinguishment loss
   
-
   
-
   
-
 
Derivative revaluations
   
(72,236
)
 
437,588
   
365,352
 
Equity instruments issued for services
   
478,113
   
1,577,147
   
3,488,794
 
Mega-C Trust Share Augmentation (Return)
   
-
   
(1,125,000
)
 
400,000
 
Changes in Operating Assets & Liabilities
             
Accounts receivable
   
(88,639
)
 
(51,878
)
 
(140,517
)
Other receivables
   
87,233
   
(88,206
)
 
(319,841
)
Prepaid expenses
   
10,478
   
(47,933
)
 
(79,514
)
Inventory
   
(108,449
)
 
(267,186
)
 
(375,635
)
Accounts payable
   
661,969
   
619,977
   
3,228,080
 
Other current liabilities
   
(252,500
)
 
555,109
   
604,721
 
Deferred revenue
   
840,945
   
-
   
840,945
 
Liability to Issue equity Instruments
   
178,419
   
-
   
178,419
 
Net cash used by operating activities
   
(3,730,062
)
 
(4,602,466
)
 
(15,071,726
)
 
             
Cash Flows from Investing Activities
             
Investments in notes receivable
   
-
   
-
   
(1,217,016
)
Purchase of property & equipment
   
(1,250,643
)
 
(801,870
)
 
(2,381,967
)
Investment in intangible assets
   
-
   
-
   
(167,888
)
Net cash used by investing activities
   
(1,250,643
)
 
(801,870
)
 
(3,766,871
)
 
             
Cash Flow from Financing Activities
             
Proceeds from related party debt
   
1,630,032
   
3,309,714
   
6,663,256
 
Proceeds from sale of common stock; net of costs
   
-
   
788,900
   
3,717,405
 
Proceeds from exercise of warrants
   
-
   
-
   
1,655,500
 
Proceeds from sale of preferred stock, net of costs
   
390,500
   
4,352,500
   
7,472,181
 
Net cash provided by financing activities
   
2,020,532
   
8,451,114
   
19,508,342
 
 
             
Net Change in Cash and Cash Equivalents
   
(2,960,173
)
 
3,046,778
   
669,745
 
Effect of Exchange Rate on Cash
   
21,137
   
10,501
   
1,499
 
Cash and Cash Equivalents - Beginning
   
3,610,280
   
553,001
   
-
 
Cash and Cash Equivalents - Ending
 
$
671,244
 
$
3,610,280
 
$
671,244
 
 
The Accompanying Notes are an Integral Part of the Financial Statements

Axion Power International, Inc.
Consolidated Statement of Stockholders' Deficit-US$
For Periods Ended December 31, 2003; 2004; 2005; 2006; 2007
(A Development Stage Company)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     
Deficit
Accumulated
During
Development
Stage
 
Other
Comprehensive
Income
Cumulative
Translation
Adjustments
 
Total
Stockholders'
Equity
 
   
Preferred    
 
Common      
             
 
 
Shares
 
Senior
Preferred
 
Series A
Preferred
 
Shares
 
Common
Stock
 
Additional
Paid-In
 
Subscriptions
Receivable
             
Inception September 18, 2003
   
0
 
$
0
   
 
   
0
 
$
0
 
$
0
 
$
0
 
$
0
 
$
0
 
$
0
 
Shares to founders upon formulation of APC
                     
1,360,000
   
137
   
(137
)
 
0
               
0
 
Stock based compensation
                     
170,000
   
17
   
48,936
                     
48,953
 
Conversion of debt to equity
                     
1,108,335
   
111
   
1,449,889
   
(350,000
)
             
1,100,001
 
Debt Discount from convertible debt
                                 
86,402
                     
86,402
 
Unamortized discount on convertible debt
                                 
(77,188
)
                   
(77,188
)
Fair value of options issued as loan inducements
                                 
15,574
                     
15,574
 
Shared issued during Recapitalization
                                                             
- Shares issued to Mega-C trust
                     
6,147,483
   
615
   
(615
)
                   
0
 
- Equity acquired in recapitalization
                     
1,875,000
   
188
   
(188
)
                   
0
 
Net Loss December 31, 2003
                                             
(3,097,030
)
       
(3,097,030
)
Other Comprehensive income (loss):
                                                             
Foreign Currency Translation Adjustment
                                                   
(56,547
)
 
(56,547
)
Comprehensive loss
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
(3,153,577
)
Balance at December 31, 2003
   
0
   
0
   
     
   
10,660,818
 
$
1,067
 
$
1,522,674
 
$
(350,000
)
$
(3,097,030
)
$
(56,547
)
$
(1,979,836
)
Shares issued to founders
                     
445,000
   
45
   
(45
)
                   
0
 
Augmentation shares issued to Mega-C trust
                     
180,000
   
18
   
(18
)
                   
0
 
Conversion of debt
                     
283,333
   
28
   
451,813
   
350,000
               
801,841
 
Warrants in consideration for technology purchased
                                 
563,872
                     
563,872
 
Common stock offering - net of cost
                     
823,800
   
81
   
1,607,053
                     
1,607,134
 
Proceeds from exercise of warrants
                     
475,200
   
48
   
867,972
                     
868,020
 
Liability converted as partial prepayment on options
                                 
306,000
                     
306,000
 
Stock based compensation
                     
45,000
   
5
   
191,738
                     
191,742
 
Fraction Shares Issued Upon Reverse Spilt
                     
48,782
   
5
   
(5
)
                   
0
 
Net Loss December 31, 2004
                                             
(3,653,637
)
       
(3,653,637
)
Other Comprehensive income (loss):
                                                             
Foreign Currency Translation Adjustment
                                                   
(74,245
)
 
(74,245
)
Comprehensive loss
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
(3,727,882
)
Balance at December 31, 2004
   
0
   
0
   
 
   
12,961,933
 
$
1,296
 
$
5,511,054
 
$
0
 
$
(6,750,667
)
$
(130,792
)
$
(1,369,109
)
Proceeds From Exercise of Warrants & Options
                     
853,665
   
85
   
1,283,395
   
(496,000
)
             
787,480
 
Common Stock Offering Proceeds
                     
600,000
   
60
   
1,171,310
   
(200,000
)
             
971,370
 
Preferred Stock Offering proceeds
   
385,000
   
3,754,110
                           
(25,000
)
             
3,729,110
 
Conversion of preferred to common
   
(245,000
)
 
(2,475,407
)
       
1,470,000
   
147
   
2,475,260
                     
0
 
Stock issued for services
                     
500,000
   
50
   
1,524,950
                     
1,525,000
 
Fair Value of Options for Non-Employee Services
                                 
237,568
                     
237,568
 
Employee incentive share grants
                     
219,000
   
22
   
647,480
                     
647,502
 
Impact of beneficial conversion feature
                                 
3,099,156
         
(3,099,156
)
       
0
 
Preferred Stock Dividends
         
176,194
                                 
(176,194
)
       
0
 
Net Loss December 31, 2005
                                             
(6,325,113
)
       
(6,325,113
)
Other Comprehensive income (loss):
                                                             
Foreign Currency Translation Adjustment
                                                   
(24,780
)
 
(24,780
)
Comprehensive loss
                                                         
(6,349,893
)
                                                               
Balance at December 31, 2005
   
140,000
 
$
1,454,897
   
 
   
16,604,598
 
$
1,661
 
$
15,950,173
 
$
(721,000
)
$
(16,351,130
)
$
(155,572
)
$
179,029
 
                                                               
Balance at December 31, 2005
   
140,000
 
$
1,454,897
   
  
   
16,604,598
 
$
1,661
 
$
15,950,173
 
$
(721,000
)
$
(16,351,130
)
$
(155,572
)
$
179,029
 
Preferred Series A Proceeds
   
782,997
         
7,571,768
                                       
7,571,768
 
Preferred - Dividends
         
119,092
   
103,101
                           
(222,193
)
       
0
 
Senior Preferred Cancellation
   
(2,500
)
 
(25,000
)
                         
25,000
               
0
 
Common Stock Offering Proceeds
                     
80,000
   
8
   
199,992
   
696,000
               
896,000
 
Proceeds from exercise of warrants
                     
56,700
   
6
   
113,394
                     
113,400
 
Employee incentive share grants
                     
6,000
   
1
   
23,999
                     
24,000
 
Augmentation shares issued to Mega-C trust
                     
(500,000
)
 
(50
)
 
(1,124,950
)
                   
(1,125,000
)
Stock based compensation
                                 
1,241,231
                     
1,241,231
 
Fair value of warrants with related party debt
                                 
885,126
                     
885,126
 
Modification of preexisting warrants
                                 
392,811
                     
392,811
 
Fair value warrants issued for services
                                 
86,848
                     
86,848
 
Beneficial conversion feature on related party debt
                                 
95,752
                     
95,752
 
Beneficial conversion feature on Preferred Stock
               
(6,096,634
)
             
6,709,970
         
(613,336
)
       
0
 
Net Loss December 31, 2006
                                             
(7,027,963
)
       
(7,027,963
)
Other Comprehensive income (loss):
                                                         
0
 
Foreign Currency Translation Adjustment
                                                   
(95,387
)
 
(95,387
)
Comprehensive loss
                                                         
(7,123,350
)
Balance at December 31, 2006
   
920,497
 
$
1,548,989
 
$
1,578,235
   
16,247,298
   
1,625
   
24,574,346
   
-
   
(24,214,622
)
 
(250,959
)
$
3,237,614
 
                                                               
Preferred Series A Proceeds
   
40,000
         
337,270
                                       
337,270
 
Preferred - Dividends
         
130,566
   
1,790,755
                           
(1,921,321
)
       
0
 
Employee incentive share grants
                     
1,000
   
-
   
315,950
                     
315,950
 
Stock based compensation
                                 
215,393
                     
215,393
 
Fair value of warrants with related party debt
                                 
98,463
                     
98,463
 
Modification of preexisting warrants
         
(164,179
)
                   
164,179
                     
0
 
Beneficial conversion feature on Preferred Stock
               
6,096,634
               
400,000
         
(6,496,634
)
       
0
 
Net Loss December 31, 2007
                                             
(5,866,127
)
       
(5,866,127
)
Other Comprehensive income (loss):
                                                         
0
 
Foreign Currency Translation Adjustment
                                                   
21,136
   
21,136
 
Comprehensive loss
                                                         
(5,844,991
)
Balance at December 31, 2007
   
960,497
 
$
1,515,376
 
$
9,802,894
   
16,248,298
 
$
1,625
 
$
25,768,331
   
-
 
$
(38,498,704
)
$
(229,823
)
$
(1,640,301
)
 
The Accompanying Notes are an Integral Part of the Financial Statements
 
F-6
 
AXION POWER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(A DEVELOPMENT STAGE COMPANY)
 
Note 1 — Organization and Operations  
 
These consolidated financial statements of Axion Power International, Inc., a Delaware corporation (API), include the operations of its wholly owned subsidiaries; Axion Power Battery Manufacturing, Inc (APB), Axion Power Corporation, a Canadian Federal corporation (“APC”), and C & T Co. Inc., an Ontario corporation (“C&T”) (collectively, the Company).
 
 Axion is developing innovative battery/energy storage device technology. The Company continues its research and development and has entered the testing phase of its unique battery designs. The Company also acquired the equipment and inventory from a closed battery manufacturing plant from a bank (which had acquired the assets in foreclosure) and commenced limited manufacture of specialty batteries (see footnote captioned “Purchase of Assets of Failed Battery Manufacturing Company [Asset Purchase]).”
 
Note 2 —Accounting Policies
 
Use of Estimates:     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statement and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates.
 
Principles of Consolidation   : The consolidated financial statements include the accounts of Axion, and its wholly owned subsidiaries, APB, APC and C&T (collectively, the Company). All significant inter-company balances and transactions have been eliminated in consolidation.
 
Basis of Presentation   : The financial statements have been presented in a “development stage” format in accordance with the provisions of Statement of Financial Accounting Standards (FASB) No. 7, Accounting and Reporting by Development Stage Enterprises . Since inception, the Company’s primary activities have been raising capital, obtaining financing, developing Axion’s energy storage technology and testing its proposed products.
 
Segment Reporting: Management has determined that the Company is organized, managed and internally reported as one business segment. Segments are determined based on differences in products, internal reporting and how operational decisions are made.
 
Foreign Currency Translation:     The accounts of APC and C&T are measured using the Canadian dollar as the functional currency for all the periods presented in the financial statements. The translation from Canadian dollars to U.S. dollars is performed for the balance sheet accounts using current exchange rates in effect at each of the balance sheet dates, and for the revenue and expense accounts using the average rate in effect during the periods. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity. Gains or losses resulting from transactions denominated in currencies other than the functional currency are included in the results of operations as incurred. The gains or losses arising from the inter-company loan denominated in U.S. dollars are directly reflected in other comprehensive income, as the amounts are not expected to be repaid in the foreseeable future.
 
Comprehensive Income: The Company follows FASB No. 130, “ Reporting Comprehensive Income .” Comprehensive income, as defined by Statement 130, is the change in equity of a business enterprise during a reporting period from transactions and other events and circumstances from non-owner sources. In addition to the Company’s net loss, the change in equity components under comprehensive income include the foreign currency translation adjustment.
 
F-7

Fair Value of Financial Instruments:     FASB No. 107, " Disclosures about Fair Value of Financial Instruments ," requires disclosure of fair value information about certain financial instruments, including, but not limited to, cash and cash equivalents, accounts receivable, refundable tax credits, prepaid expenses, accounts payable, accrued expenses, notes payable to related parties and convertible debt-related securities. Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 2007 and 2006. The carrying value of the balance sheet financial instruments included in the Company’s consolidated financial statements approximated their fair values.
 
Cash and Cash Equivalents:     For financial statement presentation purposes, the Company considers those short-term, highly liquid investments with original maturities of three months or less to be cash or cash equivalents.
 
Concentration of Credit Risk: The Company’s cash and cash equivalents are on deposit with banks. Only a portion of the cash and cash equivalents would be covered by deposit insurance and the uninsured balances are substantially greater than the insured amounts. Although cash and cash equivalent balances exceed insured deposit amounts, management does not anticipate non-performance by the banks.
 
Accounts Receivable: The Company records its accounts receivable at the original invoice amount less an allowance for doubtful accounts. An account receivable is considered to be past due if any portion of the receivable balance is outstanding beyond its scheduled due date. On a quarterly basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts, based on its history of past write-offs and collections, and current credit conditions. No interest is accrued on past due accounts receivable. The Company has concluded that there is no need for an allowance for doubtful accounts at December 31, 2007 and 2006.
 
Inventory: Inventory is recorded at the lower of cost or market value, and adjusted as appropriate for decreases in valuation and obsolescence. Adjustments to the valuation and obsolescence reserves are made after analyzing market conditions, current and projected sales activity, inventory costs and inventory balances to determine appropriate reserve levels. As of December 31, 2007, no reserve for obsolescence was deemed necessary. Cost is determined using the first-in first-out (FIFO) method. As of December 31, 2007, inventory included $375,635 of lead-acid battery components, consisting of $301,701 of raw materials, $55,323 of work-in-process and $18,611 of finished goods.
 
Property and Equipment:     Property and equipment are recorded at cost. Depreciation is computed using the straight line method over the estimated useful lives of the assets, ranging from 3 to 22 years. This method represents a change in accounting policy effective January 1, 2006; previously the Company depreciated its assets using the double declining balance method of depreciation. In connection with the change in policy, the Company reassessed the useful lives assigned and changed its estimate therefore. The changes in accounting estimate and policy did not have a material impact on depreciation expense for the period ended December 31, 2006, or the Company’s financial statements as a whole,
 
Expenditures for renewals and betterments are capitalized. Expenditures for minor items, repairs and maintenance are charged to operations as incurred. Gain or loss upon sale or retirement due to obsolescence is reflected in the operating results in the period the event takes place.
 
Impairment or Disposal of Long-Lived Assets: The Company adopted the provisions of FASB No. 144 (FASB 144), “ Accounting for the Impairment or Disposal of Long-lived Assets .” This standard requires, among other things, that long-lived assets be reviewed for potential impairment whenever events or circumstances indicate that the carrying amounts may not be recoverable. The assessment of possible impairment is based on the ability to recover the carrying value of the asset from the expected future pre-tax cash flows (undiscounted and without interest charges) of the related operations. If these expected cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. The primary measure of fair value is based on discounted cash flows. The measurement of impairment requires management to make estimates of these cash flows related to long-lived assets, as well as other fair value determinations.
 
F-8

Impairment of Notes Receivable (Mega-C) : The Company tests its notes receivable for collectability pursuant to the standards in the FASB No. 5, Accounting for Contingencies (FASB 5) . Based on management’s assessment of substantial doubt as to collectability pursuant to FASB 5, the Company had no impairment for notes receivable for the years ended December 31, 2007 and 2006.
 

 
Shipping and Handling Costs: All shipping and handling costs charged to customers are recorded as Net Sales and all related expenses are included in Cost of Sales. Shipping and handling costs not billed to customers are included in selling, general and administrative expense.
 
Stock-Based Compensation: Prior to January 1, 2006, the Company accounted for stock option awards in accordance with the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “ Accounting for Stock Issued to Employees, (APB 25) ” and related interpretations, as permitted by Statement of Financial Accounting Standard No. 123, “ Accounting for Stock-Based Compensation ”, (SFAS 123). Under APB 25, compensation cost for stock options issued to employees was measured as the excess, if any, of the fair value of the Company’s stock at the date of grant over the exercise price of the option granted. Compensation cost was recognized for stock options, if any, ratably over the vesting period. As permitted by SFAS 123, the Company reported pro-forma disclosures presenting results and earnings as if the Company had used the fair value recognition provisions of SFAS 123 in the Notes to the Consolidated Financial Statements.
 
Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123(R)) using the modified prospective transition method. See footnote captioned “Equity Compensation” for further detail on the impact of SFAS 123(R) to the Company’s consolidated financial statements.
 
Stock-based compensation related to non-employees is recognized as compensation expense in the accompanying consolidated statements of operations and is based on the fair value of the services received or the fair value of the equity instruments issued, whichever is more readily determinable . The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of EITF 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services” and EITF 00-18, “Accounting Recognition for Certain Transactions Involving Equity Instruments granted to Other Than Employees.” The measurement date for the fair value of the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
 
Research and Development   : Research and development costs are recorded in accordance with FASB No, 2, “ Accounting for Research and Development Costs, ” which requires that costs incurred in research and development activities covering basic scientific research and the application of scientific advances to the development of new and improved products and their uses be expensed as incurred. The policy of expensing the costs of research and development activities relate to (i) in-house work conducted by the Company; (ii) costs incurred in connection with contracts that outsource research and development to third party developers; and (iii) costs incurred in connection with the acquisition of intellectual property that is properly classified as in-process research and development. All research and development costs have been expensed.
 
Income Taxes: Deferred income taxes are recorded in accordance with FASB No. 109, “ Accounting for Income Taxes ,” or FASB 109, and deferred tax assets and liabilities are determined based on the differences between financial reporting and the tax basis of assets and liabilities using the tax rates and laws in effect when the differences are expected to reverse. FASB 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not to occur. Realization of net deferred tax assets is dependent upon generating sufficient taxable income in future years in appropriate tax jurisdictions to realize benefit from the reversal of temporary differences and from net operating loss, or NOL, carryforwards. The Company has determined it more likely than not that the deferred tax asset resulting from these timing differences will not materialize and have provided a valuation allowance against the entire net deferred tax asset. Management will continue to evaluate the realizability of the deferred tax asset and its related valuation allowance. If the assessment of the deferred tax assets or the corresponding valuation allowance were to change, the Company would record the related adjustment to income during the period in which the determination is made. The tax rate may also vary based on actual results and the mix of income or loss in domestic and foreign tax jurisdictions in which operations take place.


Refundable tax credits are recorded, to the extent receipt is assured, in the year that they are earned and included in other income.
 
The provision for taxes represents corporate-level franchise taxes which may be based on assets, equity, capital stock or a variation thereof.
 
Recent Accounting Pronouncements: 
 
 In June 2006, The FASB issued Interpretation No. 48 “ Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 ” (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB No. 109, “ Accounting for Income Taxes .” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material impact on the Company's consolidated financial position, results of operations, or cash flows.
 
In September 2006, the FASB issued FASB No. 157, “ Fair Value Measurements ” which establishes a framework for measuring fair value, and expands disclosures about fair value measurements. While FASB No. 157 does not apply to transactions involving share-based payment covered by FASB No. 123, it establishes a theoretical framework for analyzing fair value measurements that is absent from FASB No. 123. We have relied on the theoretical framework established by FASB No. 157 in connection with certain valuation measurements that were made in the preparation of these financial statements. FASB No. 157 is effective for years beginning after November 15, 2007. Subsequent to the Standard’s issuance, the FASB issued an exposure draft that provides a one year deferral for implementation of the Standard for non-financial assets and liabilities. The Company is currently evaluating the impact FASB No. 157 will have on its consolidated financial statements.
 
In February 2007, Statement of Financial Accounting Standards No. 159, “ The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115 ,” (FASB 159), was issued. This standard allows a company to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities on a contract-by-contract basis, with changes in fair value recognized in earnings. The provisions of this standard are effective as of the beginning of our fiscal year 2008, with early adoption permitted. The Company is currently evaluating what effect the adoption of FASB 159 will have on its consolidated financial statements.
 
In December of 2006 the Financial Accounting Standards Board issued FSP No. EITF 00-19-2, “ Accounting for Registration Payment Arrangements .” This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement should be separately recognized and measured. The FSP also clarifies that a financial instrument subject to a registration payment arrangement should be separately accounted for in accordance with the applicable guidance without regard to the registration payment arrangement’s contingent obligation. The FSP is effective immediately for registration payment arrangements and the financial instruments subject to those arrangements that are entered into or modified subsequent to December 21, 2006. For registration payment arrangements and financial instruments subject to those arrangements that were entered into prior to December 21, 2006, the guidance is effective for financial statements issued for fiscal years beginning after December 15, 2006, and interim periods within those fiscal years. The adoption of EITF 00-19-2 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
 
F-10

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations and SFAS No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51. These new standards will significantly change the accounting for and reporting of business combinations and non-controlling (minority) interests in consolidated financial statements. Statement Nos. 141(R) and 160 are required to be adopted simultaneously and are effective for the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently evaluating the impact of adopting SFAS Nos. 141(R) and SFAS 160 on its consolidated financial statements.
 

In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140" This Statement amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. The provisions of this Statement are effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The adoption of SFAS No. 156 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
 
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140.” This Statement, among other things, allows a preparer to elect fair value measurement of instruments in cases in which a derivative would otherwise have to be bifurcated.  The provisions of this Statement are effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The adoption of SFAS No. 155 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
 
In December 2007, the Commission issued Staff Accounting Bulletin No. 110 (“SAB 110”). SAB 110 permits companies to continue to use the simplified method, under certain circumstances, in estimating the expected term of “plain vanilla” options beyond December 31, 2007. SAB 110 updates guidance provided in SAB 107 that previously stated that the Staff would not expect a company to use the simplified method for share option grants after December 31, 2007. The Company will continue to use the simplified method until it has sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term of its options.
 
Note 3 -   Grant Revenue
 
Grant from Commonwealth of Pennsylvania: On April 30, 2007, the Company was awarded a series of retroactive grants from the Commonwealth of Pennsylvania with an aggregate value of $1.2 million. Grants for $900,000 were specifically designated for equipment purchases and the remaining $300,000 for job training and tax credits, The $150,000 OGP grant requires the Company to hire 86 full-time employees by March 31, 2009, spend a total of $6,492,300 of non-public funds as part of the company’s operating and equipment purchases by March 31, 2008 and maintain an operation in Neshannock Township through March 31, 2011. Failure to meet these goals could result in a partial return of the $150,000 grant allocation. During the year ended December 31, 2007, the Company recognized amounts related to these grants for the purchase of equipment. The Company records equipment grants as other receivables and deferred revenue based on qualifying equipment purchases that are billed to the Commonwealth for reimbursement at a rate of 75% of the amount paid by the Company. Deferred revenue is amortized into income over the estimated useful life of the related equipment. As of December 31, 2007, other receivables included $239,861 and deferred revenue of $840,945 was recorded for equipment grants. During the year ended December 31, 2007, $662,000 of cash was received and $60,916 of income was recorded for the amortization of the deferred revenue.
 

Note 4 — Property and Equipment
 
A summary of property and equipment at December 31, 2007 and 2006 is as follows:
 
 
 
    Estimated
useful
 
 
 
 
 
 
 
     life    
 
2007    
 
2006    
 
Asset deposit
       
$
-
 
$
-
 
Leasehold improvements
   
10
   
92,525
   
84,975
 
Machinery & equipment
   
3-22 years
   
2,382,749
   
1,139,657
 
Less accumulated depreciation
         
356,022
   
179,827
 
Net
       
$
2,119,252
 
$
1,044,805
 
Depreciation expense
       
$
176,195
 
$
96,249
 
 

Note 5 - Purchase of Assets of Failed Battery Manufacturing Company (Asset Purchase)
 
Incorporation of new subsidiary: In January 2006, the Company incorporated a new wholly owned subsidiary named Axion Battery Products, Inc. (“APB”) under the laws of the Commonwealth of Pennsylvania for the purpose of operating a battery manufacturing facility in New Castle, Pennsylvania. The Company changed the name of this subsidiary to Axion Power Battery Manufacturing Inc.
 
Purchase of battery manufacturing assets: In February 2006, APB entered into an agreement to purchase all of the equipment, inventory and other tangible assets of the New Castle Battery Manufacturing Company, Inc. from National City Bank, Pennsylvania in a foreclosure sale conducted pursuant to the provisions of Article 9 of the Pennsylvania Uniform Commercial Code. The assets were purchased by APB and include all equipment, molds, inventories, parts and supplies that were subject to the bank’s security interest. Since the former New Castle Battery Manufacturing Company had been closed for several months prior to the acquisition and there were no employees, distribution systems, sales force, customer base, vendor relationships, or established revenue stream, the transaction was accounted for as a purchase of assets rather than as a business combination.
 
Consideration paid: APB paid $800,000 for the assets and incurred $20,244 of legal expenses directly associated with negotiating and executing this transaction. Of the $800,000 paid, $710,000 was paid to the seller at closing and $90,000 was initially placed in an interest bearing escrow account pending the seller’s resolution of certain encumbrances on a portion of the purchased assets. In August 2006, it was determined that the encumbered assets would not be transferred to APB and $83,250 of the deposit was returned resulting in a final purchase price of $736,994 that was allocated to manufacturing equipment and inventory valued at approximately $540,000 and $197,000, respectively, on the date of the purchase.  
 
Property rental: In February 2006, APB entered into a lease agreement for an industrial building located in New Castle, Pennsylvania. The agreement provides for an initial term of two years with two renewal terms of five years each. The monthly rent payable for the initial term of the agreement is $11,265. During the two extension terms, the rent will be based on market rates as determined by negotiation between the parties, or if the parties are unable to reach a mutually agreed rental rate, by an independent appraisal process. The renewal and extension of the lease is being negotiated as of the date of filing of this report. In addition to the monthly rental, APB is obligated to pay all required maintenance costs, taxes and special assessments, maintain public liability insurance in the amount of $1 million, and maintain fire and casualty insurance for an amount equal to at least 80% of the replacement value of the leased premises.
 
Note 6 — Transactions with a related party (C&T)
 
Research and development payments to C&T: During 2005, the Company issued 1,562,900 warrants to the former shareholders of C&T to purchase intangible assets from C&T. These warrants were valued at approximately $564,000 and recorded as in-process research and development. During the year ended December 31, 2006, the terms of the warrants granted were modified. The modification resulted in additional expense of approximately $342,000, which has been classified as research and development expense. See note captioned “Stockholders’ Equity for further discussion.
 
F-12

Purchase of equipment: In connection with the acquisition of C&T stock, the Company was granted the option to purchase certain tangible personal property owned by C&T Labs, Inc., an affiliate of C&T, for the appraised value up to a year subsequent to the transaction. In April 2006 the option was exercised and the Company took ownership of the equipment and a liability for approximately $84,000 was recorded related to the purchase. The liability remains unpaid as of the date of this report.
 

Note 7 - Related Party Debt Financing
 
2006 Activity:
 
In January 2006, APB entered into a secured loan agreement with Robert Averill, a director of the Company, whereby Mr. Averill agreed to provide $1 million in acquisition and working capital financing for APB’s purchase of the battery manufacturing facility which was increased to $1.2 million in September 2006 and amended to incorporate the conversion terms of the second and third quarter loans discussed below. The loan agreements require APB to pay interest on the outstanding balance at the annual rate of 10%. Interest payments are due on the first day of each month and commenced in February 2006. The entire principal balance of the loan was initially due on February 1, 2007, provided that the loan may be repaid at any time without notice or penalty. The loan was secured by a first priority interest in all of APB’s equipment, inventory, furniture and fixtures, together with all substitutions or replacements and all proceeds from the sale thereof. The amount of the secured loan was further increased to $1,510, 000 in November 2006, at which time the interest rate was amended retroactively to an annual rate of 12% and amended to extend the maturity date to February 2008. With the November loan modification, Mr. Averill received a warrant to purchase an additional 20,000 shares of common stock with a commitment to issue a warrant for an additional 20,000 shares of common stock at each three-month anniversary thereafter, until the loan is paid in full. With the extension of the maturity into 2008, Mr. Averill is to receive an additional 50,000 shares of common stock at each three-month anniversary of the original loan, until the loan is paid in full. In November 2007, the loan was subsequently extinguished in exchange for the security provided under the Secured Bridge Loan program offered during the fourth quarter of 2007. See Note captioned “Subsequent Events” for further discussion.
 
The Company has signed the loan agreement as an accommodation party and assumed direct liability for the payment of APB’s obligations. APB and the Company each granted Mr. Averill a first priority security interest in all of their equipment, inventory, furniture, fixtures and intellectual property, together with all substitutions or replacements and all proceeds from any bulk sale thereof. As additional consideration for the loan, the Company issued Mr. Averill 50,000 common stock purchase warrants in January 2006 with an additional 50,000 warrants each quarter the loan was outstanding, resulting in the issuance of an additional 200,000 warrants in December 2006. The warrants are exercisable for a period of three & four years from the issue date at a price of $6 per share. The warrants have been valued as of each date of grant using the Black-Scholes-Merton option pricing model. This amount was recorded as a note discount and amortized into interest expense over the term of the loan.
 
During 2006, the Company borrowed an additional $1,985,000 from three directors of the Company, including Mr. Averill, along with two of the original founders of APC. Certain of the loan agreements provided for a second priority security interest in the Company’s property consisting of all accounts receivable, equipment, inventory, furniture and fixtures, and intellectual property, together with all substitutions, replacements, developments or accessions thereto and all proceeds from the sale thereof. The loan agreements required the Company to pay interest on the outstanding balance at annual rates of 10% to 12% and provided for the issuance of 553,000 common stock purchase warrants that were partially redeemable if the loans were repaid in a timely manner. The warrants are exercisable for a period of three & four years from the date of issuance at a price of $6 per share, and provide that the holders would be entitled to tender their respective notes in full or partial payment of the subscription price of any equity securities the Company elected to offer while the loans were outstanding.
 
Borrowings under the loan arrangements discussed above are convertible into offering units at a price of $2.50 per unit. The unit consists of one share of common stock and one warrant to purchase one share of common stock at a price of $4.00 per share. The warrants are exercisable up until the first anniversary of the effective date of the common stock registration statement. The effective conversion price of certain of these loans was at a price lower than the market price of the common stock at the date of the issuance, resulting in a non-cash beneficial conversion feature of $95,792. This beneficial conversion feature was immediately recognized as additional interest expense during the year ended December 31, 2006.  
 
F-13

In October 2006, the Company redeemed 15,000 warrants and converted $48,217 of interest and $1,491,783 of principal on related party loans into shares of the Company’s Series A Preferred Stock for a total subscription of $1,540,000.  In December 2006, lenders converted an aggregate of $1,502,418 in principal and $130,833 in accrued interest into shares of the Company’s Series A Preferred Stock, as discussed below, and the Company redeemed 66,387 warrants at this time. The unpaid balance of the Company’s loans was $500,799 plus $11,066 in interest at December 31, 2006, with a maturity date of February 1, 2008. $72,124 of this balance was repaid on January 25, 2007, while the remainder was converted into obligations under the Secured Bridge Loan program discussed in the Note captioned “Subsequent Events,” subheading “Debt Financing.”
 
Warrants: The loan agreements disclosed above provided for the aggregate issuance of 741,613 common stock purchase warrants, which were issuable as of December 31, 2006. The warrants due under these agreements were valued using a Black-Scholes-Merton option pricing model at $271,567 and initially recorded as a note discount. Of this amount, $251,234 has been amortized into interest expense during the twelve-month period ended December 31, 2006 with $1,317 to be amortized during 2007. The remainder of $19,016 was recognized as a loss on extinguishment of certain of the loans as described below.  430,000 of these warrants, (the amount of warrants net of those subsequently redeemed), were not issued consistent with the originating document. Originally valued at $156,080, the liability to issue these equity instruments was settled in the fourth quarter of 2006. Using the stock price at the date of issuance, the warrant valuations based on their original terms amounted to $593,668 or $437,588 more than the original liability. However, the warrants when actually issued were issued with a four year term extending the exercise period through December 29, 2010. This modification added an additional $175,971 in expense recognized during the fourth quarter of 2006. See the footnotes captioned “Stockholder's Equity” and “Subsequent Events” for additional disclosure of these transactions.
 
Interest Expense: Interest expense recognized for the year ended December 30, 2006 in connection with these notes and related liabilities amounted to $713,048, of which $251,234 relates to the amortization of the note discount related to the warrants granted, $95,752 relates to the beneficial conversion feature, $175,971 results from the warrant extension, and the remainder relates to the stated interest rate on the outstanding balance.
 
2007 Activity:
 
The Company issued a total of 270,000 warrants against the 2006 loan agreement executed with Mr. Averill during 2006 and has an obligation to issue an additional 230,000 warrants from these loans through the November 2007 date of extinguishment. In November 2007, the 2006 loan was subsequently extinguished in exchange for the security provided under the Secured Bridge Loan program offered during the fourth quarter of 2007. (See discussion of this loan under the caption “Secured Bridge Loan Financing” below).
 
In August 2007, Mr. Averill loaned the Company an additional $460,000 earning interest at a coupon rate of 12% per annum. The debt matures in two parts, with the $230,000 payable no later than September 30, 2007 and the final balance to be paid no later than December 31, 2007. As additional consideration for this loan, Mr. Averill is to receive a 3-year warrant to purchase 30,000 shares of common stock upon loan inception, an additional 2,000 warrants for each business day between the loan inception date and first repayment date, with the number of warrants pegged to the first repayment not to exceed 42,000 warrants, and an additional 1,000 warrants for each business day between the date of first repayment and second repayment date, with the number of warrants pegged to the second repayment not to exceed 64,000 warrants. The Company repaid Mr. Averill $115,000 on September 28, 2007, from which he is to receive the maximum number of warrants pegged to the first repayment date. On November 27, 2007 this loan was subsequently extinguished in exchange for the security provided under the Secured Bridge Loan program offered during the fourth quarter of 2007. The Company has an obligation to issue an additional 64,000 warrants from these loans through the November 27, 2007 extinguishment date. (See discussion of this loan under the caption “Secured Bridge Loan Financing” below).
 
On November 1, 2007, the Company borrowed an additional $267,900 from Robert Averill. This amount was invested in anticipation of the Secured Bridge Loan discussed below, earning interest at 14% per annum.
 
F-14

On November 27, 2007, Mr. Averill and the Company entered into an agreement to convert all outstanding debt obligations due and owing to Mr. Averill, into obligations under the Secured Bridge Loan discussed below, extinguishing the security interest Mr. Averill had in all of the assets of Axion Power Battery, Inc. in exchange for the security provided under the Secured Bridge Loan. At the time this indebtedness was converted, the Company owed Mr. Averill outstanding principal plus interest amounting to $1,111,910 together with new borrowings of $544,090 and $144,000 of loan origination fees recognized as a note discount, resulting in Mr. Averill holding a note for $1,800,000 under the Secured Bridge Loan financing. The loan has an original maturity of March 31, 2008, bears an initial interest rate of 14% per annum, and is jointly secured, along with all other investors in the Secured Bridge Loan, by all the assets including intellectual property assets of the Company and its subsidiaries. As additional consideration for this loan, Mr. Averill is to receive a warrant to purchase 61,290 shares of common stock. The warrants are exercisable for a period of five years from loan inception at a price of $2.35 per share.
 

Mr. Averill’s loan obligations specifically state that the warrant will be dated three years from date of issue. Whereas none of these warrants have yet been issued, the expiration date on his warrants relating to both the 2006 carryover and the 2007 have yet to be determined.
 
In October 2007, Igor Filipenko, a former member of our board of directors and majority shareholder of C&T, loaned the Company $115,000 under substantially the same agreement as Mr. Averill’s loan agreement of August 2007. Mr. Filipenko earns interest at a coupon rate of 12% per annum with a scheduled maturity of December 31, 2007. As additional consideration for this loan, Mr. Filipenko is to receive a 3-year warrant to purchase 5,250 shares of common stock upon loan inception, and an additional on 500 warrants for each business day between the loan inception date and repayment date. The number of warrants pegged to repayment is not to exceed 26,500 warrants. The Company has an obligation to issue an additional 26,500 warrants from this loan upon extinguishment on December 17, 2007. (See discussion of this loan under the caption “Secured Bridge Loan Financing” below).
 
In December 2007, Mr. Filipenko elected to participate in the fourth quarter short-term bridge loan arrangement whereby he converted his October loan of $115,000, contributed an additional $92,000 in cash, and received a note discount of $18,000 reflecting loan origination fees, resulting in Mr. Filipenko holding a note for $225,000 under the Secured Bridge Loan. The loan has an original maturity of March 31, 2008, bears an initial interest rate of 14% per annum, and is jointly secured, along with all other investors in the Secured Bridge Loan, by all the assets including intellectual property assets of the Company and its subsidiaries. As additional consideration for this loan, Mr. Filipenko is to receive a warrant to purchase 7,661 shares of common stock. The warrants are exercisable for a period of five years from loan inception at a price of $2.35 per share. (See discussion of this loan under the caption “Secured Bridge Loan Financing” below).
 
In December 2007, Glenn Paterson, a member of the board of directors, contributed $92,000 in cash and received a note discount of $8,000 reflecting loan origination fees by participating in the fourth quarter short-term bridge loan arrangement offered by the Company. The loan has an original maturity of March 31, 2008, bears an initial interest rate of 14% per annum, and is jointly secured, along with all other investors in the Secured Bridge Loan, by all the assets including intellectual property assets of the Company and its subsidiaries. As additional consideration for this loan, Mr. Patterson is to receive a warrant to purchase 3,405 shares of common stock. The warrants are exercisable for a period of five years from loan inception at a price of $2.35 per share. (See discussion of this loan under the caption “Secured Bridge Loan Financing” below).
 
Options and Warrants: The loan agreements disclosed above provided for the aggregate issuance of 484,278 common stock purchase warrants, with only 86,528 having been issued as of December 31, 2007, and the remainder yet to be issued. As of December 31, 2007, the warrants due under these agreements have been valued at 276,882 and recorded as a note discount. Note discount of $154,201 has been amortized during the year ended December 31, 2007, of which $152,884 relates to these 2007 warrants obligations, and the balance relating to the carryover of unamortized discount from 2006. $289,075 of debt discount remains outstanding as of December 31, 2007. The obligation to issue the 397,750 unissued warrants is recorded as a liability rather than equity discussed in the “Liability   to issue equity instruments” section below. See the footnotes captioned “Stockholder's Equity” and “Subsequent Events” for additional disclosure of these transactions.

F-15

Liability to issue equity instruments: During the year ended December 31, 2007, the Company entered into financing agreements discussed above that included detachable warrants to purchase common stock. As of December 31, 2007, 397,750 of these warrants had not yet been issued to the holders. The liability originally recorded related to these warrants amounted to $178,419, which was treated as a note discount and is being recognized as interest expense as described within the “Options and Warrants” section above. For each reporting period that the warrants are not issued, the liability is re-valued and adjusted through the caption “derivative revaluation” on the statement of operations. As of December 31, 2007, the value of these warrants amounted to $106,183, which has been recorded into liabilities pending physical issue of the warrant documents.
 
Secured Bridge Loan Financing:     In December 2007 the Company offered certain of its directors, officers, and significant investors the opportunity to participate in a short-term bridge loan arrangement in increments of $100,000, each such loan to bear interest at 14% and to be secured by all of the assets, including the intellectual property assets of Axion Power International and Axion Power Battery Manufacturing Inc. (the “Secured Bridge Loan”). Elections to participate must have been made no later than January 7, 2008, and if fully subscribed, the Secured Bridge Loan could result in up to $3,000,000 in short-term funding for the Company.
 

Total funding received under the Secured Bridge Loan as of December 31, 2007 amounted to $2,541,216, with additional funding of $100,000 in January of 2008. $2,125,000 was funded by three members and former members of the board of directors, with the balance funded by four accredited investors.
 
The Secured Bridge Loan has an original maturity date of March 31, 2008, with three extensions of the maturity date at the option of the Company with higher interest rates to apply to each such extension. On March 31, 2008, the Company sent notice to the investors of its intention to extend the loan for until April 30, 2008. The extension entitles the investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 15%. If extended to May 31, 2008, the interest rate during the extension period increases to 16% with an extension fee equal to 1% of the original loan. If extended to June 30, 2008, the interest rate during the extension period increases to 18% with an extension fee equal to 2% of the original loan. A loan origination fee was paid equal to 8% of the original loan. The origination fee decreased by one-half percent each week after December 15, 2007 until the loan opportunity closed on January 7, 2008. Warrants exercisable at $2.35 until December 31, 2012 are included with each $100,000 Secured Bridge Loan note. Warrants to be issued are as follows: 3,405 warrants upon occurrence of the loan, 851 additional warrants upon extension of the loan to April 30, 2008, 1,276 additional warrants upon extension of the loan to May 31, 2008, and 2,128 additional warrants upon extension to June 30, 2008. Anti-dilution provisions apply to the warrants. The Holders of these notes shall have the right to convert the note together with interest, into any security sold by the Company in an institutional offering. Upon repayment of this note, all conversion rights shall terminate forthwith.
 
Interest Expense: Interest expense recognized for the year ended December 31, 2007 in connection with these notes and related liabilities amounted to $276,651, of which $117,058 relates to the amortization of the note discount for warrants granted, $37,143 relates to the amortization of note discount reflected by the Secured Bridge Loan’s origination fees, and the remainder relates to the stated interest rate on the outstanding balance. In December 2007, loan origination fees of $202,216 were recognized as note discounts related to funding received in the fourth quarter on the Secured Bridge Loan. In January 2008, $7,500 in origination fees were recognized as a note discount in connection with an additional $92,500 of cash received for these notes. These note discounts are being amortized as interest expense over the life of the respective notes.
 
Note 8 — Stockholders' Equity
 
Authorized Capitalization: The Company’s authorized capitalization includes 50,000,000 shares of common stock and 12,500,000 shares of preferred stock.
 
  Common Stock:   At December 31, 2007, 16,248,298 shares of common stock were issued and outstanding. The holders of common stock are entitled to one vote for each share held of record on all matters to be voted on by stockholders. There is no cumulative voting with respect to the election of directors, with the result that the holders of more than 50% of the shares voted for the election of directors can elect all of the directors. Holders of common stock are entitled to receive dividends when and if declared by the board of directors out of funds legally available. In the event of liquidation, dissolution or winding up, the common stockholders are entitled to share ratably in all assets remaining available for distribution to them after payment of liabilities and after provision has been made for each class of stock, if any, having preference over the common stock. The common stockholders have no conversion, preemptive or other subscription rights and there are no redemption provisions applicable to the common stock. All of the outstanding shares of common stock are fully paid and non-assessable.
 
F-16

Preferred Stock:  The Company’s certificate of incorporation authorizes the issuance of 12,500,000 shares of blank check preferred stock. The Company’s board of directors has the power to establish the designation, rights and preferences of any preferred stock. Accordingly, the board of directors has the power, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of common stock.
 
At December 31, 2007, 137,500 shares of 8% Cumulative Convertible Senior Preferred stock were issued and outstanding, and 822,997 shares of Series A Convertible Preferred stock were issued and outstanding.
 
Equity Transactions -period ended December 31, 2003

APC and Tamboril Cigar Company (Tamboril, now Axion) reverse acquisition :   In December 2003 Tamboril entered into a reverse acquisition agreement with APC. Under the terms of the agreement, all outstanding securities of APC were acquired by Tamboril in exchange for newly issued stock. Upon consummation of the transaction, the former stockholders of APC owned the majority of Tamboril’s outstanding shares and controlled Tamboril’s board of directors. Accordingly, t he acquisition of APC by Tamboril was structured as a reverse acquisition under which Tamboril was the legal acquirer in the transaction and APC was the accounting acquirer. The transaction was treated as a recapitalization of APC for accounting purposes. Tamboril had no material assets or liabilities and 1,875,000 common shares outstanding on December 31, 2003 when it entered into a reverse acquisition with shareholders of APC. The historical financial statements presented prior to December 31, 2003 represent those of APC since its inception on September 18, 2003. The transactions of Tamboril are included beginning January 1, 2004. Subsequently, Tamboril changed its name to Axion Power International, Inc.
 
Prior to the reverse acquisition, APC issued rights to its founders for 1,360,000 shares of APC common stock as additional shares for money contributed through the purchase of convertible debt. Accordingly, there was no expense recorded related to these issuances of these shares. However, there was one founder that did not contribute funds in which APC valued the 170,000 shares issued as expense for services rendered during the period ending December 31, 2003 amounting to $48,953 based on the value of the shares received for the funds contributed by the other founders. The founders purchased convertible debt from APC for $1,450,000 of which $350,000 was not collected until 2004 which is included as a subscription receivable as of December 31, 2003. These convertible debt instruments were converted prior to the merger in which 1,108,335 shares of APC common stock were issued as consideration for $1,450,000 of convertible debt and $92,761 in unamortized debt discount attributable to detachable warrants.
 
The following transactions were completed in conjunction with the original closings:
 
 
·
Tamboril had 1,875,000 shares of common stock outstanding at December 31, 2003 which is reflected as equity acquired in the recapitalization.
 
 
·
Tamboril settled $484,123 in pre-merger accrued related party compensation debt through the issuance of 233,400 warrants. No corresponding expense was recorded on the Company’s records because the debt was included on the legal acquirer’s (Tamboril’s) records prior to the reverse acquisition.
 
 
·
Tamboril issued 9,785,818 common shares (prior to the return of 1,000,000 shares from The Trust for the Benefit of the Shareholders of Mega-C Power Corp in the fiscal year ended December 31, 2006, as disclosed in the note captioned “Subsequent Events”) and 608,600 warrants to APC’s stockholders in exchange for a substantial controlling interest in APC. This includes the common shares issued to the founders, common shares and warrants issued in conjunction with the convertible notes, and shares issued to the Mega-C Trust.
 
F-17

 
·
As part of the above described transaction, APC shareholders, who had rights to the stock agreed to have 7,147,483 shares of Tamboril shares to be issued to the Trust and APC shareholders retained the remaining shares. As a result of the November 21, 2006 Mega-C Chapter 11 plan of reorganization, the Trust was required to return 1,000,000 shares of the common stock distributed to the Trust noted above for cancellation by the Company. The Company retroactively adjusted the return of the shares against the shares issued to the Trust resulting in 6,147,483 net shares issued to the Trust at December 31, 2003.
 
 
·
The original reverse acquisition was amended on January 9, 2004. See discussion of the amendment under the explanation of the equity 2004 below.
 
Equity Transactions -period ended December 31, 2004
 
APC and Tamboril Cigar Company (Tamboril, now Axion) reverse acquisition   :     Prior to the second part of the reverse acquisition on January 9, 2004, the Company adjusted the original shares issued to the founders by issuing rights to an additional 445,000 shares to the founders and 180,000 shares to the Trust. Since there was no additional service or money contributed there was no expense recorded related to the additional shares issued. Also, the Company issued 45,000 shares to the CEO which amounted to $72,000 valued at the pink sheet bid price on the date of grant. Certain related parties purchased convertible debt from APC for $400,000. The $400,000 of convertible debt purchased during 2004 and the remaining $50,000 of convertible debt outstanding at December 31, 2003 was converted into 283,333 shares of APC common stock during 2004.
 
2004 Private Placements:     During the year ended December 31, 2004, the Company sold 823,800 shares of common stock and 463,100 warrants for net cash proceeds of $1,607,134. The Company also received $868,020 in cash proceeds from the exercise of 475,200 outstanding common stock purchase warrants. The Company issued 48,782 shares of common stock for rounding purposes in conjunction with the 2004 one-for-sixteen reverse stock split.
 
Equity Transactions -Year ended December 31, 2005
 
Augmentation of Trust and Trust Settlement: In February 2005, the Company issued 500,000 shares of common stock to The Trust for the Benefit of the Shareholders of Mega-C Power Corp. For accounting and financial reporting purposes, the stock issuance transaction was valued at $1,525,000, which represents the value of the shares on the date of issuance. This amount was charged to operating expenses during the year ended December 31, 2005. There were 500,000 shares returned to the Company for cancellation in November 2006 in connection with the bankruptcy court confirmation of the settlement (see note captioned “ Mega-C Power Corp (Mega-C), Mega-C   Trust (the Trust), The Taylor Litigation”). Those shares were effectively the return of the 500,000 shares issued to the Trust in February, 2005. The return of those shares was recorded as a reversal of the expense at fair value on the date of return in 2006 in the amount of $1,125,000 and has been subsequently cancelled. In addition, under the bankruptcy court confirmation of the settlement, the Trust corpus was reduced another 1,000,000 shares, which were returned to the Company and cancelled. The return in 2006 was the result of a negotiated settlement and there are no contingencies surrounding the Trust shares in 2005. This cancellation was considered a retroactive adjustment to the shares issued in the 2003 reverse acquisition.
 
2005 Private Placement of Senior Preferred: In February 2005, the board of directors designated 1,000,000 shares of preferred stock as 8% Cumulative Convertible Senior Preferred Stock (the “senior preferred”). The Company sold 385,000 shares of senior preferred at a price of $10 per share. The net proceeds of the offering included $2,754,110 in cash and $1,000,000 in liability conversion (see Note captioned “Transactions with a Related Party (C&T)”). At December 31, 2005, $25,000 of this amount was included in stock subscription receivable that was subsequently reversed in 2006 when the amount was deemed uncollectible. The senior preferred offering originally required the sale of a minimum of 500,000 shares ($5,000,000) before the offering proceeds would be available to the Company. The purchasers of the senior preferred ultimately waived this minimum offering condition. The preferred stock has liquidation preference equal to the stated value on the payment date before any payment or distribution is made to the holders of common stock.
 
F-18

So long as any senior preferred shares are outstanding, the Company cannot (i) issue any series of stock having rights senior to or on parity with the senior preferred (ii) amend, alter or repeal any provision of its Certificate of Incorporation or bylaws to adversely affect the relative rights, preferences, qualifications, limitations or restrictions of the senior preferred, or (iii) effect a reclassification of the senior preferred without the consent of the holders of a two-thirds majority of the outstanding shares. The Company is not authorized to issue any additional shares of senior preferred.
 
To provide for immediate cash needs during the offering period, the Company agreed to issue warrants to any purchaser of senior preferred who agreed to loan the Company the amount of the share proceeds until the $5 million minimum subscription was reached. In connection therewith, the purchasers of $565,000 of senior preferred agreed to release their subscription payments notwithstanding the minimum subscription and other restrictions in the associated private placement memorandum. As a result, the Company issued 282,500 warrants to those purchasers. By March 2005, the $5 million minimum was still not met and the Company agreed to issue 228,500 additional warrants to the purchasers of $2,285,000 of senior preferred who agreed to waive the minimum subscription requirement. The foregoing warrants are exercisable at a price of $2 per share, and were to expire on March 21, 2007.   Because the warrants were detachable, granted in connection with the offering, immediately vested, and exercisable at a price that was less than the reported fair market value of the underlying common stock on the date of grant, the proceeds of the offering were allocated between the senior preferred and the warrants based on the relative fair value of each instrument. The assumed value of the senior preferred was determined based on the fair value of the underlying common shares and the fair value of the warrants was valued using the Black-Scholes-Merton option pricing model. The proceeds allocated to the senior preferred amounted to $3,440,268. The effective conversion price of the senior preferred was at a price lower than the market price of the common stock at the date of the issuance, resulting in a non-cash beneficial conversion feature of $2,315,482. This beneficial conversion feature was immediately recognized as additional non-cash dividends. On March 9, 2007 the board of directors unanimously agreed to extend the life 476,000 $2.00 warrants issued in March 2005 to purchasers who subscribed to the Senior Preferred private placement offering. See “Warrant Modifications” in the note captioned “Subsequent Events” below.
 
Holders of senior preferred have the right to convert their shares into common stock at any time, at an original conversion price of $2.00. The Company was required to register the underlying shares by April 30, 2005. The shares were not registered until June 2005 and as a result the conversion price was reduced to $1.86 per share. This reduction in the conversion price resulted in an additional beneficial conversion feature, valued at the fair value of the additional common shares issuable as a result of the reduced conversion price, amounting to $433,228.
 
Holders of senior preferred are entitled to anti-dilution protection for certain subsequent events, including the issuance of equity or debt securities that may be converted into common stock at a conversion price that is less than the conversion price of the senior preferred. As discussed in the note captioned “Subsequent Events,” the Company sold approximately 823,000 shares of Series A Preferred Stock that is convertible at a price of $1.25 per share. This stock sale triggered the anti-dilution provisions of the senior preferred stock and giving effect to all required adjustments, the adjusted conversion price of the senior preferred is now $1.68 per share as of December 31, 2006.
 
In September 2005, the Company offered all holders of preferred stock an early conversion incentive that was approximately equivalent to one year’s anticipated dividends on the preferred stock. While each share of senior preferred was convertible into 5.5 shares of common stock when the Company offered the early conversion incentive, 6 shares of common stock were issued for each share of senior preferred converted during the incentive period. A total of 245,000 shares were converted. The fair value of the additional common shares issued as a result of this inducement was recorded as a preferred dividend, amounting to $350,446.
 
The total of the beneficial conversion feature and conversion inducement for the year ended December 31, 2005 that is included in preferred dividends on the accompanying statement of operations amounted to $3,099,156. The Company analyzed the embedded derivative conversion feature and the free standing warrants issued in connection with the senior preferred and determined that the instruments are equity instruments and accordingly, are not accounted for as derivatives, requiring fair value accounting at each reporting period.
 
Holders of senior preferred are entitled to receive dividends at the annual rate of 8%. Dividends are payable quarterly on the last day of March, June, September and December of each year. Dividends are cumulative from the date of issuance and payable to holders of record. In order to conserve available resources, the Company did not pay cash dividends on the senior preferred in any quarter where the Company reported a net loss. Any accrued dividends that are not paid in cash will be added to the stated value of the senior preferred. Dividends accrued and added to the stated value of the senior preferred during the year ended December 31, 2006 and 2005 amounted to $119,092 and $176,194, respectively.
 
F-19

The senior preferred is redeemable by the Company under certain conditions unless the holders elect to exercise their conversion rights prior to the redemption date. Twenty percent of the senior preferred will become redeemable when the market price of the Company’s common stock exceeds $6.00 per share for at least 30 trading days within any period of 45 consecutive trading days. Thereafter, an additional twenty percent of the senior preferred will become redeemable for each $1.00 increase in the stabilized market price of the Company’s common stock. In connection with any proposed redemption of senior preferred, the Company will give each holder not less than 30 days notice of its intention to redeem a portion of the shares.
 
2005 Private Placement of Common Stock : Common stock private placement activities during the year ended December 31, 2005 were as follows:
 
 
·
The Company sold 600,000 units, each consisting of one share of common stock and a two-year warrant exercisable at $4.00 for a purchase price of $2.00 per unit, or $1,200,000, before offering costs. As of December 31, 2005, $200,000 is included in stock subscriptions receivable, which was received in 2006.

 
·
A director exercised 446,000 - $1 warrants/options and 25,000 - $2 options with a total exercise price of $496,000. The stock was issued and included in stock subscriptions receivable as of December 31, 2005. As of June 19, 2006, the full amount has been settled.

 
·
Other holders exercised 382,665 options & warrants with an aggregate exercise price of $787,395.

Equity Transactions -Year ended December 31, 2006
 
Augmentation of Trust and Trust Settlement: See above 2005 transactions and the discussion in the note captioned “ Mega-C Power Corp (Mega-C),   Mega-C   Trust (the Trust), The   Taylor Litigation” for disclosures about shares issued to the Trust, returned from the Trust in November 2006 and the accounting for those shares.
 
Senior Preferred: During 2006, a subscription for senior preferred shares was cancelled, reducing the balance by 2,500 shares or $25,000. The senior preferred had an initial stated value of $10.00 per share. Accrued dividends that are not paid in cash within 10 days of a payment date will automatically be added to the stated value and the stated value, as adjusted, will be used for all future dividend and conversion calculations. The following table summarizes the earnings through 2007 and the expected future stated value of the senior preferred at the end of each quarter through December 31, 2008.
Quarter
Ended
 
Adjusted Stated
Value
 
Quarter 
Ended
 
Adjusted Stated
Value
 
 
 
 
     
 
 
31-Mar-07
 
$
11.75
   
31-Mar-08
 
$
12.72
 
 
             
30-Jun-07
 
$
11.99
   
30-Jun-08
 
$
12.97
 
 
             
30-Sep-07
 
$
12.23
   
30-Sep-08
 
$
13.23
 
 
             
31-Dec-07
 
$
12.47
   
31-Dec-08
 
$
13.50
 
 
2006 Private Placement of Series A Preferred Stock:     On October 18, 2006, the Company’s board of directors designated, from the Company’s total authorized 12,500,000 shares, a new series of preferred stock consisting of up to 2,000,000 shares designated Series A Convertible Preferred Stock (the “series A preferred”). During the fourth quarter of 2006, the Company sold an aggregate of 782,997 shares of series A preferred at a price of $10 per share for net proceeds of $7,722,470 including $4,352,500 in cash and $3,369,970 in liability conversion. In connection with the private placement, the Company incurred total offering expenses of $258,202, of which $107,500 was paid in cash, while the remainder was paid through the issuance of options to acquire shares of the Company’s common stock.
 
F-20

Under the terms of this new series of preferred stock, no more than 1,000,000 shares may be sold for cash and the remaining shares must be reserved for (i) issuance upon exercise of the conversion rights of holders of secured and unsecured short-term debt and (ii) to pay in-kind dividends on the series A preferred. So long as any series A preferred shares are outstanding, the Company cannot (i) issue any series of stock having rights senior to or on parity with the series A preferred (ii) amend, alter or repeal any provision of its Certificate of Incorporation or bylaws to adversely affect the relative rights, preferences, qualifications, limitations or restrictions of the series A preferred (iii) effect a reclassification of the series A preferred or (iv) issue any additional shares of series A preferred, each without the consent of the holders of a two-thirds majority of the outstanding shares. The holders of series A preferred have no pre-emptive rights with respect to any other securities of the Company and a liquidation preference equal to the stated value on the payment date before any payment or distribution is made to the holders of common stock.
 
Beginning on April 23, 2007, the shares of series A preferred shall be convertible at the option of the holders of record at an initial conversion price of $1.25 per share. Holders of series A preferred are entitled to anti-dilution protection for certain subsequent events, including the issuance of equity or debt securities that may be converted into common stock at a conversion price that is less than the conversion price of the series A preferred resulting in a reduction in the conversion price of the series A preferred. No such other securities have been issued through the date of this report which would require the reduction of the conversion price of the series A preferred. In addition, the effective conversion price of the series A preferred was at a price lower than the market price of the common stock at the respective dates of issuance in the fourth quarter of 2006, resulting in an aggregate non-cash beneficial conversion feature of $6,709,970 recognized as additional non-cash dividends on a straight line basis, which did not differ materially from the effective interest method, from the respective dates of issuance of the series A preferred in the fourth quarter of 2006 through the first date these shares are convertible on April 23, 2007. As a result, $613,336 was recognized as additional non-cash dividends in the fourth quarter of 2006 with the remaining amount recognized in 2007. In addition, if all holders of the series A preferred were to have exercised their conversion rights at their respective dates of subscription, these holders would have received an additional $5,597,970 in fair value in excess of the proceeds paid for their subscriptions to the series A preferred. The Company further analyzed the embedded conversion feature and determined that it is properly classified as an equity instrument and accordingly, is not accounted for as a derivative, requiring fair value accounting at each reporting period.
 
Holders of the shares of series A preferred shall receive dividends at the annual rate of 10% of the stated value of the series A preferred so long as the Company is current with respect to its reporting obligations under the Securities Exchange Act of 1934 on any dividend payment date. Dividends are payable quarterly on the last day of March, June, September and December in each year. Dividends are cumulative from the date of issuance and payable to holders of record. Any accrued dividends that are not paid in cash will be added to the stated value of the series A preferred.
 
Because the Company has not been current with respect to its reporting obligations since the issuance of the series A preferred, the annual dividend rate increased to 20% of the stated value. All but one of the series A preferred shareholders elected to reinvest their preferred dividends back into series A preferred shares. As of December 31, 2006, $103,101 of dividends has been accrued, including $97,896 in non-cash and $5,205 in cash dividends. No cash dividends have been paid with respect to the series A preferred shares. Non-cash dividends have increased the value of the series A preferred shares by $0.13 to a stated value of $10.13 as of December 31, 2006.
 
The Series A preferred had an initial stated value of $10.00 per share. Non-cash dividends are automatically added to the stated value and the stated value, as adjusted, will be used for all future dividend and conversion calculations. The following table summarizes the earnings through 2007 and the expected future stated value of the series A preferred at the end of each quarter through December 31, 2008.

Quarter
Ended
 
Adjusted Stated
Value
 
Quarter 
Ended
 
Adjusted Stated
Value
 
                     
31-Mar-07
 
$
10.63
   
31-Mar-08
 
$
13.46
 
 
             
30-Jun-07
 
$
11.16
   
30-Jun-08
 
$
14.13
 
 
             
30-Sep-07
 
$
11.72
   
30-Sep-08
 
$
14.84
 
 
             
31-Dec-07
 
$
12.30
   
31-Dec-08
 
$
15.58
 
 
The series A preferred is redeemable by the Company under certain conditions unless the holders elect to exercise their conversion rights prior to the redemption date. Twenty percent of the series A preferred will become redeemable when the market price of the Company’s common stock exceeds $5.00 per share for at least 30 trading days within any period of 45 consecutive trading days. Thereafter, an additional twenty percent of the series A preferred will become redeemable for each $2.50 increase in the stabilized market price of the Company’s common stock. In connection with any proposed redemption of series A preferred, the Company will give each holder not less than 30 days notice of its intention to redeem a portion of the shares.
 
  Common Stock & Private Placements. The common stock transactions during the year ended December 31, 2006 are as follow:
 
 
·
Two unaffiliated individual accredited investors purchased a total of 80,000 units for a purchase price of $2.50 per unit or $200,000. Each unit consists of one share of common stock and one common stock purchase warrant with an exercise price of $4.00 per share. The warrants are exercisable up until the first anniversary of the effective date of the common stock registration statement and were valued at $26,354 on the date of issuance

 
·
The Company’s chief executive officer exercised his $2.00 warrants to purchase 56,700 shares for $113,400

 
·
The Company’s Chief Technical Officer received 6,000 unrestricted shares, valued at $24,000, pursuant to his 2005 employment contract and an additional 250,000 restricted shares, valued at $937,500, pursuant to his 2006 employment contract. The 250,000 shares will become fully vested on December 28, 2009. The expense related to these shares will be recognized over this three-year requisite service period and the shares will be considered issued and outstanding upon vesting.
 
Subscriptions Receivable: The balance sheet as of December 31, 2005 reflected $721,000 in subscriptions receivable. During the year ended December 31, 2006, the Company received subscription payments of $588,900, settled $107,100 against open invoices for legal services, and cancelled the unsettled balance of the subscription receivable for preferred stock amounting to $25,000,
 
Warrants:     741,613 warrants were issued to related parties in conjunction with the financing of debt issued during 2006. See the “Related Party” footnote within ‘Debt Financing “above. In April, 2006, the Company’s chief executive officer exercised his $2.00 warrants to purchase 56,700 shares for $113,400.   In October 2006, 200,000 3-year warrants were issued in payment for consulting services. These $3.00 warrants valued at $74,437 are scheduled to expire in October 2009. In December 2006, a former director of the Company received 9,000 $6.00 warrants valued at $12,411, and are scheduled to expire December 29, 2010. Additionally, 80,000 warrants were issued to accredited investors in connection with a private placement of units comprised of one share of the Company’s common stock and one stock purchase warrant, as discussed above.
 
On June 9, 2006 the board of directors extended the life of 1,562,900 warrants issued to the original shareholders of C&T along with 91,700 capital warrants issued to Sally Fonner in recognition of the Company’s difficulty in establishing a public trading market for its common stock. These $2 warrants scheduled to expire in 2006 and early 2007 were modified to a December 31, 2007 expiration. The warrants, valued at $521,642 prior to the extension, were revalued at the date of modification using the Black-Scholes-Merton option-pricing model. The incremental expense in 2006 resulting from the revaluations was recorded into R&D ($342,131) and SG&A ($50,680).
 

F-22

Equity Transactions -Year ended December 31, 2007
 
Senior Preferred: At December 31, 2007, 137,500 shares of 8% Cumulative Convertible Senior Preferred stock were issued and outstanding. As of December 31, 2007 $425,852 in dividends has been accrued to cover the Company’s obligations with regard to the 8% Cumulative Convertible Senior Preferred stock. No cash dividends have been paid with respect to these shares. Non-cash dividends have increased the value of the Senior Preferred shares by $2.72 to a stated value of $12.72 per share.
 
Series A Preferred : 782,997 shares of Series A Preferred were issued during 2006. In January 2007, the Company sold 40,000 additional shares of Series A Preferred to accredited investors for gross cash proceeds of $400,000. On the date of issuance, the effective conversion price of the Series A Preferred was at a price lower than the market price of the common stock resulting in a non-cash beneficial conversion feature of $400,000 recognized as additional non-cash dividends on a straight line basis through the first date these shares are convertible, being April 23, 2007. This straight line calculation did not differ materially from the effective yield method. With the 2007 subscription, the aggregate non-cash beneficial conversion feature attributable to the Series A Preferred shares is valued at $7,109,970. $613,336 was recognized as additional non-cash dividends in the fourth quarter of 2006, with the remaining balance of $6,496,634 recognized as additional non-cash dividends during the year ending December 31, 2007. Beginning on April 23, 2007, the shares of Series A Preferred became convertible at the option of the holders of record at an initial conversion of $1.25 per share. The conversion price is subject to adjustment if Axion issues any shares less than the then existing conversion price.
 
 The holders of the shares of Series A Preferred receive dividends at the annual rate of 20% of the Stated Value of the Series A Preferred so long as the Company is behind with respect to its reporting obligations under the Securities Exchange Act of 1934 on any dividend payment date. Once the company is current with respect to these reporting obligations, the dividend rate will be reduced to an annual rate of 10% of the Stated Value. As of December 31, 2007, $1,893,855 in dividends has been accrued. No cash dividends have been paid with respect to the Series A Preferred shares. Non-cash dividends have increased the value of Series A Preferred shares by $3.46 to a stated value of $13.46 per share. As of December 31, 2007, 822,997 shares of Series A Convertible Preferred stock were issued and outstanding.
 
Common Stock Issuances: The following table represents per share issuances of common stock from inception through December 31, 2007, pursuant to FASB No. 7, “ Development Stage Enterprises ”:
 
 
2003
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Date
 
Shares
 
Per share
valuation
 
    Business reason:
 
 
 
 
 
 
 
 
 
Shares issued to founders
 
 
9/18/2003
 
 
1,360,000
 
$
0.00
 
 
original capitalization-no contributed capital
 
 
 
 
 
 
 
 
 
 
 
 
 
APC Founder
 
 
9/18/2003
 
 
170,000
 
$
0.29
 
 
services rendered with respect to formation
 
 
 
 
 
 
 
 
 
 
 
 
 
Seed debt financing
 
 
12/31/2003
 
 
500,000
 
$
1.00
 
 
conversion of debt and accrued interest to common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Series I convertible debt
 
 
12/31/2003
 
 
533,334
 
$
1.50
 
 
conversion of debt and accrued interest to common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Series II convertible debt
 
 
12/31/2003
 
 
75,000
 
$
2.00
 
 
conversion of debt and accrued interest to common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Mega-C Trust
 
 
12/31/2003
 
 
6,147,484
 
$
0.00
 
 
In lieu of shares issuable to founders
 
 
 
 
 
 
 
 
 
 
 
 
 
Tamboril shareholders
 
 
12/31/2003
 
 
1,875,000
 
$
0.00
 
 
recapitalization measured at fair market value of Tamboril assets
 
 
 
 
 
 
  
 
 
  
 
 
 
2003 Totals
 
 
 
 
 
10,660,818
 
$
0.14
 
 
 
 

F-23
 

2004
 
 
 
 
 
 
 
 
 
   
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Date
 
 
Shares
 
 
Per share
valuation
 
 
Business reason:
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares issued to founders
 
 
1/9/2004
 
 
445,000
 
$
0.00
 
 
In lieu of shares issuable to founders
 
 
 
 
 
 
 
 
 
 
 
 
 
Mega-C Trust
 
 
1/9/2004
 
 
180,000
 
$
0.00
 
 
adjustment is shares issuable to founders
 
 
 
 
 
 
 
 
 
 
 
 
 
Officer
 
 
1/9/2004
 
 
45,000
 
$
1.60
 
 
services rendered by former officer
 
 
 
 
 
 
 
 
 
 
 
 
 
Series I convertible debt-Igor Filipenko
 
 
1/9/2004
 
 
50,000
 
$
1.00
 
 
conversion of debt and accrued interest to common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Series II convertible debt-Turitella
 
 
1/9/2004
 
 
133,333
 
$
1.50
 
 
conversion of debt and accrued interest to common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Series III convertible debt-Turitella
 
 
1/9/2004
 
 
100,000
 
$
2.00
 
 
conversion of debt and accrued interest to common stock
 
 
 
 
 
 
 
 
 
 
 
 
 
Series II common stock offering
 
 
2/1/2004
 
 
175,000
 
$
2.00
 
 
common stock & warrants issued for cash
 
 
 
 
 
 
 
 
 
 
 
 
 
Series III common stock offering
 
 
3/31/2004
 
 
288,100
 
$
3.00
 
 
common stock & warrants issued for cash
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of Series I warrants
 
 
various
 
 
316,700
 
$
1.50
 
 
warrants exercised pursuant to original terms
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of Series II warrants
 
 
various
 
 
125,000
 
$
2.28
 
 
warrants exercised pursuant to original terms
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of Series II warrants
 
 
various
 
 
33,500
 
$
3.23
 
 
warrants exercised pursuant to original terms
 
 
 
 
 
 
 
 
 
 
 
 
 
November emergency funding
 
 
11/1/2004
 
 
314,000
 
$
1.50
 
 
common stock & warrants issued for cash
 
 
 
 
 
 
 
 
 
 
 
 
 
December emergency funding
 
 
12/1/2004
 
 
46,700
 
$
1.50
 
 
common stock & warrants issued for cash
 
 
 
 
 
 
 
 
 
 
 
 
 
Fractional shareholders
 
 
12/31/2004
 
 
48,782
 
$
0.00
 
 
shares issued due to reverse split rounding formula
 
 
 
 
 
 
  
 
 
  
 
 
 
2004 Totals
 
 
 
 
 
2,301,115
 
$
1.37
 
 
  
 
F-24

 
2005 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Date
 
 
Shares
 
 
Per share
valuation
 
 
Business reason:
 
 
 
 
 
 
 
 
 
 
 
 
 
Mega-C Trust
 
 
2/28/2005
 
 
500,000
 
$
3.05
 
 
Trust augmentation
 
 
 
 
 
 
 
 
 
 
 
 
 
Banca di Unionale
 
 
3/18/2005
 
 
30,000
 
$
2.00
 
 
conversion of Preferred and accrued dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
Banca di Unionale
 
 
4/20/2005
 
 
20,000
 
$
2.00
 
 
conversion of Preferred and accrued dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
C&T employees
 
 
4/1/2005
 
 
219,000
 
$
2.50
 
 
employee incentive share grants
 
 
 
 
 
 
 
 
 
 
 
 
 
7 individuals
 
 
6/10/2005
 
 
29,565
 
$
3.57
 
 
Exercise of Director options
 
 
 
 
 
 
 
 
 
 
 
 
 
3 individuals
 
 
7/11/2005
 
 
190,000
 
$
1.58
 
 
conversion of Preferred and accrued dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
Banca di Unionale
 
 
7/11/2005
 
 
10,000
 
$
1.60
 
 
exercise of preferred warrants
 
 
 
 
 
 
 
 
 
 
 
 
 
3 individuals
 
 
8/28/2005
 
 
150,000
 
$
1.67
 
 
conversion of Preferred and accrued dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
James Smith
 
 
9/7/2005
 
 
30,000
 
$
1.67
 
 
conversion of Preferred and accrued dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
2 individuals
 
 
9/28/2005
 
 
1,050,000
 
$
1.69
 
 
conversion of Preferred and accrued dividends
 
 
 
 
 
 
 
 
 
 
 
 
 
2 individuals
 
 
various
 
 
226,900
 
$
1.79
 
 
exercise of Series I warrants
 
 
 
 
 
 
 
 
 
 
 
 
 
3 individuals
 
 
various
 
 
91,200
 
$
2.40
 
 
exercise of Series III warrants
 
 
 
 
 
 
 
 
 
 
 
 
 
2 individuals
 
 
various
 
 
25,000
 
$
1.60
 
 
exercise of Preferred warrants
 
 
 
 
 
 
 
 
 
 
 
 
 
Officer
 
 
10/20/2005
 
 
446,000
 
$
1.00
 
 
exercise of warrants and options
 
 
 
 
 
 
 
 
 
 
 
 
 
Officer
 
 
10/20/2005
 
 
25,000
 
$
2.00
 
 
exercise of warrants
 
 
 
 
 
 
 
 
 
 
 
 
 
6 individuals
 
 
12/1/2005
 
 
600,000
 
$
2.00
 
 
common stock and warrants
 
 
 
 
 
 
   
 
 
    
 
 
 
2005 Totals
 
 
 
 
 
3,642,665
 
$
1.94
 
 
 


F-25

2006
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2 individuals
 
 
4/21/06
 
 
80,000
 
 
2.50
 
 
Common stock and warrants issued for cash
 
 
 
 
 
 
 
 
 
 
 
 
 
Officer
 
 
4/21/06
 
 
56,700
 
 
2.00
 
 
Exercise of non-plan incentive option granted to CEO
 
 
 
 
 
 
 
 
 
 
 
 
 
Officer
 
 
4/21/06
 
 
6,000
 
 
4.00
 
 
Unrestricted share grant to CTO
 
 
 
 
 
 
 
 
 
 
 
 
 
Mega-C Trust
 
 
11/28/06
 
 
(500,000
)
 
2.25
 
 
Return of shares per settlement agreement
 
 
 
 
 
 
   
 
 
   
 
 
 
2006 Totals
 
 
 
 
 
(357,300
)
$
2.20
 
 
 

 
2007
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Officer
 
 
12/01/07
 
 
1,000
 
 
2.30
 
 
Unrestricted share grant to VP Mfg Engineering
 
 
 
 
 
 
   
 
 
    
 
 
 
2007 Totals
 
 
 
 
 
1,000
 
$
2.30
 
 
 

Warrants:     397,750 warrants are to be issued to related parties in conjunction with the financing of debt. See the “Related Party” footnote above. The following table provides summary information on warrants outstanding as of December 31, 2007, including the 301,700 warrants that were issued in escrow to facilitate the pending stock sale described above. The table provides summary information on the various warrants issued by the Company in private placement transactions; the warrants exercised to date; the warrants that are presently exercisable   and the current exercise prices of such warrants.
 
 
 
2007(restated)
 
2006
 
 
 
 
 
 
 
 
 
 
 
 
 
  Shares
 
Weighted 
Average
Exercise price
 
Shares
 
Weighted Average
Exercise price
 
 
 
 
 
 
 
 
 
 
 
Warrants outstanding January 1
   
3,761,213
 
$
3.21
   
3,242,400
 
$
2.66
 
 
                 
Granted during year
   
484,278
   
5.35
   
1,030,613
   
5.26
 
 
                 
Exercised
   
-
   
0.00
   
(56,700
)
 
2.00
 
 
                 
Lapsed
   
(1,657,100
)
 
2.00
   
(455,100
)
 
1.33
 
 
                 
Outstanding at December 31
   
2,588,391
 
$
4.39
   
3,761,213
 
$
3.21
 
 
                 
Weighted average years remaining
   
2.1
       
1.57
     


On March 9, 2007 the board of directors unanimously agreed to extend the life 476,000 $2.00 warrants issued in March 2005 to purchasers who subscribed to the Senior Preferred private placement offering. These warrants, originally scheduled to expire on March 17, 2007 were modified to March 17, 2008, so that the holders of these warrants would have a reasonable opportunity to realize the benefit of their original bargain.  The warrants, valued at $381,832 prior to the extension, were revalued at the date of modification using the Black-Scholes-Merton option-pricing model. The incremental expense resulting from the revaluations was recorded as preferred dividends during the first quarter of 2007 in the amount of $164,179.
 
F-26

Registration Rights
 
General : The Company filed a resale registration statement for the shares of common stock held by the Mega-C Trust. See the discussion in the note titled “Mega-C Power (Mega-C), Mega-C Trust (the Trust), The Taylor Litigation.”
 
Senior Preferred: The Company registered the resale of the shares of common stock issuable upon conversion of the senior preferred and was required to maintain an effective registration statement until September 18, 2006, the 18-month anniversary of the closing date of the preferred stock offering. In the event that the current registration statement was subsequently terminated, withdrawn or suspended for a period of more than 10 days, then the conversion price of the senior preferred was to be decreased by an initial delay adjustment of three percent (3%), plus an additional delay adjustment of two percent (2%) for every thirty day period (or portion thereof) that the underlying common stock is not subject to and included in an effective registration statement. The holders of senior preferred, or common stock issued upon conversion thereof, also have certain piggy-back registration rights with respect to future offerings. The registration statement included Axion’s Financial Statements for the period ended June 30, 2005 and the financial statements became out of date. Axion did not terminate, withdraw or suspend the registration statement. The Company believes that the financial statements going out of date is not enough to reactivate the registration delay provisions of the Senior Preferred Stock.
 
Series A Preferred   : The Company is required to file a registration statement within 180 days after the initial closing of the offering and use its best efforts to maintain its effectiveness for two years subsequent to the date it is declared effective. If, at any time after the issuance of the series A preferred, the Company files a registration statement for a proposed public offering of common stock, then holders of the series A preferred will be able to participate in that offering as Selling Shareholder.
 
Warrants: The Company has registered the resale of the shares of common stock issuable upon exercise of all warrants that were issued and outstanding in June 2005 and is required to maintain an effective registration statement until the expiration dates of the warrants. It is also obligated to file a resale registration statement for the warrants issued after June 2005. The recently issued warrants generally provide that they will be exercisable for terms of two to three years after the effective date of the required registration statements. However there are no cash penalties or exercise price adjustments associated with registration delays.
 
During 2006 & 2007, as a response to substantial unanticipated registration delays, the Company extended the expiration dates of certain warrants that were issued in 2003, 2004 and 2005. Under the extensions, which presently expire in December 2007 and March 2008, the Company has retained the right to redeem the warrants at a price of $.01 per warrant if the underlying stock has been included in an effective registration statement under the Securities Act and has traded at an average bid price of $4 per share or more for at least 30 days before the call for redemption. The accounting treatment for the modifications is discussed above.
 
Note 9 - Equity Compensation
 
In December 2004, the Financial Accounting Standards Board issued FASB 123R, “ Share-Based Payment” (FASB 123R). FASB 123R supersedes FASB 123, “ Accounting for Stock Based Compensation ,” and Accounting Principles Board Opinion 25, “ Accounting for Stock Issued to Employees” (APB 25) and its related implementation guidance. On January 1, 2006, the Company adopted the provisions of FASB 123R using the modified prospective transition method. Under this method, compensation expense is recorded for all stock based awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding as of the beginning of the adoption. Prior periods have not been restated for the effects of FASB 123R. Under FASB 123R, employee-compensation expense related to stock based payments are recorded over the requisite service period based on the grant date fair value of the awards.

F-27

Prior to the adoption of FASB 123R, the Company accounted for employee stock options using the intrinsic value method in accordance with APB 25. Accordingly, no compensation expense was recognized for stock options issued to employees as long as the exercise price was greater than or equal to the market value of the common stock at the date of grant. In accordance with FASB 123, the Company disclosed the summary of pro forma effects to reported net loss as if the Company had elected to recognize compensation costs based on the fair value of the awards at the grant date.
 
The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of EITF 96-18, “ Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services ” and EITF 00-18 “Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees.” The measurement date for fair value of the equity instruments is determined by the earlier of (i) the date at which commitment for performance by the vendor or consultant is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
 
The compensation cost that has been charged against income for options granted under the plans was approximately $162,163 for the year ended December 31, 2007. The impact of these expenses to basic and diluted loss per share was approximately $0.01 per share during the year. The adoption of FASB 123R did not have an impact on cash flows from operating or financing activities. For stock options issued as non-qualified stock options, a tax deduction is not allowed until the options are exercised. The amount of this deduction will be the difference between the fair value of the Company’s common stock and the exercise price at the date of exercise. Accordingly, there is a deferred tax asset recorded for the tax effect of the financial statement expense recorded. The tax effect of the income tax deduction in excess of the financial statement expense will be recorded as an increase to additional paid-in capital. Due to the uncertainty of the Company’s ability to generate sufficient taxable income in the future to u utilize the tax benefits of the options granted, the Company has recorded a valuation allowance to reduce gross deferred tax assets to zero. As a result, for the year ended December 31, 2007, there is no income tax expense impact from recording the fair value of options granted. There is no tax deduction allowed by the Company for incentive stock options.
 
The Company has two stockholder approved equity compensation plans and occasionally enters into employment and other contracts that provide for equity compensation arrangements other than those contemplated by the stockholder approved plans. The following sections summarize the Company’s equity compensation arrangements.
 
Incentive Stock Plan Approved by Stockholders: The Company’s stockholders have adopted an incentive stock plan for the benefit of its employees, consultants and advisors. Under the terms of the original plan, the Company was authorized to grant incentive awards for up to 1,000,000 shares of common stock. At the Company’s 2005 annual meeting, its shareholders increased the authorization under the incentive stock plan to 2,000,000 shares.
 
The incentive stock plan authorizes a variety of awards including incentive stock options, non-qualified stock options, shares of restricted stock, shares of phantom stock and stock bonuses. In addition, the plan authorizes the payment of cash bonuses when a participant is required to recognize income for federal income tax purposes because of the vesting of shares of restricted stock or the grant of a stock bonus.
 

The plan authorizes the grant of incentive awards to full-time employees of the Company who are not eligible to receive awards under the terms of their employment contract or another specialty plan. The plan also authorizes the grant of incentive awards to directors who are not eligible to participate in the Company’s outside directors’ stock option plan, independent agents, consultants and advisors who have contributed to the Company’s success.
 
The compensation committee administers the plan. The committee has absolute discretion to decide which employees, consultants and advisors will receive incentive awards, the type of award to be granted and the number of shares covered by the award. The committee also determines the exercise prices, expiration dates and other features of awards.
 
F-28

The exercise price of incentive stock options must be equal to the fair market value of such shares on the date of the grant or, in the case of incentive stock options granted to the holder of more than 10% of the Company’s common stock, at least 110% of the fair market value of such shares on the date of the grant. The maximum exercise period for incentive stock options is ten years from the date of grant, or five years in the case of an individual who owns more than 10% of the Company’s common stock. The aggregate fair market value determined at the date of the option grant, of shares with respect to which incentive stock options are exercisable for the first time by the holder of the option during any calendar year, shall not exceed $100,000.
 
The following awards have been granted under the Plan since its inception:
 
In February 2004, Igor Filipenko, a Director of the Company, was granted options to purchase 6,300 shares of common stock at a price of $3.20 per share. In June 2004, Mr. Filipenko was granted options to purchase 10,800 shares of common stock at a price of $5.60 per share. The options are fully vested and may be exercised at any time during the five-year period commencing one year after the date of grant. The market value of the Company stock at the date of grant was less than the exercise price; therefore there was no intrinsic value in accordance with APB 25. Options for 7,200 shares were cancelled in April 2005 after Mr. Filipenko was issued additional options in March 2005 as part of the offering to the former employees of C&T discussed below.
 
In February 2004, John Petersen, a Director of the Company (and general corporate counsel), and Kirk Tierney, each were granted options to purchase 6,300 shares of common stock at a price of $3.20 per share. In June 2004, Messrs. Petersen and Tierney were each granted options to purchase 3,600 shares of common stock at a price of $5.60 per share. The options are fully vested and may be exercised at any time during the five-year period commencing one year after the date of grant. The market value of the Company stock at the date of grants was less than the exercise price; therefore there was no intrinsic value in accordance with APB 25.
 
In February 2004, an advisor to the board of directors was granted an option to purchase 6,300 shares of common stock at a price of $3.20 per share as compensation for services. In June 2004, Mr. the advisor was granted options to purchase 3,600 shares of common stock at a price of $5.60 per share. The options are fully vested and may be exercised at any time during the five-year period commencing one year after the date of grant. The options were valued at $17,067 using the Black-Scholes-Merton option pricing model and were included as expense in 2004 
 
In November 2004, the Company’s President and Chief Operating Officer, Charles Mazacatto, was granted options to purchase 6,250 shares of common stock at an exercise price of $3.20. This option vested in 2004 and is exercisable until November 2010. The market value of the Company stock at the date of grant was less than the exercise price; therefore there was no intrinsic value in accordance with APB 25.
 
In March 2005, the compensation committee authorized stock bonuses to the former employees of C&T for an aggregate of 219,000 shares of common stock. These stock grants are fully vested and unrestricted, subject to compliance with the Company’s insider trading policies. The fair value of these shares, as determined by the Company’s stock price on the date of grant, amounted to $565,202 and was recorded as compensation during the year ended December 31, 2005.
 
In April 2005, the former employees of C&T were granted options to purchase an aggregate of 744,500 shares of common stock at an exercise price of $2.50. These options vest at a rate of 20% per year beginning in April 2006. The market value of the Company stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. On January 1, 2006, the Company adopted the provisions of FASB 123R as noted above which resulted in the Company recording compensation expense of $86,954 during the year ended December 31, 2006. Various options lapsed when several individuals terminated their employment with the Company in 2005 and 2006. During the years ended December 31, 2005 and 2006, an aggregate of 157,700 and 454,000 options, respectively, forfeited unvested as a result of these terminations
 
In September 2005, the compensation committee awarded 6,000 shares of restricted common stock to the Company’s Chief Technical Officer, Edward Buiel, pursuant to his 2005 employment agreement, which were valued at $24,000 on the date of grant and became fully vested in April 2006. The Company recorded $8,000 and $16,000 of compensation in 2005 and 2006, respectively, related to this award.
 

In December 2006, the Company issued 250,000 shares of restricted common stock to the Company’s Chief Technical Officer, Edward Buiel, pursuant to his 2006 employment agreement, which were valued at $937,500 on the date of grant and will become fully vested on December 2009. The Company will recognize this as compensation over the requisite service period. No compensation expense was recorded for the year ended December 31, 2006.
 
In December 2007, the Company’s Vice-President of Manufacturing Engineering, Robert Nelson, was granted 36,000 shares of restricted common stock pursuant to his 2007 employment agreement which were valued at $82,800 on the date of grant. The shares vest at a rate of 1,000 shares per month, with provision for immediate vesting based on significant changes in the relative ownership of the company. The Company will recognize this as compensation over the 2 year employment contract, with $3,450 of compensation expense recorded for the year ended December 31, 2007.
 
Outside Directors' Stock Option Plan Approved by Stockholders   : The Company’s stockholders have adopted an outside directors' stock option plan for the benefit of its non-employee directors in order to encourage their continued service as directors. Under the terms of the original plan, the Company was authorized to grant incentive awards for up to 125,000 shares of common stock. At the 2005 annual meeting, the Company’s shareholders increased the authorization under the incentive stock plan to 500,000 shares.
 
Each eligible director who is, on or after the effective date, appointed to fill a vacancy on the board of directors or elected to serve as a member of the board of directors may participate in the plan. Each eligible director shall automatically be granted an option to purchase the maximum number of shares having an aggregate fair market value on the date of grant of twenty thousand dollars ($20,000). The option price of the stock subject to each option is required to be the fair market value of the stock on its date of grant. Options generally expire on the fifth anniversary of the date of grant. Any option granted under the plan shall become exercisable in full on the first anniversary of the date of grant, provided that the eligible director has not voluntarily resigned or been removed "for cause" as a member of the board of directors on or prior to the first anniversary of the date of grant (qualified option). Any qualified option shall remain exercisable after its first anniversary regardless of whether the optionee continues to serve as a member of the board of directors.
 
The following awards have been granted under the Plan since its inception:
 
During the year ended December 31, 2004, the Company issued 54,000 5-year options to four of its directors vesting in one year from the date of issuance. The market value of the Company stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. During the year ended December 31, 2005, these directors waived an aggregate of $105,542 in accrued compensation as full payment of the exercise price of 29,565 options. An additional 14,400 options were forfeited in 2005.
 
During the year ended December 31, 2005, the Company issued 70,000 5-year options to five of its directors vesting 1/3 per year over three years from the date of grant. The market value of the Company stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. On January 1, 2006, the Company adopted the provisions of FASB 123R as noted above and recorded compensation of $41,024 during the year ended December 31, 2006.
 
During the year ended December 31, 2006, the Company issued 60,000 5-year options to two of its directors vesting 1/3 per year over the next three years. These options are exercisable at a price of $2 per share, expiring five years from vest date and are valued at $71,680 utilizing the Black-Scholes-Merton option pricing model, of which $20,230 was expensed in 2006.
 
 

In January 2004, members of the law firm of Fefer, Petersen & Cie, general corporate counsel (of which one member was a director of the Company at the time) were granted two-year contractual options to purchase 189,300 shares of common stock at a price of $2.00 per share as partial compensation for services rendered, valued at $68,296. As represented in the note captioned “Stockholder’s Equity,” these members also received 116,700 warrants as consideration of pre-merger Tamboril debt (the amount cited in “Stockholder’s Equity” is actually 233,400 because another party received the same number of warrants for a total of 233,400 warrants). In August 2004, $1.00 of the exercise price of the total 306,000 options and warrants owned by these members was considered paid in advance in consideration of unbilled legal services provided by the firm. The Company recorded $306,000 related to this reduction. All of the warrants and options were exercised in the fourth quarter of 2005, however; $306,000 of the amount is included in stock subscription receivable as of December 31, 2005 and was received in 2006.
 
In July 2004, the Company’s President and Chief Operating Officer, Charles Mazzacato, was granted a contractual option to purchase 240,000 shares of common stock at a price of $4.00 per share. This option vests on a monthly basis at the rate of 60,000 shares per year commencing July 31, 2005 and is exercisable for five years after each vesting date. The market value of the Company stock at the date of grant was greater than the exercise price, which resulted in a total intrinsic value of $180,000. In accordance with APB 25 the Company expensed the intrinsic value over the vesting period which resulted in expense of $18,750 and $45,000 during the years ended December 31, 2004 and 2005, respectively. On January 1, 2006, the Company adopted the provisions of FASB 123R as noted above and recorded compensation of $124,364 during the year ended December 31, 2006. During the year ended December 31, 2006 the options were forfeited as a result of his termination of employment from the Company in 2006.
 
In July 2004, the Company’s Chief Financial Officer, Peter Roston, was granted a contractual option to purchase 200,000 shares of common stock at a price of $4.00 per share. This option will vest on a monthly basis at the rate of 50,000 shares per year commencing July 31, 2005 and is exercisable for five years after each vesting date. The market value of the Company stock at the date of grant was greater than the exercise price, which resulted in a total intrinsic value of $150,000. In accordance with APB 25 the Company has expensed the intrinsic value over the vesting period which resulted in expense of $15,625 and $37,500 during the years ended December 31, 2004 and 2005, respectively. On January 1, 2006, the Company adopted the provisions of FASB 123R as noted above and recorded compensation of $138,182 during the year ended December 31, 2006. During the year ended December 31, 2006 the options were forfeited as a result of his termination of employment from the Company in 2006.
 
In April 2005, the Company’s Chief Executive Officer, Thomas Granville, was granted a contractual option to purchase 180,000 shares of common stock at a price of $2.50 per share. This option vests at the rate of 7,500 shares per month commencing May 1, 2005 and is exercisable for five years after each vesting date. The market value of the Company stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. On January 1, 2006, the Company adopted the provisions of FASB 123R as noted above and recorded compensation of $112,500 during the year ended December 31, 2006.
 
In April 2005, a European financial advisor was granted a contractual option to purchase 30,000 shares of common stock at a price of $2.50 per share. Options for an aggregate of 20,000 shares vested during the year ended December 31, 2005 and will be exercisable for two years. On December 31, 2005, a total of 10,000 unvested options were forfeited when the advisory agreement was terminated. The options were valued at $35,998 using the Black-Scholes-Merton option pricing model and included as expense in 2005.
 
In September 2005, the Company’s Chief Technical Officer, Edward Buiel, was granted a contractual option to purchase 90,000 shares of common stock at a price of $4.00 per share. This option vests at the rate of 2,500 shares per month commencing October 2005 and is exercisable for five years after each vesting date. The market value of the Company stock at the date of grant was less than the exercise price, which resulted in no intrinsic value in accordance with APB 25. On January 1, 2006, the Company adopted the provisions of FASB 123R as noted above and recorded compensation of $68,100 during the year ended December 31, 2006.
 
In February 2006, the Company’s Chief Executive Officer, Thomas Granville, was granted an option to purchase 500,000 shares of common stock at an exercise price of $6.00. Of this total 300,000 options vested immediately and the balance is expected to vest, subject to the attainment of certain specified objectives, over the next one to three years. These options are valued at $300,187 utilizing the Black-Scholes-Merton option pricing model with $259,027 of compensation recorded in 2006.
 
F-31

In February 2006, the Company’s, Chief Technical Officer, Edward Buiel, was granted an option to purchase 35,000 shares of common stock at an exercise price of $6.00. Of this total 10,000 options vested immediately and the balance is expected to vest, subject to the attainment of certain specified objectives, over the next two to three years. These options are valued at $20,994 utilizing the Black-Scholes-Merton option pricing model with $13,330 of compensation recorded in 2006.
 
In February 2006, members and affiliates of the law firm of Fefer, Petersen & Cie, general corporate counsel (of which one member was a director of the Company at the time) were granted an option to purchase 360,000 shares of common stock at an exercise price of $6.00. Of this total 240,000 options vested immediately and the balance will vest at the rate of 10,000 shares per month during the year ended December 31, 2006. These options are valued at $193,449 utilizing the Black-Scholes-Merton option pricing model and are recorded as legal expense in 2006.
 
In February 2006, the Company’s external bankruptcy counsel, Cecilia Rosenauer, was granted an option to purchase 15,000 shares of common stock at an exercise price of $6.00. The options vested on the effective date of Mega-C’s Chapter 11 plan of reorganization, which took place in November 2006. These options are valued at $2,483 utilizing the Black-Scholes-Merton option pricing model and are recorded as legal expense in 2006.
 
In March 2006, two employees were granted options to purchase a total of 24,000 shares of common stock at an exercise price of $4.00 and $6.00. The options vest at a rate of 2,500 per month over the first 6 months and 1,500 per month thereafter. These options are valued at $28,257 utilizing the Black-Scholes-Merton option pricing model with $24,408 of compensation recorded in 2006.
 
In December 2006, the Company’s Chief Technical Officer, Edward Buiel, was granted a contractual option to purchase an additional 100,000 shares of our common stock at a price of $3.75 per share. A total of 50,000 options will vest on December 29, 2009 and the remaining 50,000 will vest on December 29, 2010. The options will be exercisable for a period of six years from the vesting date. These options are valued at $267,372, utilizing the Black-Scholes-Merton option pricing model with $6,481 of compensation recorded in 2006.
 
In February 2006, a consultant, Trey Fecteau, was granted an option to purchase 97,000 shares of common stock at an exercise price of $4.00. The options vested upon completion of contractual services in December 2006. These options are valued at $150,702 utilizing the Black-Scholes-Merton option pricing model. This amount reduced the proceeds of the Series A Preferred Stock offering in 2006.
 
In January 2007, Walker Wainwright, a director of the Company, was granted an option to purchase 40,000 shares of common stock at an exercise price of $5.00 as compensation for services related to due diligence, negotiation and sale of the 2006 Series A Preferred Stock offering. These three-year options were immediately vested on the date of grant, and are valued at $52,230 utilizing the Black-Scholes-Merton option pricing model and are recorded as offering costs in 2007.
 
In August 2007, the Company’s Chief Financial Officer, Andrew Carr Conway, Jr., was granted a contractual option to purchase 80,000 shares of common stock at an exercise price of $4.50. 20,000 vested immediately upon contract inception and the remainder vest at a rate of 10,000 per month over the life of his six-month employment contract. These two-year options are valued at $37,356 utilizing the Black-Scholes-Merton option pricing model with $24,904 recorded as compensation in 2007.
 
In December 2007, the Company’s Vice-President of Manufacturing Engineering, Robert Nelson, was granted a contractual option to purchase 108,000 shares of common stock at an exercise price of $5.00. The options vest at a rate of 3,000 per month over a three year period, but are being amortized over the term of his two year employment contract. These five-year options are valued at $108,504 utilizing the Black-Scholes-Merton option pricing model with $4,521 recorded as compensation in 2007.

F-32

The Company uses the Black-Scholes-Merton Option Pricing Model to estimate the fair value of awards on the measurement date using the weighted average assumptions noted in the following table:  
 
Year
 
Interest Rate
 
Dividend Yield
 
Expected Volatility
 
Expected Life
 
2004
   
3.8
%
 
0.0
%
 
59.1
%
 
60 months
 
2005
   
4.0
%
 
0.0
%
 
52.0
%
 
100 months
 
2006
   
4.7
%
 
0.0
%
 
53.6
%
 
45 months
 
2007
   
3.9
%
 
0.0
%
 
54.4
%
 
62 months
 
 
Expected volatilities are calculated based on the historical volatility of the Company’s stock since its listing on the public markets. Management has determined that it cannot reasonably estimate a forfeiture rate given the insufficient amount of time and activity of share option exercise and employee termination patterns. The expected life of options represents the period of time that options granted are expected to be outstanding was determined using the contractual term. The risk-free interest rate for periods within the expected life of the option is based on the interest rate for a similar time period of a U.S. Treasury note in effort on the date of the grant.
 
The following table provides consolidated summary information on the Company’s equity compensation plans for the years ended December 31 2004, 2005, 2006 and 2007.
 
 
 
 
2004
 
 
 
 
 
 
 
Weighted Average
 
 
 
All Plan & Non-Plan Compensatory Options
 
Number of
Options
 
Exercise
 
Fair Value
 
Remaining
Life (years)
 
Aggregate
Intrinsic
Value
 
Options outstanding at December 31,2003
   
-
 
$
0.00
 
$ $
0.00
           
Granted
   
736,350
 
$
3.53
 
$ $
2.87
           
Exercised
   
-
 
$
0.00
 
$ $
0.00
           
Forfeited or lapsed
   
-
 
$
0.00
 
$ $
0.00
         
Options outstanding at December 31,2004
   
736,350
 
$
3.53
 
$ $
2.87
   
6.34
     
 
 
           
2005
       
           
Weighted Average  
       
All Plan & Non-Plan Compensatory Options
   
Number of
Options
   
Exercise
   
Fair Value
   
Remaining
Life (years)
   
Aggregate
Intrinsic
Value
 
Options outstanding at December 31,2004
   
736,350
 
$
3.53
 
$ $
2.87
       
 
 
Granted
   
1,254,500
 
$
2.48
 
$ $
1.34
         
Exercised
   
(358,865
)
$
1.65
 
$ $
2.32
         
Forfeited or lapsed
   
(182,100
)
$
3.04
 
$ $
1.44
         
Options outstanding at December 31,2005
   
1,449,885
 
$
3.12
 
$ $
1.86
   
7.73
     
 
 
 
 
 
2006
 
 
 
 
 
 
 
Weighted Average
 
 
 
All Plan & Non-Plan Compensatory Options
 
Number of
Options
 
Exercise
 
Fair Value
 
Remaining
Life (years)
 
Aggregate
Intrinsic
Value
 
Options outstanding at December 31,2005
   
1,449,885
 
$
3.12
 
$
1.86
           
Granted
   
1,191,000
 
$
5.42
 
$
0.82
           
Exercised
   
-
 
$
0.00
 
$
0.00
           
Forfeited or lapsed
   
(894,000
)
$
3.24
 
$
1.94
           
Options outstanding at December 31,2006
   
1,746,885
 
$
4.62
 
$
1.05
   
3.70
 
$
634,903
 
Options exercisable at December 31,2006
   
1,192,385
 
$
5.11
 
$
0.97
   
2.90
 
$
254,903
 
 
 
 
 
 
2007
 
 
 
 
 
 
 
Weighted Average
 
 
 
All Plan & Non-Plan Compensatory Options
 
Number of
Options
 
Exercise
 
Fair Value
 
Remaining
Life (years)
 
Aggregate
Intrinsic
Value
 
Options outstanding at December 31,2006
   
1,746,885
 
$
4.65
 
$
1.03
           
Granted
   
228,000
 
$
4.82
 
$
0.87
           
Exercised
   
-
 
$
0.00
 
$
0.00
           
Forfeited or lapsed
   
(124,000
)
$
2.50
 
$
1.14
         
Options outstanding at December 31,2007
   
1,850,885
 
$
4.81
 
$
1.00
   
1.5
 
$
18,000
 
Options exercisable at December 31,2007
   
1,442,385
 
$
4.88
 
$
0.93
   
2.0
 
$
6,000
 

The following table summarizes the status of the Company’s non-vested options under the stock option plans:
 
 
Shares
 
Fair Value
 
Options subject to future vesting at December 31,2006  
   
554,500
 
$
1.34
 
Options granted  
   
228,000
 
$
0.87
 
Options forfeited or lapsed  
   
(124,000
)
$
1.14
 
Options vested  
   
(250,000
)
$
1.17
 
Options subject to future vesting at December 31,2007  
   
408,500
 
$
1.25
 

As of December 31, 2007, there was $350,754 of unrecognized compensation related to non-vested options granted under the plans. The Company expects to recognize the cost over a weighted average period of 1.3 years. The total fair value of options vested during the year ended December 31, 2007 was $236,054 ($ 830,181 during the year ended December 31, 2006). 
 
Note 10—Earnings/Loss Per Share  
 
 Basic earnings per share is computed by dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) for the period. Diluted earnings per share is computed by assuming that any dilutive convertible securities outstanding were converted, with related preferred stock dividend requirements and outstanding common shares adjusted accordingly. It also assumes that outstanding common shares were increased by shares issuable upon exercise of those stock options for which market price exceeds the exercise price, less shares which could have been purchased by us with the related proceeds. In periods of losses, diluted loss per share is computed on the same basis as basic loss per share as the inclusion of any other potential shares outstanding would be anti-dilutive
 
F-34

Had the Company recorded income applicable to common shareholders for the periods ended December 31, 2003, 2004, 2005, 2006 and 2007, weighted-average number of common shares outstanding would have increased by 785,897; 1,386,612; 2,970,730; 2,135,938 and 8,975,643 (restated), respectively, for the fiscal years, reflecting the addition of dilutive securities in the calculation of diluted earnings per share. The increase in weighted average common shares for the cumulative period (September 18, 2003 to December 31, 2007) is 4,215,284 shares.
 
Note 11 — Income Taxes
 
Following is a summary of the components giving rise to the income tax provision for the periods ended December 31, 2007 and 2006.
 
Currently payable:
   
2007
   
2006
 
Federal
 
$
-
 
$
-
 
State
   
83,469
   
-
 
Foreign
   
-
   
-
 
Total currently payable
   
83,469
   
-
 
Deferred:
             
Federal
   
1,817,000
   
1,386,000
 
State
   
537,000
   
456,000
 
Foreign
   
446,000
   
787,000
 
Total deferred
   
2,800,000
   
2,629,000
 
Less increase in allowance
   
(2,800,000
)
 
(2,629,000
 
Net deferred
   
-
   
-
 
Total income tax provision
 
$
83,469
 
$
-
 
 
Individual components giving rise to the deferred tax asset are as follows:
   
  2007
 
2006  
 
Future tax benefit arising from net operating loss carry forwards
 
$
5,977,000
 
$
3,242,000
 
Future tax benefit arising from available tax credits
   
1,026,000
   
864,000
 
Future tax benefit arising from options/warrants issued for Services
   
602,000
   
536,000
 
Other
   
98,000
   
149,000
 
Total
   
7,703,000
   
4,791,000
 
Less valuation allowance
   
(7,703,000
)
 
(4,791,000
)
Net deferred
 
$
-
 
$
-
 


The components of pretax net loss are as follows:
     
2007
   
2006
 
United States
 
$
(5,776,191
)
$
(4,867,383
)
Foreign
   
(6,467
)
 
(2,160,580
)
 
 
$
(5,782,658
)
$
(7,027,963
)
 
The Company has net operating loss carryforwards of approximately $10,053,000 and $4,930,000 available to reduce future income taxes in United States and Canadian, respectively. The United States carryforwards expire at various dates between 2024 and 2027. The Canadian carryforwards expire at various dates between 2010 and 2026. The Company also has generated Canadian tax credits related to research and development activities. A portion of this credit, amounting to approximately $102,000 is refundable and has been presented as such in the accompanying balance sheet. The remaining credit, amounting to $1,026,000, is available to offset future taxable income in Canada and expires at various dates between 2014 and 2027. The Company has adopted FASB 109 which provides for the recognition of a deferred tax asset based upon the value certain items will have on future income taxes and management's estimate of the probability of the realization of these tax benefits. The Company has determined it more likely than not that these timing differences will not materialize and have provided a valuation allowance against the entire net deferred tax asset. The utilization of NOL and tax credit carryforwards from Tamboril prior to the reorganization may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended and similar state provisions. Accordingly, these amounts have not been included in the gross deferred tax asset number above. In addition, due to equity transactions that have occurred subsequent to the reorganization with Tamboril, the utilization of NOL carryforwards may be subject to further change in control limitations that generally restricts the utilization of the NOL per year.
 
F-35

The reconciliation of the United States statutory federal income rate and the effective income tax rate in the accompanying consolidated statements of operations is as follows:
 
 
 
2007
 
2006
 
Statutory U.S. federal income tax rate
   
(34.0
)%
 
(34.0
)%
State taxes
   
(6.4
)%
 
(6.4
)%
Mega-C Trust Shares augmentation/return
   
0.0
%
 
(5.4
)%
Equity based compensation
   
1.0
%
 
2.0
%
Nondeductible research and development
   
0.0
%
 
3.2
%
Warrant modifications
   
0.0
%
 
5.1
%
Other permanent non-deductible differences
   
1.7
%
 
(1.9
)%
Change in valuation allowance
   
37.7
%
 
37.4
%
Effective income tax rate
   
0.0
%
 
0.0
%
 
Note 12 — Related Party Transactions
 
Trust for the Benefit of the Shareholders of Mega-C Power Corp: The Trustee for The Trust for the Benefit of the Shareholders of Mega-C Power Corp. served as an officer of one of our consolidated companies in 2004. See discussion of the transactions with the trust in the note captioned “ Mega-C Power Corp (Mega-C), Mega-C Trust (the Trust), The Taylor Litigation 
 
Transactions with C&T:     A current member of the board of directors of the Company is the former majority shareholder of C&T prior to the acquisition by the Company. See the note captioned “Transactions with Related (C&T)” for disclosure of transactions with C&T prior to and in connection with the acquisition.  
 
Related party notes payable: During the years ending December 31, 2007 and December 31, 2006, the Company borrowed certain amounts from related parties; certain of these borrowings were extinguished through the issuance of the Company’s Series A Preferred Stock in 2006 and through the issuance of the Secured Bridge Financing during the fourth quarter of 2007. Refer to Notes captioned “Related Party Debt Financing” and “Stockholders’ Equity” for discussion on these matters.
 
Series A Preferred stock sales - The Company raised capital in a preferred stock offering during the year ended December 31, 2006, discussed further in the note captioned “Stockholder’s Equity,” of which $3,829,970 related to transactions with members of the board of directors and their family members.
 
Legal fees: John Petersen was a director of the Company until January 15, 2007, and a partner in the law firm of Fefer, Petersen & Cie, which serves as the Company’s legal counsel. During the year ended December 31, 2006, fees incurred for services amounted to $287,463, including $49,352 related to the value of options vesting. This amount is offset by a credit of $64,943 for the change in value of equity instruments accrued in the fourth quarter of 2005 with a measurement date in the first quarter of 2006.
 
F-36

Warrants: In January 2007, Walker Wainwright, a director of the Company, was granted an option to purchase 40,000 shares of common stock at an exercise price of $5.00 as compensation for services related to due diligence, negotiation and sale of the 2006 Series A Preferred Stock offering. These three-year options were immediately vested on the date of grant, and are valued at $52,230 utilizing the Black-Scholes-Merton option pricing model and are recorded as offering costs in 2007.
 
Note    13 — Significant Non-Cash Transactions
 
The following table provides summary information on our significant non-cash investing and financing transactions during the twelve-month periods ended December 31, 2007 and 2006.
 
 
 
  2007
 
2006
 
Notes payable to related parties converted to preferred stock
 
$
-
 
$
3,184,292
 
 
         
Preferred Dividends attributable to warrant modifications
 
$
164,179
 
$
-
 
 
         
Dividend accrued to preferred stock - Senior
 
$
130,566
 
$
103,101
 
 
         
Dividend accrued to preferred stock - Series A
 
$
1,790,755
 
$
119,092
 
 
         
Beneficial conversion feature on preferred stock
 
$
6,496,634
 
$
613,336
 
 
         
Amount due for warrants exercised satisfied by extinguishment of liability
 
$
-
 
$
113,400
 
 
         
Satisfaction of accrued legal liability with equity instruments
 
$
-
 
$
144,097
 
 
         
Subscription receivable satisfied extinguishment of liability
 
$
-
 
$
107,100
 
 
         
Equipment purchases included in accounts payable
 
$
-
 
$
66,813
 
 
         
Reversal of stock subscription receivable
 
$
-
 
$
25,000
 
 
         
Conversion of Interest and fees into debt instrument
 
$
74,573
 
$
-
 
 
         
Satisfaction of 2005 Liability to issue stock
 
$
-
 
$
24,000
 
 
         
Warrants issued for commission on sale of preferred
 
$
53,230
 
$
150,702
 
 
         
Fair value of warrants issued with related party note
 
$
276,882
 
$
271,567
 
 
There were only minor cash payments for interest and no payments of income taxes during the years ended 2007 and 2006.
 
Note 14 — Mega-C   Power Corp (Mega-C ), Mega-C   Trust (the Trust), The Taylor Litigation
 
Mega-C Power Corp Business and Trust rationale: Mega-C Power Corporation was a Nevada corporation that previously held limited and non-exclusive license rights to the technology that APC licensed from C&T and that the Company purchased from C&T [as discussed in the note captioned “Transactions with a related party (C&T]. Mega-C had ceased substantive operations as a result of the investigation of the promoters and management by the Ontario Securities Commission (OSC) in the spring of 2003 and was placed into an involuntary bankruptcy in April, 2004, as further described below.
 

Trust Creation: The Trust was created on December 31, 2003, in connection with a reverse acquisition between APC and the Company, through its public shell then known as Tamboril Cigar Company, in response to the potential perceived equities of the Mega-C shareholders and risks of the situation. APC’s founders believed that the investors in Mega-C might be able to assert a variety of equitable claims to the energy storage technology the Company acquired from C&T. The Trust document required that when the Trust made its distribution, the beneficiary released any claims against all parties. Therefore, while Axion had no control over the Trust, its mandates were believed to be an effective way to eliminate conflicting claims to the technology. The Company’s founders were also shareholders in Mega-C for the most part.
 
Trust corpus: The original corpus of the Trust was 7,327,500 shares of the common stock that APC’s shareholders had rights to in connection with the reverse acquisition on December 31, 2003. In connection with the execution of the Amended and Restated Trust Agreement in February 2005, which formally recognized the jurisdiction of the bankruptcy court on all matters, Axion issued 500,000 additional shares to the Trust. There was no contingency surrounding the issuance of these shares at that time. This issuance was intended to be Axion’s contribution to the Trust to obtain clear title to the technology and resolve all related matters and was charged to operating expense during the year ended December 31, 2005. The stock issuance transaction was valued at $1,525,000, which was the value of the shares on the date of issuance
 
As a result of the bankruptcy court’s confirmation of a Chapter 11 Plan and the substantial consummation of the confirmed plan in November 2006 the settlement disclosed below became effective and 1,500,000 shares were returned to the Company for cancellation in 2006, of which 1,000,000 represented a retroactive adjustment to the shares issued in the reverse acquisition in December 31, 2003 and 500,000 shares represented a return of the 2005 augmentation. The return in 2006 was the result of a negotiated settlement and there were no contingencies surrounding the Trust shares in 2005 or 2006. The 500,000 shares recovered were recorded as a reversal of the expense at fair value on the date of return in 2006 amounting to $1,125,000 and were promptly cancelled as were the 1,000,000 shares.
 
Trust Operations: The Trust did not conduct any substantive operations because, as described below, Mega-C was placed into involuntary bankruptcy shortly after the Trust’s inception. As a result of the confirmation of Mega-C’s plan of reorganization by an order entered on November 8, 2008 and the substantial consummation of the confirmed plan on November 21, 2006, as described below, the Trust is now governed by a court appointed Trustee along with a court appointed Board from the Trust’s beneficiaries.
 
The Trust for the Benefit of the Shareholders of Mega-C Power Corp . Analysis of Consolidation: Under FASB Interpretation No. 46 (revised December 2003) Consolidation of Variable Interest Entities an interpretation of ARB No. 51 , (FIN 46R), reporting companies are required to consolidate a related variable interest entity (“VIE”) when the reporting company is the “primary beneficiary” of that entity and holds a variable interest in the VIE. The determination of whether a reporting company is the primary beneficiary of a VIE ultimately stems from whether the reporting entity will absorb a majority of the VIE’s anticipated losses or receive a majority of the VIE’s anticipated gains.
 
Variable Interest Entity: The Trust may be a variable interest entity because it has required outside infusions of cash over its existence.
 
Variable Interest: The Company analyzed its transactions with and relationship to the Trust and concluded that it may have had a very small variable interest in the Trust based on its obligation to perform the acts necessary to have the Commission declare a registration statement effective. Further, Axion appeared to have had a limited variable interest based on its obligation, pursuant to the requirements in the Trust instrument that Axion pay Trust expenses until the required registration statement was declared effective. However, in reality, Axion never paid any significant Trust expenses for three reasons: (1) while the Trust included a provision for payment of expenses, no significant expenses were ever paid, (2) the Trust suspended operations on April 4, 2004 when Mega-C Power Corp. entered bankruptcy; and (3) the explicit obligation the Company had to pay certain expenses of the Trust ended on January 7, 2005 when the required registration statement was declared effective. The Company’s relationship to and transactions with the Trust, based on actual transactions, constituted a very small variable interest, if any, compared to other entities who provided much larger amounts of support to the Trust, for which the Company had no responsibility. Further no shares were expected to be returned to Axion at the time these assessments were made. The relative size of the variable interest is relevant to the determination of the primary beneficiary, as discussed below.
 

Primary Beneficiary: Axion did not and will not absorb a majority of the Trust’s anticipated losses or derive the benefit of a majority of the Trust’s gains, if any, at any time. The primary beneficiary, at the time of assessment, based on an assessment of what entity (entities) absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests, was the creditors and shareholders of Mega-C Power Corp, as a group. These were the entities, as groups, who would be affected by increases and decreases in the Trust’s primary asset, the Axion stock. These two groups will also suffer a diminution in assets available for distribution to them because of the expenses the Trust incurs. The increases and decreases in the value of the Axion stock in the Trust will have no effect on Axion. Axion may have had a very limited obligation in the first quarter of 2004 but few, if any, expenses were incurred by the Trust in that quarter. In the second quarter, Mega-C Power Corp. entered bankruptcy and the Trust became dormant and, effectively, under the jurisdiction of the Bankruptcy Court. Upon registration of the Trust shares in January 2005 Axion’s obligation to the Trust ended except as described below relative to possible registration of shares.
 
Based on the above, Axion was not the primary beneficiary and accordingly, Axion is not required to consolidate the Trust. Axion’s relationship with the Trust ended when the Bankruptcy Court in Reno confirmed the bankruptcy plan in 2006 except as described below relative to possible registration of shares. (See “Settlement Agreement” below
 
Trust Registration Rights   : The Company registered 7,327,500 shares of common stock held by the Mega-C Trust by a registration statement the Commission declared effective January 7, 2005.  Pursuant to the confirmed Chapter 11 Plan (See footnote captioned “Subsequent Events”), as referenced above, the Company may be required to register 5,700,000 of those shares (the "Plan Funding Shares") which fund the Chapter 11 Plan.  The Company filed a post-effective amendment relating to the resale or other disposition of 1,627,500 shares, of which, 1 million represent a portion of the Plan Funding Shares and 627,500 represent shares to pay expenses of the Trust. In paragraph 1(d) of the Settlement Agreement, the Company further agreed to file such additional registration statements or post-effective amendments as may be necessary or desirable to facilitate or accommodate the sale or distribution of 4,700,000 of those shares. The Settlement Agreement was incorporated and approved in its entirety in paragraph 6.1 of the Second Amended Plan, which further provided in paragraph 6.12 that the Second Amended Shareholder Trustee and the Liquidation Trustee have the right and power to request that the Company file such amendments to the registration statement for the Plan Funding Shares.
 
Taylor Litigation: On February 10, 2004, Lewis “Chip” Taylor, Chip Taylor in Trust, Jared Taylor, Elgin Investments, Inc. and Mega-C Technologies, Inc. (collectively the “Taylor Group”) filed a lawsuit in the Ontario Superior Court of Justice Commercial List (Case No. 04-CL-5317) that named Tamboril, APC, Rene Pardo, Marvin Winick, Kirk Tierney, Joseph Piccirilli, Ronald Bibace, Robert Averill, James Smith, James Eagan, Thomas Granville, Joseph Souccar, Glenn W. Patterson, Canadian Consultants Bureau Inc., Robert Appel, Harold Rosen, Igor Filipenko, Valeri Shtemberg, Yuri Volfkovich, Pavel Shmatko, Michael Kishinevsky, Mega-C Power Corporation (Nevada), Mega-C Power Corporation (Ontario), C&T, Turitella Corporation, Gary Bouchard, Fogler Rubinoff LLP, Netprofitetc Inc., 503124 Ontario Ltd., HAP Investments LLC, Infinity Group LLC, James Keim, Benjamin Rubin and John Doe Corporation as defendants. Although the complaint alleges a number of complex and intersecting causes of action, it appears that with respect to the Company and certain of its directors, officers and stockholders, the lawsuit alleged a conspiracy to damage the value of the Taylor Group’s investment in Mega-C and deprive the Taylor Group of its alleged interests in the technology based on an alleged “oral” agreement, as well as damages of $250,000,000.
 
Based on orders entered in the Bankruptcy Court on February 11, 2008, management believes that this litigation against the Company is resolved, as set forth more fully in the section entitled “Settlement Agreement and Confirmed Chapter 11 Plan.”
 
Mega-C Bankruptcy Court Litigation   : As described above, shortly after the formation of the Trust, Lewis “Chip” Taylor, Chip Taylor in Trust, Elgin Investments, Jared Taylor and Mega-C Technologies filed suit against Axion and APC’s founders (the “Taylor Litigation”). The Company, APC and Thomas Granville filed an involuntary Chapter 11 petition against Mega-C in the U.S. Bankruptcy Court for the District of Nevada (Case No. BK-N-04-50962-gwz).

F-39

In February 2005, the Bankruptcy Court stayed the Taylor Litigation pending resolution of Mega-C’s Chapter 11 bankruptcy case. In March 2005, the Bankruptcy Court appointed William M. Noall to serve as Chapter 11 Trustee for the Mega-C case. On June 7, 2005, the Chapter 11 Trustee commenced an adversary proceeding against Sally Fonner, the trustee of the Trust (Adversary Proceeding No. 05-05042-gwz), demanding, among other things, the turnover of at least 7,327,500 shares of the Company’s stock held by the Trust as property of the bankruptcy estate.
 
On July 27, 2005, the Company commenced an adversary proceeding against the Chapter 11 Trustee and Ms. Fonner (Adversary Proceeding No. 05-05082-gwz) for the purpose of obtaining a judicial determination that as of the petition date: 
 
 
·
Mega-C's license to commercialize the technology was terminated; 
 
 
 
 
·
Mega-C does not have any interest in the technology; 
 
 
 
 
·
Mega-C did not transfer any property to the Company with the intent to damage or defraud any entity;  
 
 
 
 
·
Mega-C did not transfer any property to the Company for less than reasonably equivalent value; and 
 
 
·
If the court ultimately decides that Mega-C has a valid legal interest in the technology, then the Company is entitled to terminate the Trust. Further, Axion amended its complaint in September 2005 to assert its legal right to have the Trustee of the Mega-C Trust hold the assets of the Trust for the benefit of the Company in the event the bankruptcy court were to grant the Chapter 11 Trustee's request for turnover of the Trust assets and to set aside the Trust. Among other things these theories made it necessary to name Sally A. Fonner as a defendant in the lawsuit.
 
Settlement Agreement and Confirmed Chapter 11 Plan   : On December 12, 2005, the Company entered into a settlement agreement with Mega-C, represented by its Chapter 11 Trustee William M. Noall ("Noall"), and the Trust, represented by its trustee Sally A. Fonner ("Fonner"). Additional signatories to the settlement agreement include: (a) the Company's subsidiaries APC and C&T; (b) Fonner in both her capacity as Mega-C's sole officer and director and as trustee of the Trust; (c) certain former stockholders of APC including Robert Averill, Joe Piccirilli, Canadian Consultants Bureau Inc., James Smith, James Eagan, Tom Granville, Joe Souccar, HAP Investments, LLC, Glenn Patterson, Igor Filipenko, Ron Bibace, Kirk Tierney, Infinity Group, LLC, James Keim and Turitella Corporation; (d) Paul Bancroft, and (e) certain former stockholders of C&T including, Yuri Volkovich, Pavel Shmatko, Albert Shtemberg, Edward Shtemberg, C&T Co., Inc. in Trust, Oksana Fylypenko, Andriy Malitskiy, Valeri Shtemberg, Yuri Shtemberg, Victor Eshkenazi, Miraslav E. Royz, and Rimma Shtemberg.   
 
The settlement agreement was approved by the Bankruptcy Court after a hearing in an order dated February 1, 2006. Certain terms were subject to confirmation and effectiveness of Mega-C's Chapter 11 plan of reorganization. On November 8, 2006, the Bankruptcy Court entered an order confirming the plan which was subsequently substantially consummated on November 21, 2006. The settlement agreement was fully incorporated in the confirmed Chapter 11 plan. At the date of these financial statements, the plan is fully effective and substantially consummated.  Accordingly, all pending and potential disputes between the parties to the Settlement Agreement have been resolved. In summary, the following steps have been accomplished:   
 
 
·
The Company has compromised and withdrawn  its notes receivable from Mega-C to an allowed unsecured claim of $100;  
 
 
 
 
·
Mega-C has assigned all of its right, title and interest, if any, in the technology and any and all tangible and intangible personal property in the Company's possession to the Company;  

F-40
 
 
 
 
 
·
The Trust has been restated and retained 4,700,000 shares that will be sold to pay creditor claims that remain unsatisfied from the Liquidation Trust described below, with the balance to be proportionately distributed to the holders of allowed equity interests in Mega-C in connection with the implementation of Mega-C's Chapter 11 plan. It is also the owner of 685,002 share certificates which serve as collateral for loans paid to the newly created Liquidation Trust in the amount of $2,055,000;
 
 
 
 
·
A newly created Liquidation Trust received the proceeds of loans in the amount of $2,055,000, secured by 685,002 shares and has legal title to 314,998 shares that will be sold to pay creditor claims and Liquidation Trust expenses.
 
 
 
 
·
The former trustee of the Trust has received 627,500 shares as compensation by the Trust through the effective date of Mega-C's plan; and  
 
 
 
 
·
The Trust surrendered 1,500,000 shares to the Company which were promptly cancelled as discussed under “Trust corpus” above.
 
The litigation settlement and releases provided by the plan, which are as broad as the law allows, are now binding on Mega-C, the Chapter 11 trustee, the Taylor Group and all other parties described in the plan of reorganization. The plan requires the Liquidation Trustee or the Second Amended Shareholders Trustee to seek dismissals of the Taylor litigation to the extent the litigation asserts derivative or other causes of action that belong to the Chapter 11 estate of Mega-C

While certain aspects of the litigation discussed above are on appeal to the Ninth Circuit Court of Appeals and to the United States District Court for the District of Nevada, management believes the possibility of any adverse decision to the Company to be remote.
 
In orders entered on February 11, 2008, the Bankruptcy Court held that the alleged “oral” agreement creating rights or interests in the Technology in favor of the Taylor Group never existed and, even if it had, the Taylor Group transferred any such rights to the Debtor which were then transferred to the Company by the confirmed Chapter 11 Plan. The Bankruptcy Court held that the Taylor Group has no interest in or rights to the Technology. The Bankruptcy Court held that the only rights the Taylor Group has are as putative creditors or shareholders of Mega-C and that any attempts to claim an interest in or contest the Company’s title to the Technology are contrary to the permanent injunction of the Chapter 11 Plan.
 
Future Litigation Costs: No amounts have been accrued in the accompanying balance sheet related to future litigation costs. Protracted litigation or higher than anticipated costs could significantly reduce available working capital and have a material adverse impact on the company’s financial condition.
 
Notes Receivable-Mega-C: The Company advanced funds to Mega-C over the years from 2003 to 2005. The Company considered these notes impaired, by recording an allowance for doubtful accounts, in an amount equal to the aggregate of the advances, net of certain repayments, against the Mega-C advances as the advances were made.
 
Because of the uncollectibility of the Mega-C receivable, as confirmed by the above described transactions and events, the Company recorded a recovery of notes receivable previously written off in November of 2006 in the amount of $100 as well as other assets received from Mega-C Power Corp. The other assets received, primarily miscellaneous fixed assets, have been determined to be negligible in value and no attempt has been made to secure an appraisal or record any amounts for these assets. Most importantly, the confirmation of the plan of reorganization conveyed all of Mega-C’s right, title and interest, if any, in the technology to the Company, thereby resolving a significant challenge to the Company’s ownership of the technology.
 
Note 15 — Commitments and Contingencies
 
Facilities During 2006 the Company closed the facilities in Woodbridge, Ontario and moved to New Castle, Pennsylvania. See the note captioned “Purchase of Assets of Failed Battery Manufacturing Company (Equipment Purchase).” The agreement provided for an initial term of two years with two renewal terms of five years each. The monthly rent payable for the initial term of the agreement was $10,000. During the two extension terms, the rent was to be based on market rates as determined by negotiation between the parties, or if the parties are unable to reach a mutually agreed rental rate, by an independent appraisal process. In April of 2008, the company signed a new lease that also added to our existing space at our manufacturing plant in New Castle, Pennsylvania. The new lease calls for a monthly payment of $16,142 with an initial term of two (2) years beginning April 2008. In addition to the monthly rental, APB is obligated to pay all required maintenance costs, taxes and special assessments, maintain public liability insurance in the amount of $1 million, and maintain fire and casualty insurance for an amount equal to 1000% of the replacement value of the leased premises. Rent expense for the plant in New Castle amounted to approximately $135,800 and $103,000 for the years ended December 31, 2007 and 2006, respectively. Future commitments under the initial term of the lease amount to $20,000 in 2008.
 
F-41

Employment Agreements: The Company’s Chief Executive Officer, President, Chief Financial Officer, Chief of Research and Development and Vice President of Manufacturing Engineering have each executed written employment agreements with the terms set forth in the following table.
Name
 
Position
 
Date
 
Term
 
Salary  
 
Options  
 
Price  
 
Vesting
 
Thomas Granville (1)
 
 
CEO
 
 
4/4/05
 
 
24 Months
 
$
261,000
 
 
180,000
 
$
2.50
 
 
Monthly
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dr. Edward Buiel (2)
 
 
CTO
 
 
9/1/05
 
 
36 Months
 
$
168,000
 
 
100,000
 
$
3.75
 
 
Monthly
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Andrew Carr Conway, Jr. (3)
 
 
CFO
 
 
8/31/07
 
 
6 months
 
$
180,000
 
 
80,000
 
$
4.50
 
 
Monthly
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dr. Robert Nelson (4)
 
 
VP Mfg. Eng.
 
 
12/1/07
 
 
24 Months
 
$
132,000
 
 
108,000
 
$
5.00
 
 
Monthly
 
 
 
(2) In December 2006, Mr. Buiel was promoted to the post of Vice President and Chief Technology Officer. Pursuant to his promotion, a new employment agreement was approved retroactive to October 2006 in which Mr. Buiel receives an annual salary of $168,000 and bonuses as determined by the compensation committee. In addition, Mr. Buiel receives an option to purchase 100,000 shares of our common stock at a price of $3.75 per share that vest over two years commencing December 2008 and 250,000 shares of restricted common stock that fully vest in December 2009.
 
(3) On August 31, 2007, the Company entered into a 6 month service contract with Andrew Carr Conway, Jr. to fill the position of Chief Financial Officer. The contract automatically renewed for an additional six month term when the initial six months expired with the same terms and conditions. The agreement calls for a $15,000 per month consulting fee, and the issuance of 80,000 $4.50 options with an exercise period of 2 years. 30,000 options vested with the execution of the contract, and the balance vest periodically over the remainder of the contract. Mr. Conway is also entitled to whatever additional fees and bonuses he and the Company may agree upon.
 
(4) Dr. Nelson’s employment agreement also provides for a stock grant at a vesting rate of 1,000 shares per month with immediate vesting in the event of a change in control or the acquisition of 20% or more of the Company’s voting securities.
 
Contingent Shares:   In connection with a prospective offering, four holders of warrants to purchase the Company’s common stock agreed to exercise their warrants to purchase, in the aggregate, 301,700 (the Incompletely Exercised Warrant Shares) common shares of stock for the purpose of selling them to the foreign partnership in a transaction that was substantially similar to the one the Company entered into with the same foreign partnership.  These shares were to be issued to the foreign partnership upon receipt of payment, which was in turn contingent upon the foreign partnership tendering the payment of the purchase price for these shares.  Contrary to the terms and conditions of their agreements, the Company believes the foreign partnership is in possession of a stock certificate representing these shares without tendering the purchase price to either the Company or to the warrant holders.  As such, the Incompletely Exercised Warrant Shares have not been duly issued and have been excluded from all calculations of the issued and outstanding shares of common stock in these financial statements. The Company has included the Incompletely Exercised Warrant Shares as outstanding warrants, pending receipt of the exercise price from the four warrant holders.  The Company has not yet located the Incompletely Exercised Warrant Shares. The Company retained counsel to cause the parties who have possession of the Incompletely Exercised Warrant shares to return the shares absent payment. Counsel was retained October 6, 2007.
 

Management concluded there is no requirement, pursuant to the requirements of FASB 5, “ Accounting for Contingencies ,” to accrue any loss contingency based on the above described matters involving the 301,700 shares. As a result, there has been no accounting recognition of these events in the financial statements.
 
Note 16 — Subsequent Events
 
Quercus Trust Investment: On January 14, 2008, we entered into a Securities Purchase Agreement (the “Agreement”) with The Quercus Trust (“Quercus”), pursuant to which we have agreed to issue to Quercus up to 8,571,429 shares of our common stock, together with common stock purchase warrants that will entitle the holder to purchase up to 10,000,000 additional shares of our common stock
 
At the initial closing on January 14, 2008, we issued and sold 1,904,762 first closing units (a unit is one share of common stock, and a 5-year warrant to purchase 1.5 additional shares of common stock at an exercise price of $2.60 per share) issuable to Quercus for an aggregate purchase price of $4,000,000, or $2.10 per Unit.
 
In the second closing (the “Second Quercus Closing”), which will occur within five business days after we file the last of our delinquent reports under the Securities Exchange Act of 1934 (the “Delinquency Cure Date”), Quercus has agreed to purchase 1,904,762 additional units for $4,000,000. Each Quercus Second Closing unit will consist of one share of common stock, and a 5-year warrant to purchase 1.25 additional shares of common stock at an exercise price of $2.60 per share.
 
In the third closing (the “Third Quercus Closing”) Quercus has agreed to make an additional investment of $10,000,000 on or before June 30, 2008 upon our execution of one or more qualifying contracts that satisfy the requirements of the   Securities Purchase Agreement. There is no assurance that we will be able to satisfy this condition. Upon the occurrence of the Third Quercus Closing, Quercus has agreed to purchase an additional 4,761,905 units for $10,000,000. Each Third Quercus Closing unit will consist of one share of common stock, and a 5-year warrant to purchase one additional share of common stock at an exercise price of $2.60 per share.
 
The warrants contain conventional anti-dilution provisions for adjustment of the exercise price in the event we issue additional shares of our common stock or securities convertible into common stock (subject to certain specified exclusions) at a price less than $1.00 per share.
 
In the Securities Purchase Agreement, we agreed to file one or more registration statements under the Securities Act of 1933 (the “Securities Act”) covering the resale by Quercus of the shares of our common stock issued pursuant to the Agreement and the shares of our common stock issued upon exercise of the warrants. The registration rights provisions of the Agreement contain conventional terms including indemnification and contribution undertakings and a provision for liquidated damages in the event any of the following occurs:
 
 
·
any registration statement is not filed on or prior to the date it is required to be filed, and in the case of the initial registration statement, that date is 30 days after the Second Quercus Closing (the “Filing Deadline”) or a Restriction Termination Date (as defined below),
 
 
·
any post-effective amendment is not filed on or prior to the seventh business day after the registration statement ceases to be effective pursuant to applicable securities laws due to the passage of time or the occurrence of an event requiring the Company to file a post-effective amendment ( the “Post-Effective Amendment Filing Deadline”), or
 
 
·
we fail to file with the SEC a request for acceleration of effectiveness within five business days after the date that we are notified by the SEC; or
 
 
·
we fail to respond to any comments made by the SEC within 15 business days after the receipt of such comments, or
 
 
·
a registration statement filed hereunder is not declared effective by the SEC within 150 days of the filing of the registration, or
 
 
·
a post-effective amendment is not declared effective on or prior to the fifteenth business day following the Post-Effective Amendment Filing Deadline, or
 
 
·
after a registration statement is filed with and declared effective by the SEC, such registration statement ceases to be effective as to all securities registrable pursuant to the Agreement (“Registrable Securities”) to which it is required to relate at any time until the earlier of (i) the fifth anniversary of the effective date, (ii) the date when all Registrable Securities covered by such Registration Statement have been sold publicly, or (iii) the date on which the Registrable Securities are eligible for sale without volume limitation pursuant to Rule 144 of the Securities Act for a period of more than 60 days in any twelve month period without being succeeded by an amendment to such registration statement or by a subsequent registration statement filed with and declared effective by the SEC, or
 
·
an amendment to a registration statement is not filed with the SEC within 15 business days after the SEC having notified us that such amendment is required in order for such Registration Statement to be declared effective (any such failure or breach being referred to as an “Registration Failure Event”).
 
If at any time the staff of the SEC takes the position that the offering of some or all of these registrable securities in a registration statement is not eligible to be made on a delayed or continuous basis under the provisions of Rule 415 under the Securities Act or requires Quercus to be named as an “underwriter” (an “SEC Objection”), we shall promptly notify Quercus of such SEC Objection and if Quercus requests, we shall use commercially reasonable efforts to persuade the staff of the Commission that the offering contemplated by the registration statement is a valid secondary offering and not an offering “by or on behalf of the issuer” as defined in Rule 415 and that Quercus is not an “underwriter” (a “Rule 415 Response Effort”). In the event that, despite our commercially reasonable efforts, the staff of the Commission has not altered its position and Quercus provides notice to us to cease any further Rule 415 Response Efforts (the “Quercus Rule 415 Determination”), we shall (i) remove from any registration statement such portion of the Registrable Securities (the “Cut Back Shares”) and/or (ii) agree to such restrictions and limitations on the registration and resale of the Registrable Securities as the staff of the Commission may require to assure our compliance with the requirements of Rule 415; provided, however, that we shall not agree to name Quercus as an “underwriter” in such Registration Statement without the prior written consent of Quercus (collectively, the “SEC Restrictions”). Notwithstanding any other provision of the Agreement to the contrary, no liquidated damages shall accrue during the period beginning on the date of an SEC Objection and ending on the date that either we receive written notification from the SEC that our Rule 415 Response Effort has been successful or Quercus provides us with an Quercus Rule 415 Determination or as to any Cut Back Shares until such time as we are able, using commercially reasonable efforts, to effect the filing of an additional Registration Statement with respect to the Cut Back Shares in accordance with any SEC Restrictions (such date, the “Restriction Termination Date”)
 
In case any Registration Failure Event occurs, we would be obligated to pay liquidated damages to the Quercus in an amount equal to 1% of the aggregate purchase price paid by the Quercus pursuant to the Agreement for any of our securities that were required to be registered but were not covered under an effective registration statement (the “Monthly Liquidated Damages”) for the first month and each successive month thereafter until the Registration Failure Event shall have been cured. Failure to make payments of the Monthly Liquidated Damages shall result in our being obligated to pay interest on any unpaid Monthly Liquidated Damages at a rate of 18% per year.
 
The Agreement also grants to Quercus a right of first refusal to participate in any subsequent financing we undertake prior to the second anniversary of the second closing (subject to certain conventional exceptions) in order to permit Quercus to maintain its fully-diluted ownership interest in our common stock.
 
As an inducement to Quercus to enter into the Agreement and to purchase the shares of our common stock and the warrants issuable under the Agreement, certain directors, officers and principal holders of our issued and outstanding convertible securities, warrants and stock options agreed to refrain from converting any of their convertible securities or exercising any of their stock purchase rights until the board of directors proposes and our stockholders approve a charter amendment that will increase the number of authorized common shares from the current limit of 50 million shares of common stock to a proposed limit of not less than 75 million shares of common stock. Concurrently, we agreed to extend the expiration date of the warrants and options that are subject to forbearance agreements for a period of time equal to the forbearance period.

F-44
 
C&T and Series A Warrants . In January of 2004 the Company issued warrants (the “C&T Warrants”) to the shareholders of C&T (the “C&T Warrant Holders”) in exchange for the acquisition of certain intellectual property rights associated with the lead/carbon hybrid supercapacitor formerly referred to as the E3 Cell. In February of 2005 we issued shares of our Series A Convertible Preferred Stock (the “Series A Preferred Stock”) to a group of investors (the “Series A Holders”), and in recognition of certain concessions, we issued warrants to the Series A Holders (the “Series A Warrants”). Both the C&T Warrants and the Series A Warrants expired during the period of time in which the Company was not current in its Exchange Act Reporting Obligations. In recognition of this, our board has authorized management to commence discussions and potential negotiations with the C&T Warrant Holders and the Series A Holders in an effort to recognize that the economic benefits that these parties and the Company expected at the time these warrants were issued was frustrated by the length of the time the Company was out of compliance with its Exchange Act reporting obligations and to provide some form of tangible value to the C&T Warrant Holders and the Series A Holders.
 
F-46
 
PART I- FINANCIAL INFORMATION
 
ITEM 1.   CONSOLIDATED FINANCIAL STATEMENTS  
 
AXION POWER INTERNATIONAL, INC.
 
CONSOLIDATED BALANCE SHEETS
 
(A Development Stage Company)
 
   
     
December 31,
 
   
(Unaudited)
 
2007
 
ASSETS
         
Current Assets:
         
Cash & cash equivalents
 
$
1,689,973
 
$
671,244
 
Accounts receivable
   
156,113
   
133,646
 
Other receivables
   
335,321
   
341,801
 
Inventory
   
475,916
   
375,635
 
Prepaid expenses
   
95,619
   
82,102
 
Total current assets
   
2,752,942
   
1,604,428
 
               
Property & equipment, net
   
2,352,709
   
2,119,252
 
TOTAL ASSETS
 
$
5,105,651
 
$
3,723,680
 
               
LIABILITIES & STOCKHOLDERS' EQUITY (DEFICIT)
             
Current Liabilities:
             
Accounts payable
 
$
883,838
 
$
1,573,436
 
Other current liabilities
   
1,189,504
   
583,591
 
Notes payable to related parties
   
2,417,497
   
2,259,826
 
Liability to issue equity instrument
   
-
   
106,183
 
Total current liabilities
   
4,490,839
   
4,523,036
 
               
Deferred revenue
   
816,211
   
840,945
 
Total liabilities
   
5,307,050
   
5,363,981
 
               
Stockholders' Equity (Deficit):
             
Convertible preferred stock-12,500,000 shares authorized
             
Senior preferred - 1,000,000 shares designated . 137,500 issued and outstanding (137,500 in 2007)
   
1,549,696
   
1,515,376
 
Series A preferred - 2,000,000 shares designated . 822,997 shares issued and outstanding (822,997 in 2007)
   
10,055,989
   
9,802,894
 
Common stock-50,000,000 shares authorized $0.0001 par value
             
18,262,719 issued & outstanding (16,248,298 in 2007)
   
1,826
   
1,625
 
Additional paid in capital
   
29,889,664
   
25,768,331
 
Deficit accumulated during development stage
   
(41,465,311
)
 
(38,498,704
)
Cumulative foreign currency translation adjustment
   
(233,263
)
 
(229,823
)
Total Stockholders' Equity (Deficit)
   
(201,399
)
 
(1,640,301
)
               
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY (DEFICIT)
 
$
5,105,651
 
$
3,723,680
 
               
See notes to unaudited interim financial statements
 

AXION POWER INTERNATIONAL, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
(A Development Stage Company)
 
UNAUDITED
 
   
Three Months Ended
 
Inception
 
   
March 31,
 
(9/18/2003) to
 
   
2008
 
2007
 
March 31, 2008
 
       
 
     
Revenues
 
$
215,727
 
$
164,513
 
$
1,025,015
 
Cost of tangible products sold
   
394,236
   
228,890
   
2,083,104
 
Gross profit / (loss)
   
(178,509
)
 
(64,377
)
 
(1,058,089
)
                     
Expenses
                   
Selling, general & administrative
   
1,713,165
   
879,462
   
14,882,357
 
Research & development
   
382,017
   
320,374
   
9,525,250
 
Impairment of assets
   
-
   
-
   
1,391,485
 
Interest expense - related party
   
419,673
   
17,202
   
1,434,160
 
Derivative revaluation
   
(2,844
)
 
7,108
   
362,508
 
Mega C Trust Share Augmentation (Return)
   
-
   
-
   
400,000
 
Other, net
   
(11,328
)
 
(22,543
)
 
(488,256
)
Net loss before income taxes
   
(2,679,192
)
 
(1,265,980
)
 
(28,565,593
)
                     
Income taxes
   
-
   
-
   
83,469
 
Deficit accumulated during development stage
   
(2,679,192
)
 
(1,265,980
)
 
(28,649,062
)
                     
Less preferred stock dividends and beneficial conversion feature
   
(287,415
)
 
(5,283,092
)
 
(12,816,250
)
Net loss applicable to common shareholders
 
$
(2,966,607
)
$
(6,549,072
)
$
(41,465,312
)
                     
Basic and diluted net loss per share
 
$
(0.17
)
$
(0.40
)
$
(2.90
)
Weighted average common shares outstanding
   
17,861,987
   
16,247,299
   
14,277,316
 
                     
See notes to unaudited interim financial statements
 
 
AXION POWER INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(A Development Stage Company)
UNAUDITED
 
   
Three Months Ended
March 31,
 
Inception
(9/18/2003) to
 
   
2008
 
2007
 
3/31/2008
 
               
Cash Flows from Operating Activities:
             
Deficit accumulated during development stage
 
$
(2,679,192
)
$
(1,265,980
)
$
(28,649,062
)
Adjustments required to reconcile deficit
                   
accumulated during development stage to cash flows
                   
used by operating activities
                   
Depreciation
       
29,896
   
414,592
 
Impairment of assets
   
-
   
-
   
1,391,486
 
Non-cash interest expense
   
307,493
   
3,499
   
1,269,865
 
Derivative revaluations
   
(2,844
)
 
-
   
362,508
 
Equity instruments issued for services
   
150,058
   
7,108
   
3,638,852
 
Mega C Trust Share Augmentation (Return)
   
-
   
138,188
   
400,000
 
Changes in Operating Assets & Liabilities
               
-
 
Accounts receivable
   
(22,467
)
 
(38,085
)
 
(162,984
)
Other receivables
   
6,480
   
(465,753
)
 
(313,360
)
Prepaid expenses
   
(13,517
)
 
36,022
   
(93,032
)
Inventory
   
(100,281
)
 
(40,404
)
 
(475,916
)
Accounts payable
   
(689,598
)
 
(351,725
)
 
2,538,482
 
Other current liabilities
   
605,725
   
(287,492
)
 
1,210,447
 
Deferred revenue
   
(24,734
)
 
447,504
   
816,211
 
Liability to Issue equity Instruments
   
-
   
6,546
   
178,419
 
Net cash used by operating activities
   
(2,401,766
)
 
(1,780,676
)
 
(17,473,492
)
                     
Cash Flows from Investing Activities
                   
Investments in notes receivable
   
-
   
-
   
(1,217,016
)
Purchase of property & equipment
   
(294,567
)
 
(284,589
)
 
(2,676,534
)
Investment in intangible assets
   
-
   
-
   
(167,888
)
Net cash used by investing activities
   
(294,567
)
 
(284,589
)
 
(4,061,438
)
                     
Cash Flow from Financing Activities
                   
Proceeds from related party debt
   
92,315
   
(9,509
)
 
6,755,571
 
Proceeds from sale of common stock; net of costs
   
3,626,000
   
-
   
7,343,405
 
Proceeds from exercise of warrants
   
-
   
-
   
1,655,500
 
Proceeds from sale of preferred stock, net of costs
   
-
   
390,500
   
7,472,181
 
Net cash provided by financing activities
   
3,718,315
   
380,991
   
23,226,657
 
                     
Net Change in Cash and Cash Equivalents
   
1,021,982
   
(1,684,274
)
 
1,691,727
 
Effect of Exchange Rate on Cash
   
(3,253
)
 
5,422
   
(1,754
)
Cash and Cash Equivalents - Beginning
   
671,244
   
3,610,280
   
-
 
Cash and Cash Equivalents - Ending
 
$
1,689,973
 
$
1,931,428
 
$
1,689,973
 
                   
See notes to unaudited interim financial statements
 

  AXION POWER INTERNATIONAL, INC.
(A Development Stage Company)
NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
 
1.   Basis of Presentation
 
The unaudited interim financial statements presented herein have been prepared in accordance with the accounting policies described in Axion Power International, Inc.’s Annual Report on Form 10-KSB for the year ended December 31, 2007 and should be read in conjunction with the Notes that appear in that report. Unless otherwise noted the terms “the Company,” “our Company,” “we,” “us,” and “our” refer to Axion Power International, Inc. and its subsidiaries. These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries Axion Power Corporation (“APC”), Axion Power Battery Manufacturing Inc. (“APB”) and C&T Co. Inc. (“C&T”).
 
In the opinion of management, the information furnished in this Form 10-Q reflects all adjustments necessary for a fair statement of the financial position and results of operations and cash flows as of and for the three month periods ended March 31, 2008 and 2007, as well as the cumulative period from inception through March 31, 2008. Certain adjustments are of a normal recurring nature. Operating results for the interim period are not necessarily indicative of results expected for the full year.

2.   New Accounting Policies and Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “ Fair Value Measurements ” (“SFAS 157”) which establishes a framework for measuring fair value, and expands disclosures about fair value measurements. While SFAS 157 does not apply to transactions involving share-based payment covered by Statement of Financial Accounting Standards No. 123 “ Accounting for Stock Based Compensation” (“SFAS 123”) it establishes a theoretical framework for analyzing fair value measurements that is absent from No. 123. We have relied on the theoretical framework established by SFAS 157 in connection with certain valuation measurements that were made in the preparation of these financial statements. SFAS 157 is effective for years beginning after November 15, 2007. Subsequent to the Standard’s issuance, the FASB issued an exposure draft that provides a one year deferral for implementation of the Standard for non-financial assets and liabilities. The adoption of SFAS 157 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In February 2007, Statement of Financial Accounting Standards No. 159, “ The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115 ,” (“SFAS 159”), was issued. This standard allows a company to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities on a contract-by-contract basis, with changes in fair value recognized in earnings. The provisions of this standard are effective as of the beginning of our fiscal year 2008, with early adoption permitted. The adoption of SFAS 159 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), Business Combinations and Statement of Financial Accounting Standards No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS 141(R)” and “SFAS 160”, respectively). These new standards will significantly change the accounting for and reporting of business combinations and non-controlling (minority) interests in consolidated financial statements. SFAS 141(R) and SFAS 160 are required to be adopted simultaneously and are effective for the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently evaluating the impact of adopting SFAS 141(R) and SFAS 160 on its consolidated financial statements.

In December 2007, the Commission issued Staff Accounting Bulletin No. 110 (“SAB 110”). SAB 110 permits companies to continue to use the simplified method, under certain circumstances, in estimating the expected term of “plain vanilla” options beyond December 31, 2007. SAB 110 updates guidance provided in Staff Accounting Bulletin No. 107 that previously stated that the Commission would not expect a company to use the simplified method for share option grants after December 31, 2007. The Company will continue to use the simplified method until it has sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term of its options.
 

3.   Warrants:     The following table provides summary information on warrants outstanding as of March 31, 2008, including the 301,700 incompletely exercised warrants that were issued in escrow to facilitate a stock sale. 3 ,405 5-year warrants were issued to accredited investors in conjunction with the financing of debt issued during 2008. See the “Recent Financing Activities” footnote below.     In January 2008, 380,952 5-year warrants were issued in partial payment of a NASDA broker commission for services related to the securities purchase by the Quercus Trust (“Quercus”). These $2.60 warrants valued at $354,852 are scheduled to expire in January 2013. Additionally, 2,857,143 warrants were issued to Quercus in connection with the purchase of units comprised of one share of the Company’s common stock and a warrant, to purchase an additional 1.5 shares of the Company’s stock as discussed in “Recent Financing Activities” below.

     
Shares
   
Weighted average
exercise price
   
Weighted average
remaining contract
term (years)
 
Warrants outstanding at December 31,2007  
   
2,588,391
 
$
4.39
   
2.1
 
Granted
   
3,241,500
 
$
2.60
   
5.0
 
Exercised  
   
-
 
$
-
       
Forfeited or lapsed  
   
(473,500
)
$
2.00
   
0
 
Warrants outstanding at March 31, 2008
   
5,356,391
 
$
3.52
   
3.5
 
 
4.   Equity Compensation

In December 2004, the Financial Accounting Standards Board issued FASB 123R, “ Share-Based Payment” (“SFAS 123R”). SFAS 123R supersedes SFAS 123, and Accounting Principles Board Opinion 25, “ Accounting for Stock Issued to Employees” (“APB 25”) and its related implementation guidance. On January 1, 2006, the Company adopted the provisions of SFAS 123R using the modified prospective transition method. Under this method, compensation expense is recorded for all stock based awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding as of the beginning of the adoption. Prior periods have not been restated for the effects of SFAS 123R. Under SFAS 123R, employee-compensation expense related to stock based payments are recorded over the requisite service period based on the grant date fair value of the awards.
 
The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of EITF 96-18, “ Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services ” and EITF 00-18 “ Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees .” The measurement date for fair value of the equity instruments is determined by the earlier of (i) the date at which commitment for performance by the vendor or consultant is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.

The Company has adopted an incentive stock option plan covering an aggregate of 2,000,000 shares of common stock that authorizes a variety of awards including incentive stock options, non-qualified stock options, shares of restricted stock, shares of phantom stock and stock bonuses. The Company has also adopted an outside directors’ stock option plan covering an aggregate of 500,000 shares of common stock which provides that each eligible director will automatically be granted an option to purchase shares having an aggregate fair market value on the date of grant of twenty thousand dollars ($20,000) for each year of his term in office. From time to time, based on the recommendations of the compensation committee of the board of directors, the Company enters into non-plan equity incentive agreements with officers, employees, attorneys and third party consultants.
 
During the three months ended March 31, 2008, the Company issued a total of 30,000 non-plan stock options as follows:
 
In February 2008, Andrew Carr Conway Jr., the Chief Financial Officer of the Company, was granted an option to purchase 30,000 shares of common stock at an exercise price of $4.50 as compensation for services related to the extension of his 2007 employment contract. These options vest ratably through May 2008, and are valued at $15,465 utilizing the Black-Scholes-Merton option pricing model.
 


The assumptions noted in the following table were used for the options granted for the period ended March 31, 2008.
 
Risk-free interest rate
   
4.2
%
Dividend yield
   
0
 
Expected volatility
   
53.0
%
Expected term (in years)
   
2.0
 
 
The compensation cost that has been charged against income for options was $61,583 for the period ended March 31, 2008. The impact of this expense was to increase basic and diluted loss per share by $0.003 for period ended March 31, 2008. The adoption of SFAS 123R did not have an impact on cash flows from operating or financing activities.
 
A tax deduction is not allowed for non-qualified stock options until the options are exercised. The amount of this deduction will be the difference between the fair value of the Company’s common stock and the exercise price at the date of exercise. Accordingly, there is a deferred tax asset recorded related for the tax effect of the financial statement expense recorded. The tax effect of the income tax deduction in excess of the financial statement expense will be recorded as an increase to additional paid-in capital. Due to the uncertainty of the Company’s ability to generate sufficient taxable income in the future to utilize the tax benefits of the options granted, the Company has recorded a valuation allowance to reduce gross deferred tax asset to zero. As a result for the period ended March 31, 2008, there is no income tax expense impact from recording the fair value of options granted. There is no tax deduction allowed by the Company for incentive stock options.
 
The following table provides summary information on all outstanding options as of March 31, 2008, based on the grant date for options.
 
     
Shares
   
Weighted
average
exercise price
   
Weighted
average
fair value
   
Weighted average remaining contract
term (years)
   
Aggregate
intrinsic
value
 
Options outstanding at December 31,2007  
   
1,850,885
 
$
4.81
 
$
1.00
   
2.7
 
$
0
 
Granted   
   
30,000
   
4.50
   
0.52
   
2.0
   
0
 
Exercised  
   
-
   
0.00
   
0.00
   
-
   
0
 
Forfeited or lapsed  
   
-
   
0.00
   
0.00
   
-
   
0
 
Options outstanding at March 31, 2008
   
1,880,885
   
4.81
   
1.00
   
2.5
 
$
18,000
 
Options exercisable at March 31, 2008
   
1,493,385
   
4.87
   
0.93
   
1.8
 
$
6,000
 
 
The weighted-average grant date fair value of options granted during the period ended March 31, 2007 was $1.33. The total intrinsic value of options exercised during the period ended March 31, 2007 was $0.00.

The following table provides summary information on all non-vested stock options as of March 31, 2008
 
     
All Plan & Non-Plan Compensatory Options
 
     
 Shares
   
Weighted average grant date fair value
 
Options subject to future vesting at December 31,2007
   
408,500
 
$
1.25
 
Options granted
   
30,000
 
$
0.52
 
Options forfeited or lapsed
   
-
 
$
0.00
 
Options vested
   
(51,000
)
$
0.88
 
Options subject to future vesting at March 31, 2008
   
387,500
 
$
1.24
 

As of March 31, 2008, there was $480,158 of unrecognized compensation related to non-vested options granted under the plans. The Company expects to recognize the cost over a weighted average period of 1.1 years. The total fair value of options which newly vested during the period ended March 31, 2008 was $45,083 ($124,030 during the comparable period ended March 31, 2007).  
 

5.   Earnings/Loss Per Share
 
Basic earnings per share is computed by dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) for the period. Diluted earnings per share is computed by assuming that any dilutive convertible securities outstanding were converted, with related preferred stock dividend requirements and outstanding common shares adjusted accordingly. It also assumes that outstanding common shares were increased by shares issuable upon exercise of those stock options for which the market price exceeds the exercise price, less shares which could have been purchased by us with the related proceeds. In periods of losses, diluted loss per share is computed on the same basis as basic loss per share as the inclusion of any other potential shares outstanding would be anti-dilutive.
 
If the Company had generated earnings during the three months ended March 31, 2008, the Company would have added 9,245,438 common equivalent shares to the weighted average shares outstanding to compute the diluted weighted average shares outstanding. If the Company had generated earnings during the three months ended March 31, 2007, the Company would have added 8,938,726 common equivalent shares to the weighted average shares outstanding to compute the diluted weighted average shares outstanding.

6.   Comprehensive Income and Significant Non-Cash Transactions
 
Statement of Financial Accounting Standard No. 130, “ Reporting Comprehensive Income ,” establishes standards for reporting comprehensive income and its components in a financial statement. Comprehensive income as defined includes all changes in equity (net assets) during a period from non-owner sources.
 
The components of comprehensive loss for the period ended March 31, 2008 and 2007 are as follows:
   
 
2008
 
2007 
 
Deficit accumulated during development stage  
 
$
(2,966,607
)
$
(6,549,072
)
Foreign currency translation adjustment  
 
$
(3,253
)
$
5,423
 
Comprehensive Income/(loss)  
 
$
(2,969,860
)
$
(6,543,649
)
 
The following table provides summary information on our significant non-cash investing and financing transactions during the three month periods ended March 31, 2008 and 2007.

 
 
2008
 
2007
 
Satisfaction of 2007 liability to issue equity instruments
 
$
103,339
 
$
-
 
Preferred Dividends attributable to warrant modifications
 
$
-
 
$
164,179
 
Dividend accrued to preferred stock - Senior
 
$
34.319
 
$
31,678
 
Dividend accrued to preferred stock - Series A
 
$
253,096
 
$
412,270
 
Warrants issued for commission on sale of preferred
 
$
-
 
$
53,230
 
Beneficial conversion feature on preferred stock
 
$
-
 
$
4,839,143
 
Fair value of warrants issued with related party note
 
$
3,153
 
$
6,546
 
Origination fees issued with related party note
 
$
7,500
 
$
-
 
Notes payable to converted to common stock
 
$
223,984
 
$
-
 
 
7 .     Commitments and Contingencies

Employment Agreements: The Company is currently negotiating contract extensions, on new terms, for the Chief Executive Officer, Chief Technology Officer and several other key employees. The Company’s Chief Executive Officer, Chief Financial Officer, Vice President and Chief Technology Officer and Vice President of Manufacturing Engineering have each executed written employment agreements with the terms set forth in the following table.

 
Name
 
Position
 
Date
 
Term
 
Salary
 
Options
 
Price
 
Vesting
 
Thomas Granville (1)
 
 
CEO
 
 
4/4/05
 
 
24 Months
 
$
261,000
 
 
180,000
 
$
2.50
 
 
Monthly
 
Dr. Edward Buiel (2)
 
 
VP and CTO
 
 
9/1/05
 
 
36 Months
 
$
168,000
 
 
100,000
 
$
3.75
 
 
Monthly
 
 
Andrew Carr Conway, Jr. (3)
 
 
CFO
 
 
8/31/07
 
 
6 months
 
$
180,000
 
 
80,000
 
$
4.50
 
 
Monthly
 
Dr. Robert Nelson (4)
 
 
VP Mfg. and Eng.
 
 
12/1/07
 
 
24 Months
 
$
132,000
 
 
108,000
 
$
5.00
 
 
Monthly
 
 
(1) Thomas Granville’s employment agreement was automatically extended for another 24 months through April 2009 based on the terms of the agreement. The terms in the agreement did not change.

(2) In December 2006, Mr. Buiel was promoted to the post of Vice President and Chief Technology Officer. Pursuant to his promotion, a new employment agreement was approved retroactive to October 2006 in which Mr. Buiel receives an annual salary of $168,000 and bonuses as determined by the compensation committee. In addition, Mr. Buiel receives an option to purchase 100,000 shares of our common stock at a price of $3.75 per share that vest over two years commencing December 2008 and 250,000 shares of restricted common stock that fully vest in December 2009.

(3) On August 31, 2007, the Company entered into a 6 month service contract with Andrew Carr Conway, Jr. to fill the position of Chief Financial Officer. The contract automatically renewed for an additional six month term when the initial six months expired with the same terms and conditions. The agreement calls for $180,000 of annualized salary, and the issuance of 80,000 options to purchase shares of common stock for $4.50 with an exercise period of 2 years. An additional 30,000 options were awarded during the first quarter of 2008 in consideration for the extension of his original agreement. All of his original options, including the recent grant, have vested. Mr. Conway is also entitled to whatever additional fees and bonuses may be authorized by the Compensation Committee of the board of directors.

(4) Dr. Nelson’s employment agreement also provides for a stock grant at a vesting rate of 1,000 shares per month with immediate vesting in the event of a change in control or the acquisition of 20% or more of the Company’s voting securities.

8   Related Parties

Options and Warrants: In conjunction with loan obligations carried over from 2007, the Company satisfied the remainder of its obligations to issue 397,750 warrants to two of its directors. Because of the delay in processing, these 3 year $6.00 warrants are being issued with an expiration date of March 31, 2011. Due to lower stock prices the modification of these instruments resulted in a net decrease in fair value of these instruments. Decreases in fair value of embedded options resulting from a modification should not be recognized and accordingly are not reflected on the Company’s financial statements.

Interest Expense: Interest expense recognized for the period ended March 31, 2008 in connection with certain notes payable to related parties amounted to $340,997. Of this total $98,688 relates to the interest coupon and $242,309 to the amortization of note discount associated with loan origination fees and detachable warrants. An additional $78,676 in interest is reported under the related party caption on the face of the financial statement due to certain associations of four accredited investors to related parties.

9   Recent Financing Activities
 
As further described below, in January, Quercus entered into a funding agreement with us that obligated it to invest $18,000,000 over a five month period if we achieved certain milestones. We have already received $8.0 million, which should enable us to conduct operations through March 30, 2009. Based on our projections for increased revenues for the next 12 months and assuming the closing of the final equity financing transaction with Quercus totaling $10.0 million, we believe that our available cash will provide sufficient cash resources to finance our operations and expected capital expenditures over the next 18 months. To obtain the remaining $10.0 million, we are obligated to meet one additional milestone that we anticipate will occur sometime before June 30, 2008. The proceeds of this $10 million investment will be deployed for the purchase of previously approved equipment and for general operating purposes. If we do not significantly increase our revenues to meet our projections, obtain the final Quercus closing or obtain additional financing within the next 12 months, we will likely be unable to implement our business plan, fund our liquidity needs or even continue our operations beyond that time. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, most likely will result in dilution to our stockholders.

In November of 2007 we began discussions related to a bridge loan offer with our directors, officers, and significant investors. We eventually structured a short term secured bridge loan arrangement in increments of $100,000, such loans to bear interest at the rate of 14% and were secured by all of our assets, including our intellectual property and all of the equipment and inventory assets of our wholly-owned subsidiary, Axion Power Battery Manufacturing Inc. Total funding received under the secured bridge loan as of December 31, 2007 amounted to approximately $2,540,000, with an additional funding of $100,000, received in January of 2008, bringing the entire loan total to approximately $2,640,000.
 
The bridge loan had an original maturity date of March 31, 2008, with three extensions of the maturity date at the option of the Company, with higher interest rates to apply to each such extension. On March 31, 2008, we sent notice to the investors of our intention to extend the loan until April 30, 2008. In accordance with the option terms contained in the loan agreement, three of the investors chose to convert a total of $328,984 into equity under the same terms offered to Quercus. The extension entitled the remaining investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 15%. On April 29, 2008, we sent notice to the investors of our intention to extend the loan until May 31, 2008. The extension entitles investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 16%. If extended to June 30, 2008, the interest rate during the extension period increases to 18% with an extension fee equal to 2% of the original loan. A loan origination fee was paid equal to 8% of the original loan. The origination fee decreased by one-half percent each week after December 15, 2007 until the loan closed on January 7, 2008. Warrants exercisable at $2.35 until December 31, 2012 are included. For each $100,000 increment, in the secured bridge loan note, the investor will be issued warrants as follows: 3,405 warrants upon occurrence of the secured bridge loan, 851 additional warrants upon extension of the loan to April 30, 2008, 1,276 additional warrants upon extension of the loan to May 31, 2008 and 2,128 additional warrants upon extension to June 30, 2008. Typical anti-dilution provisions apply to the warrants as well as registration rights.
 
As the secured bridge loan financing will mature no later than June 30, 2008, if not for the financing provided by Quercus, described below, we would not have had sufficient capital to pay our day-to-day operating costs, finance our research and development, cover costs associated with our manufacturing activities, pay for the development of a sales and marketing organization and finance the acquisition of complimentary assets, technologies and businesses.
 
On January 14, 2008, we entered into the Securities Purchase Agreement with Quercus, pursuant to which we agreed to issue to Quercus up to 8,571,429 shares of our common stock, together with common stock purchase warrants that will entitle the holder to purchase up to 10,000,000 additional shares of our common stock.
 
At the initial closing on January 14, 2008, we issued and sold 1,904,762 units (a unit is one share of common stock and a five-year warrant to purchase 1.5 additional shares of common stock at an exercise price of $2.60 per share) issuable to Quercus for an aggregate purchase price of $4.0 million, or $2.10 per unit.
 
At the second closing on April 7, 2008, Quercus purchased 1,904,762 additional units (a unit consisting of one share of common stock and a five-year warrant to purchase 1.25 additional shares of common stock at an exercise price of $2.60 per share) issuable to Quercus for an aggregate purchase price of $4.0 million.
 
For the final closing, Quercus has agreed to make an additional investment of $10.0 million on or before June 30, 2008, upon our execution of one or more qualifying contracts that satisfy certain requirements set forth in the Securities Purchase Agreement. There is no assurance that we will be able to satisfy this condition. Upon the occurrence of the final closing, Quercus has agreed to purchase an additional 4,761,905 units for $10.0 million. Each unit issued in the final closing will consist of one share of common stock and a five-year warrant to purchase one additional share of common stock at an exercise price of $2.60 per share.
 

The warrants contain conventional anti-dilution provisions for adjustment of the exercise price in the event we issue additional shares of our common stock or securities convertible into common stock (subject to certain specified exclusions) at a price less than $1.00 per share.
 
10 .     Subsequent Events

Quercus Trust Investment: As discussed under “Recent Financing Activities” above, in the second closing (the “Second Quercus Closing”), which occurred on April 7, 2008, Quercus purchased 1,904,762 additional units for $4,000,000. Each Quercus Second Closing unit consists of one share of common stock, and a 5-year warrant to purchase 1.25 additional shares of common stock at an exercise price of $2.60 per share.

Secured Bridge Loan Financing: As discussed under “Recent Financing Activities”, on March 31, 2008 and then again on April 30, 2008, the Company sent notice to the investors of its intention to extend the loan until April 30, 2008, and May 31, 2008, respectively. The extension entitles the investors to earn an extension fee of 1% of the original loan on each extension date. With the March 31, 2008 extension, the investors earned interest on principal plus interest, accrued through the extension date, at an annual rate of 15%. The April extension increased the annual interest rate to 16%. Warrants exercisable at $2.35 until December 31, 2012 are included with each $100,000 of principal invested. Warrants issuable under the extensions are as follows: 851 warrants upon extension of the loan to April 30, 2008, 1,276 additional warrants upon extension of the loan to May 31, 2008. During April 2008, three investors in the bridge loan converted $328,984, into 156,659 shares of the Company’s common stock; the remaining $106,000 was repaid and not extended into May.
 


AZION POWER
 
2,615,490 Shares of Common Stock
 
61
 
PART II – INFORMATION NOT REQUIRED IN PROSPECTUS
 
Item 13. Other Expenses of Issuance and Distribution
 
We estimate that our expenses in connection with this offering, other than underwriting discounts and commissions, will be as follows:
 
Securities and Exchange Commission registration fee
 
$
726.73
 
Printing and engraving expenses
 
$
1,000.00
 
Legal fees and expenses
 
$
50,000.00
 
Accountant fees and expenses
 
$
8,500.00
 
Total
 
$
60,226.73
 

Item 14. Indemnification of Directors and Officers
 
Section 102 of the Delaware General Corporation Law (the “DGCL”) allows a corporation to eliminate the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except where the director breached his or her duty of loyalty to the corporation or its stockholders, failed to act in good faith, engaged in intentional misconduct or knowingly violated a law, authorized the payment of a dividend or approved a stock purchase or redemption in violation of the DGCL or obtained an improper personal benefit.
 
Our Certificate of Incorporation specifically limits each director’s personal liability, as permitted by Section 102 of the DGCL, and provides that if it is hereafter amended to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of the corporation shall be eliminated or limited to the fullest extent permitted by the DGCL as so amended.
 
Section 145 of the DGCL provides, among other things, that a corporation may indemnify any and all persons whom it shall have power to indemnify under said section from and against any and all of the expenses, liabilities, or other matters referred to in or covered by said section, and the indemnification provided for herein shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any by-law, agreement, vote of stockbrokers or disinterested directors of otherwise both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee, or agent and shall inure to the benefit of the heirs, executors, and administrators of such a person. Our Certificate of Incorporation provides for indemnification of our directors, officers, employees and agents to the fullest extent permitted by the DGCL.
 
Item 15. Recent Sales of Unregistered Securities
 
Since June 30, 2005, Axion has issued and sold the following securities:
 
Equity Transactions –Year ended December 31, 2005:
 
In February 2005, the board of directors designated 1,000,000 shares of preferred stock as Senior Preferred Stock. The Company sold 385,000 shares of Senior Preferred Stock at a price of $10 per share to C&T and its stockholders. The net proceeds of the offering included $2,754,110 in cash and $1,000,000 in liability conversion. In connection with the sale, the Company issued 282,500 warrants to certain of the purchasers. In March 2005, the Company issued 228,500 additional warrants to the purchasers of $2,285,000 of Senior Preferred Stock.
 
Holders of Senior Preferred Stock have the right to convert their shares into common stock at any time, at an original conversion price of $2.00. The Company was required to register the underlying shares by April 30, 2005. The shares were not registered until June 2005 and as a result the conversion price was reduced to $1.86 per share. This reduction in the conversion price resulted in an additional beneficial conversion feature, valued at the fair value of the additional common shares issuable as a result of the reduced conversion price, amounting to $433,228.
 
Common stock private placement activities during the year ended December 31, 2005 were as follows:
 
 
·
The Company sold 600,000 units to two related parties and four unaffiliated accredited investors, each consisting of one share of common stock and a two-year warrant exercisable at $4.00 for a purchase price of $2.00 per unit, or $1,200,000, before offering costs.
 
 
 
·
A director exercised 446,000 - $1 warrants/options and 25,000 - $2 options with a total exercise price of $496,000.
 
 
·
Other holders exercised 382,665 options and warrants for 382,665 shares of common stock with an aggregate exercise price of $787,395.
 
Equity Transactions –Year ended December 31, 2006:
 
On October 18, 2006, the Company’s board of directors designated, from the Company’s total authorized 12,500,000 shares, a new series of preferred stock consisting of up to 2,000,000 shares designated Series A Preferred Stock. During the fourth quarter of 2006, the Company sold an aggregate of 782,997 shares of Series A Preferred Stock at a price of $10 per share for net proceeds of $7,722,470. The shares of Series A Preferred Stock are convertible at the option of the holders of record at an initial conversion price of $1.25 per share.
 
The common stock transactions during the year ended December 31, 2006 are as follow:
 
 
·
Two unaffiliated individual accredited investors purchased a total of 80,000 units for a purchase price of $2.50 per unit or $200,000. Each unit consists of one share of common stock and one common stock purchase warrant with an exercise price of $4.00 per share. The warrants are exercisable up until the first anniversary of the effective date of the common stock registration statement and were valued at $26,354 on the date of issuance
 
 
·
The Company’s chief executive officer exercised his $2.00 warrants to purchase 56,700 shares for $113,400
 
 
·
The Company’s chief technical officer received 6,000 unrestricted shares, valued at $24,000, pursuant to his 2005 employment contract and an additional 250,000 restricted shares, valued at $937,500, pursuant to his 2006 employment contract. The 250,000 shares will become fully vested on December 28, 2009. The expense related to these shares will be recognized over this three-year requisite service period and the shares will be considered issued and outstanding upon vesting.
 
741,613 warrants were issued to related parties   in conjunction with the financing of debt issued during 2006. In April 2006, the Company’s chief executive officer exercised his $2.00 warrants to purchase 56,700 shares of common stock for $113,400. In October 2006, 200,000 3-year warrants were issued to Cypress in payment for consulting services. These $3.00 warrants valued at $74,437 are scheduled to expire in October 2009. In December 2006, a former director of the Company received 9,000 $6.00 warrants valued at $12,411, and are scheduled to expire December 29, 2010. Additionally, 80,000 warrants were issued to accredited investors in connection with a private placement of units comprised of one share of the Company’s common stock and one stock purchase warrant, as discussed above.
 
During 2006, 782,997 shares of Series A Preferred Stock were issued to four related parties and ten unaffiliated accredited investors at a purchase price of $10.00 per share for aggregate proceeds to the Company of $7,829,970.
 
Equity Transactions - Year ended December 31, 2007:
 
During 2007, 40,000 shares of Series A Preferred Stock were issued to two unaffiliated accredited investors at a purchased price of $10.00 per share for aggregate proceeds to the Company of $40,000.
 
Equity Transactions - Six-month period ended June 30, 2008:
 
At the second Quercus closing on April 8, 2008, we issued and sold 1,904,762 second closing units (a unit is one share of common stock, and a 5-year warrant to purchase 1.25 additional shares of common stock at an exercise price of $2.60 per share) issuable to Quercus for an aggregate purchase price of $4,000,000, or $2.10 per Unit.
 
On April 21, 2008, two accredited investors under the terms of their 2007 Bridge Loan agreement, converted $105,000 of their Bridge Loans to purchase 50,000 second closing units under the same terms and conditions as was offered to Quercus, at $2.10 per Unit.
 
On May 6, 2008, one accredited investor under the terms of the 2006 Series A Preferred private placement offering, converted 50,000 preferred shares with a stated value of $629,432 to purchase 503,546 shares of the Company’s common stock at the stated conversion price of $1.25 per share.
 
On May 29, 2008, a director under the terms of his 2007 Bridge Loan agreement, converted $4,200 of his Bridge Loan to purchase 2,000 second closing units under the same terms and conditions as was offered to Quercus, at $2.10 per Unit.
 
At the third and final Quercus closing on June 30, 2008, we issued and sold 4,761,905 third closing units (a unit is one share of common stock, and a 5-year warrant to purchase 1 additional shares of common stock at an exercise price of $2.60 per share) issuable to Quercus for an aggregate purchase price of $10,000,000, or $2.10 per Unit.
 
On June 30, 2008, a director under the terms of his 2007 Bridge Loan agreement, converted $800.000 of his Bridge Loan to purchase 380,952 third closing units under the same terms and conditions as was offered to Quercus, at $2.10 per Unit.
 
During the first 6 months of 2008, an officer vested in 6,000 shares of his 2007 restricted stock award.
 
II-2
 
Common Stock Issuances : The following table represents per share issuances of common stock from May 1, 2005 through March 31, 2008.
 
2005
                 
                   
Description:
 
Date
 
Shares
 
Per share
valuation
 
Business reason:
 
                   
7 individuals
   
6/10/2005
   
29,565
 
$
3.57
   
Exercise of Director options
 
                           
3 individuals
   
7/11/2005
   
190,000
 
$
1.58
   
Conversion of Preferred and accrued dividends
 
                       
 
 
Banca di Unionale
   
7/11/2005
   
10,000
 
$
1.60
   
Exercise of preferred warrants
 
                           
3 individuals
   
8/28/2005
   
150,000
 
$
1.67
   
Conversion of Preferred and accrued dividends
 
                       
 
 
James Smith
   
9/7/2005
   
30,000
 
$
1.67
   
Conversion of Preferred and accrued dividends
 
                       
 
 
2 individuals
   
9/28/2005
   
1,050,000
 
$
1.69
   
Conversion of Preferred and accrued dividends
 
                           
2 individuals
   
various
   
226,900
 
$
1.79
   
Exercise of Series I warrants
 
                       
 
 
3 individuals
   
various
   
91,200
 
$
2.40
   
Exercise of Series III warrants
 
                       
 
 
2 individuals
   
various
   
25,000
 
$
1.60
   
Exercise of Preferred warrants
 
                       
 
 
Officer
   
10/20/2005
   
446,000
 
$
1.00
   
Exercise of warrants and options
 
                       
 
 
Officer
   
10/20/2005
   
25,000
 
$
2.00
   
Exercise of warrants
 
                           
6 individuals
   
12/1/2005
   
600,000
 
$
2.00
   
Common stock and warrants
 
                       
 
 
2005 Totals
   
 
   
3,642,665
 
$
1.94
   
 
 
                           
2006
                     
 
 
                           
2 individuals
   
4/21/06
   
80,000
   
2.50
   
Common stock and warrants issued for cash
 
                       
 
 
Officer
   
4/21/06
   
56,700
   
2.00
   
Exercise of non-plan incentive option granted to CEO
 
                       
 
 
Officer
   
4/21/06
   
6,000
   
4.00
   
Unrestricted share grant to CTO
 
                           
Mega-C Trust
   
11/28/06
   
(500,000
)
 
2.25
   
Return of shares per settlement agreement
 
                       
 
 
2006 Totals
         
(357,300
)
$
2.20
   
 
 
 
II-3
 
2007
                     
 
 
                           
Officer
   
12/01/07
   
1,000
   
2.30
   
Unrestricted share grant to VP Mfg Engineering
 
                           
2007 Totals
   
 
   
1,000
 
$
2.30
   
 
 
 
2008
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The Quercus Trust
   
1/14/2008
   
1,904,762
   
2.10
   
Securities purchase agreement
 
                           
1 individual
   
3/31/2008
   
106,659
   
2.10
   
2007 Bridge Loan Conversion
 
                           
V.P. Mfg Engineering
   
3/31/2008
   
3,000
   
2.30
   
Unrestricted share Grant- 1 st Qtr
 
                           
V.P. Mfg Engineering
   
4/01/2008
   
3,000
   
2.30
   
Unrestricted share Grant -2 nd Qtr
 
                           
The Quercus Trust
   
4/08/2008
   
1,904,762
   
2.10
   
Securities purchase agreement
 
                           
2 individuals
   
4/21/2008
   
50,000
   
2.10
   
2007 Bridge Loan Conversion
 
                           
Lichtensteiniche Landsbank
   
5/06/2008
   
503,546
   
1.25
   
Series A Preferred Conversions
 
                           
Director
   
5/29/2008
   
2,000
   
2.10
   
2007 Bridge Loan Conversion
 
                           
The Quercus Trust
   
6/30/2008
   
4,761,905
   
2.10
   
Securities purchase agreement
 
                           
Director
   
6/30/2008
   
380,952
   
2.10
   
2007 Bridge Loan Conversion
 
                           
2008 Totals (as of June 30)
       
9,620,586
 
$
2.06
     
 
During 2007, 397,750 warrants were to be issued to related parties in conjunction with the financing of debt. See the “Related Party” footnote above. Because of a delay in processing, these 3-year $6.00 warrants issued on March 31, 2008 are being issued with an expiration date of March 31, 2011. The following table provides summary information on warrants outstanding as of December 31, 2007, including the 301,700 warrants that were issued in escrow to facilitate the pending stock sale described above. The table provides summary information on the various warrants issued by the Company in private placement transactions; the warrants exercised to date; the warrants that are presently exercisable and the current exercise prices of such warrants.
 
All of the above equity transactions were made in reliance on Section 4(2) of the Securities Act and/or Regulation D promulgated under the Securities Act.
 
Item 16. Exhibits and Financial Statement Schedules
 
2.1
 
Reorganization Agreement (without exhibits) between Tamboril Cigar Company, Axion Power Corporation and certain stockholders of Axion Power Corporation dated December 31, 2003.
 
(1)
 
 
 
 
 
2.2
 
First Addendum to the Reorganization Agreement between Tamboril Cigar Company, Axion Power Corporation and certain stockholders of Axion Power Corporation dated January 9, 2004.
 
(1)
 
 
 
 
 
3.1
 
Amended and Restated Certificate of Incorporation of Tamboril Cigar Company dated February 13, 2001.
 
(2)
 
 
 
 
 
3.3
 
Amendment to the Certificate of Incorporation of Tamboril Cigar Company dated June 4, 2004.
 
(3)
 
 
 
 
 
3.4
 
Amendment to the Certificate of Incorporation of Axion Power International, Inc. dated June 4, 2004.
 
(3)
 
 
 
 
 
3.5
 
Amended By-laws of Axion Power International, Inc. dated June 4, 2004.
 
(3)
 
 
 
 
 
4.1
 
Specimen Certificate for shares of Company’s $0.00001 par value common stock.
 
(7)
 
 
 
 
 
4.2
 
Second Amended and Restated Trust Agreement for the Benefit of the Shareholders of Mega-C Power Corporation dated November 21, 2006.
 
**
 
 
 
 
 
4.3
 
Succession Agreement Pursuant to the Provisions of the Trust Agreement for the Benefit of the Stockholders of Mega-C Power Corporation dated March 25, 2004.
 
(4)
 
 
 
 
 
4.4
 
Form of Warrant Agreement for 1,796,300 capital warrants.
 
(7)
 
 
 
 
 
4.5
 
Form of Warrant Agreement for 667,000 Series I investor warrants.
 
(7)
 
 
 
 
 
4.6
 
Form of Warrant Agreement for 350,000 Series II investor warrants.
 
(7)
 
II-4
 
4.7
 
Form of Warrant Agreement for 313,100 Series III investor warrants.
 
(7)
 
 
 
 
 
4.8
 
Form of 8% Cumulative Convertible Senior Preferred Stock Certificate
 
(18)
         
4.9
 
First Amended and Restated Trust Agreement for the Benefit of the Stockholders of Mega-C Power Corporation dated February 28, 2005.
 
(8)
 
 
 
 
 
4.10
 
Certificate of Powers, Designations, Preferences and Rights of the 8% Convertible Senior Preferred Stock of Axion Power International, Inc. dated March 17, 2005.
 
(9)
 
 
 
 
 
4.11
 
Certificate of Powers, Designations, Preferences and Rights of the Series A Convertible Preferred Stock, Par Value $0.0001 Per Share, of Axion Power International, Inc. dated October 23, 2006.
 
(10)
 
 
 
 
 
4.12
 
Amended Certificate of Powers, Designations, Preferences and Rights of the Series A Convertible Preferred Stock, Par Value $0.0001 Per Share, of Axion Power International, Inc. dated October 26, 2006.
 
(10)
         
5.1
 
Opinion of Andrews Kurth LLP
 
*
 
 
 
 
 
9.1
 
Agreement respecting the voting of certain shares beneficially owned by the Trust for the Benefit of the Stockholders of Mega-C Power Corporation.
 
Included in Exhibit 4.2
 
 
 
 
 
10.1
 
Development and License Agreement between Axion Power Corporation and C and T Co. Incorporated dated November 15, 2003.
 
(1)
         
10.2  
Letter Amendment to Development and License Agreement between Axion Power Corporation and C and T Co. Incorporated dated November 17, 2003.
 
(1)
         
10.3   Tamboril Cigar Co. Incentive Stock plan Dated January 8, 2004  
(16)
         
10.4
 
Tamboril Cigar co. Outside Directors Stock Option Plan Dated February 2, 2004
 
(16)
         
10.5
 
Stock Purchase & Investment Representation Letter Dated January 9, 2004
 
(1)
 
 
 
 
 
10.6
 
First Amendment to Development and License Agreement between Axion Power Corporation and C and T Co. Incorporated dated as of January 9, 2004.
 
(5)
 
 
 
 
 
10.7
 
Definitive Incentive Stock Plan of Axion Power International, Inc. dated June 4, 2004.
 
(3)
 
 
 
 
 
10.8
 
Definitive Outside Directors’ Stock Option Plan of Axion Power International, Inc. dated June 4, 2004.
 
(3)
 
 
 
 
 
10.9
 
Executive Employment Agreement of Charles Mazzacato.
 
(7)
 
 
 
 
 
10.10
 
Executive Employment Agreement of Peter Roston.
 
(7)
         
10.11
 
Bankruptcy Settlement Agreement Between Axion Power International, Inc. and  Mega-C Dated December, 2005
 
(19)
 
II-5
 
10.12 
 
Second Amendment to Development and License Agreement between Axion Power International, Inc. and C and T Co. Incorporated dated as of March 18, 2005.
 
(9)
         
10.13
 
Executive Employment Agreement of Thomas Granville dated June 23, 2008.
 
(17)
         
10.14
 
Loan agreement dated January 31, 2006 between Axion Battery Products, Inc. as borrower, Axion Power International, Inc. as accommodation party and Robert Averill as lender respecting a $1,000,000 purchase money and working capital loan.
 
(11)
 
 
 
 
 
10.15
 
Security agreement dated January 31, 2006 between Axion Battery Products, Inc. as debtor and Robert Averill as secured party.
 
(11)
 
 
 
 
 
10.16
 
Security agreement dated January 31, 2006 between Axion Power International, Inc. as debtor and Robert Averill as secured party.
 
(11)
 
 
 
 
 
10.17
 
Promissory Note dated February 14, 2006 between Axion Battery Products, Inc. as maker and Robert Averill as payee.
 
(11)
 
 
 
 
 
10.18
 
Form of Warrant Agreement between Axion Power International, Inc. and Robert Averill.
 
(11)
 
 
 
 
 
10.19
 
Commercial Lease Agreement dated February 14, 2006 between Axion Battery Products, Inc. as lessee and Steven F. Hoye and Steven C. Warner as lessors.
 
(11)
 
 
 
 
 
10.20
 
Asset Securities Purchase Agreement dated February 10, 2006 between Axion Battery Products, Inc. as buyer and National City Bank of Pennsylvania as seller.
 
(11)
 
 
 
 
 
10.21
 
Escrow Agreement dated February 14, 2006 between Axion Battery Products, Inc. and National City Bank of Pennsylvania as parties in interest and William E. Kelleher, Jr. and James D. Newell as escrow agents.
 
(11)
 
 
 
 
 
10.22
 
Executive Employment Agreement of Edward Buiel dated June 23, 2008.
 
(12)
 
 
 
 
 
10.23
 
Consulting Agreement, dated as of September 27, 2007, by and between Axion Power International, Inc. and Andrew Carr Conway, Jr.
 
(13)
 
 
 
 
 
10.24
 
Amendment No. 1 to Consulting Agreement, dated as of October 31, 2007, by and between Axion Power International, Inc. and Andrew Carr Conway, Jr.
 
(13)
 
 
 
 
 
10.25
 
Securities Purchase Agreement dated as of January 14, 2008, by and between Axion Power International, Inc. and Selling Stockholder.
 
**
         
10.26
 
Common Stock Purchase Warrant dated January 14, 2008, executed by Axion Power International, Inc.
 
(14)
         
10.27
  Executive Employment Agreement of Donald T. Hillier dated June 18, 2008  
**
         
16.1
 
Letter from Want & Ender CPA, PC Re: Change in Certifying Accountant.
 
(6)
 
 
 
 
 
16.2
 
Letter from Freed Maxick & Battaglia, CPAs, PC, dated January 31, 2008.
 
(15)
 
 
 
 
 
21.1
 
List of Subsidiaries of Axion Power International, Inc.
 
***
         
23.1
 
Consent of Andrews Kurth LLP (included in Exhibit 5.1)
 
 
         
23.2
 
Consent of Rotenberg & Co., LLP
 
**
 
(1)
Incorporated by reference from our Current Report on Form 8-K dated January 15, 2004.
(2)
Incorporated by reference from our Current Report on Form 8-K dated February 5, 2003.
(3)
Incorporated by reference from our Current Report on Form 8-K dated June 7, 2004.
(4)
Incorporated by reference from our Current Report on Form 8-K dated April 13, 2004.
 
II-6
 
(5)
Incorporated by reference from our Form S-3 registration statement dated May 20, 2004.
(6)
Incorporated by reference from our Current Report on Form 8-K dated February 16, 2004.
(7)
Incorporated by reference from our Form S-1 registration statement dated September 2, 2004.
(8)
Incorporated by reference from our Current Report on Form 8-K dated February 28, 2005.
(9)
Incorporated by reference from our Current Report on Form 8-K dated March 21, 2005.
(10)
Incorporated by reference from our Current Report on Form 8-K dated November 8, 2006.
(11)
Incorporated by reference from our Current Report on Form 8-K dated February 16, 2006
(12)
Incorporated by reference from our Current Report on Form 8-K dated July 2, 2008.
(13)
Incorporated by reference from our Current Report on Form 8-K dated November 6, 2007.
(14)
Incorporated by reference from our Current Report on Form 8-K dated January 17, 2008.
(15)
Incorporated by reference from our Current Report on Form 8-K dated January 31, 2008.
(16)
Incorporated by reference from our Current Report on Form 8-K/A dated February 2, 2004.
(17)
Incorporated by reference from our Current Report on Form 8-K dated June 27, 2008.
(18)
Incorporated by reference from our Registration Statement on Form SB-2 dated April 26, 2005.
(19)
Incorporated by reference from our Current Report on Form 8-K dated December 30, 2005.

*To be filed by amendment.
**Filed herewith
*** Previously filed with the initial filing
 
Item 17. Undertakings
 
The undersigned registrant hereby undertakes:
 
1.
To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement:
 
 
i.
To include any prospectus required by section 10(a)(3) of the Securities Act;
 
 
ii.
To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement.
 
 
iii.
To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement.
 
2.
That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment 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.
 
3.
To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering.
 
4.
That, for the purpose of determining liability under the Securities Act to any purchaser:
 
 
i.
If the registrant is relying on Rule 430B (Section 430B of this chapter):
 
 
A.
Each prospectus filed by the registrant pursuant to Rule 424(b)(3)shall be deemed to be part of the registration statement as of the date the filed prospectus was deemed part of and included in the registration statement; and
 
II-7
 
 
B.
Each prospectus required to be filed pursuant to Rule 424(b)(2), (b)(5), or (b)(7) as part of a registration statement in reliance on Rule 430B relating to an offering made pursuant to Rule 415(a)(1)(i), (vii), or (x) for the purpose of providing the information required by section 10(a) of the Securities Act shall be deemed to be part of and included in the registration statement as of the earlier of the date such form of prospectus is first used after effectiveness or the date of the first contract of sale of securities in the offering described in the prospectus. As provided in Rule 430B, for liability purposes of the issuer and any person that is at that date an underwriter, such date shall be deemed to be a new effective date of the registration statement relating to the securities in the registration statement to which that prospectus relates, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such effective date, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such effective date; or
 
 
ii.
If the registrant is subject to Rule 430C, each prospectus filed pursuant to Rule 424(b) as part of a registration statement relating to an offering, other than registration statements relying on Rule 430B or other than prospectuses filed in reliance on Rule 430A, shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use.
 
5.
That, for the purpose of determining liability of the registrant under the Securities Act to any purchaser in the initial distribution of the securities: The undersigned registrant undertakes that in a primary offering of securities of the undersigned registrant pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser by means of any of the following communications, the undersigned registrant will be a seller to the purchaser and will be considered to offer or sell such securities to such purchaser:
 
 
i.
Any preliminary prospectus or prospectus of the undersigned registrant relating to the offering required to be filed pursuant to Rule 424;
 
 
ii.
Any free writing prospectus relating to the offering prepared by or on behalf of the undersigned registrant or used or referred to by the undersigned registrant;
 
 
iii.
The portion of any other free writing prospectus relating to the offering containing material information about the undersigned registrant or its securities provided by or on behalf of the undersigned registrant; and

iv.
Any other communication that is an offer in the offering made by the undersigned registrant to the purchaser.
 
II-8
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1933, the registrant has duly caused this Amendment No. 1 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized in New Castle, Pennsylvania, on the 25th day of June, 2008.
 
AXION POWER INTERNATIONAL, INC.
 
By:
/s/ Thomas Granville
 
Thomas Granville, Principal Executive Officer
 
 
Date: July 3, 2008
 
By:
/s/ Donald T. Hillier
 
Donald T. Hillier, Principal Financial Officer and Principal Accounting officer.
 
 
Date: July 3, 2008
 
II-9
 
POWER OF ATTORNEY  

Pursuant to the requirements of the Securities Act, this Amendment No. 1 to the Registration Statement has been signed by the following persons in the capacities and on the dates indicated:

Signature
 
Title
 
Date
 
 
 
 
 
/s/ Stanley A. Hirschman*
 
 
 
 
Stanley A. Hirschman
 
Director
 
July 3, 2008
 
 
 
 
 
 
 
 
 
 
Robert G. Averill
 
Director
 
July 3, 2008
 
 
 
 
 
/s/ Glenn Patterson*
 
 
 
 
Glenn Patterson
 
Director
 
July 3, 2008
 
 
 
 
 
/s/ Michael Kishinevsky*
 
 
 
 
Michael Kishinevsky
 
Director
 
July 3, 2008
 
 
 
 
 
/s/ Igor Filipenko*
 
 
 
 
Igor Filipenko
 
Director
 
July 3, 2008
 
 
 
 
 
/s/ Howard K. Schmidt*
 
 
 
 
Howard K. Schmidt
 
Director
 
July 3, 2008
         
/s/ D. Walker Wainwright*
 
 
 
 
D. Walker Wainwright
 
Director
 
July 3, 2008

*By: 
/s/ Thomas Granville
 
Thomas Granville
 
Attorney-in Fact
 
II-10
 























AXION POWER INTERNATIONAL, INC.

Securities Purchase Agreement

This Securities Purchase Agreement (this “Agreement” ) is dated as of January 14, 2008, by and between Axion Power International, Inc., a Delaware corporation (the “Company” ), and The Quercus Trust (the “Investor” ).

WHEREAS, subject to the terms and conditions set forth in this Agreement and pursuant to Section 4(2) of the Securities Act (as defined below) and Rule 506 promulgated thereunder, the Company desires to issue and sell to the Investor, and the Investor desires to purchase from the Company certain securities of the Company, as more fully described in this Agreement.

NOW, THEREFORE, IN CONSIDERATION of the mutual covenants contained in this Agreement, and for other good and valuable consideration the receipt and adequacy of which are hereby acknowledged, the Company and the Investor agree as follows:
 
ARTICLE 1

Definitions

Section 1.1. Definitions . In addition to the terms defined elsewhere in this Agreement, for all purposes of this Agreement, the following terms have the meanings indicated in this Section 1.1:

“Action” means any action, suit, inquiry, notice of violation, proceeding (including any partial proceeding such as a deposition) or investigation pending or threatened in writing against or affecting the Company, any Subsidiary or any of their respective properties before or by any court, arbitrator, governmental or administrative agency, regulatory authority (federal, state, county, local or foreign), stock market, stock exchange or trading facility.

“Adjusted Purchase Price” has the meaning set forth in Section 2.2.

“Affiliate” means any Person that, directly or indirectly through one or more intermediaries, controls or is controlled by or is under common control with a Person, as such terms are used in and construed under Rule 144.

“Board” means the Board of Directors of the Company.

“Business Day” means any day except Saturday, Sunday and any day which is a federal legal holiday or a day on which banking institutions in the City of New York are authorized or required by law or other governmental action to close.

“Buy-In” has the meaning set forth in Section 5.1(c).

“Charter Amendment” means a proposed amendment to the Company’s Certificate of Incorporation that its board of directors intends to submit for consideration by stockholders at the Company’s 2008 Annual Meeting and will, if approved in accordance with the DGCL, increase the number of authorized shares of Common Stock from the current limit of 50 million shares to a proposed limit of not less than 75 million shares.

“Claim” has the meaning set forth in Section 4.6(c).
 
 
“Closing” means each closing of the purchase and sale of Units consisting of Shares and Warrants pursuant to Article 2.

“Closing Date” means the First Closing Date, the date on which the Second Closing, if any, occurs pursuant to Section 2.2 hereof, and the date on which the Third Closing, if any, occurs pursuant to Section 2.3 hereof.

“Commission” means the Securities and Exchange Commission.

“Common Stock” means the common stock of the Company, par value $0.001 per share, and any securities into which such common stock may hereafter be reclassified.

“Common Stock Equivalents” means any securities of the Company or any Subsidiary which entitle the holder thereof to acquire Common Stock at any time, including without limitation, any debt, preferred stock, rights, options, warrants or other instrument or right that is at any time convertible into or exchangeable for, or otherwise entitles the holder thereof to receive, Common Stock or other securities that entitle the holder to receive, directly or indirectly, Common Stock.

“Company Counsel” means Fefer Petersen & Cie with respect to the First Closing and Andrews Kurth, LLP with respect to the Second and Third Closings.

“Company Deliverables” has the meaning set forth in Section 2.2(a).

“ Company Stock Options ” has the meaning set forth in Section 3.1(g).

“Compliance Date” means the date the Chief Financial Officer of the Company certifies in writing to the Investor that, to the knowledge of such officer after reasonable investigation, the Company is current in its reporting obligations under the Securities Exchange Act of 1934, that each report filed complied in form with the applicable requirements of the Commission with respect to such filing on the date of filing, and that the Company’s filings, taken together, do not contain any untrue or misleading statements of fact, or fail to contain any statements necessary to make the statements made therein not misleading.

“Contingent Obligations” has the meaning set forth in Section 3.1(r).

“ Convertible Securities ” has the meaning set forth in Section 3.1(g).

“Cut Back Shares” has the meaning assigned thereto in Section 4.1(a).

“Delaware Courts” has the meaning set forth in Section 7.9.  

“Effective Date” means the date that any Registration Statement filed pursuant to Article 4 is first declared effective by the Commission.

“Effectiveness Period” has the meaning set forth in Section 4.1(b).

“Environmental Law” has the meaning set forth in Section 3.1(aa).

“ ERISA ” means the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder.
 
2
 
“ERISA Affiliate” means any trade or business, whether or not incorporated, that together with the Company would be deemed to be a single employer for purposes of Section 4001 of ERISA or Sections 414(b), (c), (m), (n) or (o) of the Internal Revenue Code of 1986, as amended.
 
“Evaluation Date” has the meaning set forth in Section 3.1(r).  

“Event” has the meaning set forth in Section 4.1(d).

“Event Date” has the meaning set forth in Section 4.1(d).

“Exchange Act” means the Securities Exchange Act of 1934, as amended.

“Exempt Issuance” means the issuance by the Company (a) to employees, officers, directors of, and consultants to, the Company of shares of Common Stock or options for the purchase of shares of Common Stock pursuant to stock option or long-term incentive plans approved by the Board, (b) of shares of Common Stock upon the exercise of Warrants issued hereunder, (c) of shares of Common Stock upon exercise of Prior Warrants or conversion of Prior Convertible Securities, (d) of securities issued pursuant to acquisitions, licensing agreements, or other strategic transactions, (e) of securities issued in connection with equipment leases, real property leases, loans, credit lines, guaranties or similar transactions approved by the Board , (f) of securities issued in connection with join ventures or similar strategic relationships approved by the Board, (g) of securities in a merger, or (h) of securities in a public offering registered under the Securities Act; provided that in the case of securities issued pursuant clauses (e), (f) and (g), the purpose of such issuance may not be primarily to obtain cash financing.
 
“ Filing Date” means the date that is 30 days after the Second Closing Date.  

“Financing Notice” has the meaning set forth in Section 5.5(b).

“First Closing Date” means the fifth Business Day immediately following the date on which all of the conditions set forth in Sections 6.1 and 6.2 hereof are satisfied, or such other date as the parties may agree.

“First Closing Unit” means a Unit consisting of one Share and a Warrant to purchase one and one-half shares of Common Stock, issued in combination.

“GAAP” means generally accepted accounting principles as in effect from time to time in the United States of America.

“ Governmental Authority” has the meaning set forth in Section 3.1(e).

“Hazardous Substance” has the meaning set forth in Section 3.1(aa).

“Indebtedness” has the meaning set forth in Section 3.1(r).

“Indemnified Party” has the meaning set forth in Section 4.6(c).

“Indemnified Person” has the meaning set forth in Section 4.6(a).

“Indemnifying Party” has the meaning set forth in Section 4.6(c).

“Initial Purchase Price” has the meaning set forth in Section 2.1.
 
3
 
“Intellectual Property Rights” has the meaning set forth in Section 3.1(o).

“Investor Deliverables” has the meaning set forth in Section 2.2(b).

“Lien” means any lien, charge, encumbrance, security interest, right of first refusal or other restrictions of any kind.

“Liquidated Damages Base” has the meaning set forth in Section 4.1(d).

“Losses” has the meaning set forth in Section 5.7.

“Material Adverse Effect” means any of (i) a material and adverse effect on the legality, validity or enforceability of any Transaction Document, (ii) a material and adverse effect on the results of operations, assets, prospects, business or financial condition of the Company and the Subsidiaries, taken as a whole, or (iii) a material impairment of the Company’s ability to perform on a timely basis its obligations under any Transaction Document.

“NASD Rules” has the meaning set forth in Section 4.3(o).

“OFAC” has the meaning set forth in Section 3.1(ee).

“Outside Date” means June 30, 2009.

“Person” means an individual or corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or subdivision thereof) or other entity of any kind.

“Placement Agent” has the meaning set forth in Section 3.1(s).

“Plan of Distribution” has the meaning set forth in Section 4.2(o).

“Post-Effective Amendment” means a post-effective amendment to the Registration Statement.
 
“ Post-Effective Amendment Filing Deadline ” means the seventh Business Day after the Registration Statement ceases to be effective pursuant to applicable securities laws due to the passage of time or the occurrence of an event requiring the Company to file a Post-Effective Amendment; provided, however, that in the event that a Post-Effective Amendment must be filed to include information contained in an annual report on Form 10-K or Form 10-KSB that is not otherwise incorporated by reference into the Registration Statement, then the Company shall have thirty (30) days after the date such annual report is filed to file such Post-Effective.
 
“Pre-Notice” has the meaning set forth in Section 5.5(b).
 
“ Prior Warrants ” has the meaning set forth in Section 3.1(g).

“Proceeding” means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened.
 
4
 
“Production Contract” means a fully-executed contract between the Company and an unaffiliated third party battery manufacturer or wholesale battery distributor (a) pursuant to which the Company agrees to produce, and the third party agrees to purchase (which agreements shall not be conditional (including, without limitation as to amounts) except to the extent of customary conditions such as to quality and delivery dates), and (b) which provides for the production of a minimum of 60,000 lead-acid batteries to be produced quarterly on a profitable basis, substantially as set forth in the business plan previously provided by the Company to the Investor.

“ Prospectus” has the meaning set forth in Section 4.3.

“Proposed Financing” has the meaning set forth in Section 5.5(a).

“Proposed Financing Notice” has the meaning set forth in Section 5.5(b).

“ Purchase Price” means either the Initial Purchase price or the Adjusted Purchase Price, as the context indicates.

“Registrable Securities” means the Shares held by and the Warrant Shares issuable to the Investor on such date or dates as the Company may be required to file a registration statement pursuant to Article 4 hereof; provided, however, that the Investor shall not be required to exercise the Warrants in order to have the Warrant Shares included in any Registration Statement. The term shall not include the Shares and Warrant Shares included in the Third Closing Units unless and until the Investor has purchased those units.

“Registration Period” means the period commencing on the date hereof and ending on the date on which all of the Investor’s remaining Registrable Securities may be sold to the public during a three month period without registration under the Securities Act in reliance on Rule 144.

“Registration Statement” means a registration statement filed on the appropriate Form with, and declared effective by, the Commission under the Securities Act and covering the resale by the Investor of the Registrable Securities.

“Requested Information” has the meaning set forth in Section 4.3(a).

“Required Effectiveness Date” means the earlier of (i) the date that is 150 days after the First Closing Date, or, in the case of the registration of Cut Back Shares, 120 days after the Restriction Termination Date or (ii) five Business Days after receipt by the Company from the Commission of notice of “no review” of the Registration Statement.

“Restriction Termination Date” has the meaning assigned thereto in Section 4.1(a).

“Rule 144” means Rule 144 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule.

“Rule 415 Response Effort” has the meaning assigned thereto in Section 4.1(a).

“Second Closing Date” means the fifth Business Day immediately following the later of (i) the Compliance Date or (ii) if all other conditions set forth in Section 6.1 and 6.2 are not satisfied on the Compliance date, the date following the Compliance Date on which all other conditions set forth in Sections 6.1 and 6.2 hereof are satisfied, or such other date as the parties may agree.
 
“Second Closing Unit” means a Unit consisting of one Share and a Warrant to purchase one and one-quarter shares of Common Stock, issued in combination.
 
5
 
“SEC Objection” has the meaning assigned thereto in Section 4.1(a).

“SEC Restrictions” has the meaning assigned thereto in Section 4.1(a).

“SEC Reports” has the meaning set forth in Section 3.1(h).

“Securities” means the Shares, the Warrant, and the Warrant Shares.

“Securities Act” means the Securities Act of 1933, as amended.

“Senior Preferred Stock” means the shares of the preferred stock of the Company, par value $0.0001 per share, that have been designated as “8% Convertible Senior Preferred Stock” by a Certificate of Designations, Preferences and Rights dated March 17, 2005.

“Series A Preferred Stock” means the shares of the preferred stock of the Company, par value $0.0001 per share, that have been designated as “Series A Convertible Preferred Stock” by an Amended and Restated Certificate of Designations, Preferences and Rights dated October 26, 2006.

“Shares” means the shares of Common Stock issuable to the Investor at the Closings.

“Subsidiary” means any “significant subsidiary” as defined in Rule 1-02(w) of Regulation S-X promulgated by the Commission under the Exchange Act.

“Third Closing Date” means the fifth Business Day immediately following the later of (i) the date of delivery to the Investor of a copy of the Production Contract, or (ii) if all other conditions set forth in Section 6.1 and 6.2 are not satisfied on such date, the date following the date of delivery of the Production Contract on which all other conditions set forth in Sections 6.1 and 6.2 hereof are satisfied, such other date as the parties may agree.

“Third Closing Unit” means a Unit consisting of one Share and a Warrant to purchase one share of Common Stock, issued in combination.

“Trading Day” means (i) a day on which the Common Stock is traded on a Trading Market, or (ii) if the Common Stock is not listed on a Trading Market, a day on which the Common Stock is traded in the over-the-counter market, as reported by the OTC Bulletin Board, or (iii) if the Common Stock is not then listed or quoted on the OTC Bulletin Board, a day on which the Common Stock is quoted in the over-the-counter market as reported by the National Quotation Bureau Incorporated (or any similar organization or agency succeeding to its functions of reporting prices); provided, that in the event that the Common Stock is not listed or quoted as set forth in (i), (ii) and (iii) hereof, then Trading Day shall mean a Business Day.

“Trading Market” means whichever of the New York Stock Exchange, the American Stock Exchange, the Nasdaq Capital or Global Markets, or the Over-the-Counter Market on which the Common Stock is listed or traded on the date in question.

“Transfer Agent” has the meaning set forth in Section 5.1(c).

“Transaction Documents” means this Agreement, the Warrant and any other documents or agreements executed in connection with the transactions contemplated hereunder.
 
6
 
“Unit” means a First Closing Unit, a Second Closing Unit or a Third Closing Unit, as the context indicates.

“Warrant” means any of the Common Stock Purchase Warrants, in the form of Exhibit A , which are issuable to the Investor at the Closings.

“Warrant Shares” means the shares of Common Stock issuable upon exercise of the Warrants.
 
ARTICLE 2

Purchase and Sale

Section 2.1. Issuance of Securities at the First Closing . Upon the terms and subject to the conditions set forth in this Agreement, and in accordance with applicable law, the Company agrees to sell to the Investor, and the Investor agrees to purchase from the Company, on the First Closing Date, for the purchase price of $4.0 million, a number of Units equal to the number obtained by dividing $4.0 million by $2.10 per unit (the “Purchase Price” ), each Unit to consist of (i) one Share and (ii) a Warrant to purchase 1.5 shares of Common Stock.  

Section 2.2. Issuance of Securities at the Second Closing . Upon the terms and subject to the conditions set forth in this Agreement, and in accordance with applicable law, the Company agrees to sell to the Investor, and the Investor agrees to purchase from the Company, on the Second Closing Date, for the purchase price $4.0 million, a number of Units equal to the number obtained by dividing $4.0 million by the Purchase Price, each Unit to consist of (i) one Share and (ii) a Warrant to purchase 1.25 shares of Common Stock.
 
Section 2.3. Issuance of Securities at the Third Closing . Upon the terms and subject to the conditions and limitations set forth in this Agreement, the Company’s Certificate of Incorporation and Delaware law, the Company agrees to sell to the Investor, and the Investor agrees to purchase from the Company, on the Third Closing Date, for the purchase price $10.0 million, a number of Units equal to the number obtained by dividing $10.0 million by the Purchase Price, each Unit to consist of (i) one Share and (ii) a Warrant to purchase 1.0 shares of Common Stock.  
 
Section 2.4. Payment of Purchase Price; Delivery of Securities . As consideration for the issuance of the Securities being purchased at each Closing, the Investor shall on the respective Closing Date pay to the Company, by wire transfer or other form of immediately available funds, an amount equal to applicable Purchase Price for the Securities being purchased at such Closing, and the Company shall, against payment by the Investor of the applicable Purchase Price, (i) issue to the Investor the Warrants included in the Units being purchased at such Closing and (ii) execute and deliver to the transfer agent for the Common Stock irrevocable instructions to issue to the Investor the number of Shares included in the Units being purchased at such Closing.
 
Section 2.5. Additional Closing Deliveries . At each Closing, the Company shall deliver or cause to be delivered to the Investor the following (the “Company Deliverables” ):

 
(i)
The legal opinion of Company Counsel, in substantially the form of Exhibit B hereto, addressed to the Investor;
 
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(ii)
The Certificate of Incorporation of the Company, together with all amendments thereto, certified by the Secretary of State of the State of Delaware as of a date not more than five Business Days prior to the Closing Date;

 
(iii)
Copies of each of the following documents, in each case certified by the Secretary of the Company to be in full force and effect on the Closing Date:

 
(A)
resolutions of the board of directors of the Company approving the execution, delivery and performance of the Transaction Documents and the transactions contemplated thereby;

 
(B)
the By-laws of the Company; and

 
(C)
irrevocable instructions to the Company’s transfer agent as to the reservation and issuance of the Warrant Shares; and

 
(iv)
A good standing certificate of the Company issued by the Secretary of State of the State of Delaware dated as of a date no earlier than five Business Days prior to the Closing Date.

 
(v)
A certificate, signed by the President of the Company, certifying that all of the conditions set forth in Section 6.1 and Section 6.2 are satisfied upon the applicable Closing Date.

 
(vi)
In the case of the Second Closing only, a Certificate of the Chief Financial Officer of the Company, certifying that the Chief Financial Officer is not aware of any condition or circumstance that would reasonably be expected to cause the Company not to be able to timely file its 2007 Annual Report on Form 10-K with the Commission, taking into account any extension to which the Company is entitled pursuant to Rule 12b-24 of the Commission.
 
ARTICLE 3

Representations and Warranties

Section 3.1. Representations and Warranties of the Company . The Company hereby makes the following representations and warranties to the Investor:

 
(a)
Subsidiaries . The Company has no direct or indirect Subsidiaries other than as specified in the SEC Reports. Except as disclosed in the SEC Reports, the Company owns, directly or indirectly, all of the capital stock of each Subsidiary free and clear of any and all Liens other than Liens disclosed in the SEC Reports, and all the issued and outstanding shares of capital stock of each Subsidiary are validly issued and are fully paid, non-assessable and free of preemptive and similar rights.
 
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(b)
Organization and Qualification . Each of the Company and each Subsidiary is duly incorporated or otherwise organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization (as applicable), with the requisite power and authority to own and use its properties and assets and to carry on its business as currently conducted. Neither the Company nor any Subsidiary is in violation of any of the provisions of its respective certificate or articles of incorporation, bylaws or other organizational or charter documents. Each of the Company and each Subsidiary is duly qualified to conduct its respective business and is in good standing as a foreign corporation or other entity in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect, and no proceedings have been instituted in any such jurisdiction revoking, limiting or curtailing, or seeking to revoke, such power and authority or qualification.

 
(c)
Authorization; Enforcement . Subject to the qualifications set forth in this Section 3.1(c), the Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated by each of the Transaction Documents and otherwise to carry out its obligations thereunder. The execution and delivery of each of the Transaction Documents by the Company and the consummation by it of the transactions contemplated thereby have been duly authorized by all necessary action on the part of the Company and no further action is required by the Company in connection therewith. Each Transaction Document has been (or upon delivery will have been) duly executed by the Company and, when delivered in accordance with the terms hereof, will constitute the valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors’ rights and remedies or by other equitable principles of general application. The Company has advised the Investor that it has issued approximately 16.8 million shares of Common Stock, together convertible preferred stock, warrants, options and convertible debt securities (“Derivative Securities”) that are, in the aggregate, presently convertible or exercisable to acquire approximately 20.9 million additional shares of common stock. In the aggregate, the Company may required to issue approximately 20 million additional shares of common stock under this Agreement (including the Warrant Shares included in the Units and additional shares issuable to Merriman Curhan Ford & Co. upon exercise of certain warrants that will be issued to them as compensation for services. In the aggregate, the number of shares that the Company has issued, is presently obligated to issue and will become obligated to issue under the provisions of this Agreement exceeds the 50 million of shares of Common Stock currently authorized under the Company’s Certificate of Incorporation;. The Company has obtained the agreement of certain of holders of Derivative Securities that are presently convertible or exercisable to acquire approximately 9.1 million to execute and deliver, on or prior to the Closing, an agreement (the “Forbearance Agreement”) in the form of Exhibit D hereto that requires such holders to forbear from exercising or converting the Derivative Securities designated in such agreements (the “Designated Securities”) without the consent of the Company, and in certain cases, the Investor. The Company agrees that it will not allow the conversion or exercise of any of the Designated Securities that are subject to Forbearance Agreements unless after giving effect to such exercise or conversion there remain sufficient authorized and unissued shares of Common Stock to allow (a) the conversion and/or exercise of all Derivative Securities other than the Designated Securities, and (b) all other issuances of Common Stock which the Company is legally committed to issue. In the event that the Investors rights to exercise warrants are ever limited by the provisions of the Company’s Certificate of Incorporation, for any reason, then the expiration date of any warrants that the Investor is unable to purchase shall be automatically extended from time to time until one year after the date that a Charter Amendment increasing the Company’s authorized capital has been proposed to is stockholders and approved in accordance with the requirements of Delaware law.
 
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(d)
No Conflicts . The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the transactions contemplated thereby do not and will not (i) conflict with or violate any provision of the Company’s or any Subsidiary’s certificate or articles of incorporation, bylaws or other organizational or charter documents, or (ii) conflict with, or constitute a default (or an event that with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation (with or without notice, lapse of time or both) of, or result in the imposition of any Lien upon any of the material properties or assets of the Company or of any Subsidiary pursuant to, any agreement, credit facility, debt or other instrument (evidencing a Company or Subsidiary debt or otherwise) or other understanding to which the Company or any Subsidiary is a party or by which any property or asset of the Company or any Subsidiary is bound or affected, or (iii) result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company or a Subsidiary is subject (including federal and state securities laws and regulations), or by which any property or asset of the Company or a Subsidiary is bound or affected; except in the case of each of clauses (ii) and (iii), such as could not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect.

 
(e)
Filings, Consents and Approvals . The Company is not required to obtain any consent, waiver, authorization or order of, give any notice to, or make any filing or registration with, any court or other federal, state, local or other governmental authority (a “Governmental Authority” ) or other Person in connection with the execution, delivery and performance by the Company of the Transaction Documents and the consummation of the transactions contemplated thereby, other than (i) the filing of a Notice of Sale of Securities on Form D with the Commission under Regulation D of the Securities Act (ii) the filing of one or more current reports on Form 8-K; (iii) filings required under applicable state securities laws, and (iv) the filing with the Commission of one or more Registration Statements in accordance with the requirements of Article 4 of this Agreement.

 
(f)
Issuance of the Securities . Subject to the qualifications set forth in Section 3.1(c), the Securities have been duly authorized. Each Share, when issued and paid for in accordance with this Agreement, will be duly and validly issued, fully paid and nonassessable, free and clear of all Liens. Each Warrant, when issued and paid for in accordance with this Agreement, will be duly and validly issued. The Company has reserved and set aside from its duly authorized capital stock a sufficient number of shares of Common Stock to satisfy in full the Company’s obligations to issue the Warrant Shares upon exercise of the Warrants. The Warrants Shares, when issued and paid for upon exercise of the Warrants in accordance with their terms, will be duly and validly issued, fully paid and nonassessable, free and clear of all Liens
 
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(g)
Capitalization . The authorized capital stock of the Company presently consists of 50,000,000 shares of Common Stock and 12,500,000 shares of Preferred Stock, par value $0.0001 per share. At its 2008 Annual Meeting of Stockholders, the Company intends to submit the Charter Amendment to its stockholders for their approval. As of the close of business on the Business Day immediately prior to the date hereof, (i) 16,834,998 shares of Common Stock were issued and outstanding, all of which are validly issued, fully-paid and non-assessable, (ii) no shares of Common Stock were held by the Company in Treasury, (iii) 1,019,832 shares of Common Stock were reserved for issuance upon conversion of 137,500 shares of Senior Preferred Stock; (iv) 8,015,344 shares of Common Stock were reserved for issuance upon conversion of 822,997 shares of Series A Preferred Stock; (v) 4,531,320 shares of Common Stock were reserved for issuance upon exercise of options authorized under the Company’s Incentive Stock Plan and Directors Stock Option Plan, or previously granted to employees, directors, and consultants by contracts that provided for the issuance of non-plan options (the “ Company Stock Options ”); (vi) 3,777,541 shares of Common Stock were reserved for issuance upon exercise of outstanding warrants to purchase Common Stock (the “ Prior Warrants ”); (vii) 3,142,857 shares of Common Stock were reserved for issuance upon conversion of other convertible notes, debentures and securities, including warrants issuable in connection with such conversions ( “Prior Convertible Securities ”). No Person has any right of first refusal, preemptive right, right of participation, or any similar right to participate in the transactions contemplated by the Transaction Documents.  Except pursuant to (i) the Company Stock Options, (ii) the Prior Warrants or (iii) the Prior Convertible Securities, or as a result of the purchase and sale of the Securities as contemplated by this Agreement, there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities, rights or obligations convertible into or exchangeable for, or giving any Person any right to subscribe for or acquire, any shares of Common Stock, or contracts, commitments, understandings or arrangements by which the Company or any Subsidiary is or may become bound to issue additional shares of Common Stock or Common Stock Equivalents.  The issue and sale of the Securities will not obligate the Company to issue shares of Common Stock or other securities to any Person (other than the Investor and Merriman Curhan Ford & Co.) and will not result in a right of any holder of Company securities to adjust the exercise or conversion price under such securities. No further approval or authorization of any stockholder, the Board of Directors of the Company or any other Person is required for the issuance and sale of the Securities.  There are no stockholders agreements, voting agreements or other similar agreements with respect to the Company’s capital stock to which the Company is a party or, to the knowledge of the Company, between or among any of the Company’s stockholders.

 
(h)
SEC Reports; Financial Statements . The Company has filed all reports required to be filed by it under the Securities Act and the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for all annual and quarterly periods through and including the quarterly periods ended September 30, 2006 (the foregoing materials, being collectively referred to herein as the “SEC Reports” ). As of their respective dates, the SEC Reports complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder, and none of the SEC Reports, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. The financial statements of the Company included in the SEC Reports comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect at the time of filing. Such financial statements have been prepared in accordance with GAAP applied on a consistent basis during the periods involved, except as may be otherwise specified in such financial statements or the notes thereto, and fairly present in all material respects the financial position of the Company and its consolidated Subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal, immaterial, year-end audit adjustments. The Company has provided the Investor with draft financial statements for the year ended December 31, 2006 and the nine months ended September 30, 2007, and expects that these draft financial statements will be filed, in substantially the form provided to the Investor, subject to revisions requested or required by the Company’s independent auditors prior to filing (the “Draft Financial Statements”) Except as disclosed to the investor in writing, (i) the financial statements of the Company included in the SEC Reports comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect on the date hereof, (ii) such financial statements have been prepared in accordance with GAAP applied on a consistent basis during the periods involved, except as may be otherwise specified in such financial statements or the notes thereto, and (iii) fairly present in all material respects the financial position of the Company and its consolidated Subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject to normal, immaterial, year-end audit adjustments.
 
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(i)
Financial Statements and Material Changes . Except as set forth in the SEC Reports, the Draft Financial Statements and as disclosed to the investor in writing, (i) there has been no event, occurrence or development that has had or that could reasonably be expected to result in a Material Adverse Effect, (ii) the Company has not incurred any liabilities or obligations (contingent or otherwise) other than (A) trade payables, accrued expenses and other liabilities incurred in the ordinary course of business consistent with past practice since the date of the latest Draft Financial Statement, and (B) liabilities incurred in the ordinary course of business not required to be reflected in the Company’s financial statements pursuant to GAAP or required to be disclosed in filings made with the Commission, (iii) the Company has not altered its method of accounting or the identity of its auditors, (iv) the Company has not declared or made any dividend or distribution of cash or other property to its stockholders or purchased, redeemed or made any agreements to purchase or redeem any shares of its capital stock, and (v) the Company has not issued any equity securities to any officer, director or Affiliate, except pursuant to existing Company stock option plans. The Company does not have pending before the Commission any request for confidential treatment of information.

 
(j)
Litigation and Investigations . There is no Action which (i) adversely affects or challenges the legality, validity or enforceability of any of the Transaction Documents or the Securities or (ii) except as disclosed in the SEC Reports, could, if there were an unfavorable decision, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect. Neither the Company nor any Subsidiary, nor any director or officer thereof (in his capacity as such), is or has been the subject of any Action involving a claim of violation of or liability under federal or state securities laws or a claim of breach of fiduciary duty, except as specifically disclosed in the SEC Reports. There has not been, and to the knowledge of the Company, there is not pending any investigation by the Commission involving the Company or any current or former director or officer of the Company (in his or her capacity as such). The Commission has not issued any stop order or other order suspending the effectiveness of any registration statement filed by the Company or any Subsidiary under the Exchange Act or the Securities Act. There are no outstanding comments by the Staff of the Commission on any filing by the Company or any Subsidiary under the Exchange Act or the Securities Act.

 
(k)
Labor Relations . No material labor dispute exists or, to the knowledge of the Company, is imminent with respect to any of the employees of the Company.
 
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(l)
Compliance . Neither the Company nor any Subsidiary (i) is in default under or in violation of (and no event has occurred that has not been waived that, with notice or lapse of time or both, would result in a default by the Company or any Subsidiary under), nor has the Company or any Subsidiary received notice of a claim that it is in default under or that it is in violation of, any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound (whether or not such default or violation has been waived), (ii) is in violation of any order of any court, arbitrator or governmental body, or (iii) is or has been in violation of any statute, rule or regulation of any governmental authority, including without limitation all foreign, federal, state and local laws relating to environmental protection, occupational health and safety, product quality and safety and employment and labor matters, except in each case as could not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect.

 
(m)
Regulatory Permits . The Company and the Subsidiaries possess all certificates, authorizations and permits issued by the appropriate federal, state, local or foreign regulatory authorities necessary to conduct their respective businesses as described in the SEC Reports, except where the failure to possess such permits could not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect, and neither the Company nor any Subsidiary has received any notice of proceedings relating to the revocation or modification of any such permits.

 
(n)
Title to Assets . The Company and the Subsidiaries have good and marketable title in fee simple to all real property owned by them that is material to their respective businesses and good and marketable title in all personal property owned by them that is material to their respective businesses, in each case free and clear of all Liens, except for Liens that have been disclosed to the investor in writing or which do not otherwise materially affect the value of such property and do not materially interfere with the use made and proposed to be made of such property by the Company and the Subsidiaries. All real property and facilities held under lease by the Company and the Subsidiaries are held by them under valid, subsisting and enforceable leases of which the Company and the Subsidiaries are in material compliance, except as could not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect.

 
(o)
Patents and Trademarks . The Company and the Subsidiaries have, or have rights to use, all patents, patent applications, trademarks, trademark applications, service marks, trade names, copyrights, licenses and other similar rights that are necessary or material for use in connection with their respective businesses as described in the SEC Reports and which the failure to so have could, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect (collectively, the “Intellectual Property Rights” ). No claims or Actions have been made or filed by any Person against the Company to the effect that Intellectual Property Rights used by the Company or any Subsidiary violate or infringe upon the rights of such claimant. To the knowledge of the Company, after commercially reasonable investigation, all of the Intellectual Property Rights are enforceable and there is no existing infringement by another Person of any of the Intellectual Property Rights.
 
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(p)
Insurance . The Company and the Subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as are prudent and customary in the businesses in which the Company and the Subsidiaries are engaged. The Company has no reason to believe that it will not be able to renew its and the Subsidiaries’ existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business on terms consistent with the market for the Company’s and such Subsidiaries’ respective lines of business.

 
(q)
Transactions With Affiliates and Employees . Except as set forth in the SEC Reports or as disclosed to the investor in writing, none of the officers or directors of the Company and, to the knowledge of the Company, none of the employees of the Company is a party to any transaction with the Company or any Subsidiary (other than for services as employees, officers and directors), including any contract, agreement or other arrangement providing for the furnishing of services to or by, providing for rental of real or personal property to or from, or otherwise requiring payments to or from any officer, director or such employee or, to the knowledge of the Company, any entity in which any officer, director, or any such employee has a substantial interest or is an officer, director, trustee or partner.

 
(r)
Sarbanes-Oxley; Internal Accounting Controls .   Except to the extent it has not filed its quarterly and annual reports for periods ending after September 30, 2006, the Company is in material compliance with all mandatory provisions of the Sarbanes-Oxley Act of 2002 (including the rules and regulations of the Commission adopted thereunder) that are applicable to it as of the Closing Date.  The Company’s certifying officers have evaluated the effectiveness of the Company’s controls and procedures as of the filing date of the most recently filed periodic report under the Exchange Act (such date, the “ Evaluation Date ”).  The Company presented in its most recently filed periodic report under the Exchange Act the conclusions of the certifying officers about the effectiveness of the disclosure controls and procedures based on their evaluations as of the Evaluation Date.  Except as has been disclosed to the Investor, there have, since the Evaluation Date, been no significant adverse changes in the Company’s internal controls (as such term is defined in Item 307(b) of Regulation S-K under the Exchange Act) or, to the Company’s knowledge, in other factors that could significantly affect the Company’s internal controls. The Company maintains a standard system of accounting established and administered in accordance with GAAP.

 
Certain Fees . No brokerage or finder’s fees or commissions are or will be payable by the Company to any broker, financial advisor or consultant, finder, placement agent, investment banker, bank or other Person with respect to the transactions contemplated by this Agreement except to Merriman Curhan Ford & Co. (the “Placement Agent” ). The Investor shall have no obligation with respect to any fees or with respect to any claims (other than such fees or commissions owed by the Investor pursuant to written agreements executed by the Investor which fees or commissions shall be the sole responsibility of the Investor) made by or on behalf of the Placement Agent or any other Persons for fees of a type contemplated in this Section that may be due in connection with the transactions contemplated by this Agreement.

 
(t)
Certain Registration Matters . Assuming the accuracy of the Investor’s representations and warranties set forth in Section 3.2(b)-(e), no registration under the Securities Act is required for the offer and sale of the Securities by the Company to the Investor under the Transaction Documents.
 
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Investment Company . The Company is not, and is not an Affiliate of, and immediately following the Closing will not have become, an “investment company” within the meaning of the Investment Company Act of 1940, as amended.

 
(v)
No Additional Agreements . The Company does not have any agreement or understanding with the Investor with respect to the transactions contemplated by the Transaction Documents other than as specified in the Transaction Documents.

 
(w)
Full Disclosure . All written disclosures provided to the Investor regarding the Company, its business and the transactions contemplated hereby, furnished by or on behalf of the Company (including the Company’s representations and warranties set forth in this Agreement) are true and correct in all material respects and do not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading.

 
(x)
Environmental Matters . To the Company’s knowledge, after commercially reasonable investigation: (i) the Company and its Subsidiaries have complied with all applicable Environmental Laws; (ii) the properties currently owned or operated by Company (including soils, groundwater, surface water, buildings or other structures) are not contaminated with any Hazardous Substances; (iii) the properties formerly owned or operated by Company or its Subsidiaries were not contaminated with Hazardous Substances during the period of ownership or operation by Company and its Subsidiaries; (iv) Company and its Subsidiaries are not subject to liability for any Hazardous Substance disposal or contamination on any third party property; (v) Company and its Subsidiaries have not been associated with any release or threat of release of any Hazardous Substance; (vi) Company and its Subsidiaries have not received any notice, demand, letter, claim or request for information alleging that Company and its Subsidiaries may be in violation of or liable under any Environmental Law; and (vii) Company and its Subsidiaries are not subject to any orders, decrees, injunctions or other arrangements with any Governmental Authority or subject to any indemnity or other agreement with any third party relating to liability under any Environmental Law or relating to Hazardous Substances.
 
As used in this Agreement, the term “ Environmental Law ” means any federal, state, local or foreign law, regulation, order, decree, permit, authorization, opinion, common law or agency requirement relating to: (A) the protection, investigation or restoration of the environment, health and safety, or natural resources; (B) the handling, use, presence, disposal, release or threatened release of any Hazardous Substance or (C) noise, odor, wetlands, pollution, contamination or any injury or threat of injury to persons or property.
 
As used in this Agreement, the term “ Hazardous Substance ” means any substance that is: (i) listed, classified or regulated pursuant to any Environmental Law; (ii) any petroleum product or by-product, asbestos-containing material, lead-containing paint or plumbing, polychlorinated biphenyls, radioactive materials or radon; or (iii) any other substance which is the subject of regulatory action by any Governmental Authority pursuant to any Environmental Law.
 
(y)
Taxes.  The Company and its Subsidiaries have filed all necessary state franchise tax returns when due (or obtained appropriate extensions for filing) and have paid or accrued all taxes shown as due thereon. While the Company and its Subsidiaries have not filed all necessary federal, state and foreign income tax returns, the Company has had no taxable income during any of the five preceding years, has retained its independent accountants to prepare the required returns promptly after the completion of work on the Company's delinquent Exchange Act reports, and has no knowledge of a tax deficiency that has been or might be asserted or threatened against it or any Subsidiary which would have a Material Adverse Effect.
 
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(z)
Private Offering . Assuming the correctness of the representations and warranties of the Investors set forth in this Agreement, the offer and sale of the Warrants hereunder are, and upon exercise of the Warrants, the issuance of the Warrant Shares will be exempt from registration under the Securities Act. The Company has offered the Warrants for sale only to the Investor.
 
(aa)
ERISA . Neither the Company nor any ERISA Affiliate maintains, contributes to or has any liability or contingent liability with respect to any employee benefit plan subject to ERISA.
 
(bb)
Foreign Assets Control Regulations and Anti-Money Laundering .
 
(i)        OFAC . Neither the issuance of the Convertible Note and Warrant to the Investor, nor the use of the respective proceeds thereof, shall cause the Investor to violate the U.S. Bank Secrecy Act, as amended, and any applicable regulations thereunder or any of the sanctions programs administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“ OFAC ”) of the United States Department of Treasury, any regulations promulgated thereunder by OFAC or under any affiliated or successor governmental or quasi-governmental office, bureau or agency and any enabling legislation or executive order relating thereto. Without limiting the foregoing, neither the Company nor any Subsidiary (i) is a person whose property or interests in property are blocked or subject to blocking pursuant to Section 1 of Executive Order 13224 of September 23, 200l Blocking Property and Prohibiting Transactions With Persons Who Commit, Threaten to Commit, or Support Terrorism (66 Fed. Reg. 49079 (2001)), (ii) engages in any dealings or transactions prohibited by Section 2 of such executive order, or is otherwise associated with any such person in any manner violative of Section 2, or (iii) is a person on the list of Specially Designated Nationals and Blocked Persons or subject to the limitations or prohibitions under any other OFAC regulation or executive order.
 
(ii)         Patriot Act . The Company and each of its Subsidiaries are in compliance, in all material respects, with the USA PATRIOT Act. No part of the proceeds of the sale of the Shares and the Warrants hereunder will be used, directly or indirectly, for any payments to any governmental official or employee, political party, official of a political party, candidate for political office, or anyone else acting in an official capacity, in order to obtain, retain or direct business or obtain any improper advantage, in violation of the United States Foreign Corrupt Practices Act of 1977, as amended.

Section 3.2. Representations and Warranties of the Investor . The Investor hereby represents and warrants to the Company as follows:
 
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(a)
Authority . This Agreement has been duly executed by the Investor, and when delivered by the Investor in accordance with terms hereof, will constitute the valid and legally binding obligation of the Investor, enforceable against him in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors’ rights and remedies or by other equitable principles of general application.

 
(b)
Investment Intent . The Investor is acquiring the Securities as principal for its own account for investment purposes only and not with a view to or for distributing or reselling such Securities or any part thereof, without prejudice, however, to the Investor’s right at all times to sell or otherwise dispose of all or any part of such Securities in compliance with applicable federal and state securities laws. The Investor does not have any agreement or understanding, directly or indirectly, with any Person to distribute any of the Securities.

 
(c)
Investor Status . The Investor is an “accredited investor” as defined in Rule 501(a) under the Securities Act and a “qualified institutional buyer” as defined in Rule 144A under the Securities Act. The Investor is not a registered broker-dealer under Section 15 of the Exchange Act.

 
(d)
Access to Information . The Investor acknowledges that he has reviewed the SEC Reports and has been afforded (i) the opportunity to ask such questions as he has deemed necessary of, and to receive answers from, representatives of the Company concerning the terms and conditions of the offering of the Securities and the merits and risks of investing in the Securities; (ii) access to information about the Company and the Subsidiaries and their respective financial condition, results of operations, business, properties, management and prospects sufficient to enable him to evaluate his investment; and (iii) the opportunity to obtain such additional information that the Company possesses or can acquire without unreasonable effort or expense that is necessary to make an informed investment decision with respect to the investment.

 
(e)
General Solicitation . The Investor is not purchasing the Securities as a result of any advertisement, article, notice or other communication regarding the Securities published in any newspaper, magazine or similar media or broadcast over television or radio or presented at any seminar or any other general solicitation or general advertisement.
 
 
(f)
Disclosure . The Investor acknowledges and agrees that the Company neither makes nor has made any representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in Section 3.1 .
 
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ARTICLE 4

Registration Rights
Section 4.1.   Shelf Registration .
 
(a) As promptly as possible, and in any event on or prior to the Filing Date, the Company shall prepare and file with the Commission a “shelf” Registration Statement covering the resale of all Registrable Securities for an offering to be made on a continuous basis pursuant to Rule 415. The Registration Statement shall be on Form S-3, unless Form S-3 is not available for the registration of the resale of Registrable Securities hereunder, in which case the Company shall (i) register the resale of the Registrable Securities on another appropriate form in accordance herewith and (ii) attempt to register the Registrable Securities on Form S-3 as soon as such form is available, provided that the Company shall maintain the effectiveness of the Registration Statements then in effect until such time as a Registration Statement on Form S-3 covering the Registrable Securities has been declared effective by the Commission. If at any time the staff of the Commission takes the position that the offering of some or all of the Registrable Securities in a Registration Statement is not eligible to be made on a delayed or continuous basis under the provisions of Rule 415 under the Securities Act or requires any Investor to be named as an “underwriter” (an “ SEC Objection ”), the Company shall promptly notify the Investor of such SEC Objection and if the Investor shall request, the Company shall use its commercially reasonable efforts to persuade the staff of the Commission that the offering contemplated by the Registration Statement is a valid secondary offering and not an offering “by or on behalf of the issuer” as defined in Rule 415 and that the Investor is not an “underwriter” (a “ Rule 415 Response Effort ”). The Investor shall have the right to participate or have its counsel participate in any meetings or discussions with the staff of the Commission regarding such position and to comment or have its counsel comment on any written submission made to the staff of the Commission with respect thereto, and to have such comments relayed to the staff of the Commission with the consent of the Company, not to be unreasonably withheld. No such written submission shall be made to the staff of the Commission to which the Investor’s counsel reasonably objects. In the event that, despite the Company’s commercially reasonable efforts and compliance with the terms of this Section 4.1(a), the staff of the Commission has not altered its position and the Investor provides notice to the Company to cease any further Rule 415 Response Efforts (the “Investor Rule 415 Determination”), the Company shall (i) remove from the Registration Statement such portion of the Registrable Securities (the “ Cut Back Shares ”) and/or (ii) agree to such restrictions and limitations on the registration and resale of the Registrable Securities as the staff of the Commission may require to assure the Company’s compliance with the requirements of Rule 415; provided, however, that the Company shall not agree to name any Investor as an “underwriter” in such Registration Statement without the prior written consent of such Investor (collectively, the “ SEC Restrictions ”). Notwithstanding any other provision of this Agreement to the contrary, no liquidated damages shall accrue pursuant to Section 4.1(d) (i) during the period beginning on the date of an SEC Objection and ending on the date that either the Company receives written notification from the Commission that the Company’s Rule 415 Response Effort has been successful or the Investor provides the Company with an Investor Rule 415 Determination or (ii) on or as to any Cut Back Shares until such time as the Company is able, using commercially reasonable efforts, to effect the filing of an additional Registration Statement with respect to the Cut Back Shares in accordance with any SEC Restrictions (such date, the “ Restriction Termination Date ”). From and after the Restriction Termination Date, all of the provisions of this Article 4 (including the liquidated damages provisions) shall again be applicable to the Cut Back Shares; provided, however, that for such purposes, references to the Filing Date shall be deemed to be the date that is 30 days after the Restriction Termination Date.
 
(b) The Company shall use its best efforts to cause each Registration Statement filed hereunder to be declared effective by the Commission as promptly as possible after the filing thereof, but in any event prior to the Required Effectiveness Date, and shall use its best efforts to keep the Registration Statement continuously effective under the Securities Act until the earlier of (i) the fifth anniversary of the Effective Date, (ii) the date when all Registrable Securities covered by such Registration Statement have been sold publicly, or (iii) the date on which the Registrable Securities are eligible for sale without volume limitation pursuant to subparagraph (k) of Rule 144 (the “Effectiveness Period” ). The Company shall notify the Investor in writing promptly (and in any event within one Business Day) after receiving notification from the Commission that the Registration Statement has been declared effective.
 
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(c) As promptly as possible, and in any event no later than the Post-Effective Amendment Filing Deadline, the Company shall prepare and file with the Commission a Post-Effective Amendment. The Company shall use its best efforts to cause the Post-Effective Amendment to be declared effective by the Commission as promptly as possible after the filing thereof. The Company shall notify the investor in writing promptly (and in any event within one Business Day) after receiving notification from the Commission that the Post-Effective Amendment has been declared effective.
 
(d) If: (i) any Registration Statement is not filed on or prior to the Filing Date (or the Restriction Termination Date, as applicable) or a Post-Effective Amendment is not filed on or prior to the Post-Effective Amendment Filing Deadline, or (ii) the Company fails to file with the Commission a request for acceleration of effectiveness in accordance with Rule 461 promulgated under the Securities Act, within five Business Days after the date that the Company is notified (orally or in writing, whichever is earlier) by the Commission that a Registration Statement will not be “reviewed,” or will not be subject to further review, or (iii) the Company fails to respond to any comments made by the Commission within 15 Business Days after the receipt of such comments, or (iv) a Registration Statement filed hereunder is not declared effective by the Commission by the Required Effectiveness Date (which date shall be extended by 30 days in the case of a comment regarding Rule 415), or a Post-Effective Amendment is not declared effective on or prior to the fifteenth Business Day following the Post-Effective Amendment Filing Deadline, or (v) after a Registration Statement is filed with and declared effective by the Commission, such Registration Statement ceases to be effective as to all Registrable Securities to which it is required to relate at any time prior to the expiration of the Effectiveness Period for a period of more than 60 days in any twelve month period without being succeeded by an amendment to such Registration Statement or by a subsequent Registration Statement filed with and declared effective by the Commission, or (vi) an amendment to a Registration Statement is not filed by the Company with the Commission within 15 Business Days after the Commission’s having notified the Company that such amendment is required in order for such Registration Statement to be declared effective (any such failure or breach being referred to as an “Event” and the date on which such Event occurs being referred to as “Event Date” ), then: (x) on each such Event Date the Company shall pay to the Investor an amount in cash, as liquidated damages and not as a penalty, equal to 1% of the aggregate Purchase Price paid by the Investor pursuant to this Agreement for Registrable Securities that are not covered under an effective Registration Statement (the “Liquidated Damages Base” ); and (y) on the same day of each successive month following such Event Date (so long as the applicable Event shall not have been cured by such date) until the applicable Event is cured, the Company shall pay to the Investor an amount in cash, as liquidated damages and not as a penalty, equal to 1% of the Liquidated Damages Base. Such payments shall be the Investor’s sole and exclusive remedy for such Events. If the Company fails to pay any liquidated damages pursuant to this Section in full within seven Business Days after the date payable, the Company will pay interest thereon at a rate of 18% per annum (or such lesser maximum amount that is permitted to be paid by applicable law) to the Investor, accruing daily from the date such liquidated damages are due until such amounts, plus all such interest thereon, are paid in full.
 
(e)   The Company shall not, prior to the Effective Date of the Registration Statement, prepare and file with the Commission a registration statement relating to an offering for its own account or the account of others under the Securities Act of any of its equity securities.
 
(f)   If the Company issues to the Investor any Common Stock pursuant to the Transaction Documents that is not included in the initial Registration Statement, then the Company shall file an additional Registration Statement covering such number of shares of Common Stock on or prior to the Filing Date and shall use it best efforts, but in no event later than the Required Effectiveness Date, to cause such additional Registration Statement to be declared effective by the Commission.
 
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Section 4.2.   Registration Process . In connection with the registration of the Registrable Securities pursuant to Section 4.1, the Company shall:
 
(a) Prepare and file with the Commission the Registration Statement and such amendments (including post-effective amendments) to the Registration Statement and supplements to the prospectus included therein (a “ Prospectus ” ) as the Company may deem necessary or appropriate and take all lawful action such that the Registration Statement and any amendment thereto does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, not misleading and that the Prospectus forming part of the Registration Statement, and any amendment or supplement thereto, does not at any time during the Registration Period include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading . ;
 
(b) Comply with the provisions of the Securities Act with respect to the Registrable Securities covered by the Registration Statement until the earlier of (i) such time as all of such Registrable Securities have been disposed of in accordance with the intended methods of disposition by the Investor as set forth in the Prospectus forming part of the Registration Statement or (ii) the date on which the Registration Statement is withdrawn;
 
(c) Prior to the filing with the Commission of the Registration Statement (including any amendments thereto) and the distribution or delivery of any Prospectus (including any supplements thereto), provide draft copies thereof to the Investor and reflect in such documents all such comments as the Investor (and its counsel) reasonably may propose and furnish to the Investor and its legal counsel identified to the Company (i) promptly after the same is prepared and publicly distributed, filed with the Commission, or received by the Company, one copy of the Registration Statement, each Prospectus, and each amendment or supplement thereto, and (ii) such number of copies of the Prospectus and all amendments and supplements thereto and such other documents, as the Investor may reasonably request in order to facilitate the disposition of the Registrable Securities;
 
(d) (i) register or qualify the Registrable Securities covered by the Registration Statement under such securities or “blue sky” laws of such jurisdictions as the Investors reasonably request, (ii) prepare and file in such jurisdictions such amendments (including post-effective amendments) and supplements to such registrations and qualifications as may be necessary to maintain the effectiveness thereof at all times during the Registration Period, (iii) take all such other lawful actions as may be necessary to maintain such registrations and qualifications in effect at all times during the Registration Period, and (iv) take all such other lawful actions reasonably necessary or advisable to qualify the Registrable Securities for sale in such jurisdictions; provided, however, that the Company shall not be required in connection therewith or as a condition thereto to (A) qualify to do business in any jurisdiction where it would not otherwise be required to qualify, (B) subject itself to general taxation in any such jurisdiction or (C) file a general consent to service of process in any such jurisdiction;
 
(e) As promptly as practicable after becoming aware of such event, notify the Investor of the occurrence of any event, as a result of which the Prospectus included in the Registration Statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, and promptly prepare an amendment to the Registration Statement and supplement to the Prospectus to correct such untrue statement or omission, and deliver a number of copies of such supplement and amendment to each Investor as such Investor may reasonably request;
 
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(f) As promptly as practicable after becoming aware of such event, notify the Investor (or, in the event of an underwritten offering, the managing underwriters) of the issuance by the Commission of any stop order or other suspension of the effectiveness of the Registration Statement and take all lawful action to effect the withdrawal, rescission or removal of such stop order or other suspension;
 
(g) Take all such other lawful actions reasonably necessary to expedite and facilitate the disposition by the Investor of his Registrable Securities in accordance with the intended methods therefor provided in the Prospectus which are customary under the circumstances;
 
(h) Make generally available to its security holders as soon as practicable, but in any event not later than 1 8 months after the Effective Date of the Registration Statement, an earnings statement of the Company and its subsidiaries complying with Section 11(a) of the Securities Act and the rules and regulations of the Commission thereunder;
 
(i) In the event of an underwritten offering, promptly include or incorporate in a Prospectus supplement or post-effective amendment to the Registration Statement such information as the underwriters reasonably agree should be included therein and to which the Company does not reasonably object and make all required filings of such Prospectus supplement or post-effective amendment as soon as practicable after it is notified of the matters to be included or incorporated in such Prospectus supplement or post-effective amendment;
 
(j) Make reasonably available for inspection by the Investor, any underwriter participating in any disposition pursuant to the Registration Statement, and any attorney, accountant or other agent retained by such Investors or any such underwriter all relevant financial and other records, pertinent corporate documents and properties of the Company and its subsidiaries, and cause the Company’s officers, directors and employees to supply all information reasonably requested by the Investor or any such underwriter, attorney, accountant or agent in connection with the Registration Statement, in each case, as is customary for similar due diligence examinations; provided, however, that all records, information and documents that are designated in writing by the Company, in good faith, as confidential, proprietary or containing any nonpublic information shall be kept confidential by such Investors and any such underwriter, attorney, accountant or agent (pursuant to an appropriate confidentiality agreement in the case of any such holder or agent), unless such disclosure is made pursuant to judicial process in a court proceeding (after first giving the Company an opportunity promptly to seek a protective order or otherwise limit the scope of the information sought to be disclosed) or is required by law, or such records, information or documents become available to the public generally or through a third party not in violation of an accompanying obligation of confidentiality; and provided, further, that, if the foregoing inspection and information gathering would otherwise disrupt the Company’s conduct of its business, such inspection and information gathering shall, to the maximum extent possible, be coordinated on behalf of the Investors and the other parties entitled thereto by one firm of counsel designated by and on behalf of the majority in interest of Investors and other parties;
 
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(k) In connection with any offering, make such representations and warranties to the Investor and to the underwriters if an underwritten offering , in form, substance and scope as are customarily made by a company to underwriters in secondary underwritten offerings;
 
(l) In connection with any underwritten offering, deliver such documents and certificates as may be reasonably required by the underwriters;  
 
(m) Cooperate with the Investor to facilitate the timely preparation and delivery of certificates representing Registrable Securities to be sold pursuant to the Registration Statement, which certificates shall, if required under the terms of this Agreement, be free of all restrictive legends, and to enable such Registrable Securities to be in such denominations and registered in such names as any Investor may request and maintain a transfer agent for the Common Stock;
 
(n) Use its commercially reasonable efforts to cause all Registrable Securities covered by the Registration Statement to be listed or qualified for trading on the principal Trading Market, if any, on which the Common Stock is traded or listed on the Effective Date of the Registration Statement; and
 
(o) Include in each Prospectus and Registration the Plan of Distribution attached hereto as Exhibit C (the “ Plan of Distribution ”), unless and to the extent that such Plan of Distribution requires modification due to inaccuracy or due to a change in the Commission’s rules and regulations under the Securities Act .
 
Section 4.3. Obligations and Acknowledgements of the Investor . In connection with the registration of the Registrable Securities, the Investor shall have the following obligations and hereby make the following acknowledgements:
 
(a) It shall be a condition precedent to the obligations of the Company to include the Registrable Securities in the Registration Statement that the Investor (i) shall furnish to the Company such information regarding itself, the Registrable Securities held by it and the intended method of disposition of the Registrable Securities held by it as shall be reasonably required to effect the registration of such Registrable Securities and (ii) shall execute such documents in connection with such registration as the Company may reasonably request. At least five Business Days prior to the first anticipated filing date of a Registration Statement, the Company shall notify the Investor of the information the Company requires from the Investor (the “ Requested Information ” ) if the Investor elects to have any of its Registrable Securities included in the Registration Statement. If at least two Business Days prior to the anticipated filing date the Company has not received the Requested Information from the Investor, then the Company may file the Registration Statement without including any Registrable Securities of the Investor and the Company shall have no further obligations under this Article 4 to the Investor after such Registration Statement has been declared effective. If the Investor notifies the Company and provides the Company the information required hereby prior to the time the Registration Statement is declared effective, the Company will file an amendment to the Registration Statement that includes the Registrable Securities of the Investor ; provided, however, that the Company shall not be required to file such amendment to the Registration Statement at any time less than 5 Business Days prior to the Effectiveness Date.
 
(b) The Investor agrees to cooperate with the Company in connection with the preparation and filing of a Registration Statement hereunder, unless the Investor has notified the Company in writing of its election to exclude all of its Registrable Securities from such Registration Statement;
 
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(c) The Investor agrees that, upon receipt of any notice from the Company of the occurrence of any event of the kind described in Section 4.2(e) or 4.2(f), the Investor shall immediately discontinue its disposition of Registrable Securities pursuant to the Registration Statement covering such Registrable Securities until the Investor’s receipt of the copies of the supplemented or amended Prospectus contemplated by Section 4.2(e) and, if so directed by the Company, the Investor shall deliver to the Company (at the expense of the Company) or destroy (and deliver to the Company a certificate of destruction) all copies in the Investor’s possession, of the Prospectus covering such Registrable Securities current at the time of receipt of such notice ; and
 
(d) The Investor acknowledges that it may be deemed to be a statutory underwriter within the meaning of the Securities Act with respect to the Registrable Securities being registered for resale by it, and if the Investor includes Registrable Securities for offer and sale within a Registration Statement the Investor hereby consents to the inclusion in such Registration Statement of a disclosure to such effect.
 
Section 4.4. Expenses of Registration . All expenses (other than underwriting discounts and commissions and the fees an expenses of the Investor’s counsel) incurred in connection with registrations, filings or qualifications pursuant to this Article 4, including, without limitation, all registration, listing, and qualifications fees, printing and engraving fees, accounting fees, and the fees and disbursements of counsel for the Company, shall be borne by the Company.
 
Section 4.5   Accountant’s Letter . If the Investor proposes to engage in an underwritten offering of any Registrable Shares, the Company shall deliver to the Investor, at the Company’s expense, a letter dated as of the effective date of each Registration Statement or Post-Effective Amendment thereto, from the independent public accountants retained by the Company, addressed to the underwriters and to the Investor, in form and substance as is customarily given in an underwritten public offering, provided that the Investor has made such representations and furnished such undertakings as the independent public accountants may reasonably require;
 
Section 4.6. Indemnification and Contribution
 
(a) Indemnification by the Company . The Company shall indemnify and hold harmless the Investor and each underwriter, if any, which facilitates the disposition of Registrable Securities, and each of their respective officers and directors and each Person who controls such underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act (each such Person being sometimes hereinafter referred to as an “ Indemnified Person ” ) from and against any losses, claims, damages or liabilities, joint or several, to which such Indemnified Person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Registration Statement or an omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, not misleading, or arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Prospectus or an omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and the Company hereby agrees to reimburse such Indemnified Person for all reasonable legal and other expenses incurred by them in connection with investigating or defending any such action or claim as and when such expenses are incurred; provided, however, that the Company shall not be liable to any such Indemnified Person in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon (i) an untrue statement or alleged untrue statement made in, or an omission or alleged omission from, such Registration Statement or Prospectus in reliance upon and in conformity with written information furnished to the Company by such Indemnified Person expressly for use therein or (ii) in the case of the occurrence of an event of the type specified in Section 4.3(e), the use by the Indemnified Person of an outdated or defective Prospectus after the Company has provided to such Indemnified Person an updated Prospectus correcting the untrue statement or alleged untrue statement or omission or alleged omission giving rise to such loss, claim, damage or liability.
 
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(b) Indemnification by the Investor and Underwriters . The Investor agrees, as a consequence of the inclusion of any of its Registrable Securities in a Registration Statement, and each underwriter, if any, which facilitates the disposition of Registrable Securities shall agree, severally and not jointly,   as a consequence of facilitating such disposition of Registrable Securities to (i) indemnify and hold harmless the Company, its directors (including any person who, with his or her consent, is named in the Registration Statement as a director nominee of the Company), its officers who sign any Registration Statement and each Person, if any, who controls the Company within the meaning of either Section 15 of the Securities Act or Section 20 of the Exchange Act, against any losses, claims, damages or liabilities to which the Company or such other persons may become subject, under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in such Registration Statement or Prospectus or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein (in light of the circumstances under which they were made, in the case of the Prospectus), not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to the Company by the Investor or underwriter expressly for use therein , and (ii) reimburse the Company for any legal or other expenses incurred by the Company in connection with investigating or defending any such action or claim as such expenses are incurred ; provided, however, that the Investor shall not be liable under this Section 4.6(b) for any amount in excess of the net proceeds paid to the Investor in respect of Registrable Securities sold by it.
 
(c) Notice of Claims, etc.   Promptly after receipt by a Person seeking indemnification pursuant to this Section 4.6 (an “ Indemnified Party ” ) of written notice of any investigation, claim, proceeding or other action in respect of which indemnification is being sought (each, a “ Claim ” ), the Indemnified Party promptly shall notify the Person against whom indemnification pursuant to this Section 4.6 is being sought (the “ Indemnifying Party ” ) of the commencement thereof; but the omission to so notify the Indemnifying Party shall not relieve it from any liability that it otherwise may have to the Indemnified Party, except to the extent that the Indemnifying Party is materially prejudiced and forfeits substantive rights and defenses by reason of such failure. In connection with any Claim as to which both the Indemnifying Party and the Indemnified Party are parties, the Indemnifying Party shall be entitled to assume the defense thereof. Notwithstanding the assumption of the defense of any Claim by the Indemnifying Party, the Indemnified Party shall have the right to employ separate legal counsel and to participate in the defense of such Claim, and the Indemnifying Party shall bear the reasonable fees, out-of-pocket costs and expenses of such separate legal counsel to the Indemnified Party if (and only if): (i) the Indemnifying Party shall have agreed to pay such fees, costs and expenses, (ii) the Indemnified Party shall reasonably have concluded that representation of the Indemnified Party by the Indemnifying Party by the same legal counsel would not be appropriate due to actual or, as reasonably determined by legal counsel to the Indemnified Party, potentially differing interests between such parties in the conduct of the defense of such Claim, or if there may be legal defenses available to the Indemnified Party that are in addition to or disparate from those available to the Indemnifying Party, or (iii) the Indemnifying Party shall have failed to employ legal counsel reasonably satisfactory to the Indemnified Party within a reasonable period of time after notice of the commencement of such Claim. If the Indemnified Party employs separate legal counsel in circumstances other than as described in the preceding sentence, the fees, costs and expenses of such legal counsel shall be borne exclusively by the Indemnified Party. Except as provided above, the Indemnifying Party shall not, in connection with any Claim in the same jurisdiction, be liable for the fees and expenses of more than one firm of counsel for the Indemnified Party (together with appropriate local counsel). The Indemnified Party shall not, without the prior written consent of the Indemnifying Party (which consent shall not unreasonably be withheld), settle or compromise any Claim or consent to the entry of any judgment that does not include an unconditional release of the Indemnifying Party from all liabilities with respect to such Claim or judgment or contain any admission of wrongdoing .
 
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(d) Contribution . If the indemnification provided for in this Section 4.6 is unavailable to or insufficient to hold harmless an Indemnified Party in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, then each Indemnifying Party shall contribute to the amount paid or payable by such Indemnified Party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party and the Indemnified Party in connection with the statements or omissions or alleged statements or omissions which resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative fault of such Indemnifying Party and Indemnified Party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by such Indemnifying Party or by such Indemnified Party, and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 4.6(d) were determined by pro rata allocation (even if the Investors or any underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in this Section 4.6(d). The amount paid or payable by an Indemnified Party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such Indemnified Party in connection with investigating or defending any such action or claim. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation.
 
(e) Limitation on Investor’s and Underwriters’ Obligations . Notwithstanding any other provision of this Section 4.6, in no event shall (i) the Investor have any liability under this Section 4.6 for any amounts in excess of the dollar amount of the proceeds actually received by the Investor from the sale of Registrable Securities (after deducting any fees, discounts and commissions applicable thereto) pursuant to any Registration Statement under which such Registrable Securities are registered under the Securities Act and (ii) any underwriter be required to undertake liability to any Person hereunder for any amounts in excess of the aggregate discount, commission or other compensation payable to such underwriter with respect to the Registrable Securities underwritten by it and distributed pursuant to the Registration Statement.
 
(f) Other Liabilities . The obligations of the Company under this Section 4.6 shall be in addition to any liability which the Company may otherwise have to any Indemnified Person and the obligations of any Indemnified Person under this Section 4.6 shall be in addition to any liability which such Indemnified Person may otherwise have to the Company. The remedies provided in this Section 4.6 are not exclusive and shall not limit any rights or remedies which may otherwise be available to an indemnified party at law or in equity.
 
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Section 4.7. Rule 144 . With a view to making available to the Investor the benefits of Rule 144, the Company agrees to use its best efforts to:
 
(i) comply with the provisions of paragraph (c)(1) of Rule 144; and
 
(ii) file with the Commission in a timely manner all reports and other documents required to be filed by the Company pursuant to Section 13 or 15(d) under the Exchange Act; and, if at any time it is not required to file such reports but in the past had been required to or did file such reports, it will, upon the request of any Investor, make available other information as required by, and so long as necessary to permit sales of, its Registrable Securities pursuant to Rul e 144.
 
Section 4.8. Common Stock Issued Upon Stock Split, etc . The provisions of this Article 4 shall apply to any shares of Common Stock or any other securities issued as a dividend or distribution in respect of the Shares or the Warrant Shares.

ARTICLE 5

Other Agreements of the Parties

Section 5.1. Certificates; Legends .

(a)   The Securities may only be transferred in compliance with state and federal securities laws. In connection with any transfer of the Securities other than (i) pursuant to an effective registration statement, (ii) to the Company, or (iii) to an Affiliate of the Investor, the Company may require the transferor thereof to provide to the Company an opinion of counsel selected by the transferor and reasonably acceptable to the Company, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such transferred Securities under the Securities Act. In the event of a private transfer of the Securities, the transferee shall be required to execute a counterpart to this Agreement, agreeing to be bound by (and shall have the benefits of) the terms hereof other than those set forth in Article 2 hereof, and such transferee shall be deemed to be an “Investor” for purposes of this Agreement.

(b)   The certificates representing the Shares and the Warrants to be delivered at the Closings and the certificates evidencing the Warrant Shares to be delivered upon exercise of the Warrants will contain appropriate legends referring to restrictions on transfer relating to the registration requirements of the Securities Act and applicable state securities laws.

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(c)   In connection with any sale or disposition of the Securities by the Investor pursuant to Rule 144 or pursuant to any other exemption under the Securities Act such that the purchaser acquires freely tradable shares and upon compliance by the Investor with the requirements of this Agreement, the Company shall, or, in the case of Common Stock, shall cause the transfer agent for the Common Stock (the “ Transfer Agent ”) to, issue replacement certificates representing the Securities sold or disposed of without restrictive legends. Upon the earlier of (i) registration of any Securities for resale pursuant Article 4 or (ii) Rule 144 becoming available with respect to any Securities, the Company shall (A) deliver to the Transfer Agent irrevocable instructions that the Transfer Agent shall reissue a certificate representing such Securities without legends upon receipt by such Transfer Agent of the legended certificates, together with either (1) a customary representation by the Investor that Rule 144 applies to the shares of Common Stock represented thereby, (2) a statement by the Investor that the Investor has sold the shares of Common Stock represented thereby in accordance with the Plan of Distribution contained in the Registration Statement, or (3) a statement by the Investor that the securities will be sold in compliance with the volume limitations of Rule 144, if any, and (B) cause its counsel to deliver to the Transfer Agent one or more blanket opinions to the effect that the removal of such legends in such circumstances may be effected under the Securities Act. From and after the earlier of such dates, upon the Investor’s written request, the Company shall promptly cause certificates evidencing the Investor’s Securities to be replaced with certificates which do not bear such restrictive legends, and Warrant Shares subsequently issued upon due exercise of the Warrants shall not bear such restrictive legends provided the provisions of either clause (i) or clause (ii) above, as applicable, are satisfied with respect to such Warrant Shares. When the Company is required to cause an unlegended certificate to replace a previously issued legended certificate, if: (1) the unlegended certificate is not delivered to an Investor within five Business Days after submission by the Investor of a legended certificate and supporting documentation to the Transfer Agent as provided above and (2) prior to the time such unlegended certificate is received by the Investor, the Investor, or any third party on behalf of such Investor or for the Investor’s account, purchases (in an open market transaction or otherwise) shares of Common Stock to deliver in satisfaction of a sale by the Investor of shares represented by such certificate (a “ Buy-In ”), then the Company shall pay in cash to the Investor (for costs incurred either directly by such Purchaser or on behalf of a third party) the amount by which the total purchase price paid for Common Stock as a result of the Buy-In (including brokerage commissions, if any) exceeds the proceeds received by such Investor as a result of the sale to which such Buy-In relates. The Investor shall provide the Company written notice indicating the amounts payable to the Investor in respect of the Buy-In.
 
Section 5.2. Integration . The Company has not and shall not, and shall use its best efforts to ensure that no Affiliate of the Company shall, sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the Securities in a manner that would require the registration under the Securities Act of the sale of the Securities to the Investor, or that would be integrated with the offer or sale of the Securities for purposes of the rules and regulations of any Trading Market in a manner that would require stockholder approval of the sale of the securities to the Investor.

Section 5.3. Securities Laws Disclosure; Publicity . By 9:00 a.m. (New York time) on the Trading Day following the execution of this Agreement, and by 5:00 p.m. (New York time) on the First Closing Date, the Company shall issue press releases disclosing the transactions contemplated hereby and the Closing. On the Trading Day following the execution of this Agreement the Company will file a Current Report on Form 8-K disclosing the material terms of the Transaction Documents (and attach the Transaction Documents as exhibits thereto), and on each Closing Date the Company will file an additional Current Report on Form 8-K to disclose the Closing. In addition, the Company will make such other filings and notices in the manner and time required by the Commission and the Trading Market on which the Common Stock is listed.
 
Section 5.4. Use of Proceeds . Th e Company shall use the net proceeds from the sale of the Securities hereunder (i) for working capital purposes (including if necessary repayment of up to $3 million of the convertible short-term bridge notes disclosed to the investor in writing ), (ii) to purchase fixed assets used in the development or production of the Company’s products or (iii) for investment in new technologies related to the Company’s business (including without limitation through the acquisition of other companies).

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Section 5.5. Investor’s   Right of First Refusal .
 
(a) Proposed Financings . In the event that, during the period commencing on the First Closing Date and continuing to the earlier of (i) the second anniversary of the Second Closing Date or (ii) the second anniversary of the Outside Date, the Company seeks to raise additional funds through a private placement of its securities (a “Proposed Financing” ), other than Exempt Issuances, the Investor shall have the right to participate in the Proposed Financing on a pro rata basis, based on the percentage that (a) the number of shares of Common Stock then held by the Investor plus the number of shares of Common Stock issuable upon conversion of the Warrants bears to (b) the total number of shares of Common Stock outstanding plus the number of shares of Common Stock issuable upon conversion of the Series A Preferred Stock and the Prior Convertible Securities and exercise of the Company Stock Options, the Warrants and the Prior Warrants.
 
(b) Pre-Notice of Proposed Financings . At least 15 Business Days prior to the closing of any Proposed Financing, the Company shall deliver to each Investor a written notice of its intention to effect a Proposed Financing (“ Pre-Notice ”). If within 10 Business Days after receipt of the Pre-Notice, the Investor delivers to the Company a written request for detailed information regarding the Proposed Financing, the Company shall promptly, but no later than the Business Day immediately following its receipt of such request, deliver to the Investor a notice (a “ Proposed Financing Notice ”) which shall describe in reasonable detail the proposed terms of such Proposed Financing, the amount of proceeds intended to be raised thereunder, and the Person with whom such Proposed Financing is proposed to be effected, and shall have attached thereto be a term sheet or similar document relating to the Proposed Financing. The Investor shall notify the Company no later than 6:30 p.m. (Little Rock time) on the fifth Business Day after receipt of the Proposed Financing Notice of its willingness to participate in the Proposed Financing on the terms described in the Proposed Financing Notice, subject to completion of mutually acceptable documentation and diligence investigation. The Company shall promptly provide to the Investor such diligence materials as it may reasonably request, subject to execution of a non-disclosure agreement, in reasonable form, mutually acceptable to the parties.
 
( c) Investment Terms . The terms on which the Investor shall purchase securities pursuant to the Proposed Financing shall be the same as such securities are purchased by other investors in such Proposed Financing. In the event that the terms of the Proposed Financing are changed, the Borrower shall provide the Investor with the same notice of the revised terms that is provided to the other investors in such Proposed Financing in reasonably sufficient time to allow the Investor to review the Proposed Financing and the Company’s financial condition and prospects in light of the changed terms.  
 
(d)   Financings . In the event that the Investor does not exercise, within 12 Business Days after receipt of the Financing Notice, its right to participate in the Proposed Financing, the Company may sell the securities in the Proposed Financing at a price and on terms which are no more favorable to the investors in such Proposed Financing than the terms offered to the Investor. If the Company subsequently changes the price or terms so that the terms are at a price or more favorable to the investors in the Proposed Financing, the Company shall re-offer the securities to the Investor as provided in this Section 5.5.  

Section   5.6.   Company’s Right of First Refusal .
 
(a) Proposed Sales . In the event that the Investor plans to resell shares of the Company’s stock in open market transactions at prevailing prices, the Investor shall consult with the Company so as not to negatively affect the value of the Company’s shares in the public market. In the event that the Investor plans to resell a substantial number shares of the Company’s stock in one or more transactions that are neither an open market resale at prevailing prices or effected in connection with an underwritten transaction involving a sale to the general public, then at least thirty (30) days before a disposition of more than 1,000,000 shares of stock, the Investor shall notify the Company in writing (the “Notice”) of its intention. After the date of such Notice (the “Notice Date”), the Company may inform the Investor that the Company intends to exercise its right to acquire all or a portion of the shares which are the subject of the Notice only as follows:

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(i)   If the number of shares referred to in the Notice is more than 1,000,000 but less than 2,000,000, the Company shall have the right to advise the Investor in writing within ten (10) days of the Notice Date of its commitment to buy all of said shares, and the Company shall conclude for cash the share purchase transaction within ten (10) days of the Notice Date;

(ii)   If the number of shares referred to in the Notice is between 2,000,000 and 5,000,000, the Company shall have the right to advise the Investor in writing within twenty (20) days of the Notice Date of its commitment to buy all of said shares, and the Company shall conclude for cash the share purchase transaction within thirty (30) days of the Notice Date;

(iii)   If the number of shares referred to in the Notice is more than 5,000,000, the Company shall have the right to advise the appropriate trustee in writing within thirty (30) days of the Notice Date of its commitment to buy all of said shares, and the Company shall conclude for cash the share purchase transaction within forty-five (45) days of the Notice Date.

(b) Purchase Terms. With each Notice, the Investor shall provide the Company with the Investor’s best estimate of the minimum and maximum consideration that the Investor anticipates receiving from the proposed disposition. As the condition to the exercise by the Company of its right of first refusal, the Company agrees to pay the minimum consideration that the Investor estimates receiving from the proposed disposition. If the Company does not timely exercise its right to purchase shares described in a particular Notice as provided herein, then it shall have no further rights to acquire the shares that are the subject of the Notice, provided however, that the Investor conclude the proposed disposition for no less than the minimum consideration within 30 days of the last day the Company had to exercise the right of first refusal or else the shares the subject of the Notice will be subject to a new right of first refusal as provided for herein. If the Company exercises its right to purchase the shares described in a particular Notice but fails to conclude the transaction within the time provided herein, the Investor’s sole remedy shall be the right to seek damages from the Company for the difference between the exercise price and the proceeds ultimately received by the Investor from the sale of said shares.

Section 5.7. No Disclosure of Material Non-Public Information . The Company will not disclose to the Investor any material non-public information concerning the Company except (a) with the consent of the Investor and (b) if such consent is given, pursuant to a non-disclosure agreement which provides, among other things, that the Investor will not disclose the material non-public information to any person and the Investor or the Agent will not engage in any transactions involving the Company’s securities while in possession of material non-public information.

ARTICLE 6

Conditions Precedent to Closing

Section 6.1. Conditions Precedent to the Obligations of the Investor to Purchase Securities . The obligation of the Investor to acquire Securities at any Closing is subject to the satisfaction or waiver by the Investor, at or before Closing, of each of the following conditions:
 
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(a)
Representations and Warranties . The Company shall have delivered a certificate of the Company’s Chief Executive Officer certifying that the representations and warranties of the Company contained herein are true and correct in all material respects as of the date when made and as of the Closing Date as though made on and as of such Closing Date, provided that at the Second Closing and Third Closings any representations and warranties made as of a specific date shall be deemed to be made as of such date and not as of the date of the Second Closing or the Third Closing, as the case may be;

 
(b)
Performance . The Company shall have performed, satisfied and complied in all material respects with all covenants, agreements and conditions required by the Transaction Documents to be performed, satisfied or complied with by it at or prior to the Closing;

 
(c)
No Injunction . No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction that prohibits the consummation of any of the transactions contemplated by the Transaction Documents;

 
(d)
No Adverse Changes . Since the date of execution of this Agreement, no event or series of events shall have occurred that reasonably could have or result in a Material Adverse Effect;

 
(e)
Company Deliverables . The Company shall have delivered to Investor the Forbearance Agreement and the Company Deliverables in accordance with Section 2.

Section 6.2. Conditions Precedent to the Obligations of the Company to Sell Securities . The obligation of the Company to sell Securities at any Closing is subject to the satisfaction or waiver by the Company, at or before the Closing, of each of the following conditions:

 
(a)
Representations and Warranties . The representations and warranties of the Investor contained herein shall be true and correct in all material respects as of the date when made and as of the Closing Date as though made on and as of such date;

 
(b)
Performance . The Investor shall have performed, satisfied and complied in all material respects with all covenants, agreements and conditions required by the Transaction Documents to be performed, satisfied or complied with by such Investor at or prior to the Closing;

 
(c)
No Injunction . No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction that prohibits the consummation of any of the transactions contemplated by the Transaction Documents; and

 
(d)
Purchase Price . The Investor shall have paid the Purchase Price payable at such Closing in accordance with Section 2.3.

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ARTICLE 7

Miscellaneous
 
Section 7.1. Fees and Expenses . Each party shall pay the fees and expenses of its advisers, counsel, accountants and other experts, if any, and all other expenses incurred by such party incident to the negotiation, preparation, execution, delivery and performance of the Transaction Documents; provided, however , that, if but only if Securities are sold hereunder at the First Closing, the Company shall, at the First Closing, reimburse the Investor for its reasonable legal fees and expenses of its legal counsel, up to a maximum of $30,000, incurred in connection with the Investor’s due diligence and the negotiation and preparation of the Agreement. The Company shall pay all stamp and other taxes and duties levied in connection with the sale of the Shares.

Section 7.2. Entire Agreement . The Transaction Documents, together with the Exhibits thereto, contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements, understandings, discussions and representations, oral or written, with respect to such matters, which the parties acknowledge have been merged into such documents and exhibits.

Section 7.3. Notices . Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (a) the date of transmission, if such notice or communication is delivered via facsimile (provided the sender receives a machine-generated confirmation of successful transmission) at the facsimile number specified in this Section prior to 4:30 p.m. (Eastern time) on a Business Day, or via email (with a confirmation of successful transmission), (b) the next Business Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number specified in this Section on a day that is not a Business Day or later than 4:30 p.m. (Eastern time) on any Business Day, (c) the Business Day following the date of transmission, if sent by a nationally recognized overnight courier service, or (d) upon actual receipt by the party to whom such notice is required to be given. The address for such notices and communications shall be as follows:

If to the Company:   Axion Power International, Inc.
Attn.: Thomas Granville, Chief Executive Officer
1601 Clover Lane
New Castle, Pennsylvania 16105

Telephone: (724) 654-9300
Facsimile: (724) 654-3300
Email: tgranville@axionpower.com

With a copy to:               Andrews Kurth LLP
Attn.: Quentin Faust, Esq.
1717 Main Street, Suite 4100
Dallas, Texas 75201

Telephone: (214) 659-4589
Facsimile: (214) 659-4828
Email: quentinfaust@andrewskurth.com

If to the Investor:                 The Quercus Trust
1835 Newport Blvd
A109 - PMB 467
Costa Mesa, CA 92627

Telephone: (949) 646-3785
Facsimile: (949) 903-1598
Email: xaixai@pacbell.net

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With a copy to:                    Greenberg Glusker Fields Claman & Machtinger, LLP
Attn.: Joseph P. Bartlett, Esq.
1900 Avenue of the Stars, Suite 2100
Los Angeles, CA 90067

Telephone: (310) 201-7481
Facsimile: (310) 201-2380
Email: jbartlett@ggfirm.com

or such other address as may be designated in writing hereafter, in the same manner, by such Person.

Section 7.4. Amendments; Waivers; No Additional Consideration . No provision of this Agreement may be waived or amended except in a written instrument signed by the Company and the Investor. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any subsequent default or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of either party to exercise any right hereunder in any manner impair the exercise of any such right.

Section 7.5   Termination . This Agreement may be terminated prior to the First Closing:

 
(a)
by written agreement of the Investor and the Company; or

 
by the Company or the Investor, upon written notice to the other, if the Closing shall not have taken place by 6:30 p.m., Little Rock time, on the Outside Date; provided , that the right to terminate this Agreement under this Section 7.5(b) shall not be available to any Person whose failure to comply with its obligations under this Agreement has been the cause of or resulted in the failure of the Closing to occur on or before such time, to the extent such delay is caused by such Person.

Upon a termination in accordance with this Section 7.5, the Company and the Investor shall have no further obligation or liability (including as arising from such termination) to the other, provided that any liabilities arising prior to such termination shall not be affected by the termination.

Section 7.6. Construction . The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof. The language used in this Agreement will be deemed to be the language chosen by the parties to express their mutual intent, and no rules of strict construction will be applied against any party. This Agreement shall be construed as if drafted jointly by the parties, and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Agreement or any of the Transaction Documents.

Section 7.7. Successors and Assigns . This Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. Neither party may assign this Agreement or any rights or obligations hereunder without the prior written consent of the other party.

Section 7.8. No Third-Party Beneficiaries . This Agreement is intended for the benefit of the parties hereto and their respective successors and permitted assigns and is not for the benefit of, nor may any provision hereof be enforced by, any other Person, except as otherwise set forth in Section 4.6 (with respect to rights to indemnification and contribution).

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Section 7.9. Governing Law . All questions concerning the construction, validity, enforcement and interpretation of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of Delaware, without regard to the principles of conflicts of law thereof. Each party agrees that all Proceedings concerning the interpretations, enforcement and of the transactions contemplated by this Agreement and any other Transaction Documents (whether brought against a party hereto or its respective Affiliates, employees or agents) shall be commenced exclusively in the state or federal courts sitting in, or having jurisdiction over, the State of Delaware (the “Delaware Courts” ). Each party hereto hereby irrevocably submits to the exclusive jurisdiction of the Delaware Courts for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein (including with respect to the enforcement of the any of the Transaction Documents), and hereby irrevocably waives, and agrees not to assert in any Proceeding, any claim that it is not personally subject to the jurisdiction of any such Delaware Court, or that such Proceeding has been commenced in an improper or inconvenient forum. Each party hereto hereby irrevocably waives personal service of process and consents to process being served in any such Proceeding by mailing a copy thereof via registered or certified mail or overnight delivery (with evidence of delivery) to such party at the address in effect for notices to it under this Agreement and agrees that such service shall constitute good and sufficient service of process and notice thereof. Nothing contained herein shall be deemed to limit in any way any right to serve process in any manner permitted by law. Each party hereto hereby irrevocably waives, to the fullest extent permitted by applicable law, any and all right to trial by jury in any legal proceeding arising out of or relating to this Agreement or the transactions contemplated hereby. If either party shall commence a Proceeding to enforce any provisions of a Transaction Document, then the prevailing party in such Proceeding shall be reimbursed by the other party for its reasonable attorneys’ fees and other costs and expenses incurred with the investigation, preparation and prosecution of such Proceeding.
 
Section 7.10. Survival . The representations, warranties, agreements and covenants contained herein shall survive the Closings and the delivery of the Securities.

Section 7.11. Execution . This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) with the same force and effect as if such facsimile signature page were an original thereof, notwithstanding any subsequent failure or refusal of the signatory to deliver an original executed in ink.

Section 7.12. Severability . If any provision of this Agreement is held to be invalid or unenforceable in any respect, the validity and enforceability of the remaining terms and provisions of this Agreement shall not in any way be affected or impaired thereby and the parties will attempt to agree upon a valid and enforceable provision that is a reasonable substitute therefor, and upon so agreeing, shall incorporate such substitute provision in this Agreement.

Section 7.13. Replacement of Securities . If any certificate or instrument evidencing any Securities is mutilated, lost, stolen or destroyed, the Company shall issue or cause to be issued in exchange and substitution for and upon cancellation thereof, or in lieu of and substitution therefor, a new certificate or instrument, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction and customary and reasonable indemnity, if requested. The applicants for a new certificate or instrument under such circumstances shall also pay any reasonable third-party costs associated with the issuance of such replacement Securities. If a replacement certificate or instrument evidencing any Securities is requested due to a mutilation thereof, the Company may require delivery of such mutilated certificate or instrument as a condition precedent to any issuance of a replacement.

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Section 7.14. Remedies . In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, each of the Investors and the Company will be entitled to specific performance under the Transaction Documents. The parties agree that, except as expressly set forth herein with respect to liquidated damages, monetary damages may not be adequate compensation for any loss incurred by reason of any breach of obligations described in the foregoing sentence and hereby agrees to waive in any action for specific performance of any such obligation the defense that a remedy at law would be adequate.

Section 7.15   Attorney’s Fees . If any action at law or in equity (including arbitration) is necessary to enforce or interpret the terms of any of the Transaction Documents, the prevailing party shall be entitled to reasonable attorney’s fees, costs and necessary disbursements in addition to any other relief to which such party may be entitled.

IN WITNESS WHEREOF, the parties hereto have caused this Securities Purchase Agreement to be duly executed by their respective authorized signatories as of the date first indicated above.
 
The Quercus Trust
 
Axion Power International, Inc.
         
By:
 
/s/ David Gelbaum  
  By: AXION POWER LOGO
 
David Gelbaum
   
Thomas Granville
 
Trustee
   
Chief Executive Officer
 
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EXHIBIT A

FORM OF WARRANT
 
 
 
35
 
 
 
 
36
 
 
 
 
37
 
 
 
 
38
 
 
 
 
39
 
 
 
 
40
 
 
 
 
41
 
 
 
 
42
 
 
 
 
43
 
 
 
 
44
 
 
 
 
45
 
 
 
 
46
 
 
 
 
47
 
 
 
 
48
 
 
 
 
49
 
 
 
 
50
 
 

EXHIBIT B

OPINION OF COUNSEL
 
 
 
51
 
 
 
 
52
 
 
 
 
53
 
 
 
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EXHIBIT C

Plan of Distribution

The selling stockholders, which as used herein includes donees, pledgees, transferees or other successors-in-interest selling shares of common stock or interests in shares of common stock received after the date of this prospectus from a selling stockholder as a gift, pledge, partnership distribution or other transfer, may, from time to time, sell, transfer or otherwise dispose of any or all of their shares of common stock or interests in shares of common stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These dispositions may be at fixed prices, at prevailing market prices at the time of sale, at prices related to the prevailing market price, at varying prices determined at the time of sale, or at negotiated prices.

The selling stockholders may use any one or more of the following methods when disposing of shares or interests therein:

- ordinary brokerage transactions and transactions in which the broker-dealer solicits purchasers;

- block trades in which the broker-dealer will attempt to sell the shares as agent, but may position and resell a portion of the block as principal to facilitate the transaction;

- purchases by a broker-dealer as principal and resale by the broker-dealer for its account;

- an exchange distribution in accordance with the rules of the applicable exchange;

- privately negotiated transactions;

- short sales effected after the date the registration statement of which this Prospectus is a part is declared effective by the SEC;

- through the writing or settlement of options or other hedging transactions, whether through an options exchange or otherwise;

- broker-dealers may agree with the selling stockholders to sell a specified number of such shares at a stipulated price per share; and

- a combination of any such methods of sale.

The selling stockholders may, from time to time, pledge or grant a security interest in some or all of the shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock, from time to time, under this prospectus, or under an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending the list of selling stockholders to include the pledgee, transferee or other successors in interest as selling stockholders under this prospectus. The selling stockholders also may transfer the shares of common stock in other circumstances, in which case the transferees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus.

In connection with the sale of our common stock or interests therein, the selling stockholders may enter into hedging transactions with broker-dealers or other financial institutions, which may in turn engage in short sales of the common stock in the course of hedging the positions they assume. The selling stockholders may also sell shares of our common stock short and deliver these securities to close out their short positions, or loan or pledge the common stock to broker-dealers that in turn may sell these securities. The selling stockholders may also enter into option or other transactions with broker-dealers or other financial institutions or the creation of one or more derivative securities which require the delivery to such broker-dealer or other financial institution of shares offered by this prospectus, which shares such broker-dealer or other financial institution may resell pursuant to this prospectus (as supplemented or amended to reflect such transaction).

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The aggregate proceeds to the selling stockholders from the sale of the common stock offered by them will be the purchase price of the common stock less discounts or commissions, if any. Each of the selling stockholders reserves the right to accept and, together with their agents from time to time, to reject, in whole or in part, any proposed purchase of common stock to be made directly or through agents. We will not receive any of the proceeds from this offering. Upon any exercise of the warrants by payment of cash, however, we will receive the exercise price of the warrants.

The selling stockholders also may resell all or a portion of the shares in open market transactions in reliance upon Rule 144 under the Securities Act of 1933, provided that they meet the criteria and conform to the requirements of that rule.

The selling stockholders and any underwriters, broker-dealers or agents that participate in the sale of the common stock or interests therein may be "underwriters" within the meaning of Section 2(11) of the Securities Act. Any discounts, commissions, concessions or profit they earn on any resale of the shares may be underwriting discounts and commissions under the Securities Act. Selling stockholders who are "underwriters" within the meaning of Section 2(11) of the Securities Act will be subject to the prospectus delivery requirements of the Securities Act.

To the extent required, the shares of our common stock to be sold, the names of the selling stockholders, the respective purchase prices and public offering prices, the names of any agents, dealer or underwriter, any applicable commissions or discounts with respect to a particular offer will be set forth in an accompanying prospectus supplement or, if appropriate, a post-effective amendment to the registration statement that includes this prospectus.

In order to comply with the securities laws of some states, if applicable, the common stock may be sold in these jurisdictions only through registered or licensed brokers or dealers. In addition, in some states the common stock may not be sold unless it has been registered or qualified for sale or an exemption from registration or qualification requirements is available and is complied with.

We have advised the selling stockholders that the anti-manipulation rules of Regulation M under the Exchange Act may apply to sales of shares in the market and to the activities of the selling stockholders and their affiliates. In addition, to the extent applicable we will make copies of this prospectus (as it may be supplemented or amended from time to time) available to the selling stockholders for the purpose of satisfying the prospectus delivery requirements of the Securities Act. The selling stockholders may indemnify any broker-dealer that participates in transactions involving the sale of the shares against certain liabilities, including liabilities arising under the Securities Act.

We have agreed to indemnify the selling stockholders against liabilities, including liabilities under the Securities Act and state securities laws, relating to the registration of the shares offered by this prospectus.

We have agreed with the selling stockholders to keep the registration statement of which this prospectus constitutes a part effective until the earlier of (1) such time as all of the shares covered by this prospectus have been disposed of pursuant to and in accordance with the registration statement or (2) the date on which the shares may be sold pursuant to Rule 144 of the Securities Act.
 
 
56
 
 
 
 
57
 
 
 
 
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CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Axion Power International, Inc.
3601 Clover Lane
New Castle, Pennsylvania 16105


We consent to the use of our report dated April 3, 2008, in the Registration Statement on Form S-1, with respect to the consolidated balance sheets of Axion Power International, Inc.   as of December 31, 2007 and 2006, and the related consolidated statements of operations, changes in stockholders’ deficit, and cash flows for the years then ended and for the period since inception (September 18, 2003) through December 31, 2007. We also consent to the reference to us under the heading “Experts” in such Registration Statement.

 
/s/ ROTENBERG & CO., llp


Rochester, New York
July 3, 2008