UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

# FORM 10-KSB

(Mark One)|X|   ANNUAL REPORT PURSUANT TO SECTION 13
                                            OR 15(d) OF THE SECURITIES EXCHANGE
                                            ACT OF 1934
For the fiscal year
                                            ended December 31, 2007 or

|_|   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
                                             For the transition period from _____ to _____

Commission file number:

|Electro Energy Inc.                                           
|--------------------------------------------------------------
|(Exact name of small business issuer in its charter)          
|                                                              
|Florida                                                       
|(State or other jurisdiction of incorporation or organization)

|30 Shelter Rock RoadDanbury, CT          |  | 06810     
|---------------------------------------- |  | ----------
|(Address of principal executive offices) |  | (Zip Code)

Issuer's telephone number: (203) 797-2699

Securities Registered Under Section 12(b) of the Exchange Act: None

Securities Registered Under Section 12(g) of the Exchange Act:Common Stock, $0.001 par value(Title of class)

Check whether the Issuer (1) has
filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during
the past 12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes
|X|    No |_|

Check if there is no disclosure of
delinquent filers in response to Item 405 of Regulation S-B contained in this form, and
no disclosure will be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.    |X|

Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes
|_|    No |X|

State Issuer's revenues for its most recent fiscal year: $3,639,892.

The aggregate market value of the
voting common equity held by non-affiliates was $9,063,175 based upon the closing sales
price of Common Stock on April 11, 2008 of $0.54 per share.

As of April 11, 2008, 29,962,312
shares of Common Stock, par value $.001 per share, were outstanding.

# DOCUMENTS INCORPORATED BY REFERENCE

None.

---



## ELECTRO ENERGY INC.

## INDEX

|Part I     |  | Description                                                                                                                  | PageNumber
|---------- |  | ---------------------------------------------------------------------------------------------------------------------------- | ----------
|Item 1     |  | Description of Business                                                                                                      | 1         
|Item 2     |  | Description of Property                                                                                                      | 6         
|Item 3     |  | Legal Proceedings                                                                                                            | 6         
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                                                          | 7         
|           |  |                                                                                                                              |           
|Part II    |  |                                                                                                                              |           
|Item 5     |  | Market for Common Equity and Related Stockholder Matters                                                                     | 7         
|Item 6     |  | Management's Discussion and Analysis or Plan of Operation                                                                    | 9         
|Item 7     |  | Financial Statements                                                                                                         | 24        
|Item 8     |  | Changes In and Disagreements With Accountants on Accounting and Financial Disclosure                                         | 57        
|Item 8A    |  | Controls and Procedures                                                                                                      | 57        
|Item 8B    |  | Other Information                                                                                                            | 57        
|           |  |                                                                                                                              |           
|Part III   |  |                                                                                                                              |           
|Item 9     |  | Directors, Executive Officers, Promoters and Control Persons; Compliance with
             Section 16(a) of the Exchange Act | 58        
|Item 10    |  | Executive Compensation                                                                                                       | 60        
|Item 11    |  | Security Ownership of Certain Beneficial Owners and Management and Related
             Stockholder Matters                  | 61        
|Item 12    |  | Certain Relationships and Related Transactions                                                                               | 63        
|Item 13    |  | Exhibits                                                                                                                     | 65        
|Item 14    |  | Principal Accountant Fees and Services                                                                                       | 66        
|           |  |                                                                                                                              |           
|Signatures |  |                                                                                                                              | 66        

---



# Forward-looking
Statement Disclaimer

Forward-looking
statements in this report, including without limitation, statements related to the Companys
plans, strategies, objectives, expectations, intentions and adequacy of resources, are
made pursuant to the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. Investors are cautioned that such forward-looking statements involve risks
and uncertainties including without limitation the following: the Companys plans,
strategies, objectives, expectations and intentions are subject to change at any time at
the discretion of the Company; the Companys plans and results of operations will be
affected by the Companys ability to manage its growth; general economic and
business conditions; competition; unexpected changes in technologies and technological
advances; ability to commercialize and manufacture products; results of experimental
studies; research and development activities; changes in, or failure to comply with,
governmental regulations; the ability to obtain adequate financing in the future and
other risks and uncertainties indicated from time to time in the Companys filings
with the Securities and Exchange Commission.

In
some cases, you can identify forward-looking statements by terminology such as may, will, should, could, expects, plans, intends, anticipates, believes, estimates, predicts, potential or
continue or the negative of such terms or other comparable terminology.
Although we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance, or
achievements. Moreover, neither we nor any other person assumes responsibility for the
accuracy and completeness of such statements. We are under no duty to update any of the
forward-looking statements after the date of this report.

# PART I

# Item 1. DESCRIPTION OF
BUSINESS

# Business Development

Electro
Energy Inc. was incorporated in Connecticut on March 23, 1992. On January 11, 2001,
Electro Energy Inc. was incorporated in Delaware. On January 12, 2001, Electro Energy
Inc., the Connecticut corporation, was merged with and into Electro Energy Inc., the
Delaware corporation, with Electro Energy Inc., the Delaware corporation, (Old EEI)
as the surviving corporation. On June 11, 2003, Old EEI incorporated Mobile Energy
Products, Inc. (MEP) in Delaware, as a wholly-owned subsidiary. On October 1,
2003, MEP acquired the power systems operations of EaglePicher Technologies, LLC (EaglePicher).
In connection with the acquisition, the Company and EaglePicher entered into a ten year
technology license agreement, a five year supply agreement, a five year real estate lease
agreement, and a ground water remediation services agreement. On October 22, 2007 the
Company and EaglePicher agreed to terminate the supply agreement.

On
June 9, 2004, Old EEI, a privately held corporation, entered into an Agreement of Merger
and Plan of Reorganization dated May 7, 2004 (the Merger Agreement) with MCG
Diversified, Inc. (MCG), a publicly held Florida corporation formed in
December 1993, and EEI Acquisition Corp. (Merger Sub), a Delaware corporation
and wholly owned subsidiary of MCG. Pursuant to the Merger Agreement, Merger Sub merged
with and into Old EEI, with Old EEI remaining as the surviving corporation (the Merger).
The Board of Directors and shareholders amended MCGs Amended and Restated Articles
of Incorporation to change the corporate name of MCG to Electro Energy Inc. (EEI).
The Merger Agreement may be found at Exhibit 2.1 to the Companys Current Report on
Form 8-K, as filed with the Securities and Exchange Commission on June 24, 2004.
Following the Merger, Old EEI changed its name to EEI Technologies, Inc. (EEI
Technologies). As MCG did not have any meaningful operations prior to the merger,
the transaction was treated as a recapitalization of EEI Technologies, and accounted for
on an historical cost basis for all periods presented. On December 19, 2007, Companys
shareholders approved an increase in the number of shares of authorized common stock from
50,000,000 to 250,000,000.

---



On
August 30, 2005, EEI Acquisition Co., LLC (EEI Acquisition) was formed in
Delaware as a wholly owned subsidiary of EEI. On April 5, 2006, EEI Acquisition completed
the acquisition of certain assets and entered into certain lease agreements for real
estate relating to the manufacture of lithium-ion and nickel based rechargeable cells and
batteries located in Alachua, Florida from Lithium Nickel Asset Holding Company I, Inc.,
a Delaware corporation (the Seller or LNAH), pursuant to the
terms of an Asset Purchase Agreement by and among EEI, EEI Acquisition, and the Seller.
The Asset Purchase Agreement may be found at Exhibit 2.1 to the Companys Current
Report on Form 8-K, as filed with the Securities and Exchange Commission on April 6,
2006. The total purchase consideration for the assets consisted of 5,750,000 unregistered
shares of EEI common stock (the Consideration Shares) and a six-year warrant (Contingent
Warrant) to purchase up to 2,000,000 unregistered shares of EEI common stock at an
exercise price of $7.00 per share vesting upon meeting future contingent revenue
milestones. Upon reaching aggregate gross sales of $25,000,000 generated from the Florida
facility, the Contingent Warrant holder will have the right to exercise warrants for the
purchase of 500,000 shares of common stock. For each $1,000,000 of gross sales generated
from the Florida facility in excess of $25,000,000 prior to April 5, 2009, the Contingent
Warrant holder will have the right to exercise to purchase 10,000 shares of common stock
up to a total of 1,500,000 shares (or 2,000,000 in the aggregate, including the initial
500,000). Of the total number of shares, 1,000,000 Consideration Shares will be held in
escrow pursuant to an escrow agreement entered into at the closing in order to secure the
Sellers indemnification obligations under the Asset Purchase Agreement which shall
be incrementally released over the course of five years until all of the shares are
released on April 5, 2011. The Company has included 750,000 Consideration Shares in a
registration statement filed by the Company and declared effective by the Securities and
Exchange Commission (SEC) on January 26, 2007. In addition, the Company
agreed to include 400,000 Consideration Shares in a subsequent registration statement in
exchange for the forfeiture of 500,000 Contingent Warrants by the Seller. Further,
4,600,000 Consideration Shares and the warrants issued to the Seller in connection with
the acquisition and lease agreements are subject to a lock-up agreement restricting the
ability of the Seller to transfer the Consideration Shares and warrants for a period of
one year, and providing for a partial release for transfer in the second year after the
closing. The aggregate purchase price was $21,050,841 which consisted of the issuance of
5,750,000 shares of the Companys common stock valued at $20,741,071, and
acquisition costs of $309,770. Pursuant to Statement of Financial Accounting Standards (SFAS)
141 Business Combinations, the purchase price has been allocated to
the net assets acquired based on their estimated fair values on the date of acquisition
as follows: Machinery and equipment of $20,859,841 and leasehold improvements of
$191,000. The Company will record the value of the Contingent Warrant as additional
purchase price once the contingent performance conditions have been met in accordance
with SFAS 141 and Emerging Issues Task Force (EITF) 96-18 Accounting
for Equity Investments That Are Issued to Other Than Employees for Accounting or in
Conjunction With Selling Goods or Services. The purchased assets required
further improvements in order to become operational. On May 8, 2006, the name of EEI
Acquisition was changed to Electro Energy Florida, LLC (EEF).

On
September 28, 2006, MEP and Eagle-Picher entered into an agreement pursuant to which (i)
MEP shall continue to supply certain products to Eagle-Picher under the terms of an
existing supply agreement which expires in September 2008 with annual renewal options
thereafter, (ii) Eagle-Picher forgave $100,000 of the $150,000 balance remaining on the
note payable to Eagle-Picher due on October 1, 2006, (iii) Eagle-Picher granted MEP the
option to terminate the Colorado Springs lease after December 31, 2006 with 90 days
notice and (iv) MEP agreed to terminate its right of first refusal on buying the
Eagle-Picher nickel hydrogen battery business. On October 22, 2007 the Company and
EaglePicher agreed to terminate the supply agreement.

The
consolidated financial statements presented in this report are those of EEI and its
wholly-owned subsidiaries, EEI Technologies and EEF. Additionally, the accounts of EEI
Technologies include the accounts of MEP. Collectively, they are referred to herein as
EEI or the Company.

# Business

Principal Products and
Services

EEI
is primarily engaged in the research and development of battery technologies since 1992.
Historically, EEI has performed research and development services under fixed price
contracts primarily with the U.S. military and government agencies. The business strategy
has historically been to seek government funding to support the development of our
battery concepts with the intent to use the technology developed as a springboard into
commercial applications and manufacturing. The development work has focused on basic
materials technology and prototype development of specialty bipolar nickel-metal hydride (NiMH)
batteries and bipolar lithium-ion (Li-ion) batteries using a unique, patented
flat wafer cell design, in addition to low maintenance nickel-cadmium (NiCd)
batteries. The cells can be made in any shape and are therefore applicable to a wide
variety of military and commercial applications. Wafer cells are stacked one on top of
another to create multi-cell batteries with the required energy capacity and voltage for
a given application. EEI has supplied prototype batteries to various commercial and
government customers for use in military communications, satellites, aircraft auxiliary
power, standby power, and medical applications.

---



We
are pursuing commercial market opportunities while continuing technical development
activities. We are targeting multiple rechargeable battery markets: military and
aerospace, transportation, consumer products and utility power quality. The military and
aerospace market provides an outlet for EEIs legacy products as well as operational
supplies of the advanced rechargeable batteries being developed under various development
contracts. The transportation market requires advanced battery technology to support the
developing electric vehicle, hybrid electric vehicle and plug-in hybrid electric vehicle
applications that promise significant improvement in fuel economy, energy security and
environmental impact. Hybrid electric vehicle batteries are being developed for a wide
range of passenger car, truck, commercial and public transportation applications. Plug-in
hybrid electric vehicle batteries are being developed for both OEM and aftermarket
vehicle applications. Electric bicycle and scooter usage is growing, particularly in
Asia. Numerous consumer markets require smaller, lighter, more powerful and longer
lasting rechargeable batteries to enable or improve acceptance of products. Cordless
power tools is a representative consumer market. We believe our bipolar NiMH and Li-ion
batteries will achieve commercial success in these markets and are pursuing them
accordingly. We are pursuing a variety of strategic partners related to the target
markets.

EEI
is also engaged in the manufacture of legacy specialty battery products in its Colorado
Springs, Colorado facility. In October 2003, EEI acquired the power systems operations of
EaglePicher in Colorado Springs. The operation was established by EaglePicher in 1976 and
has been primarily engaged in the manufacture of specialty NiCd batteries for satellites
and aircraft applications. For EEI, the acquisition provided an established product line,
capacity for manufacturing, personnel with complementary skills broadening EEIs
chemistry portfolio and manufacturing opportunities, and a facility certified for the
production of products for manned spaceflight. The specialty battery products produced
include components for battery power systems used in satellites and aircraft as well as
custom orders from government agencies. The Colorado Springs facility is AS9100/ISO9001
certified.

In
April 2006, EEI acquired certain assets and entered into certain lease agreements for
real estate relating to the manufacture of Li-ion and nickel based rechargeable cells and
batteries located in Alachua County, Florida near Gainesville from Lithium Nickel Asset
Holding Company I, Inc. This acquisition will provide EEI with high volume battery
manufacturing capabilities for Ni-MH and Li-ion chemistries in cylindrical, prismatic and
bipolar designs for the target markets. This facility is currently the only one of its
type in North America and we believe that this facility is the keystone for EEIs
continued development of its battery chemistry portfolio as well as its commercial market
opportunities. Significant investment is being made to repair and upgrade the facility in
preparation for product qualification and production start-up.

Competitive Business
Conditions

Prior
to October 22, 2007, EEI was the sole source supplier for components for battery power
systems used in military and commercial satellite applications to EaglePicher under a
supply agreement. Pricing under the supply agreement was fixed, subject to possible
adjustment under periodic value engineering reviews and based on material cost
escalations. In the future, we expect to continue to supply components to EaglePicher on
a competitively bid basis.

EEI
has licensed from EaglePicher certain technologies and processes involving the use and
sale of nickel plaque and the manufacture and sale of vented NiCd and sealed NiCd
batteries on a ten year, non-exclusive, worldwide basis. Under the license agreement, EEI
is obligated to pay a royalty to EaglePicher of (a) one-half of one percent (0.5%) of the
sale price upon the sale of NiMH products which utilize the nickel plaque technology, (b)
three percent (3%) of the sale price upon the sale of vented NiCd and sealed NiCd
products utilizing the vented NiCd and sealed NiCd technologies and (c) such royalties
that the parties may agree upon for the sale of products other than NiMH and vented NiCd
and sealed NiCd products utilizing the nickel plaque technology. Also under the license
agreement, EaglePicher agreed, upon the terms and conditions thereunder, not to compete
with EEI in the manufacture or sale of prismatic NiCd batteries or cells for aircraft,
space or government applications or bipolar or NiMH batteries or cells. Additionally, EEI
agreed, upon the terms and conditions of the license agreement, not to compete with
EaglePicher in the manufacture or sale of nickel-hydrogen products or the sale of nickel
plaque, nickel plaque technologies or striker assemblies to third parties. EEI may extend
the term of the license prior to expiration upon terms mutually agreeable to the parties.
EEI may terminate the license agreement at any time prior to expiration.

---



We
plan to continue to supply components to EaglePicher, manufacture and sell specialty NiCd
batteries, transition EEIs bipolar NiMH battery to a broader mix of applications
and to broaden the product mix to include lithium rechargeable batteries. The Colorado
Springs operation is one of two organizations worldwide that produce specialty NiCd
batteries for satellites and one of three that is qualified for U.S. government
applications. EEIs NiCd processes have been developed and refined over the past
twenty years to deliver a long life product.

EEIs
NiMH processes are currently being transitioned to a commercial line. The commercial line
will contain a mix of proprietary and commercially available equipment. These processes
and equipment are not currently patent-protected and we do not anticipate licensing our
manufacturing technology at this time.

Suppliers

We
have been working with our suppliers in the development of our bipolar wafer cell NiMH
battery. The construction of the bipolar wafer cell NiMH battery utilizes a large
percentage of nickel-metal, nickel based hydride alloys and hydroxides, as well as other
metal products and plastics. We have multiple suppliers for these materials.

The
Company uses a low-pressure metal hydride (AB5) alloy in development and
fabrication processes. There are many alloy suppliers, but we are working with Treibacher
Auermet, an Austrian based company with years of technical experience and a strong
history as a U.S. supplier of AB5 alloy. The Company has not experienced any
shortages in the availability of the alloy. Additional sources are being evaluated.

Other
materials utilized in the Companys design, such as metal foils, plastics and
adhesives, are commodities and we do not expect any supply issues. However, due to
possible formulation changes and continuous price fluctuations, we will continue to
monitor and evaluate these materials, and ask the manufacturers to notify us if
formulations are changed so that the Company can seek other materials if necessary.

Significant Customers

The
Company had four customers with sales of 10% or more of total sales in 2007. Net sales to
the Companys four major customers, the U.S. Government, Sandia National
Laboratories, EaglePicher Technologies, LLC and Lockheed Martin represented approximately
38%, 18%, 14% and 12% of total net sales, respectively, in 2007. Accounts receivable from
these customers amounted to $203,143 at December 31, 2007. The Company had three
customers with sales of 10% or more of total sales in 2006. Net sales to such customers,
the U.S. Government, EaglePicher Technologies, LLC and Sandia National Laboratories
represented approximately 43%, 24% and 22% of total net sales, respectively, in 2006.

On
April 11, 2005, Eagle Picher, Inc. and its affiliates announced its voluntary Chapter 11
bankruptcy filing. On January 25, 2006, EaglePicher, Inc. filed its plan of
reorganization. On August 1, 2006, pursuant to a confirmed plan of reorganization,
substantially all the assets of EaglePicher and its U.S. Subsidiaries were transferred to
the newly formed EaglePicher Corporation (EPC) and its Subsidiaries. On
September 28, 2006, EEI and EPCs subsidiary EaglePicher Technologies, LLC (EPT)
entered into an agreement pursuant to which (i) EEI shall continue to supply certain
products to EPT under the terms of an existing supply agreement which expires in
September 2008 with annual renewal options thereafter, (ii) EPT forgave $100,000 of the
$150,000 balance remaining on the note payable to EPT due on October 1, 2006, (iii) EPT
granted EEI the option to terminate the Colorado Springs lease after December 31, 2006
with 90 days notice and (iv) EEI agreed to terminate its right of first refusal on buying
the EPT nickel hydrogen battery business. On October 22, 2007 the Company and EaglePicher
agreed to terminate the supply agreement. We believe that EPT is a viable business entity
and, although no assurance can be given, will continue to operate because of its
importance to national defense.

---



Intellectual Property

We
regard our battery technology and production processes as proprietary and rely primarily
on a combination of domestic and foreign patent and trade secret laws of general
applicability, employee confidentiality and invention assignment agreements, licensing
and OEM protection agreements and other intellectual property protection methods to
safeguard our technology and processes.

We
hold nine issued United States patents, which expire beginning in 2012 and ending in
2022. We also hold eleven issued foreign patents and a number of pending foreign patent
applications, which cover the technology that is the subject of the United States
patents. These include (i) bipolar electrochemical battery of stacked wafer cells; (ii)
method of making electrodes for bipolar electrochemical battery; (iii) method for
preparing conductive electrochemically active material; and (iv) bipolar electrochemical
battery systems. In addition, we have new applications pending and a number of new
inventions for which we intend to file additional patent applications both domestically
and internationally as we continue to improve our existing technology, develop new
technology and make advances to our bipolar NiMH and Li-ion wafer cell batteries.

We
are not aware of any current infringement upon any of our patents.

In
addition, during 2007 we acquired the rights to nine United States patents and one
foreign patent from Rutgers University covering certain materials and processes related
to rechargeable battery cells, which expire at various times through 2024.

We
are party to an exclusive worldwide technology agreement for our use of certain
commercial truck anti-idling technologies. We are also party to an exclusive worldwide
technology agreement for our use of certain smart battery system technologies.

Government Regulation

Because
of our participation in government contracts, we will be subject to audit from time to
time for our compliance with government regulations by various agencies, including the
Defense Contract Audit Agency, the Defense Investigative Service and the Office of
Federal Control Compliance Programs. These and other governmental agencies may also
periodically conduct inquiries or investigations that may cover a broad range of our
activity. Responding to any such audits, inquiries or investigations may involve
significant expense and divert our attention. In addition, an adverse finding in any such
audit, inquiry or investigation could involve penalties that may be significant.

Our
facilities will also be subject to a broad range of federal, state and local laws and
regulations relating to the environment, including those governing discharges to the air,
water and land, the handling and disposal of solid and hazardous substances and wastes
and the remediation of contamination associated with releases of hazardous substances at
our facilities and at off-site disposal locations. Risk of environmental liability is
inherent in our business, and there can be no assurance that material environmental costs
will not arise in the future. In particular, we might incur capital and other costs to
comply with increasingly stringent environmental laws and enforcement policies.

We
believe that we operate our business in material compliance with applicable government
regulations.

Backlog

Our
backlog as of December 31, 2007 was approximately $2,276,000 compared with backlog of
approximately $2,430,000 as of December 31, 2006. Backlog refers to the aggregate
revenues remaining to be earned at a specified date under contracts we hold. Due to the
long-term nature of our government contracts, fluctuations from year to year are not an
indication of any future trend. Although backlog reflects business that is considered
firm, cancellations or scope adjustments may occur and will be reflected in our backlog
when known.

---



Employees

As
of December 31, 2007, we had 53 full time employees, none of whom are covered by union
contracts. Employee relations are considered good and no foreseeable problems with the
work force are evident.

# Item 2. DESCRIPTION OF
PROPERTY

Electro
Energy Incs principal executive offices are located at 30 Shelter Rock Road,
Danbury, Connecticut 06810. The Company leases manufacturing facilities in the United
States totaling 257,000 square feet. The leased facilities are occupied under leases for
terms ranging from month to month to six years with options to extend the leases for an
additional one to six years. We believe that the Companys facilities are adequate
for the foreseeable future.

|Location             | Activities         | Lease/Own | LeaseExpiration                           | SquareFootage
|-------------------- | ------------------ | --------- | ----------------------------------------- | -------------
|Danbury, CT          | HQ, R&D            | Leased    | July 2008                                 | 14,000       
|Colorado Springs, CO | Manufacturing, R&D | Leased    | March 2009 with 90 day cancellation right | 43,000       
|Alachua, FL          | Manufacturing, R&D | Leased    | April 2012                                | 200,000      

# Item 3. LEGAL PROCEEDINGS

Electro
Energy, Inc. is engaged in litigation with LNAH and Phoenix Commercial Park, LLLP (Phoenix)
in a state court proceeding in Alachua County, Florida regarding entitlement to assets
purchased and leased pursuant to the Asset Purchase Agreement, Site Agreement, leases,
and in conjunction with the Bankruptcy Order and Letter of Intent with LNAH. LNAH sold
certain real estate and assets to Phoenix which infringe on Electro Energy asset
ownership and leasehold rights. The litigation is styled as an action seeking a
declaratory judgment. EEI was provided injunctive relief by the Circuit Court to protect
its assets and leasehold interests. EEI and Phoenix have entered into an abatement
agreement to pursue settlement discussions. LNAH has filed a motion to return the
litigation to Bankruptcy Court. We are engaged in active settlement negotiations with
LNAH and Phoenix and believe that a settlement is likely.

On
April 6, 2007, the Company provided LNAH notice of certain claims the Company is
asserting against LNAH for breach of contract and indemnification under the provisions of
the Asset Purchase Agreement and real property lease agreements. We are engaged in active
settlement negotiations with LNAH and believe that a settlement is likely.

At
this time, an evaluation  of the ultimate  outcome and an estimate of potential  loss, if
any, is unable to be determined for these issues.

On
or about January 31, 2007, Audra Mace, the Companys former Chief Financial Officer,
filed an administrative discrimination case against the Company with the Connecticut
Commission on Human Rights and Opportunities (the CHRO). The Complaint
alleges that she was constructively discharged based on her gender and
because of an alleged hostile work environment. Ms. Mace claims loss of income and
emotional distress as a result of her alleged treatment by the Company and her alleged
constructive discharge. The Company believes that the complaint has no merit
and will vigorously defend the claims set forth therein. Such defense will include a
statement that Ms. Mace left her position voluntarily. Ms. Mace has rejected the Companys
attempts to settle these issues in a No Fault Conciliation process administered by the
CHRO. The resolution of this complaint is not expected to have a material effect on the
Company.

We
are aware of no other pending or threatened litigation related to us, our business or our
officers and directors.

---



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

The
following matters were submitted to a vote of the security holders of the Company through
the solicitation of proxies or otherwise during the fourth quarter of the year ended
December 31, 2007:

|1. | Election
of Directors
|-- | ---------------------

|Person            | Term Expiring | For        | Withheld
|----------------- | ------------- | ---------- | --------
|Lawrence Schafran | 2008          | 18,041,954 | 183,897 
|Robert Hamlen     | 2009          | 17,963,509 | 262,342 
|William Wylam     | 2009          | 17,950,509 | 275,342 
|Michael Reed      | 2009          | 17,973,109 | 252,742 

|2. | Amend the Companys Amended and Restated 2005 Stock Option and Incentive
          Plan to (i) provide for the grant of restricted shares of our common stock to
          key employees, (ii) provide for acceleration of vesting upon change of control
          of the Company, and (iii) clarify terms of the effect of employee termination on
          previously granted options
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FOR
AGAINST ABSTAIN NOT          VOTED | 11,805,936359,04538,3086,022,562 | 
| | -------------------------------------- | -------------------------------- | 

|3. | Amend the Companys Articles of Incorporation to increase the number of
          authorized shares of common stock from 50 million to 250 million
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------

| | FOR
AGAINSTABSTAIN | 17,151,0791,023,12351,649 | 
| | ------------------ | ------------------------- | 

|4. | Amend the Companys By-Laws to permit the Board of Directors to (i)
          schedule its meetings and the Annual Meeting at its discretion, (ii) increase
          the number of days from which the Company can select a record date, (iii) use
          paperless stock certificates, and (iv) reflect the change in the Companys
          name (as it appears in the By-Laws) from MCG Diversified, Inc. to Electro
          Energy, Inc.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FOR
AGAINST ABSTAIN | 17,497,815488,971239,065 | 
| | ------------------- | ------------------------ | 

|5. | Appoint Marcum & Kliegman, LLP as auditors of the Company for the fiscal
          year ending December 31, 2007
|-- | ----------------------------------------------------------------------------------------------------------------

| | FOR
AGAINST ABSTAIN | 18,156,07644,48125,294 | 
| | ------------------- | ---------------------- | 

# PART II

# Item 5. MARKET FOR
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Since
December 31, 2004, the Companys common stock is listed for trading on the NASDAQ
Capital Market under the symbol EEEI. Prior to December 31, 2004, our common
stock was quoted on the Over-the-Counter Bulletin Board (OTCBB) under the
symbol EEEI. Our common stock had been quoted on the OTCBB since June 10,
2004. Prior to that date, there was no active market for our common stock, which traded
in the public market under the symbol MCGV, representing MCG Diversified,
Inc. The following table sets forth the high and low sales prices and the high and low
bid prices, as applicable, per share of common stock for the periods indicated. These
prices represent inter-dealer quotations without retail markup, markdown, or commission
and may not necessarily represent actual transactions.

---





| | Year Ended December 31, 2007 |  | High     |  | Low     
| | ---------------------------- |  | -------- |  | --------
| |                              |  |          |  |         
| | First Quarter                |  | $   1.67 |  | $   1.13
| | Second Quarter               |  | 1.33     |  | 0.95    
| | Third Quarter                |  | 1.32     |  | 0.25    
| | Fourth Quarter               |  | 1.11     |  | 0.26    

| | Year Ended December 31, 2006 |  | High     |  | Low     
| | ---------------------------- |  | -------- |  | --------
| |                              |  |          |  |         
| | First Quarter                |  | $   5.00 |  | $   3.02
| | Second Quarter               |  | 3.96     |  | 1.81    
| | Third Quarter                |  | 2.50     |  | 1.65    
| | Fourth Quarter               |  | 1.98     |  | 1.16    

As
of December 31, 2007, there were 28,811,797 shares of the Companys common stock
issued and outstanding.

As
of February 29, 2008, there were approximately 160 record owners of Electro Energy Incs
common stock. However, a significant number of the shares of the Companys common
stock are held in street name and are therefore held by several beneficial
owners. The Company estimates that it has a total of approximately 3, 500 beneficial
shareholders.

The
Company did not pay cash dividends on its common stock in 2007, 2006 and 2005. We do not
expect to pay cash dividends on our common stock in the foreseeable future. We currently
intend to retain our earnings, if any, for use in our business. Any dividends declared in
the future will be at the discretion of our Board of Directors.

On
September 14, 2007, the Company received a letter from The Nasdaq Stock Market (Nasdaq)
notifying the Company that it is not in compliance with the requirements for continued
listing under Nasdaq Marketplace Rule 4310(c)(4) because the bid price of its common
stock for the last 30 consecutive business days had closed below $1.00 per share.
Pursuant to Nasdaq Marketplace Rule 4310(c)(8)(D), the Company was provided an initial
period of 180 calendar days, or until March 12, 2008, to regain compliance.

On
March 13, 2008, Nasdaq issued a letter (the Letter) notifying the Company
that the Companys common stock had not regained compliance with the Rule and that
its common stock does not meet The Nasdaq Capital Markets initial inclusion
criteria set forth in Nasdaq Marketplace Rule 4310(c). The Letter stated that unless the
Company requests an appeal of this determination, trading of the Companys common
stock will be suspended at the opening of business on March 25, 2008 and a Form 25-NSE
will be filed with the SEC, which will result in the removal of the Companys
securities from listing and registration on Nasdaq.

The
Company has requested an appeal to a Nasdaq Listings Qualifications Panel as set forth in
the Letter. Accordingly, the Company expects that its common stock would not be suspended
until after the Listings Qualifications Panel has rendered its decision. There can be no
assurance the Panel will grant the Companys request for continued listing.

The
Letter also stated that, historically, Nasdaq panels have generally viewed a near-term
reverse stock split as the only definitive plan acceptable to resolve a bid price
deficiency. The Companys Board of Directors has not yet determined whether it
believes that a reverse stock split would be in the best interests of the Companys
stockholders. To the extent that in the exercise of its business judgment the Board
determines to effect a reverse stock split, there can be no assurance that such reverse
stock split will cause the Companys common stock to regain compliance with the
minimum bid price requirement for the required period of time.

---



The
following table sets forth, as of the year ended December 31, 2007, information with
respect to the Companys compensation plans and individual compensation arrangements
to which the Company is a party, if any, under which equity securities of the Company are
authorized for issuance:

|Plan Category                                              | Number of securitiesto be issued uponexercise of
outstanding options | Weighted-averageexercise price ofoutstandingoptions | Number of securities
                                        remaining available for
                                        future issuance
|---------------------------------------------------------- | -------------------------------------------------------------------- | --------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------
|                                                          
|Equity compensation plans approved by
security holders     |                                                                      |                                                     |                                                                                                                                             
|1993 Stock Compensation Plan                               | 431,958                                                              | $  1.11                                             | 779,667                                                                                                                                     
|2005 Stock Compensation Plan                               | 1,615,000                                                            | $  2.61                                             | 1,385,000                                                                                                                                   
|Equity compensation plans not approved by security holders | N/A                                                                  | N/A                                                 | N/A                                                                                                                                         
|                                                          
|Total                                                      | 2,046,958                                                            | $  2.29                                             | 2,164,667                                                                                                                                   

# Item 6.
MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

You
should read the following discussion and analysis together with the financial statements
and related notes included elsewhere in this report. This discussion may contain
forward-looking statements that involve risks and uncertainties. Our actual results could
differ materially from those anticipated in any forward-looking statements as a result of
many factors.

# Results of Operations

# Year Ended December 31,
2007 Compared to Year Ended December 31, 2006

Net Revenue

Consolidated
net revenue for the year ended December 31, 2007 was $3,639,892 compared with $4,666,737
for the year ended December 31, 2006, a decrease of $1,026,845 or 22%.

Revenues
of $3,117,345 from service operations increased $197,270 or 7% as a result of new research
and development contract awards from the U.S. Army for battery development for
communications applications, from the U.S. Navy for thermal battery development, from
Universal Technology Corporation for low temperature nickel metal hydride wafer cell
battery development and from Lockheed Martin for lithium ion wafer cell battery
development for the High Altitude Air Ship, partially offset by lower revenue from several
completed contracts. During 2007, service revenues accounted for 86% of total revenues
compared with 63% of total revenues in 2006. The service contract backlog as of December
31, 2007 was approximately $1,640,000.

Revenues
of $522,547 from product manufacturing operations decreased $1,224,115 or 70% as a result
of $394,066 lower sales of Apache helicopter batteries, $257,572 lower sales of general
aircraft products and sales to EaglePicher. During 2007, product revenues accounted for
14% of total revenues compared with 37% of total revenues in 2006. The product order
backlog was approximately $636,000 as of December 31, 2007, of which $598,000 is expected
to be shipped and invoiced beginning in the second quarter of 2008.

The
underlying government and commercial contracts pertaining to net revenue from services
for the periods mentioned require deliverables involving periodic status reports and, in
certain cases, prototypes. Most government contracts are negotiated as cost plus fixed
fee (CPFF), while others are firm fixed price (FFP), milestone or
cost plus cost share (CPCS) type contracts. Commercial orders are contracted
by purchase order. At the completion of each contract and after all contract requirements
have been met, a final invoice is submitted, audited, and satisfied. Historically, the
Company has received substantially all contract funding on awards as agreed.

We
anticipate that we will continue to receive funding for development contracts and orders
for battery products from the US government. Future revenue growth from the sale of
commercial products is highly dependent on product qualification and production start-up
at our Florida facility.

---



Gross Profit (Loss)

Consolidated
gross loss for the year ended December 31, 2007 was $(479,724) or (13.2)% of net revenue
compared with consolidated gross profit of $105,991 or 2.3% in 2006. The decline in gross
profit was mainly a result of lower revenue and the lack of absorption of overhead costs.

Gross
loss from services for the year ended December 31, 2007 was $(338,563) or (10.9)% of net
service revenue compared with $(226,518) or (7.8)% of net service revenue in 2006. The
gross loss from services relates to the Companys research and development contracts
with the U.S. government and its agencies. The gross loss increase was mainly due to lack
of absorption of overhead costs.

Gross
loss from products for the year ended December 31, 2007 was $(141,161) or (27.0)% of net
product revenue compared with gross profit from products of $332,509 or 19.0% of net
product revenue in 2006. The gross loss on products revenue in 2007 compared with the
gross profit in 2006 was mainly due to the decline in products revenues which resulted in
a decline in product manufacturing volume and a consequent lack of absorption of overhead
costs.

The
components of costs of revenues for services include direct materials, direct labor, an
operating overhead allocation based upon direct labor usage, and a general and
administrative overhead allocation based upon the percentage of contract costs relative
to the total. Overhead and general and administrative expenses are billable at contracted
fixed rates during the course of the year. Spending in excess of the contracted amount
can be recovered provided there are funds available in the contract sufficient to cover
the excess expenses and the adjustment is approved by the Defense Contract Audit Agency.

The
components of costs of revenues for products include direct materials, direct labor, and
an operating overhead allocation based upon direct labor usage. An operating overhead
cost pool is estimated to support the forecasted manufacturing activities in advance of
the year. The overhead is absorbed as product is manufactured based upon direct labor
charges. Any unabsorbed overhead is expensed in the period incurred.

Selling, General and
Administrative Expenses

Selling,
general and administrative (SG&A) expenses for the year ended December
31, 2007 were $8,758,468 or 240.6% of total net revenue compared with $3,855,315 or 82.6%
of total net revenue in 2006, an increase of $4,903.153 or 127%. The increase in SG&A
was a result of $3,099,166 higher start-up costs associated with the Florida
manufacturing facility, $418,153 of licensing fees and related expenses for truck
anti-idling auxiliary power unit technology, $175,000 of licensing fees for certain smart
battery system technologies and an increase of $818,755 and $422,059 in legal, accounting
and other professional fees and general and administrative wages, respectively. We will
continue to classify start-up costs associated with the Florida manufacturing facility
as SG&A expenses until we begin commercial production, at which time these costs will be classified as
cost of product revenue.

Research and Development
Expenses

Research
and development (R&D) expenses for the year ended December 31, 2007 were
$1,359,360 or 37.3%% of total net revenue compared with $972,977 or 20.8% of total net
revenue in 2006, an increase of $386,383 or 40%. The R&D expenses relate to
experimentation and product development for bipolar nickel metal hydride batteries for
hybrid electric vehicle (HEV) and plug-in hybrid vehicle (PHEV) applications in the
automotive industry, for improved nickel cadmium batteries for the aerospace market, and
for bipolar lithium ion batteries for advanced military applications. During 2007 and
2006, R&D was conducted in applying the Companys patented bipolar wafer cell
design to lithium ion batteries in connection with a development agreement and a stock
purchase agreement with In-Q-Tel, a shareholder of the Companys common stock.

Other (Income) Expense

Interest
expense for the year ended December 31, 2007 was $1,679,587 compared to interest expense
of $1,093,744 in 2006, reflecting twelve months expense on outstanding notes in 2007 compared with nine months
expense on outstanding notes in 2006, late registration penalties in 2006 on the 8.5% Notes and the additional expense
associated with the payment of the semi-annual interest due on March 31, 2007 and
September 30, 2007 and the August 1, 2007 put payment under the 8.5% Notes in shares of
the Companys common stock. Interest and dividend income was $144,221 for the year
ended December 31, 2007 compared with $239,261 in 2006 due to lower average cash balances
during 2007.

---



For
the year ended December 31, 2007, the amortization of deferred financing costs was
$385,389, consisting of $351,750 relating to the 8.5% Notes and $33,640 relating to the
10% Senior Secured Convertible Notes (the 10% Notes) issued in December 2007.
For the year ended December 31, 2006, the amortization of deferred financing costs was
$228,777. The amortization of deferred debt discount was $660,933, consisting of $424,480
relating to 8.5% Notes and $236,453 relating to the 10% Notes. For the year ended December
31, 2006, the amortization of deferred debt discount was $256,152. During the year ended
December 31, 2007, the Company realized a $84,432 loss on the disposal of certain fixed
assets. During the year ended December 31, 2006, EaglePicher agreed to forgive $100,000 on
the balance of the non-interest bearing note in exchange for certain other revisions to
our agreements. During the year ended December 31, 2007, the Company recognized a
$4,801,688 loss on the redemption of the 8.5% Notes.

Net Loss

During
the year ended December 31, 2007, the Company recorded dividends of $43,721 on the Series
B Convertible Preferred Stock and the net loss available to common stockholders for the
year ended December 31, 2007 was $(18,109,081) or $(0.73) per basic and diluted share
compared with $(5,961,713) or $(0.28) per share in 2006.

# Related Parties

The
Company has agreements with certain related parties who provide consulting services to
the Company. Related party services of an administrative nature were included in S,G&A
in the amount of $213,272 for the year ended December 31, 2007 compared with $152,973 in
2006. The owner of E.F.S. Management Systems and Maryann Phillips, shareholders of the
Companys common stock, provide accounting services to the Company. The Company has
agreements with Martin Klein, a shareholder of the Companys common stock and member
of the Companys Board of Directors, and Robert Hamlen and William Wylam, members of
the Companys Board of Directors, to provide consulting services.

On
March 31, 2005, the Company entered into a development agreement to receive a total of
$450,000 in cash funding from In-Q-Tel, a shareholder of the Companys common stock,
for intended use in the research and development of certain battery technologies. The
contract provides for scheduled payments to the Company if it performs certain research
and development activities over a 24-month period. The Company has entered into a
sub-contract agreement with Rutgers University to perform certain of these activities for
$350,000. In connection with this development agreement, the Company issued warrants
containing certain cashless provisions to purchase up to 15,000 shares of the Companys
common stock. The warrants are exercisable at $9.06 per share over a four-year period
expiring in March 2009. The weighted average fair value of the warrants at the date of
issuance using the Black Scholes option-pricing model was estimated at $5.58 per warrant
and the total estimated value of the warrants, amounting to $83,767, was recorded as cost
of services-related parties expense and other accrued liability. Further, a deferred
contract cost and additional paid-in capital was recorded as of the date of issuance. The
number of warrants that are exercisable are directly proportional to the amount of the
scheduled payments that are received by the Company for performance of the development
agreement. As of December 31, 2007, the Company has received the $450,000 of cash funding
and the estimated value of the warrants has been fully amortized.

On October 17, 2005, the Company
entered into a Stock Purchase Agreement with In-Q-Tel, pursuant to which In-Q-Tel has
agreed to purchase 241,692 shares of unregistered common stock of the Company along with
three-year warrants to purchase 75,829 shares of unregistered common stock of the Company
at an exercise price of $3.11 per share. The total purchase price for the stock and
warrants was $800,000 to be paid over the course of 14 months following the closing,
conditioned upon the Company achieving certain development milestones. As of December 31,
2007, the Company completed the program and has received $800,000 and issued 241,692
shares of unregistered common stock and warrants to purchase 75,829 shares of unregistered
common stock in connection with this agreement. During the year ended December 31, 2007,
the Company received $500,000 and issued 151,060 shares of unregistered common stock and
warrants to purchase 47,395 shares of unregistered common stock in connection with this
agreement. During the year ended December 31, 2006, the Company received $200,000 and
issued 60,424 shares of unregistered common stock and warrants to purchase 18,958 shares
of unregistered common stock in connection with this agreement.

---



On
July 5, 2007 the Company entered into a consulting agreement (the Klein Consulting
Agreement) with Mr. Martin Klein, a stockholder and member of the Board of Directors
of the Company. The Klein Consulting Agreement provides that Mr. Klein will consult with
the Company on an ongoing basis. Under the terms of the Klein Consulting Agreement, Mr.
Klein will be compensated at the rate of $1,000 per day as well as reasonable
out-of-pocket expenses, and he has agreed not to engage in or conduct any business which
competes with the business conducted by the Company during the term of the Klein
Consulting Agreement. The Klein Consulting Agreement will expire on July 5, 2008, and
shall be automatically renewed for additional successive one year periods unless earlier
terminated in accordance with the Klein Consulting Agreement.

On
August 1, 2006, the Company entered into a consulting agreement (the Hamlen
Consulting Agreement) with Dr. Robert Hamlen, a member of the Board of Directors of
the Company. The Hamlen Consulting Agreement provides that Dr. Hamlen will consult with
the Company on an ongoing basis. Under the terms of the Hamlen Consulting Agreement, Dr.
Hamlen will be compensated at the rate of $1,500 per month, plus additional compensation
for extra work at a rate of $1,000 per day as well as reasonable out-of-pocket expenses,
and he has agreed not to engage in or conduct any business which competes with the
business conducted by the Company during the term of the Hamlen Consulting Agreement. The
Hamlen Consulting Agreement will continue until terminated by either party with thirty
days advance written notice.

On
August 1, 2006, the Company entered into a consulting agreement (the Wylam
Consulting Agreement) with Mr. William Wylam, who was appointed a member of the
Board of Directors of the Company, effective as of August 14, 2006. The Wylam Consulting
Agreement provides that Mr. Wylam will consult with the Company on an ongoing basis.
Under the terms of the Wylam Consulting Agreement, Mr. Wylam will be compensated at the
rate of $1,500 per month, plus additional compensation for extra work at a rate of $1,000
per day as well as reasonable out-of-pocket expenses, and he has agreed not to engage in
or conduct any business which competes with the business conducted by the Company during
the term of the Wylam Consulting Agreement. The Wylam Consulting Agreement will continue
until terminated by either party with thirty days advance written notice.

# Financial Condition

Liquidity and Capital
Resources

As
of December 31, 2007, the Company had cash and cash equivalents of $5,751,382. The Company
incurred a loss from operations of $10,597,552 and $4,722,301 for the years ended December
31, 2007 and 2006, respectively. During the years ended December 31, 2007 and 2006, the
Company used $8,580,074 and $3,474,504, respectively, to fund its operating
activities.

The Company is engaged in the
development of energy storage technology, products and related systems as well as the
start up of high volume battery manufacturing operations in its Florida facility. The
Companys operating and capital requirements in connection with planned development,
testing, production, sales and marketing activities will be significant. The amount of
capital needed is directly related to the Companys success in implementing its
business plan and achieving high volume product sales. The Company is not currently
generating sufficient revenues from operations to fund these activities and execute its
business plan and is dependent on the receipt of funding from government development
contracts and cash raised in equity and debt financings to continue the development,
production, marketing and sales of its products. The Company anticipates that funding from
government development contracts together with its cash and cash equivalents will not be
sufficient to fund its operating activities in 2008. Therefore, the Companys ability
to develop high volume manufacturing and execute its product sales and marketing plans
will be dependent on the Companys ability to raise cash through future equity and
debt financings. No assurance can be given that the Company will be successful in
developing high volume manufacturing and executing its product sales and marketing plans
or in obtaining additional financing under terms acceptable to the Company or in amounts
sufficient to fund its future operating activities. The funds that the Company does raise,
if any, may not allow it to maintain its current and planned operations and such
additional financing could result in the dilution of shareholders percentage
interests in the Company. If the Company is unable to obtain additional capital, it may be
required to delay, scale back or eliminate some or all of its development of existing or
future business initiatives and therefore there is substantial doubt as to the Companys
ability to fund future operations and continue as a going concern.

---



The
Companys working capital, current ratio and long-term debt to equity ratio are as
follows:

|                               | December 31,2007 |  | December 31,2006
|------------------------------ | ---------------- |  | ----------------
|                               |                  |  |                 
|Working capital                | $    5,718,606   |  | $    5,423,982  
|Current ratio                  | 5.82             |  | 4.18            
|Long-term debt to equity ratio | 2.75             |  | 46.04           

Asset Purchase                On
April 5, 2006, the Company completed the acquisition of certain assets and entered into
certain lease agreements for real estate relating to the manufacture of lithium-ion and
nickel based rechargeable cells and batteries located in Alachua, Florida from Lithium
Nickel Asset Holding Company I, Inc., (the Seller), pursuant to the terms of
an Asset Purchase Agreement. The total purchase consideration for the assets consisted of
5,750,000 unregistered shares of the Companys common stock (the Consideration
Shares) and a six-year warrant (the Contingent Warrant) to purchase up to
2,000,000 unregistered shares of the Companys common stock at an exercise price of
$7.00 per share vesting upon meeting future contingent revenue milestones. Upon reaching
aggregate gross sales of $25,000,000 generated from the Florida facility, the Contingent
Warrant holder will have the right to exercise warrants for the purchase of 500,000
shares of common stock. For each $1,000,000 of gross sales generated from the Florida
facility in excess of $25,000,000 prior to April 5, 2009, the Contingent Warrant holder
will have the right to exercise to purchase 10,000 shares of common stock up to a total
of 1,500,000 shares (or 2,000,000 in the aggregate, including the initial 500,000). The
Company also issued warrants to purchase 1,000,000 shares of unregistered common stock, in connection with a lease agreement to lease
certain industrial manufacturing space from the Seller. In addition, the Company has
reserved 68,354 shares of common stock for future issuance as a contingent security
deposit under the lease agreement. Of the total number of shares, 1,000,000 Consideration
Shares will be held in escrow pursuant to an escrow agreement entered into at the closing
in order to secure the Sellers indemnification obligations under the Asset Purchase
Agreement which shall be incrementally released over the course of five years until all
of the shares are released on April 5, 2011.

The
Company has included 750,000 Consideration Shares in a registration statement filed by
the Company and declared effective by the Securities and Exchange Commission (SEC)
on January 26, 2007. In addition, the Company agreed to include 400,000 Consideration
Shares in a subsequent registration statement in exchange for the forfeiture of 500,000
Contingent Warrants by the Seller. Further, 4,600,000 Consideration Shares and the
warrants issued to the Seller in connection with the acquisition and lease agreements are
subject to a lock-up agreement restricting the ability of the Seller to transfer the
Consideration Shares and warrants for a period of one year, and providing for a partial
release for transfer in the second year after the closing. The aggregate purchase price
was $21,050,841 which consisted of the issuance of 5,750,000 shares of the Companys
common stock at $3.61 per share valued at $20,741,071, and acquisition costs of $309,770.
Pursuant to SFAS 141, the purchase price has been allocated to the net assets acquired
based on their estimated fair values on the date of acquisition as follows: Machinery and
equipment of $20,859,841 and leasehold improvements of $191,000. The Company will record
the value of the Contingent Warrant as additional purchase price once the contingent
performance conditions have been met in accordance with SFAS 141 and EITF 96-18.

The
Company is using the acquired assets to develop and commercialize its advanced,
proprietary and patented battery technology for high value and rapidly growing markets.
Targeted applications are those for which smaller size, lighter weight, higher
performance and longer life batteries are enabling technology or add significant value to
the end product. The proprietary manufacturing technology being developed by the Company
is expected to provide a cost advantage compared to other competitive technology.
Upgrades and modifications of the acquired assets have been completed. Sample products
have been sent to certain independent certification laboratories for testing, evaluation
and qualification. Once these products have passed the certification process, the Company
will begin shipping cells to target customers for their approval and expects to secure
production orders shortly thereafter. Additional assets specifically for bipolar wafer
cell manufacturing will be installed in the Florida location.

The
Company is pursuing business opportunities to utilize the cylindrical cell manufacturing
capabilities for niche, high value battery products for customers that value domestic
manufacture of high quality, high reliability battery components. This includes advanced
lithium ion cells in the 18650 industry standard size and may in the future include the
26650 industry standard size.

---



To
support the Florida facility improvements, product development activities and market
development plans, the Company is hiring technical and marketing staff, based primarily
in Connecticut and Florida. Demonstration projects to showcase the Companys
technology are being pursued and are expected to provide revenue, but on a cost share
basis that will not recover full project costs. Significant commercial contracts are
expected to be signed in the latter part of 2008. Primary target markets are military
and government, transportation, utility power quality and backup, and power tools. It is
not possible to predict the success of managements efforts to achieve our goals for
the facility in Florida.

While
Florida is expected to become the high volume manufacturing facility for the Company,
manufacturing of legacy products and new products as well as contract R&D are
expected to continue in Colorado. Headquarters functions and R&D will continue in
Connecticut.

8.5% Secured Convertible
Debentures                On
March 31, 2006, the Company entered into a Note and Warrant Purchase Agreement (the
8.5% Note and Warrant Purchase Agreement) with seven institutional accredited
investors (the 8.5% Note Holders) and, on April 5, 2006, the Company issued
and sold to the 8.5% Note Holders $11,000,000 in aggregate principal amount of 8.5% Senior
Secured Convertible Notes due 2010 (the 8.5% Notes) and issued warrants to purchase 578,947
shares of common stock (the 8.5% Note Warrants) to purchase common stock that are
exercisable until March 31, 2010 at an exercise price of $3.80 per share. The 8.5% Notes
were senior secured debt with all assets of the Company, except inventory and accounts
receivable, pledged as security. Interest was payable semiannually on September 30 and
March 31. Holders of the 8.5% Notes had put rights on August 1, 2007, April 1, 2008,
December 1, 2008, and August 3, 2009 for the greater of 10% of the aggregate initial
principal amount, or $1,000,000. A portion of the proceeds from the issuance of the 8.5%
Notes was placed in escrow to pay the first two years of interest, as well as payment for
the 8.5% Note Holders first put right. The interest and put right are payable in
cash or, at the Companys option, in advance in common stock at a 10% discount to the
market value as described in the 8.5% Note and Warrant Purchase Agreement. Upon payment of
the interest or put right in stock, an amount equal to the interest payment or put payment
was released from escrow and became available for general corporate use.

In
connection with the 8.5% Note and Warrant Purchase Agreement, the Company entered into a
Registration Rights Agreement (the 8.5% Note Registration Rights Agreement),
dated as of March 31, 2006, by and among the Company and the 8.5% Notes Holders. The 8.5%
Note Registration Rights Agreement required the Company to file a shelf registration
statement (the 8.5% Note Shelf Registration Statement) with the SEC under the
Securities Act of 1933, as amended (the Securities Act) to be declared
effective by the SEC no later than 180 days after the date of the 8.5% Note Registration
Rights Agreement. Failure to do so would trigger interest penalties of $110,000
(representing 1.0% of the principal amount of the 8.5% Notes) for each month beyond the
180 day period that the 8.5% Note Shelf Registration Statement remains not having been
declared effective, up to a maximum of $550,000 per year. The SEC declared the 8.5% Note
Shelf Registration Statement effective January 26, 2007. Consequently, the Company
incurred aggregate interest penalties of $440,000 for the period October 27, 2006 through
January 27, 2007.

The
Company elected to pay the semi-annual interest and late registration penalties due on
March 31, 2007 related to the 8.5% Notes in shares of the Companys common stock at
the Interest Conversion Rate as described in the 8.5% Note and Warrant Purchase Agreement.
According to the 8.5% Note and Warrant Purchase Agreement, 20 trading days prior to the
interest payment due date, the Company is obligated to initially issue a number of shares
of the Companys common stock to the note holders to be applied against the amount
due as interest and late registration penalties based upon the average of the five lowest
volume weighted average prices for the 20 trading days ending on the 27th
trading day prior to the interest payment due date. If the average of the five lowest
volume weighted average prices for the 20 trading days ending on the trading day
immediately prior to the interest payment due date is less than the average of the five
lowest volume weighted average prices for the 20 trading days prior to the interest
payment due date, the Company is obligated to issue an additional number of shares based
upon the average of the five lowest volume weighted average prices for the 20 trading days
ending on the trading day immediately prior to the interest payment due date. Accordingly,
on March 2, 2007 and April 9, 2007, the Company, pursuant to the 8.5% Note and Warrant
Purchase Agreement, delivered an aggregate of 765,769 and 90,872 shares of the
Companys common stock, respectively, to the 8.5% Note Holders accounts with
The Depository Trust Company, representing the initial number of shares required to pay
the March 31, 2007 interest payment and late registration penalties under the 8.5% Notes.
On September 21, 2007 and October 3, 2007, the Company, pursuant to the 8.5% Note and
Warrant Purchase Agreement, delivered an aggregate of 730,994 and 658,308 shares of the
Companys common stock, respectively, to the 8.5% Note Holders accounts with
The Depository Trust Company, representing the initial number of shares required to pay
the September 31, 2007 interest payment under the 8.5% Notes. During the year ended
December 31, 2007, $935,000 was released from escrow as a result of the payment of the
March 31, 2007 and September 30, 2007 interest payments under the 8.5% Notes in shares of
the Companys common stock.

---



On
August 1, 2007, the 8.5% Notes Holders exercised their put right and the Company elected
to pay the put right in shares of the Companys common stock as described in the 8.5%
Note and Warrant Purchase Agreement. Accordingly, on August 3, 2007, the Company, pursuant
to the 8.5% Note and Warrant Purchase Agreement, issued an aggregate of 1,229,973 shares
of the Companys common stock to the 8.5% Note Holders, representing the number of
shares required to pay the August 1, 2007 put right, plus accrued and unpaid interest.
During the year ended December 31, 2007, $1,186,167 was released from escrow as a result
of the payment of the August 1, 2007 put right, plus accrued and unpaid interest, under
the 8.5% Notes in shares of the Companys common stock.

The
fair value of the 8.5% Note Warrants was estimated as of the issue date using a
Black-Scholes pricing model, with the following assumptions: common stock based on a
closing market price of $3.70 per share, exercise price of $3.80, zero dividends,
expected volatility of 53.7%, risk free interest rate of 4.79% and contractual life of 4
years. The gross proceeds of the 8.5% convertible debt were allocated to the 8.5% Notes
and the 8.5% Note Warrants. The fair value of the 8.5% Note Warrants of $906,415 resulted
in a discount to the face value of the 8.5% Notes that was recorded as additional paid in
capital and was amortized over the term of the 8.5% Notes as additional interest expense.
The effective rate of interest was 11.11%.

In
accordance with EITF 98-5 and 00-27, the Company evaluated the conversion feature
embedded in the debt instrument and concluded that the 8.5% Notes contained a beneficial
conversion feature since the effective conversion price of the shares was less than the
stock price at the date of issuance based upon the allocation of the fair value of the
convertible debt between the 8.5% Notes and the 8.5% Note Warrants. The beneficial
conversion feature of $607,895 resulted in a discount to the face value of the 8.5% Notes
that has been recorded as additional paid in capital and is being amortized over the term
of the 8.5% Notes as additional interest expense.

The
Company evaluated the provisions of EITF 00-19 Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Companys Own Stock(EITF
00-19) and View A of EITF 05-4 The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument Subject to Issue No. 00-19 (EITF 05-4),
and determined that the conversion option embedded in the 8.5% Notes and the 8.5% Note
Warrants should be classified as equity in the accompanying consolidated financial statements.

Interest
expense on the 8.5% Notes amounted to $1,549,668, including $373,113 of additional
interest expense related to the August 1, 2007 put payment and $110,000 of late
registration penalties, and $1,087,625, including $330,000 of late registration penalties,
for the years ended December 31, 2007 and 2006, respectively. The amortization of the
deferred debt discount recorded in connection with the 8.5% Notes and 8.5% Note Warrants
amounted to $424,480 and $256,152, respectively, for the years ended December 31, 2007 and
2006. The amortization of the deferred financing costs recorded in connection with the
8.5% Notes amounted to $351,750 and $228,777, respectively, for the
years ended December 31, 2007 and 2006.

On
December 7, 2007, the Company redeemed the remaining $9,900,000 principal value of the
8.5% Notes in connection with the issuance of the 10% Secured Convertible Debenture as
described below. In connection with the redemption, the Company recorded a loss on
extinguishment of debt of $4,801,688, consisting of the acceleration of the amortization
of the deferred debt discount, and deferred financing costs of $833,678 and $642,326,
respectively, relating to the 8.5% Notes, the fair value of the warrants and the Series B
Convertible Preferred Stock of $1,303,138 and $1,543,404, respectively, issued to the 8.5%
Note Holders, the repricing of the 8.5% Note Warrants of $145,187 and cash of $333,956.

---



10% Secured Convertible
Debentures                On
December 7, 2007, the Company entered into a transaction whereby the Company (i) issued,
pursuant to that certain Note Sale and Preferred Stock and Warrant Purchase Agreement,
dated December 7, 2007 (the 8.5% Note Holders Agreement), to the 8.5% Note
Holders shares of Series B Cumulative Convertible Preferred Stock (the Series B
Preferred) and warrants (the 8.5% Note Holders New Warrants) to purchase
the Companys common stock, paid cash of $333,956 and reduced the exercise price of
the 8.5% Note Warrants from $3.80 per share to $0.55 per share and (ii) issued, pursuant
to that certain Debenture and Warrant Purchase Agreement, dated December 7, 2007 (the
Debenture and Warrant Purchase Agreement), a 10% Senior Secured Convertible
Debenture (the 10% Notes), a warrant (the 10% Note Warrants) to
purchase common stock to the Quercus Trust (Quercus).

Pursuant
to the 8.5% Note Holders Agreement, the 8.5% Note Holders sold the 8.5% Notes, which had
an aggregate outstanding principal amount of $9,900,000, to Quercus for a cash payment of
$7,425,001 and, in consideration therefore, the Company issued to the 8.5% Note Holders,
in the aggregate, (i) $488,320 from restricted cash, comprised of $333,956 for the sale of
the 8.5% Notes recorded as a loss on extinguishment of debt and $154,364 for accrued and
unpaid interest through December 6, 2007, (ii) 5,401 shares of Series B Convertible
Preferred Stock (the Series B Preferred Stock) with a liquidation preference
of $275 per share and (iii) the 8.5% Note Holders New Warrants to purchase an aggregate of
5,400,000 shares of the Companys common stock and (iv) reduced the exercise price of
the 8.5% Note Warrants from $3.80 per share to $0.55 per share. The conversion price of
the 10% Notes is specified as the greater of (A) 70% of the volume weighted average price
of the Companys common stock for the ten business day period prior to the Conversion
Date, or (B) $0.25. The 8.5% Note Holders Agreement contains prohibitions from exercising
the 8.5% Note Holders New Warrants until the Company has obtained stockholder approval, which approval was obtained on March 5, 2008.

Each
share of Series B Preferred is convertible after December 6, 2008 at the option of the
holder into shares of common stock and has a liquidation preference of $275 per share.
Each share of Series B Preferred shall initially be convertible into common stock at the
Conversion Rate of 500 shares of common stock for each share of Series B Preferred,
subject to adjustments. After the date of the first issuance of any shares of Series B
Preferred, the conversion rate for each share of Series B Preferred shall equal the
fraction whose numerator is the liquidation preference of such share of Series B Preferred
and the denominator is the greater of (A) 70% of the volume weighted average price of the
Companys common stock for the ten business day period prior to the conversion date,
or (B) $0.25. Holders of the Series B Preferred shall not be entitled to vote on any
matters submitted to a vote of the shareholders holding any other class of stock of the
Company.

Each
holder of the Series B Preferred shall be entitled to an annual cash dividend equal to 2%
of the outstanding principal amount of the Series B Preferred held by such holder (subject
to adjustment in the event that such Series B Preferred is held for less than one year).
payable in cash on January 1, April 1, July 1 and October 1. No dividends or other
distributions shall be declared or paid with respect to the common stock of the Company or
stock of any other class or series of junior securities unless at the same time an
equivalent dividend or distribution is declared or paid on all outstanding shares of the
Series B Preferred. As of December 31, 2007, the Company accrued $1,980 in dividends
relating to the Series B Preferred.

The
fair value of the Series B Preferred was estimated as of the issue date by allocating a
portion of the fair value to the value of the dividend component and a portion of the fair
value to the value of the common stock equivalent component. The value of the interest
component was based on the present value of the projected stream of interest payments. The
value of the common stock equivalent component was estimated using a lattice pricing model
with the following assumptions: common stock based on a closing market price of $0.95 per
share, exercise price of $0.55, zero dividends, expected volatility of 71.73%, risk free
interest rate of 3.51% and life of five years. The fair value of the Series B Preferred of
$1,543,404 was recorded as loss on extinguishment of the 8.5% Secured Convertible Notes in
the accompanying consolidating financial statements.

The
exercise price of the 8.5% Note Holders New Warrants is $0.55 per share and is adjustable
in the event the Company issues common stock or securities that are convertible into
common stock for less than $0.55 per share (the Subsequent Lower Price), in
which case the exercise price of the 8.5% Note Holders New Warrants shall be the
Subsequent Lower Price, but in no event shall the exercise price be less than $0.25 per
share. The term of the 8.5% Note Holders New Warrant is three years. As partial
consideration for the sale of the 8.5% Notes to Quercus, the exercise price of the 8.5%
Note Warrants issued on April 5, 2006 was reduced from $3.80 per share to $0.55 per share.

---



The
fair value of the 8.5% Note Holders New Warrants, and the repricing of the 8.5% Note
Warrants, was estimated as of the issue date using a lattice pricing model, with the
following assumptions: common stock based on a closing market price of $0.95 per share,
exercise price of $0.55, zero dividends, expected volatility of 71.73%, risk free interest
rate of 3.15% and contractual life of three years. The fair value of the 8.5% Note Holders
New Warrants of $1,303,138 has been recorded as loss on extinguishment of the 8.5% Secured
Convertible Notes in the accompanying consolidated financial statements. As a result of repricing the
8.5% Note Warrants, an additional $145,187 was recorded as loss on extinguishment of debt
representing the difference in the fair value of $184,234 on the 8.5% Note Warrants using
the above assumptions, and the fair value of $39,047 on the 8.5% Note Warrants using the
following assumptions: common stock based on a closing market price of $0.95 per share,
exercise price of $3.80, zero dividends, expected volatility of 71.73%, risk free interest
rate of 3.15% and contractual life of approximately two and a half years.

In
accordance with EITF 98-5 and 00-27, the Company has evaluated the conversion feature
embedded in the Series B Preferred Stock and concluded that a beneficial conversion
feature exists since the effective conversion price of the shares was less than the stock
price at the commitment date. The Company determined the value of the beneficial
conversion feature to be $636,546, which is being accreted monthly from the issuance date
of the Series B Preferred Stock through December 7, 2008, the date of first possible conversion, and is
being recorded as a deemed dividend in the accompanying consolidated financial statements. For the
year ended December 31, 2007, the Company accreted $41,741 in dividends.

The
Company issued the 10% Notes in the principal amount of $18,000,000 in exchange for the
redemption of the outstanding principal amount of the 8.5% Notes of $9,900,000 and
$8,100,000 cash. The 10% Notes are senior secured debt with all assets of the Company,
except inventory and accounts receivable, pledged as security. Interest is payable
quarterly on March 31, June 30, September 30 and December 31 in cash or, at the
Companys option, in common stock valued at the volume weighted average price of the
Companys common stock for the ten business day period prior to the interest payment
date as described in the Debenture and Warrant Purchase Agreement. The 10% Notes are
convertible into common stock commencing on the earlier of (i) twelve months after the
issuance date of the 10% Notes or (ii) the date of effectiveness of the Companys
registration statement to be filed pursuant to the terms of that certain registration
rights agreement dated December 7, 2007 between the Company and Quercus (the 10%
Notes Registration Rights Agreement). The initial conversion price of the 10% Notes
is $0.55 per share (the Initial Conversion Rate). The Initial Conversion Rate
is subject to change, and is a function of the market price per share of the
Companys common stock. The conversion price of the 10% Notes is specified as the
greater of (A) 70% of the volume weighted average price of the Companys common stock
for the ten business day period prior to the conversion date, or (B) $0.25.

The
10% Note Registration Rights Agreement requires the Company to file a shelf registration
statement with the SEC under the Securities Act of 1933, as amended (the Securities
Act) no later than 90 days after the issuance date of the 10% Notes (the Required
Filing Date) and to respond to any SEC comment letter within 30 calendar days of
receipt such SEC comment letter (the Required Response Date). Failure to do
so would trigger interest penalties equal to 2% of the principal amount of the 10% Notes
outstanding for each month beyond the Required Filing Date or Required Response Date up
to a maximum of 12% percent of the principal amount of the 10% Notes outstanding.

The
10% Note Warrants are convertible into 32,727,273 shares of common stock, and have an
exercise price of $0.55 per share. In the event the Company subsequently issues common
stock or Common Stock Equivalents for a lower price, the 10% Note Warrants are convertible
at such subsequent lower price, provided that in no event shall the exercise price be less
than $0.25 per share. The term of the 10% Note Warrants is three years.

The
fair value of the 10% Note Warrants was estimated as of the issue date using a lattice
pricing model, with the following assumptions: common stock based on a closing market
price of $0.95 per share, exercise price of $0.55, zero dividends, expected volatility of
71.73%, risk free interest rate of 3.15% and contractual life of three years. The gross
proceeds of the 10% convertible debt were allocated to the 10% Notes and the 10% Note
Warrants. The fair value of the 10% Note Warrants of $5,897,680 resulted in a discount to
the face value of 10% Notes that has been recorded as additional paid in capital and is
being amortized over the term of the 10% Notes as additional interest expense on a
straight line basis.

---



In
accordance with EITF 98-5 and 00-27, the Company has evaluated the conversion feature
embedded in the 10% Note and concluded that a beneficial conversion feature exists since
the effective conversion price of the shares was less than the stock price at the
commitment date. The Company determined the value of the beneficial conversion feature to
be $12,102,320, which resulted in a discount to the face value of the 10% Notes that has
been recorded as additional paid in capital and is being amortized over the term of the
10% Notes as additional interest expense on a straight line basis.

The
Company evaluated the provisions of EITF 00-19 Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Companys Own Stock(EITF
00-19) and determined that the conversion option embedded in the 10% Notes and the
10% Note Warrants should be classified as equity in the accompanying consolidated financial
statements.

The
Company issued warrants (the Placement Agent Warrants) to purchase 2,618,181
shares of the Companys common stock to the placement agent in connection with the
issuance of the 10% Notes. The fair value of the Placement Agent Warrants was estimated as
of the issue date using a lattice pricing model, with the following assumptions: common
stock based on a closing market price of $0.95 per share, exercise price of $0.55, zero
dividends, expected volatility of 71.73%, risk free interest rate of 3.15% and contractual
life of three years. The fair value of the Placement Agent Warrants of $630,981 has been
recorded as deferred financing cost and is being amortized over the term of the 10% Notes.

The
Company incurred financing costs of $1,387,389 which have been recorded as deferred
financing costs and are being amortized over the term of the 10% Notes.

Interest
expense on the 10% Notes amounted to $123,288 for the year ended December 31, 2007. The
amortization of the deferred debt discount and deferred financing costs recorded in
connection with the 10% Notes and the 10% Note Warrants amounted to $236,453 and $33,640,
respectively, for the year ended December 31, 2007.

The
Company had a note payable to Connecticut Innovations, Incorporated (CII) for
$183,579, commencing December 2004 and maturing December 2007 with interest at 5%, and
three equal annual installments of $61,193. On December 31, 2007, the Company made the
final payment owed to CII. Interest expense related to the long-term debt of CII amounted
to $3,060 and $6,119 for the years ended December 31, 2007 and 2006, respectively.

The
Company had a non-interest bearing note payable to EaglePicher secured by certain assets
acquired in connection with the Companys purchase of EaglePichers Colorado
Springs energy business. On September 28, 2006, EaglePicher agreed to forgive $100,000 of
the remaining $150,000 note balance. The remaining balance of the note of $50,000 was
paid on December 1, 2006 and the remaining discount to fair value was fully accreted at
that time.

On
March 31, 2005, the Company entered into a development agreement to receive a total of
$450,000 in cash funding from In-Q-Tel, a shareholder of the Companys common stock,
for intended use in the research and development of certain battery technologies. The
contract provides for scheduled payments to the Company if it performs certain research
and development activities over a 24-month period. The Company has entered into a
sub-contract agreement with Rutgers University to perform certain of these activities for
$350,000. In connection with this development agreement, the Company issued warrants
containing certain cashless provisions to purchase up to 15,000 shares of the Companys
common stock. The warrants are exercisable at $9.06 per share over a four-year period
expiring in March 2009. The weighted average fair value of the warrants at the date of
issuance using the Black Scholes option-pricing model was estimated at $5.58 per warrant
and the total estimated value of the warrants, amounting to $83,767, was recorded as cost
of services-related parties expense and other accrued liability. Further, a deferred
contract cost and additional paid-in capital was recorded as of the date of issuance. The
number of warrants that are exercisable are directly proportional to the amount of the
scheduled payments that are received by the Company for performance of the development
agreement. As of December 31, 2007, the Company has received the $450,000 of cash funding
and the estimated value of the warrants has been fully amortized as SG&A expenses.

---



On October 17, 2005, the Company
entered into a Stock Purchase Agreement with In-Q-Tel, pursuant to which In-Q-Tel has
agreed to purchase 241,692 shares of unregistered common stock of the Company along with
three-year warrants to purchase 75,829 shares of unregistered common stock of the Company
at an exercise price of $3.11 per share. The total purchase price for the stock and
warrants was $800,000 to be paid over the course of 14 months following the closing,
conditioned upon the Company achieving certain development milestones. As of December 31,
2007, the Company completed the program and has received $800,000 and issued 241,692
shares of unregistered common stock and warrants to purchase 75,829 shares of common stock
in connection with this agreement. During the year ended December 31, 2007, the Company
received $500,000 and issued 151,060 shares of unregistered common stock and 47,395
warrants in connection with this agreement. During the year ended December 31, 2006, the
Company received $200,000 and issued 60,424 shares of unregistered common stock and
warrants to purchase 18,958 shares of common stock in connection with this agreement.

During
the year ended December 31, 2006, warrants were exercised for proceeds of $175,000 in
exchange for 92,687 shares of common stock. No warrants were exercised during 2007. As of
December 31, 2007, 48,013,757 warrants are outstanding with expiration dates ranging from
July 16, 2008 through October 25, 2012 and exercise prices ranging from $0.30 to $9.06.
The weighted average exercise price of the outstanding warrants is $1.02. The maximum
potential future proceeds from the exercise of warrants in-the-money as of December 31,
2007 is approximately $23 million.

During
the years ended December 31, 2006, the Company issued 72,297 shares of common stock in
connection with the exercise of employee stock options for proceeds of $39,101. No stock
options were exercised in 2007. As of December 31, 2007, 2,046,958 options are
outstanding with expiration dates ranging from February 27, 2010 through September 11,
2017 and exercise prices ranging from $0.26 to $6.76. The weighted average exercise price
of the outstanding options is $2.29. The maximum potential future proceeds from the
exercise of the options vested and in-the-money as of December 31, 2007 is $6,708.

Net
cash used in operating activities totaled $8,580,074 and $3,474,504 for the years ended
December 31, 2007 and 2006, respectively. The Company invested $206,830 and $622,109 in
equipment during the years ended December 31, 2007 and 2006, respectively. Current and
prior year equipment additions relate primarily to the construction in progress for
production equipment for the development of its nickel metal hydride and lithium-ion
product lines.

Unregistered Sales of
Equity Securities                On
April 5, 2006, the Company entered into an Asset Purchase Agreement issuing 5,750,000
shares of common stock in exchange for manufacturing equipment as described above.

On
April 5, 2006, the Company entered in to a lease agreement for industrial space as
described above and has reserved 68,354 shares of common stock for future issuance as a
contingent security deposit under the lease agreement.

On
September 18, 2007, the Companys Board of Directors voted to issue 101,695 shares
of the Companys common stock to the Companys Chief Executive Officer as
compensation for services previously rendered. Such shares were valued at $60,000 based
upon the market price of such shares.

On
October 25, 2007, the Company entered into a Common Stock and Warrant Purchase Agreement
(the KIT Stock Purchase Agreement) with KIT Financial, Inc. (KIT)
for the purchase of 2,500,000 shares of the Companys common stock for the aggregate
purchase price of $750,000. Pursuant to the KIT Stock Purchase Agreement, KIT also
purchased for $10.00 a warrant (the KIT Warrant) for the purchase of up to
2,500,000 shares of common stock, subject to certain limitations contained in the KIT
Stock Purchase Agreement, at an exercise price of $0.30 per share, exercisable within
three years of any issuance of shares of common stock or securities exercisable,
convertible or exchangeable into the Companys common stock, to future third-party
investors, that occurs on or before October 25, 2009. In no event shall the total amount
of common stock issuable under the KIT Warrant exceed the lesser of (i) that number of
shares, which when added to (x) 2.815 million plus (y) any additional shares of Common
Stock issued to KIT pursuant to the KIT Stock Purchase Agreement, exceed 9.98% of the
total outstanding common stock of EEI at the time of exercise or (ii) 2.5 million shares.

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Off-balance Sheet
Arrangements

We
have not entered into any transactions with unconsolidated entities in which we have
financial guarantees, subordinated retained interests, derivative instruments or other
contingent arrangements that expose us to material continuing risks, contingent
liabilities or any other obligations under a variable interest in an unconsolidated
entity that provides us with financing, liquidity, market risk or credit risk support. At
December 31, 2007 and 2006, a non-revocable standby letter of credit in the amount of
$10,000 was outstanding as security for the Companys electric utility account for
its Alachua, Florida manufacturing facility. The value of the beneficial conversion of
the Series B Preferred Stock is considered a deemed dividend and is being accreted
monthly as a preferred stock dividend from the issuance date of the Series B Preferred
Stock through the date of first possible conversion. At December 31, 2007, the unaccreted
balance of the deemed dividend was $594,805.

# Application of Critical
Accounting Policies and Use of Estimates

Our
financial statements and accompanying notes are prepared in accordance with generally
accepted accounting principles used in the United States. Preparing financial statements
requires us to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue, and expenses. These estimates and assumptions are affected by our
application of accounting policies. We believe that understanding the basis and nature of
the estimates and assumptions involved with the following aspects of our consolidated
financial statements is critical to an understanding of our financials.

Revenue Recognition

In
general, we record revenue when persuasive evidence of an arrangement exists, services
have been rendered or product delivery has occurred, the sales price to the customer is
fixed or determinable, and collectability is reasonably assured. The following policies
reflect specific criteria for our various revenue streams:

Revenue
on research and development type contracts with the U.S. Government and its agencies are
typically cost plus type contracts that contain a fixed fee element and/or a
cost sharing arrangement. We are reimbursed for actual material, labor and overhead costs
as incurred up to the funding limit of the contract. We calculate overhead and G&A
rates annually based on our cost structure and we submit the cost structure and resultant
rates to the Defense Contract Audit Agency (DCAA) for approval to use these
rates on government contracts. Throughout the life of each contract we estimate the cost
to complete the contract. When we estimate that the completed cost of a contract will
exceed the funding amount, we seek additional funding from the customer or another
outside source. Contract terms allow us to stop work should additional funding not be
available. Should the Company decide to complete a contract without funding, the Company
will accrue the loss on the contract when the cost is estimated to exceed the revenue.

Contracts
with the U.S. Government and its agencies with milestone billing provisions are fixed
cost type contracts. Once the conditions for revenue recognition as described above have
been satisfied, we recognize revenue once the milestone has been achieved.

We
recognize revenue on commercial contracts when products are shipped or services are
rendered and the conditions for revenue recognition described above have been satisfied.

Stock-Based Compensation

Our
Company accounts for equity instruments issued to employees for services based on the
fair value of the equity instruments issued and accounts for equity instruments issued to
other than employees based on the fair value of the consideration received or the fair
value of the equity instruments, whichever is more reliably measurable.

---



In
December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) (SFAS
No. 123R), Share-Based Payment which revised SFAS No. 123, Accounting
for Stock-Based Compensation. This statement supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees. The revised statement addresses the accounting for
share-based payment transactions with employees and other third parties, eliminates the
ability to account for share-based compensation transactions using APB 25 and requires
that the compensation costs relating to such transactions be recognized in the
consolidated statement of operations. The revised statement is effective as of the first
interim period beginning after December 15, 2005 for small business filers. The Company
adopted the provisions of SFAS No. 123R on January 1, 2006.

Inventory Valuation

Inventories
are valued at the lower of cost or market, with cost determined on the first-in, first
out basis. The Companys products are produced on a make-to-order basis and, as a
result, the Company does not carry finished goods inventory. The raw materials inventory
and work in process inventory are adjusted to net realizable value based upon a periodic
impairment review.

Allowances for Doubtful
Accounts

We
maintain an allowance for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. If the financial condition of our
customers were to deteriorate, resulting in an impairment of the ability to make
payments, additional allowances may be required, which would increase our expenses during
the periods in which any such allowances were made. The amount recorded as an allowance
for doubtful accounts in each period is based upon an assessment of the likelihood that
we will be paid on our outstanding receivables, based on customer-specific as well as
general considerations. To the extent that our estimates prove to be too high, and we
ultimately collect a receivable previously determined to be impaired, we may record a
reversal of the provision in the period of such determination. As of December 31, 2007
and 2006, management determined that an allowance for doubtful accounts was not required.

Property and Equipment

Property
and equipment are recorded at cost. The costs of additions and betterments are
capitalized and expenditures for repairs and maintenance are expensed in the period
incurred. When items of property and equipment are sold or retired, the related costs and
accumulated depreciation are removed from the accounts and any gain or loss is included
in income.

We
periodically evaluate the carrying amount of property and equipment for potential
impairment by comparing the carrying amount to the undiscounted cash flows expected to
result from the use and eventual disposition of the asset whenever events or circumstances
indicate that its carrying amount may not be recoverable.

Accounting for Income
Taxes

In
preparing our consolidated financial statements, we are required to estimate our income
taxes in each of the jurisdictions where we operate. This process involves estimating
actual current tax exposure, together with assessing temporary differences resulting from
differing treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities. We must then assess the likelihood that our deferred
tax assets will be recovered from future taxable income, and to the extent that we
believe that recovery is not likely, we must establish a valuation allowance. To the
extent we establish a valuation allowance, we must include an expense within the tax
provision of the statement of income in each period in which the allowance is increased.

Significant
judgment is required in determining the provision for income taxes, deferred tax assets
and liabilities, and any valuation allowance, against our deferred tax assets. In the
event that actual results differ from these estimates or the estimates are adjusted in
future periods, then we may need to establish an additional valuation allowance, which
could materially impact our consolidated financial position, results of operations and
cash flows. The Company has concluded that a full valuation allowance was appropriate for
the deferred tax asset.

---



The
Company adopted Financial Accounting Standards Board Interpretation No. 48,
Accounting for Uncertainty in Income Taxes(FIN 48)
effective January 1, 2007. FIN 48 prescribes a single, comprehensive model for how a
company should recognize, measure, present and disclose in its financial statements
uncertain tax positions that the company has taken or expects to take on its tax returns.
As part of the adoption of FIN 48, the Company evaluated its position on various tax
issues. Based upon this evaluation, the Company had no unrecognized tax benefits or
liabilities as of January 1, 2007 or thereafter requiring adjustment or disclosure in the
financial statements.

Research and Development
Expenses

Research
and development expenses are incurred to develop our battery technologies. They are
funded by the Company and expensed as incurred.

# Recent Accounting
Pronouncements

In
March 2008, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 161, Disclosures about
Derivative Instruments and Hedging Activitiesan amendment of FASB Statement
No. 133 (SFAS 161). SFAS 161 changes the disclosure
requirements for derivative instruments and hedging activities. Entities are required to
provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedged items are accounted
for under SFAS No. 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entitys financial position, financial
performance and cash flows. The guidance in SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November 15,
2008, with early application encouraged. This Statement encourages, but does not require,
comparative disclosures for earlier periods at initial adoption.  At this time,
management is evaluating the implications of SFAS 161 and its impact on the consolidated financial
statements has not yet been determined.

In
December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS
141R), which replaces SFAS No. 141, Business Combinations. SFAS 141R
establishes principles and requirements for determining how an enterprise recognizes and
measures the fair value of certain assets and liabilities acquired in a business
combination, including noncontrolling interests, contingent consideration, and certain
acquired contingencies. SFAS 141R also requires acquisition-related transaction expenses
and restructuring costs be expensed as incurred rather than capitalized as a component of
the business combination. SFAS 141R will be applicable prospectively to business
combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. SFAS 141R would have an
impact on accounting for any businesses acquired after the effective date of this
pronouncement.

In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements  An Amendment of ARB No. 51(SFAS
160). SFAS 160 establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary (previously referred to as minority interests).
SFAS 160 also requires that a retained noncontrolling interest upon the deconsolidation
of a subsidiary be initially measured at its fair value. Upon adoption of SFAS 160, the
Company would be required to report any noncontrolling interests as a separate component
of stockholders equity. The Company would also be required to present any net
income allocable to noncontrolling interests and net income attributable to the
stockholders of the Company separately in its consolidated statements of income. SFAS 160
is effective for fiscal years, and interim periods within those fiscal years, beginning
on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation
and disclosure requirements for existing minority interests. All other requirements of
SFAS 160 shall be applied prospectively. SFAS 160 would have an impact on the
presentation and disclosure of the noncontrolling interests of any non wholly-owned
businesses acquired in the future.

---



In
December 2007, the FASB issued FASB Staff Position (FSP) 157-b, Effective Date
of FASB Statement No. 157, that would permit a one-year deferral in
applying the measurement provisions of Statement No. 157 to non-financial assets and
non-financial liabilities (non-financial items) that are not recognized or disclosed at
fair value in an entitys financial statements on a recurring basis (at least
annually). Therefore, if the change in fair value of a non-financial item is not required
to be recognized or disclosed in the financial statements on an annual basis or more
frequently, the effective date of application of Statement 157 to that item is deferred
until fiscal years beginning after November 15, 2008 and interim periods within
those fiscal years. The Company is currently evaluating the impact, if any, that the
adoption of FSP 157-b will have on the Companys operating income or net earnings.

In
June 2007, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 06-11,
Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (EITF
06-11). EITF 06-11 states that an entity should recognize a realized tax
benefit associated with dividends on nonvested equity shares, nonvested equity share
units and outstanding equity share options charged to retained earnings as an increase in
additional paid in capital. The amount recognized in additional paid in capital
should be included in the pool of excess tax benefits available to absorb potential
future tax deficiencies on share-based payment awards. EITF 06-11 should be applied
prospectively to income tax benefits of dividends on equity-classified share-based
payment awards that are declared in fiscal years beginning after December 15, 2007. We
do not expect that the adoption of EITF 06-11 will have a material impact on  the Companys consolidated financial position, results of operations or cash flows.

On
February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities.(SFAS159). The guidance
in SFAS 159 allows reporting entities to choose to measure many
financial instruments and certain other items at fair value. The objective underlying the
development of this literature is to improve financial reporting by providing reporting
entities with the opportunity to reduce volatility in reported earnings that results from
measuring related assets and liabilities differently without having to apply complex hedge
accounting provisions, using the guidance in SFAS No. 133, as amended, entitled
Accounting for Derivative Instruments and Hedging Activities. The provisions
of SFAS 159 are applicable to all reporting entities and are effective as of the beginning
of the first fiscal year that begins subsequent to November 15, 2007. The adoption of SFAS
159 is not expected to have a material effect on the Companys consolidated financial
position, results of operations or cash flows.

In
September 2006, the FASB issued SFAS 157, Fair Value Measurements(SFAS
157). SFAS 157 defines fair value, establishes a framework for measuring fair value
and expands disclosure of fair value measurements. SFAS 157 applies under other
accounting pronouncements that require or permit fair value measurements and accordingly,
does not require any new fair value measurements. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007. The Company is in
the process of evaluating the impact of the adoption of SFAS No. 157 on the Companys
consolidated financial position, results of operations or cash flows.

In
September 2006, the staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin No. 108 (SAB 108) which provides
interpretive guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year misstatement. SAB 108
became effective in fiscal 2007. Adoption of SAB 108 did not have a material impact on
the Companys consolidated financial position, results of operations or cash flows.

---



# Item 7. CONSOLIDATED
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL
STATEMENTS

|Report of Independent Registered Public Accounting Firm    | 25
|---------------------------------------------------------- | --
|Consolidated Balance Sheet                                 | 26
|Consolidated Statements of Operations                      | 27
|Consolidated Statements of Changes in Stockholders' Equity | 28
|Consolidated Statements of Cash Flows                      | 30
|Notes to Consolidated Financial Statements                 | 32

---



REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the Audit Committee of
theBoard of Directors and Stockholdersof Electro Energy, Inc. and Subsidiaries

We have audited the
accompanying consolidated balance sheet of Electro Energy Inc. and Subsidiaries  (the
Company) as of December 31, 2007 and the related consolidated statements of
operations, changes  in stockholders equity, and
cash flows for the years ended December 31, 2007 and 2006. These consolidated financial
statements are the responsibility of the Companys management. 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 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  financial statements, assessing the accounting
principles used and significant estimates made by management, as well as evaluating the
overall  financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of Electro Energy Inc. and Subsidiaries as of December 31, 2007 and the
consolidated results of their operations and their cash flows for the years ended December
31, 2007 and 2006, in conformity with accounting principles generally accepted in the
United States of America.

The accompanying consolidated
financial statements have been prepared assuming that the Company will continue as a going
concern. As more fully described in Note 1, the Company has incurred significant losses
since inception and requires significant capital to implement its business plan. These factors raise substantial doubt about the Companys
ability to continue as a going concern. Managements plans in regard to these matters
are also described in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty

As discussed in Note 2 to the
consolidated financial statements, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R), Share-Based Payment, on
January 1, 2006.

/s/ Marcum & Kliegman LLP

New York, New YorkApril 14, 2008

---





|ELECTRO ENERGY INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEET
December 31, 2007       
|---------------------------------------------------------------------------------------
|                                                                                       
|                                                                                       
|ASSETS                                                                                 
|CURRENT ASSETS                                                                         
|Cash and cash equivalents                                                              
|Accounts receivable, net                                                               
|Inventories                                                                            
|Prepaid expenses and other current assets                                              
|                                                                                       
|Total Current Assets                                                                   
|                                                                                       
|PROPERTY AND EQUIPMENT, net                                                            
|                                                                                       
|OTHER ASSETS                                                                           
|Deferred financing costs, net                                                          
|Security deposit                                                                       
|                                                                                       
|Total Other Assets                                                                     
|                                                                                       
|TOTAL ASSETS                                                                           
|                                                                                       
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                   
|CURRENT LIABILITIES                                                                    
|Accounts payable                                                                       
|Accrued expenses                                                                       
|Customer deposits                                                                      
|Current portion of capital lease                                                       
|                                                                                       
|Total Current Liabilities                                                              
|                                                                                       
|OTHER LIABILITIES                                                                      
|Secured convertible notes, net of deferred debt discount of
$17,763,547                
|Deferred rent, less current portion                                                    
|Capital lease, less current portion                                                    
|                                                                                       
|Total Other Liabilities                                                                
|                                                                                       
|TOTAL LIABILITIES                                                                      
|                                                                                       
|COMMITMENTS AND CONTINGENCIES                                                          
|                                                                                       
|STOCKHOLDERS' EQUITY                                                                   
|Preferred stock, $0.001 par value, 10,000 shares authorized;                           
|Series A
         Convertible Preferred Stock, 160 shares outstanding                  
|($160,000 liquidation preference)                                                      
|Series B Convertible Preferred Stock, 5,401 shares outstanding                         
|($1,485,275 liquidation preference)                                                    
|Common stock, $0.001 par value, 250,000,000 shares                                     
|authorized; 28,811,797 shares issued and outstanding                                   
|Additional paid-in capital                                                             
|Deferred lease costs, net                                                              
|Accumulated deficit                                                                    
|                                                                                       
|TOTAL STOCKHOLDERS' EQUITY                                                             
|                                                                                       
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                             
|                                                                                       
|The accompanying notes are an integral part of these consolidated
financial statements.

---





|ELECTRO ENERGY INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFor the Years Ended December 31, 2007 and 2006                                                                      
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|NET REVENUE                                                                                                                                                                                  
|Services                                                                                                                                                                                     
|Products                                                                                                                                                                                     
|                                                                                                                                                                                             
|TOTAL NET REVENUE                                                                                                                                                                            
|                                                                                                                                                                                             
|COST OF REVENUE                                                                                                                                                                              
|Cost of services                                                                                                                                                                             
|Cost of products                                                                                                                                                                             
|                                                                                                                                                                                             
|TOTAL COST OF REVENUE                                                                                                                                                                        
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|GROSS (LOSS) PROFIT                                                                                                                                                                          
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|OPERATING EXPENSES                                                                                                                                                                           
|Selling, general and administrative (including non-cash stock-based            compensation of $844,250 and $986,003 for the years ended            December 31, 2007 and 2006, respectively)
|Research and development                                                                                                                                                                     
|                                                                                                                                                                                             
|TOTAL OPERATING EXPENSES                                                                                                                                                                     
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|OPERATING LOSS                                                                                                                                                                               
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|OTHER EXPENSE (INCOME)                                                                                                                                                                       
|Interest expense                                                                                                                                                                             
|Interest and dividend income                                                                                                                                                                 
|Amortization of deferred financing costs                                                                                                                                                     
|Amortization of deferred debt discount                                                                                                                                                       
|Loss on disposal of fixed assets, net                                                                                                                                                        
|Forgiveness of debt - EaglePicher                                                                                                                                                            
|Loss on extinguishment of 8.5% Secured Convertible Notes                                                                                                                                     
|                                                                                                                                                                                             
|TOTAL OTHER EXPENSE                                                                                                                                                                          
|                                                                                                                                                                                             
|NET LOSS                                                                                                                                                                                     
|DIVIDENDS ON PREFERRED STOCK                                                                                                                                                                 
|                                                                                                                                                                                             
|NET LOSS AVAILABLE TO COMMON STOCKHOLDERS                                                                                                                                                    
|                                                                                                                                                                                             
|NET LOSS PER COMMON SHARE - BASIC AND DILUTED                                                                                                                                                
|                                                                                                                                                                                             
|WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED                                                                                                                               
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|The accompanying notes are an integral part of these consolidated
financial statements.                                                                                                      

---





|ELECTRO ENERGY INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITYFor the Years Ended December 31, 2007 and 2006
|-------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                           
|                                                                                                                                           
|                                                                                                                                           
|                                                                                                                                           
|                                                                                                                                           
|                                                                                                                                           
|Balance January 1, 2006                                                                                                                    
|                                                                                                                                           
|Reclassification of
deferred
compensation upon
adoption of SFAS 123R                                                                       
|                                                                                                                                           
|Proceeds of exercise
of employee stock
options                                                                                             
|                                                                                                                                           
|Employee stock
option compensation                                                                                                         
|                                                                                                                                           
|Remeasurement and
amortization of
non-employee stock
options                                                                               
|                                                                                                                                           
|Issuance and
amortization of
warrants for
deferred contract
costs                                                                          
|                                                                                                                                           
|Proceeds from
issuance of common
stock                                                                                                     
|                                                                                                                                           
|Proceeds from
exercise of warrants                                                                                                         
|                                                                                                                                           
|Conversion of
preferred stock into
common stock                                                                                            
|                                                                                                                                           
|Issuance of common
stock in connection
with Asset Purchase                                                                                 
|                                                                                                                                           
|Issuance of warrants
in connection with
leases                                                                                             
|                                                                                                                                           
|Issuance of warrants
in connection with
8.5% Senior Secured
Convertible Note                                                               
|                                                                                                                                           
|Beneficial
conversion feature
of 8.5% Senior
Secured Convertible
Notes                                                                     
|                                                                                                                                           
|Amortization of
deferred lease costs                                                                                                       
|                                                                                                                                           
|Net loss                                                                                                                                   
|                                                                                                                                           
|Balance December 31, 2006                                                                                                                  
|                                                                                                                                           

---





|                                                                                                  |     |   |   |  |       |   |   |  |            |   |        |   |            |   |   |   |       |   |           |   |              |   |             
|------------------------------------------------------------------------------------------------- | --- | - | - |  | ----- | - | - |  | ---------- | - | ------ | - | ---------- | - | - | - | ----- | - | --------- | - | ------------ | - | ------------
|Employee stock
option compensation                                                                | -   |   | - |  | -     |   | - |  | -          |   | -      |   | 844,250    |   | - |   | -     |   | -         |   | -            |   | 844,250     
|                                                                                                  |    
|Revaluation and
amortization of
warrants for
deferred contract
costs                              | -   |   | - |  | -     |   | - |  | -          |   | -      |   | (5,249)    |   | - |   | 2,333 |   | -         |   | -            |   | (2,916)     
|                                                                                                  |    
|Issuance of common
stock for principal
payment on 8.5%
Senior Secured
Convertible Notes           | -   |   | - |  | -     |   | - |  | 894,309    |   | 894    |   | 1,099,106  |   | - |   | -     |   | -         |   | -            |   | 1,100,000   
|                                                                                                  |    
|Issuance of common
stock for interest
on 8.5% Senior
Secured Convertible
Notes                    | -   |   | - |  | -     |   | - |  | 2,581,606  |   | 2,582  |   | 2,012,939  |   | - |   | -     |   | -         |   | -            |   | 2,015,521   
|                                                                                                  |    
|Issuance of common
stock for
compensation                                                         | -   |   | - |  | -     |   | - |  | 101,695    |   | 102    |   | 59,898     |   | - |   | -     |   | -         |   | -            |   | 60,000      
|                                                                                                  |    
|Proceeds from
issuance of common
stock                                                            | -   |   | - |  | -     |   | - |  | 2,651,060  |   | 2,651  |   | 1,247,359  |   | - |   | -     |   | -         |   | -            |   | 1,250,010   
|                                                                                                  |    
|Issuance of Series B
Preferred Stock in
connection with 10%
Senior Secured
Convertible
Debentures | -   |   | - |  | 5,401 |   | 5 |  | -          |   | -      |   | 1,543,399  |   | - |   | -     |   | -         |   | -            |   | 1,543,404   
|                                                                                                  |    
|Issuance of warrants
in connection with
10% Senior Secured
Convertible
Debentures                 | -   |   | - |  | -     |   | - |  | -          |   | -      |   | 7,831,799  |   | - |   | -     |   | -         |   | -            |   | 7,831,799   
|                                                                                                  |    
|Beneficial
conversion feature
of 10% Senior
Secured Convertible
Debentures                        | -   |   | - |  | -     |   | - |  | -          |   | -      |   | 12,102,320 |   | - |   | -     |   | -         |   | -            |   | 12,102,320  
|                                                                                                  |    
|Accretion of
beneficial
conversion feature
of Series B
Convertible
Preferred Stock                | -   |   | - |  | -     |   | - |  | -          |   | -      |   | 41,741     |   | - |   | -     |   | -         |   | -            |   | 41,741      
|                                                                                                  |    
|Modification of
warrants in
connection with 10%
Senior Secured
Convertible
Debentures             | -   |   | - |  | -     |   | - |  | -          |   | -      |   | 145,187    |   | - |   | -     |   | -         |   | -            |   | 145,187     
|                                                                                                  |    
|Amortization of
deferred lease costs                                                              | -   |   | - |  | -     |   | - |  | -          |   | -      |   | -          |   | - |   | -     |   | 173,993   |   | -            |   | 173,993     
|                                                                                                  |    
|Net loss                                                                                          | -   |   | - |  | -     |   | - |  | -          |   | -      |   | -          |   | - |   | -     |   | -         |   | (18,109,081) |   | (18,109,081)
|                                                                                                  |     |   |   |  |       |   |   |  |            |   |        |   |            |   |   |   |       |   |           |   |              |   |             
|Balance December 31, 2007                                                                         | 160 | $ | - |  | 5,401 | $ | 5 |  | 28,811,797 | $ | 28,812 | $ | 64,918,395 | $ | - | $ | -     | $ | (739,471) | $ | (34,706,158) | $ | 29,501,583  
|                                                                                                  |     |   |   |  |       |   |   |  |            |   |        |   |            |   |   |   |       |   |           |   |              |   |             
|                                                                                                 
|The accompanying notes are an integral
part of these condensed consolidated financial statements.

---



|ELECTRO ENERGY INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFor the Years Ended December 31, 2007 and 2006
|-----------------------------------------------------------------------------------------------------------------------
|                                                                                                                       

|                                                                                        |   |              |  |   |            
|--------------------------------------------------------------------------------------- | - | ------------ |  | - | -----------
|                                                                                        |   | 2007         |  |   | 2006       
|                                                                                        |   |              | 
|CASH FLOWS FROM OPERATING ACTIVITIES                                                    |   |              |  |   |            
|Net loss                                                                                | $ | (18,065,360) |  | $ | (5,961,713)
|Adjustments to reconcile net loss to net cash used in operating activities:             |   |              |  |   |            
|Depreciation and amortization                                                           |   | 118,929      |  |   | 112,512    
|Loss on disposal of fixed assets                                                        |   | 84,432       |  |   | 535        
|Deferred rent                                                                           |   | 246,247      |  |   | 246,491    
|Interest accretion                                                                      |   | -            |  |   | 5,979      
|Amortization of deferred financing costs                                                |   | 385,389      |  |   | 228,777    
|Amortization of deferred debt discount                                                  |   | 660,933      |  |   | 256,152    
|Amortization of deferred expenses                                                       |   | (2,916)      |  |   | 25,474     
|Amortization of deferred lease costs                                                    |   | 173,993      |  |   | 130,495    
|Issuance of common stock for compensation                                               |   | 60,000       |  |   | -          
|Stock option compensation                                                               |   | 844,250      |  |   | 986,003    
|Forgiveness of debt                                                                     |   | -            |  |   | (100,000)  
|Non-cash loss on extinguishment of debt                                                 |   | 4,467,730    |  |   | -          
|Changes in:                                                                             |   |              |  |   |            
|Accounts receivable                                                                     |   | 586,640      |  |   | (211,475)  
|Inventory                                                                               |   | (370,228)    |  |   | 35,723     
|Prepaid expenses and other current assets                                               |   | 32,105       |  |   | 302,957    
|Accounts payable and accrued expenses                                                   |   | 2,119,784    |  |   | 467,586    
|Customer deposits                                                                       |   | 78,000       |  |   | -          
|                                                                                        |   |              | 
|NET CASH USED IN OPERATING ACTIVITIES                                                   |   | (8,580,074)  |  |   | (3,474,504)
|                                                                                        |   |              | 
|CASH FLOWS FROM INVESTING ACTIVITIES                                                    |   |              |  |   |            
|Purchases of property and equipment                                                     |   | (206,830)    |  |   | (312,339)  
|Sale of property and equipment                                                          |   | 293,250      |  |   | -          
|Expenditures for property and equipment in connection with Asset Purchase               |   | -            |  |   | (309,770)  
|Payment for security deposits                                                           |   | -            |  |   | (219,693)  
|                                                                                        |   |              | 
|NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES                                     |   | 86,420       |  |   | (841,802)  
|                                                                                        |   |              | 
|CASH FLOWS FROM FINANCING ACTIVITIES                                                    |   |              |  |   |            
|Restricted cash                                                                         |   | 2,230,063    |  |   | (2,564,021)
|Cash payment for extinguishment of debt                                                 |   | 333,958      |  |   | -          
|Repayment of long term debt                                                             |   | (61,193)     |  |   | (111,193)  
|Proceeds from issuance of common stock                                                  |   | 1,250,010    |  |   | 200,000    
|Proceeds from issuance of 8.5% secured convertible notes                                |   | -            |  |   | 11,000,000 
|Repayment of 8.5% secured convertible notes                                             |   | (9,900,000)  |  |   | -          
|Proceeds from issuance of 10% secured convertible notes                                 |   | 18,000,000   |  |   | -          
|Financing costs related to 8.5% secured convertible notes                               |   | -            |  |   | (1,222,852)
|Financing costs related to 10% secured convertible notes                                |   | (1,387,395)  |  |   | -          
|Proceeds from exercise of employee stock options                                        |   | -            |  |   | 39,102     
|Proceeds from exercise of warrants                                                      |   | -            |  |   | 175,000    
|Principal payments on capital leases                                                    |   | (10,187)     |  |   | (1,614)    
|                                                                                        |   |              | 
|NET CASH PROVIDED BY FINANCING ACTIVITIES                                               |   | 10,455,256   |  |   | 7,514,422  
|                                                                                        |   |              | 
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                               |   | 1,961,602    |  |   | 3,198,116  
|CASH AND CASH EQUIVALENTS - Beginning                                                   |   | 3,789,780    |  |   | 591,664    
|                                                                                        |   |              | 
|CASH AND CASH EQUIVALENTS - Ending                                                      | $ | 5,751,382    |  | $ | 3,789,780  
|                                                                                        |   |              | 
|                                                                                        |   |              |  |   |            
|The accompanying notes are an integral part of these
consolidated financial statements.

---





|ELECTRO ENERGY INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFor the Years Ended December 31, 2007 and 2006
|-----------------------------------------------------------------------------------------------------------------------
|                                                                                                                       

|                                                                                                |   |            |  |   |           
|----------------------------------------------------------------------------------------------- | - | ---------- |  | - | ----------
|                                                                                                |   | 2007       |  |   | 2006      
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                               |   |            |  |   |           
|Cash paid for:                                                                                  |   |            |  |   |           
|Interest                                                                                        | $ | 160,906    |  | $ | 473,619   
|                                                                                                |   |            | 
|Income taxes                                                                                    | $ | 22,000     |  | $ | 16,920    
|                                                                                                |   |            | 
|SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES                                                 |   |            |  |   |           
|Stock issued in connection with Asset Purchase                                                  | $ | -          |  | $ | 20,741,071
|                                                                                                |   |            | 
|Warrants issued for lease agreements                                                            | $ | -          |  | $ | 1,043,959 
|                                                                                                |   |            | 
|Warrants issued in connection with 8.5% senior secured convertible note                         | $ | -          |  | $ | 906,415   
|                                                                                                |   |            | 
|Beneficial conversion feature of 8.5% senior secured convertible notes                          | $ | -          |  | $ | 607,895   
|                                                                                                |   |            | 
|Acquisition of property and equipment under capital lease obligations                           | $ | -          |  | $ | 45,958    
|                                                                                                |   |            | 
|Conversion of preferred stock into common stock                                                 | $ | -          |  | $ | 8         
|                                                                                                |   |            | 
|Revaluation of options issued for compensation costs                                            | $ | -          |  | $ | 63,740    
|                                                                                                |   |            | 
|Issuance of common stock for interest on 8.5% senior secured convertible notes                  | $ | 2,015,521  |  | $ | -         
|                                                                                                |   |            | 
|Issuance of common stock for principal on 8.5% senior secured convertible notes                 | $ | 1,100,000  |  | $ | -         
|                                                                                                |   |            | 
|Revaluation of warrants issued for contract costs                                               | $ | 5,249      |  | $ | 36,461    
|                                                                                                |   |            | 
|Discount on 10% senior secured convertible notes                                                | $ | 18,000,000 |  | $ | -         
|                                                                                                |   |            | 
|Issuance of warrants to placement agent in connection with 10%        secured convertible
notes | $ | 630,982    |  | $ | -         
|                                                                                                |   |            | 
|Deemed dividends on preferred stock                                                             | $ | 43,721     |  | $ | -         
|                                                                                                |   |            | 
|                                                                                                |   |            |  |   |           
|The accompanying notes are an integral part of these
consolidated financial statements.        

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

NOTE 1  The Company

Organization                Electro
Energy Inc. was incorporated in Connecticut on March 23, 1992. On January 11, 2001,
Electro Energy Inc. was incorporated in Delaware. On January 12, 2001, Electro Energy
Inc., the Connecticut corporation, was merged with and into Electro Energy Inc., the
Delaware corporation, with Electro Energy Inc., the Delaware corporation, (Old
EEI) as the surviving corporation. On June 11, 2003, Old EEI incorporated Mobile
Energy Products, Inc. (MEP) in Delaware, as a wholly-owned subsidiary. On
October 1, 2003, MEP acquired the Colorado Springs energy business of EaglePicher
Technologies, LLC. On June 9, 2004, Old EEI, a privately held corporation, entered into a
merger with MCG Diversified, Inc. (MCG), a publicly held Florida corporation
formed on December 29, 1993. MCG issued 9,497,557 unregistered shares of common stock for
100% of the outstanding common stock of Old EEI on a one-to-one basis. Immediately
following the merger, MCG changed its name to Electro Energy Inc. (EEI). On
September 29, 2004, Old EEI changed its name to EEI Technologies, Inc. (EEI
Technologies). As MCG did not have any meaningful operations prior to the merger,
the transaction was treated as a recapitalization of EEI Technologies and accounted for on
an historical cost basis. On August 30, 2005, EEI Acquisition Co., LLC was formed in
Delaware as a wholly owned subsidiary of EEI. On May 8, 2006, the name of EEI Acquisition
Co., LLC was changed to Electro Energy Florida, LLC (EEF).

The
consolidated financial statements are those of EEI and its wholly-owned subsidiaries, EEI
Technologies and EEF. Additionally, the accounts of EEI Technologies include the accounts
of MEP. Collectively, they are referred to herein as EEI or the
Company.

Nature of Business                The
Company is engaged in the development of energy storage technology, products and related
systems primarily through contract research and development for the United States
Government or its agencies. The Company has developed and patented bipolar cell and
battery designs utilizing NiMH chemistry and is further expanding development to include
Li-ion chemistries.

Additionally,
the Company has commercial products including components and batteries employing nickel
cadmium (NiCd), nickel hydrogen and other sintered nickel materials
technologies. These products include batteries for military and commercial aerospace and
satellite applications. The Company is pursuing product development and commercial market
development utilizing its proprietary and patented technology derived from its contract
and internal research and development. Markets of primary interest are military and space
applications; transportation applications including electric vehicles (EV),
hybrid electric vehicles (HEV) and plug-in hybrid electric vehicles
(PHEV) ranging in size from bicycles to automobiles, trucks, buses and rail
applications; electrical utility power quality and backup power; and power tools and lawn
and garden applications.

Acquisition
of the Florida facility (see Note 4) provides manufacturing capabilities for prismatic and
cylindrical cell battery products that may offer product revenue opportunities while the
Companys bipolar technology is being developed and marketed.

Going Concern and Managements
Liquidity Plans                As
of December 31, 2007, the Company had cash and cash equivalents of $5,751,382. The Company
incurred a loss from operations of $10,597,552 and $4,722,301 for the years ended December
31, 2007 and 2006, respectively. During the years ended December 31, 2007 and 2006, the
Company used $8,580,074 and $3,474,504, respectively, to fund its operating
activities.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

The Company is engaged in the
development of energy storage technology, products and related systems as well as the
start up of high volume battery manufacturing operations in its Florida facility. The
Companys operating and capital requirements in connection with planned development,
testing, production, sales and marketing activities will be significant. The amount of
capital needed is directly related to the Companys success in implementing its
business plan and achieving high volume product sales. The Company is not currently
generating sufficient revenues from operations to fund these activities and execute its
business plan and is dependent on the receipt of funding from government development
contracts and cash raised in equity and debt financings to continue the development,
production, marketing and sales of its products. The Company anticipates that funding from
government development contracts together with its cash and cash equivalents will not be
sufficient to fund its operating activities in 2008. Therefore, the Companys ability
to develop high volume manufacturing and execute its product sales and marketing plans
will be dependent on the Companys ability to raise cash through future equity and
debt financings. No assurance can be given that the Company will be successful in
developing high volume manufacturing and executing its product sales and marketing plans
or in obtaining additional financing under terms acceptable to the Company or in amounts
sufficient to fund its future operating activities. The funds that the Company does raise,
if any, may not allow it to maintain its current and planned operations and such
additional financing could result in the dilution of shareholders percentage
interests in the Company. If the Company is unable to obtain additional capital, it may be
required to delay, scale back or eliminate some or all of its development of existing or
future business initiatives and therefore there is substantial doubt as to the Companys
ability to fund future operations and continue as a going concern.

On
September 14, 2007, the Company received a letter from The Nasdaq Stock Market
(Nasdaq) notifying the Company that it is not in compliance with the
requirements for continued listing under Nasdaq Marketplace Rule 4310(c)(4) because the
bid price of its common stock for the last 30 consecutive business days had closed below
$1.00 per share. Pursuant to Nasdaq Marketplace Rule 4310(c)(8)(D), the Company had been
provided an initial period of 180 calendar days, or until March 12, 2008, to regain
compliance.

On
March 13, 2008, Nasdaq issued a letter (the Letter) notifying the Company that
the Companys common stock had not regained compliance with the Rule and that its
common stock does not meet The Nasdaq Capital Markets initial inclusion criteria set
forth in Nasdaq Marketplace Rule 4310(c). The Letter stated that unless the Company
requests an appeal of this determination, trading of the Companys common stock will
be suspended at the opening of business on March 25, 2008 and a Form 25-NSE will be filed
with the SEC, which will result in the removal of the Companys securities from
listing and registration on Nasdaq.

The
Company has requested an appeal to a Nasdaq Listings Qualifications Panel as set forth in
the Letter. Accordingly, the Company expects that its common stock would not be suspended
until after the Listings Qualifications Panel has rendered its decision. There can be no
assurance the Panel will grant the Companys request for continued listing.

NOTE 2  Summary of
Significant Accounting Policies

Principles of
Consolidation                The
consolidated financial statements include the accounts of EEI and its wholly owned
subsidiaries EEI Technologies, EEF and MEP. All significant intercompany balances and
transactions have been eliminated in consolidation.

Reclassifications                Certain
accounts in the prior year financial statements have been reclassified for comparative
purposes to conform to the presentation in the current year financial statements. These
reclassifications have no effect on the previously reported net loss.

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 the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ
materially from those estimates.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Concentration of Credit
Risk                Financial
instruments that potentially subject the Company to significant concentrations of credit
risk consist of cash and accounts receivable.

The
Company maintains its cash accounts at high quality financial institutions. The Company
also has substantial cash balances which are invested in a money market account with a
major international bank. These balances, at times, exceed federally insured limits. As
of December 31, 2007, the Company had cash balances in excess of federally insured limits
of $5,917,138.

Concentrations
of credit risk with respect to accounts receivable are limited because the Companys
most significant customers are the United States Government or its agencies and
contractors to the United States Government.

As
of December 31, 2007, the Company had no other concentration of credit risk.

Allowances for Doubtful
Accounts                The
Company maintains allowances for doubtful accounts for estimated losses resulting from
the inability of its customers to make required payments. If the financial condition of
the Companys customers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required, which would increase the
Companys expenses during the periods in which any such allowances were made. The
amount recorded as an allowance for doubtful accounts in each period is based upon an
assessment of the likelihood that the Company will be paid for outstanding accounts
receivable, based on customer-specific as well as general considerations. To the extent
that the Companys estimates prove to be too high, and the Company ultimately
collects a receivable previously determined to be impaired, the Company may record a
reversal of the provision in the period of such determination. As of December 31, 2007
and 2006, management determined that an allowance for doubtful accounts was not required.

Inventories                Inventories
are valued at the lower of cost or market, with cost determined on the first-in, first
out basis. The Companys products are produced on a make-to-order basis and, as a
result, the Company does not carry finished goods inventory. The raw materials inventory
and work in process inventory are adjusted to net realizable value based upon a periodic
impairment review.

Property and Equipment                Property
and equipment are recorded at cost. The costs of additions and betterments are
capitalized and expenditures for repairs and maintenance are expensed in the period
incurred. When items of property and equipment are sold or retired, the related costs and
accumulated depreciation are removed from the accounts and any gain or loss is included
in income.

The
Company periodically evaluates the carrying amount of property and equipment for potential
impairment by comparing the carrying amount to the undiscounted cash flows expected to
result from the use and eventual disposition of the asset whenever events or circumstances
indicate that its carrying amount may not be recoverable.

Deferred Financing Costs                The
costs incurred in connection with the issuance of the 8.5% and 10% senior secured
convertible notes (see Note 7) were capitalized as deferred financing costs and are being
amortized using the straight line method, which approximates the interest rate method,
over the respective term of the notes.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Revenue Recognition                In
general, the Company records revenue when persuasive evidence of an arrangement exists,
services have been rendered or product delivery has occurred, the sales price to the
customer is fixed or determinable, and collectability is reasonably assured. The
following policies reflect specific criteria for the various revenue streams of the
Company:

Revenue
on research and development type contracts with the U.S. Government and its agencies are
typically cost plus type contracts that contain a fixed fee element and/or a
cost sharing arrangement. The Company is reimbursed for actual material, labor and
overhead costs as incurred up to the funding limit of the contract. The Company
calculates overhead and G&A rates annually based on its cost structure and submits
the cost structure and resultant rates to the Defense Contract Audit Agency (DCAA)
for approval to use these rates on government contracts. Throughout the life of each
contract the Company estimates the cost to complete the contract. When the Company
estimates that the completed cost of a contract will exceed the funding amount, the
Company will seek additional funding from the customer or another outside source.
Contract terms allow the Company to stop work should additional funding not be available.
Should the Company decide to complete a contract without funding, the Company will accrue
the loss on the contract when the cost is estimated to exceed the revenue.

Contracts
with the U.S. Government and its agencies with milestone billing provisions are fixed
cost type contracts. Once the conditions for revenue recognition described above have
been satisfied, the revenue is recognized

The
Company recognizes revenue on commercial contracts when products are shipped or services
are rendered and the conditions for revenue recognition described above have been
satisfied.

Significant Customers                The
Company had four customers with sales of 10% or more of total sales in 2007. Net sales to
the Companys four major customers, the U.S Government, Sandia National
Laboratories, EaglePicher Technologies, LLC, Defense and Lockheed Martin, represented
approximately 38%, 18%, 14% and 12%, respectively, of total net sales in 2007. Net sales
to the Companys three major customers, the U.S. Government, Sandia National
Laboratories and EaglePicher Technologies, LLC, represented approximately 43%, 22% and
24%, respectively, of total net sales in 2006. Accounts receivable from these customers
amounted to $203,143 at December 31, 2007.

Product Warranty                The
Company is responsible for providing warranty coverage on certain products. Based on
historical warranty claims, the Company accrues the estimated costs of the warranty
coverage at the time of sale. During the years ended December 31, 2007 and 2006, the cost
of providing warranty coverage was not material. As of December 31, 2007, there was no
estimated liability for product warranties.

Depreciation and
Amortization                Depreciation
and amortization is provided for under the straight-line method based upon the estimated
useful lives of the respective assets. Leasehold improvements are amortized under the
straight-line method over the lesser of the term of the related lease or the estimated
useful lives of the assets.

Income Taxes                The
Company recognizes deferred taxes under the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred income taxes are recognized
for differences between the financial statement and tax basis of assets and liabilities
at current enacted statutory tax rates for the years in which the differences are
expected to reverse. The effect on deferred taxes of a change in tax rates is recognized
in income in the period that includes the enactment date of the change in tax rates.
Valuation allowances are established when necessary to reduce deferred tax assets to the
amounts expected to be realized.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Effective
January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes  an interpretation of FASB
Statement No. 109 (FIN 48). FIN 48 prescribes a recognition
threshold and a measurement attribute for the financial statement recognition and
measurement of tax positions taken or expected to be taken in a tax return. For those
benefits to be recognized, a tax position must be more likely than not to be sustained
upon examination by taxing authorities. Differences between tax positions taken or
expected to be taken in a tax return and the benefit recognized and measured pursuant to
the interpretation are referred to as unrecognized benefits. A liability is
recognized (or amount of net operating loss carry forward or amount of tax refundable is
reduced) for an unrecognized tax benefit because it represents an enterprises
potential future obligation to the taxing authority for a tax position that was not
recognized as a result of applying the provisions of FIN 48.

In
accordance with FIN 48, interest costs related to unrecognized tax benefits are required
to be calculated (if applicable) and would be classified as Interest expense,
net in the consolidated statements of operations. Penalties would be recognized as a
component of General and administrative expenses. No interest and penalties
were recorded during the year ended December 31, 2007.

The
Company files income tax returns in the United States (federal) and in various state and
local jurisdictions. In most instances, the Company is no longer subject to federal, state
and local income tax examinations by tax authorities for years prior to 2004.

The
adoption of the provisions of FIN 48 did not have a material impact on the companys
consolidated financial position and results of operations. As of September 30, 2007, no
liability for unrecognized tax benefits was required to be recorded.

Fair Value of Financial
Instruments                The
carrying amounts reported in the consolidated financial statements for current assets and
current liabilities qualifying as financial instruments are a reasonable estimate of
their fair value. The estimated fair value of long-term debt is based on the current
rates that would be offered to the Company for debt of the same maturities.

Stock-Based Compensation                Effective
January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS)
No. 123R Share Based Payment: An Amendment of FASB Statements 123 and 95 (SFAS
123R) which replaces SFAS 123, Accounting for Stock-Based Compensation (SFAS
123). SFAS 123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on their fair
values at the date of grant. SFAS 123R supersedes the Companys previous accounting
under Accounting Principles Board Opinion No. 25 Accounting for Stock Issues to
Employees(APB 25).

The
fair value of options at date of grant was estimated using an option-pricing model with
the following weighted average assumptions:

| |                          | Years ended December 31,
| | ------------------------ | ------------------------
| |                          |                         
| |                          | 2007                    
| |                          |                         
| | Expected life (years)    |                         
| | Interest rate            |                         
| | Annual rate of dividends |                         
| | Volatility               |                         

The
weighted average fair value of the options at date of grant using the Black Scholes
option-pricing model is estimated at $0.29 and $0.73 per option for options granted in the
years ended December 31, 2007 and 2006, respectively.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Research and Development                Research
and development expenses are incurred to develop the Companys battery technologies and are expensed as incurred. Research and development expenses for the
years ended December 31, 2007 and 2006 were $1,359,360 and $972,977, respectively.

Loss Per Share                Basic
loss per share is computed by dividing the net loss attributable to common stockholders
by the weighted average number of common shares outstanding during the period. Diluted
loss per share adjusts basic loss per share for the effects of convertible securities,
warrants, stock options and other potentially dilutive financial instruments, only in the
periods in which such effect is dilutive. The shares issuable upon the conversion of
secured convertible notes and preferred stock, and the exercise of stock options and
warrants are excluded from the calculation of net loss per share for the periods
presented as their effect would be anti-dilutive.

Securities
that could potentially dilute earnings per share (EPS) in the future that
were not included in the computation of diluted loss per share consist of the following
as of December 31, 2007 and 2006:

| |                                                        | Years ended December 31,
| | ------------------------------------------------------ | ------------------------
| |                                                        |                         
| |                                                        | 2007                    
| |                                                        |                         
| | Series A preferred stock convertible into common stock |                         
| | Series B preferred stock convertible into common stock |                         
| | Warrants to purchase common stock                      |                         
| | Options to purchase common stock                       |                         
| | 8.5% secured convertible note                          |                         
| | 10% secured convertible note                           |                         
| |                                                        |                         
| | Total potential common shares                          |                         
| |                                                        |                         

Recent Accounting
Pronouncements                In
March 2008, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 161, Disclosures about
Derivative Instruments and Hedging Activitiesan amendment of FASB Statement
No. 133 (SFAS 161). SFAS 161 changes the disclosure requirements
for derivative instruments and hedging activities. Entities are required to provide
enhanced disclosures about (a) how and why an entity uses derivative instruments,
(b) how derivative instruments and related hedged items are accounted for under SFAS
No. 133 and its related interpretations, and (c) how derivative instruments and
related hedged items affect an entitys financial position, financial performance and
cash flows.  The guidance in SFAS 161 is effective for financial statements issued
for fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. This Statement encourages, but does not require, comparative
disclosures for earlier periods at initial adoption.  At this time, management is
evaluating the implications of SFAS 161 and its impact on the financial statements has not
yet been determined.

In
December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS
141R), which replaces SFAS No. 141, Business Combinations. SFAS 141R
establishes principles and requirements for determining how an enterprise recognizes and
measures the fair value of certain assets and liabilities acquired in a business
combination, including noncontrolling interests, contingent consideration, and certain
acquired contingencies. SFAS 141R also requires acquisition-related transaction expenses
and restructuring costs be expensed as incurred rather than capitalized as a component of
the business combination. SFAS 141R will be applicable prospectively to business
combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. SFAS 141R would have an
impact on accounting for any businesses acquired after the effective date of this
pronouncement.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements  An Amendment of ARB No. 51(SFAS
160). SFAS 160 establishes accounting and reporting standards for the
noncontrolling interest in a subsidiary (previously referred to as minority interests).
SFAS 160 also requires that a retained noncontrolling interest upon the deconsolidation
of a subsidiary be initially measured at its fair value. Upon adoption of SFAS 160, the
Company would be required to report any noncontrolling interests as a separate component
of stockholders equity. The Company would also be required to present any net
income allocable to noncontrolling interests and net income attributable to the
stockholders of the Company separately in its consolidated statements of income. SFAS 160
is effective for fiscal years, and interim periods within those fiscal years, beginning
on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation
and disclosure requirements for existing minority interests. All other requirements of
SFAS 160 shall be applied prospectively. SFAS 160 would have an impact on the
presentation and disclosure of the noncontrolling interests of any non wholly-owned
businesses acquired in the future.

In
December 2007, the FASB issued FASB Staff Position (FSP) 157-b, Effective Date
of FASB Statement No. 157, that would permit a one-year deferral in
applying the measurement provisions of Statement No. 157 to non-financial assets and
non-financial liabilities (non-financial items) that are not recognized or disclosed at
fair value in an entitys financial statements on a recurring basis (at least
annually). Therefore, if the change in fair value of a non-financial item is not required
to be recognized or disclosed in the financial statements on an annual basis or more
frequently, the effective date of application of Statement 157 to that item is deferred
until fiscal years beginning after November 15, 2008 and interim periods within
those fiscal years. The Company is currently evaluating the impact, if any, that the
adoption of FSP 157-b will have on the Companys operating income or net earnings.

In
June 2007, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 06-11,
Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (EITF
06-11). EITF 06-11 states that an entity should recognize a realized tax
benefit associated with dividends on nonvested equity shares, nonvested equity share
units and outstanding equity share options charged to retained earnings as an increase in
additional paid in capital. The amount recognized in additional paid in capital
should be included in the pool of excess tax benefits available to absorb potential
future tax deficiencies on share-based payment awards. EITF 06-11 should be applied
prospectively to income tax benefits of dividends on equity-classified share-based
payment awards that are declared in fiscal years beginning after December 15, 2007. We
do not expect that the adoption of EITF 06-11 will have a material impact on the Companys consolidated financial position, results of operations or cash flows.

On
February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities.(SFAS159). The guidance
in SFAS 159 allows reporting entities to choose to measure many
financial instruments and certain other items at fair value. The objective underlying the
development of this literature is to improve financial reporting by providing reporting
entities with the opportunity to reduce volatility in reported earnings that results from
measuring related assets and liabilities differently without having to apply complex hedge
accounting provisions, using the guidance in SFAS No. 133, as amended, entitled
Accounting for Derivative Instruments and Hedging Activities. The provisions
of SFAS 159 are applicable to all reporting entities and are effective as of the beginning
of the first fiscal year that begins subsequent to November 15, 2007. The adoption of SFAS
159 is not expected to have a material effect on the Companys consolidated financial
position, results of operations or cash flows.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

In
September 2006, the FASB issued SFAS 157, Fair Value Measurements(SFAS
157). SFAS 157 defines fair value, establishes a framework for measuring fair value
and expands disclosure of fair value measurements. SFAS 157 applies under other
accounting pronouncements that require or permit fair value measurements and accordingly,
does not require any new fair value measurements. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007. The Company is in
the process of evaluating the impact of the adoption of SFAS No. 157 on the Companys
consolidated financial position, results of operations or cash flows.

In
September 2006, the staff of the Securities and Exchange Commission (SEC)
issued Staff Accounting Bulletin No. 108 (SAB 108) which provides
interpretive guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a current year misstatement. SAB 108
became effective in fiscal 2007. The adoption of SAB 108 did not have a material impact
on the Companys consolidated financial position, results of operations or cash
flows.

NOTE 3  Inventories

Inventories
consist of the following as of December 31, 2007:

| | Raw materials     | $ | 291,644 |  |  | 
| | ----------------- | - | ------- |  |  | 
| | Work in progress  |   | 387,311 |  |  | 
| |                   |   |         |  | 
| | Total inventories | $ | 678,955 |  |  | 
| |                   |   |         |  | 

NOTE 4  Asset
Purchase

On
April 5, 2006, the Company completed the acquisition of certain assets and entered into
certain lease agreements for real estate relating to the manufacture of lithium-ion and
nickel based rechargeable cells and batteries located in Alachua, Florida from Lithium
Nickel Asset Holding Company I, Inc., (the Seller), pursuant to the terms of
an Asset Purchase Agreement. The total purchase consideration for the assets consisted of
5,750,000 unregistered shares of the Companys common stock (the Consideration
Shares) and a six-year warrant (the Contingent Warrant) to purchase up to
2,000,000 unregistered shares of the Companys common stock at an exercise price of
$7.00 per share vesting upon meeting future contingent revenue milestones. Upon reaching
aggregate gross sales of $25,000,000 generated from the Florida facility, the Contingent
Warrant holder will have the right to exercise warrants for the purchase of 500,000
shares of common stock. For each $1,000,000 of gross sales generated from the Florida
facility in excess of $25,000,000 prior to April 5, 2009, the Contingent Warrant holder
will have the right to exercise to purchase 10,000 shares of common stock up to a total
of 1,500,000 shares (or 2,000,000 in the aggregate, including the initial 500,000). The
Company also issued warrants to purchase 1,000,000 shares of unregistered common stock in connection with a lease agreement to lease
certain industrial manufacturing space from the Seller. In addition, the Company has
reserved 68,354 shares of common stock for future issuance as a contingent security
deposit under the lease agreement. Of the total number of shares, 1,000,000 Consideration
Shares will be held in escrow pursuant to an escrow agreement entered into at the closing
in order to secure the Sellers indemnification obligations under the Asset Purchase
Agreement which shall be incrementally released over the course of five years until all
of the shares are released on April 5, 2011. The Company has included 750,000
Consideration Shares in a registration statement filed by the Company and declared
effective by the SEC on January 26, 2007. In addition, the Company agreed to include
400,000 Consideration Shares in a subsequent registration statement in exchange for the
forfeiture of 500,000 Contingent Warrants by the Seller. Further, 4,600,000 Consideration
Shares and the warrants issued to the Seller in connection with the acquisition and lease
agreements are subject to a lock-up agreement restricting the ability of the Seller to
transfer the Consideration Shares and warrants for a period of one year, and providing
for a partial release for transfer in the second year after the closing. The aggregate
purchase price was $21,050,841 which consisted of the issuance of 5,750,000 shares of the
Companys common stock at $3.61 per share valued at $20,741,071, and acquisition
costs of $309,770. Pursuant to SFAS 141, the purchase price has been allocated to the net
assets acquired based on their estimated fair values on the date of acquisition as
follows: Machinery and equipment of $20,859,841 and leasehold improvements of $191,000.
The Company will record the value of the Contingent Warrant as additional purchase price
once the contingent performance conditions have been met in accordance with SFAS 141 and
EITF 96-18.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

NOTE 5  Property
and Equipment

Property
and equipment consists of the following as of December 31, 2007:

| |                                                 |   |            | Useful Lives
| | ----------------------------------------------- | - | ---------- | ------------
| |                                                 |   |            |             
| | Equipment                                       | $ | 22,639,365 |             
| | Leasehold improvements                          |   | 223,170    |             
| |                                                 |   |            |             
| |                                                 |   | 22,862,535 |             
| | Less: accumulated depreciation and amortization |   | 481,601    |             
| |                                                 |   |            |             
| | Property and equipment, net                     | $ | 22,380,934 |             
| |                                                 |   |            |             

Included
in property and equipment is $22,060,759 of construction in progress, including
$20,900,903 of equipment and leasehold improvements from the Asset Purchase (see Note 4) and $1,159,856 of other construction in progress,
which has not been placed in service as of December 31, 2007 and therefore not depreciated
during the year then ended. Also included in property and equipment is equipment held
under a capital lease with a net book value of $45,958 at December 31, 2007.

Depreciation
and amortization expense for the years ended December 31, 2007 and 2006 was $118,928 and
$112,512, respectively.

NOTE 6  Long-Term
Debt

The
Company had a note payable to Connecticut Innovations, Incorporated (CII) for
$183,579, commencing December 2004 and maturing December 2007 with interest at 5%, and
three equal annual installments of $61,193. On December 31, 2007, the Company made the
final payment owed to CII.

Interest
expense related to the long-term debt of CII amounted to $3,060 and $6,119 for the years
ended December 31, 2007 and 2006, respectively.

On
September 28, 2006, the Company and EaglePicher entered into an agreement pursuant to
which EaglePicher forgave $100,000 of the $150,000 remaining balance due on October 1,
2006 (see Note 8).

NOTE 7  Senior
Secured Convertible Notes

Senior
secured convertible notes consist of the following at December 31, 2007:

| | Face value of note                            | $ | 18,000,000   |  | 
| | --------------------------------------------- | - | ------------ |  | 
| | Remaining discount to fair value              |   | (17,763,547) |  | 
| |                                               |   |              |  | 
| | Fair value of senior secured convertible note |   | 236,453      |  | 
| | Less: current portion                         |   | -            |  | 
| |                                               |   |              |  | 
| | Long term portion                             | $ | 236,453      |  | 
| |                                               |   |              |  | 

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

8.5% Secured Convertible
Debentures                On
March 31, 2006, the Company entered into a Note and Warrant Purchase Agreement (the
8.5% Note and Warrant Purchase Agreement) with seven institutional accredited
investors (the 8.5% Note Holders) and, on April 5, 2006, the Company issued
and sold to the 8.5% Note Holders $11,000,000 in aggregate principal amount of 8.5% Senior
Secured Convertible Notes due 2010 (the 8.5% Notes) and issued warrants to purchase 578,947
shares of common stock (the 8.5% Note Warrants) that are
exercisable until March 31, 2010 at an exercise price of $3.80 per share. The 8.5% Notes
were senior secured debt with all assets of the Company, except inventory and accounts
receivable, pledged as security. Interest was payable semiannually on September 30 and
March 31. Holders of the 8.5% Notes had put rights on August 1, 2007, April 1, 2008,
December 1, 2008, and August 3, 2009 for the greater of 10% of the aggregate initial
principal amount, or $1,000,000. A portion of the proceeds from the issuance of the 8.5%
Notes was placed in escrow to pay the first two years of interest, as well as payment for
the 8.5% Note Holders first put right. The interest and put right were payable in
cash or, at the Companys option, in advance in common stock at a 10% discount to the
market value as described in the 8.5% Note and Warrant Purchase Agreement. Upon payment of
the interest or put right in stock, an amount equal to the interest payment or put payment
was released from escrow and became available for general corporate use.

In
connection with the 8.5% Note and Warrant Purchase Agreement, the Company entered into a
Registration Rights Agreement (the 8.5% Note Registration Rights Agreement),
dated as of March 31, 2006, by and among the Company and the 8.5% Notes Holders. The 8.5%
Note Registration Rights Agreement required the Company to file a shelf registration
statement (the 8.5% Note Shelf Registration Statement) with the SEC under the
Securities Act of 1933, as amended (the Securities Act) to be declared
effective by the SEC no later than 180 days after the date of the 8.5% Note Registration
Rights Agreement. Failure to do so would trigger interest penalties of $110,000
(representing 1.0% of the principal amount of the 8.5% Notes) for each month beyond the
180 day period that the 8.5% Note Shelf Registration Statement remains not having been
declared effective, up to a maximum of $550,000 per year. The SEC declared the 8.5% Note
Shelf Registration Statement effective January 26, 2007. Consequently, the Company
incurred aggregate interest penalties of $440,000 for the period October 27, 2006 through
January 27, 2007.

The
Company elected to pay the semi-annual interest and late registration penalties due on
March 31, 2007 related to the 8.5% Notes in shares of the Companys common stock at
the Interest Conversion Rate as described in the 8.5% Note and Warrant Purchase Agreement.
According to the 8.5% Note and Warrant Purchase Agreement, 20 trading days prior to the
interest payment due date, the Company is obligated to initially issue a number of shares
of the Companys common stock to the note holders to be applied against the amount
due as interest and late registration penalties based upon the average of the five lowest
volume weighted average prices for the 20 trading days prior to the interest payment due
date. If the average of the five lowest volume weighted average prices for the 20 trading
days ending on the trading day immediately prior to the interest payment due date is less
than the average of the five lowest volume weighted average prices for the 20 trading days
ending on the 27th trading day prior to the interest payment due date, the
Company is obligated to issue an additional number of shares based upon the average of the
five lowest volume weighted average prices for the 20 trading days ending on the trading
day immediately prior to the interest payment due date. Accordingly, on March 2, 2007 and
April 9, 2007, the Company, pursuant to the 8.5% Note and Warrant Purchase Agreement,
delivered an aggregate of 765,769 and 90,872 shares of the Companys common stock,
respectively, to the 8.5% Note Holders accounts with The Depository Trust Company,
representing the initial number of shares required to pay the March 31, 2007 interest
payment and late registration penalties under the 8.5% Notes. On September 21, 2007 and
October 3, 2007, the Company, pursuant to the 8.5% Note and Warrant Purchase Agreement,
delivered an aggregate of 730,994 and 658,308 shares of the Companys common stock,
respectively, to the 8.5% Note Holders accounts with The Depository Trust Company,
representing the initial number of shares required to pay the September 31, 2007 interest
payment under the 8.5% Notes. During the year ended December 31, 2007, $935,000 was
released from escrow as a result of the payment of the March 31, 2007 and September 30,
2007 interest payments under the 8.5% Notes in shares of the Companys common stock.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

On
August 1, 2007, the 8.5% Notes Holders exercised their put right and the Company elected
to pay the put right in shares of the Companys common stock as described in the 8.5%
Note and Warrant Purchase Agreement. Accordingly, on August 3, 2007, the Company, pursuant
to the 8.5% Note and Warrant Purchase Agreement, issued an aggregate of 1,229,973 shares
of the Companys common stock to the 8.5% Note Holders, representing the number of
shares required to pay the August 1, 2007 put right, plus accrued and unpaid interest.
During the year ended December 31, 2007, $1,186,167 was released from escrow as a result
of the payment of the August 1, 2007 put right, plus accrued and unpaid interest, under
the 8.5% Notes in shares of the Companys common stock.

The
fair value of the 8.5% Note Warrants was estimated as of the issue date using a
Black-Scholes pricing model, with the following assumptions: common stock based on a
closing market price of $3.70 per share, exercise price of $3.80, zero dividends,
expected volatility of 53.7%, risk free interest rate of 4.79% and contractual life of 4
years. The gross proceeds of the 8.5% convertible debt were allocated to the 8.5% Notes
and the 8.5% Note Warrants. The fair value of the 8.5% Note Warrants of $906,415 resulted
in a discount to the face value of the 8.5% Notes that was recorded as additional paid in
capital and was amortized over the term of the 8.5% Notes as additional interest expense.
The effective rate of interest was 11.11%.

In
accordance with EITF 98-5 and 00-27, the Company evaluated the conversion feature
embedded in the debt instrument and concluded that the 8.5% Notes contained a beneficial
conversion feature since the effective conversion price of the shares was less than the
stock price at the date of issuance based upon the allocation of the fair value of the
convertible debt between the 8.5% Notes and the 8.5% Note Warrants. The beneficial
conversion feature of $607,895 resulted in a discount to the face value of the 8.5% Notes
that has been recorded as additional paid in capital and is being amortized over the term
of the 8.5% Notes as additional interest expense.

The
Company evaluated the provisions of EITF 00-19 Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Companys Own Stock(EITF
00-19) and View A of EITF 05-4 The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument Subject to Issue No. 00-19 (EITF 05-4),
and determined that the conversion option embedded in the 8.5% Notes and the 8.5% Note
Warrants should be classified as equity in the accompanying consolidated financial statements.

Interest
expense on the 8.5% Notes amounted to $1,549,668, including $373,113 of additional
interest expense related to the August 1, 2007 put payment and $110,000 of late
registration penalties, and $1,087,625, including $330,000 of late registration penalties,
for the years ended December 31, 2007 and 2006, respectively. The amortization of the
deferred debt discount recorded in connection with the 8.5% Notes and 8.5% Note Warrants
amounted to $424,480 and $256,152 respectively, for the years ended December 31, 2007 and
2006. The amortization of the deferred financing costs recorded in connection with the
8.5% Notes amounted to $351,750 and $228,777, respectively, for the
years ended December 31, 2007 and 2006.

On
December 7, 2007, the Company redeemed the remaining $9,900,000 principal value of the
8.5% Notes in connection with the issuance of the 10% Secured Convertible Debenture as
described below. In connection with the redemption, the Company recorded a loss on
extinguishment of debt of $4,801,688, consisting of the acceleration of the amortization
of the deferred debt discount, deferred financing costs and beneficial conversion feature
of $514,533, $642,326 and $319,144, respectively, relating to the 8.5% Notes, the fair
value of the warrants and the Series B Convertible Preferred Stock of $1,303,138 and
$1,543,404, respectively, issued to the 8.5% note holders, the repricing of the 8.5% Note
Warrants of $145,187 and cash of $333,956.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

10% Secured Convertible
Debentures                On December 7, 2007, the Company
entered into a transaction whereby the Company (i) issued, pursuant to that certain Note
Sale and Preferred Stock and Warrant Purchase Agreement, dated December 7, 2007 (the
8.5% Note Holders Agreement), to the 8.5% Note Holders shares of Series B
Cumulative Convertible Preferred Stock (the Series B Preferred) and warrants
(the 8.5% Note Holders New Warrants) to purchase the Companys common
stock, paid cash of $333,956 and reduced the exercise price of the 8.5% Note Warrants from
$3.80 per share to $0.55 per share and (ii) issued, pursuant to that certain Debenture and
Warrant Purchase Agreement, dated December 7, 2007 (the Debenture and Warrant
Purchase Agreement), a 10% Senior Secured Convertible Debenture (the 10%
Notes) and a warrant (the 10% Note Warrants) to purchase common stock to
the Quercus Trust (Quercus).

Pursuant
to the 8.5% Note Holders Agreement, the 8.5% Note Holders sold the 8.5% Notes, which had
an aggregate outstanding principal amount of $9,900,000, to Quercus for a cash payment of
$7,425,001 and, in consideration therefore, the Company issued to the 8.5% Note Holders,
in the aggregate, (i) $488,320 from restricted cash, comprised of $333,956 for the sale of
the 8.5% Notes recorded as a loss on extinguishment of debt and $154,364 for accrued and
unpaid interest through December 6, 2007, (ii) 5,401 shares of Series B Convertible
Preferred Stock (the Series B Preferred Stock) with a liquidation preference
of $275 per share, (iii) the 8.5% Note Holders New Warrants to purchase an aggregate of
5,400,000 shares of the Companys common stock and (iv) reduced the exercise price of
the 8.5% Note Warrants from $3.80 per share to $0.55 per share. The conversion price of
the 10% Notes is specified as the greater of (A) 70% of the volume weighted average price
of the Companys common stock for the ten business day period prior to the conversion
date, or (B) $0.25. The 8.5% Note Holders Agreement contains prohibitions from exercising
the 8.5% Note Holders New Warrants until the Company has obtained stockholder approval, which approval was obtained on March 5, 2008 (See Note 13).

Each
share of Series B Preferred is convertible after December 6, 2008 at the option of the
holder into shares of common stock and has a liquidation preference of $275 per share.
Each share of Series B Preferred shall initially be convertible into common stock at the
Conversion Rate of 500 shares of common stock for each share of Series B Preferred,
subject to adjustments. After the date of the first issuance of any shares of Series B
Preferred, the conversion rate for each share of Series B Preferred shall equal the
fraction whose numerator is the liquidation preference of such share of Series B Preferred
and the denominator is the greater of (A) 70% of the volume weighted average price of the
Companys common stock for the ten business day period prior to the conversion date,
or (B) $0.25. Holders of the Series B Preferred shall not be entitled to vote on any
matters submitted to a vote of the shareholders holding any other class of stock of the
Company.

Each
holder of the Series B Preferred shall be entitled to an annual cash dividend equal to 2%
of the outstanding principal amount of the Series B Preferred held by such holder (subject
to adjustment in the event that such Series B Preferred is held for less than one year)
payable in cash on January 1, April 1, July 1 and October 1. No dividends or other
distributions shall be declared or paid with respect to the common stock of the Company or
stock of any other class or series of junior securities unless at the same time an
equivalent dividend or distribution is declared or paid on all outstanding shares of the
Series B Preferred. As of December 31, 2007, the Company accrued $1,980 in dividends
relating to the Series B Preferred.

The fair value of the Series B
Preferred was estimated as of the issue date by allocating a portion of the fair value to
the value of the dividend component and a portion of the fair value to the value of the
common stock equivalent component. The value of the interest component was based on the
present value of the projected stream of interest payments. The value of the common stock
equivalent component was estimated using a lattice pricing model with the following
assumptions: common stock based on a closing market price of $0.95 per share, exercise
price of $0.55, zero dividends, expected volatility of 71.73%, risk free interest rate of
3.51% and life of five years. The fair value of the Series B Preferred of $1,543,404 was
recorded as loss on extinguishment of the 8.5% Secured Convertible Notes in the
accompanying consolidated financial statements.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

The
exercise price of the 8.5% Note Holders New Warrants is $0.55 per share and is adjustable
in the event the Company issues common stock or securities that are convertible into
common stock for less than $0.55 per share (the Subsequent Lower Price), in
which case the exercise price of the 8.5% Note Holders New Warrants shall be the
Subsequent Lower Price, but in no event shall the exercise price be less than $0.25 per
share. The term of the 8.5% Note Holders New Warrant is three years. As partial
consideration for the sale of the 8.5% Notes to Quercus, the exercise price of the 8.5%
Note Warrants issued on April 5, 2006 was reduced from $3.80 per share to $0.55 per share.

The
fair value of the 8.5% Note Holders New Warrants, and the repricing of the 8.5% Note
Warrants, was estimated as of the issue date using a lattice pricing model, with the
following assumptions: common stock based on a closing market price of $0.95 per share,
exercise price of $0.55, zero dividends, expected volatility of 71.73%, risk free interest
rate of 3.15% and contractual life of three years. The fair value of the 8.5% Note Holders
New Warrants  of $1,303,138, has been recorded as loss on extinguishment of 8.5% Secured Convertible
Notes in the accompanying consolidated financial statements. As a result of repricing the 8.5% Note
Warrants, an additional $145,187 was recorded as loss on extinguishment of debt
representing the difference in the fair value of $184,234 on the 8.5% Note Warrants using
the above assumptions, and the fair value of $39,047 on the 8.5% Note Warrants using the
following assumptions: common stock based on a closing market price of $0.95 per share,
exercise price of $3.80, zero dividends, expected volatility of 71.73%, risk free interest
rate of 3.15% and contractual life of approximately two and a half years.

In
accordance with EITF 98-5 and 00-27, the Company has evaluated the conversion feature
embedded in the Series B Preferred Stock and concluded that a beneficial conversion
feature exists since the effective conversion price of the shares was less than the stock
price at the commitment date. The Company determined the value of the beneficial
conversion feature to be $636,546, which is being accreted monthly from the issuance date
of the Series B Preferred Stock through December 7, 2008, the date of first possible conversion, and is
being recorded as a deemed dividend in the accompanying consolidated financial statements. For the
year ended December 31, 2007, the Company accreted $41,741 in dividends.

The
Company issued the 10% Notes in the principal amount of $18,000,000 in exchange for the
redemption of the outstanding principal amount of the 8.5% Notes of $9,900,000 and
$8,100,000 cash. The 10% Notes are senior secured debt with all assets of the Company,
except inventory and accounts receivable, pledged as security. Interest is payable
quarterly on March 31, June 30, September 30 and December 31 in cash or, at the
Companys option, in common stock valued at the volume weighted average price of the
Companys common stock for the ten business day period prior to the interest payment
date as described in the Debenture and Warrant Purchase Agreement. The 10% Notes are
convertible into common stock commencing on the earlier of (i) twelve months after the
issuance date of the 10% Notes or (ii) the date of effectiveness of the Companys
registration statement to be filed pursuant to the terms of that certain registration
rights agreement dated December 7, 2007 between the Company and Quercus (the 10%
Notes Registration Rights Agreement). The initial conversion price of the 10% Notes
is $0.55 per share (the Initial Conversion Rate). The Initial Conversion Rate
is subject to change, and is a function of the market price per share of the
Companys common stock. The conversion price of the 10% Notes is specified as the
greater of (A) 70% of the volume weighted average price of the Companys common stock
for the ten business day period prior to the conversion date, or (B) $0.25.

The
10% Note Registration Rights Agreement requires the Company to file a shelf registration
statement with the SEC under the Securities Act of 1933, as amended (the Securities
Act) no later than 90 days after the issuance date of the 10% Notes (the Required
Filing Date) and to respond to any SEC comment letter within 30 calendar days of
receipt such SEC comment letter (the Required Response Date). Failure to do
so would trigger interest penalties equal to 2% of the principal amount of the 10% Notes
outstanding for each month beyond the Required Filing Date or Required Response Date up
to a maximum of 12% percent of the principal amount of the 10% Notes outstanding.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

The
10% Note Warrants are convertible into 32,727,273 shares of common stock, and have an
exercise price of $0.55 per share. In the event the Company subsequently issues common
stock or Common Stock Equivalents for a lower price, the 10% Note Warrants are convertible
at such subsequent lower price, provided that in no event shall the exercise price be less
than $0.25 per share. The term of the 10% Note Warrants is three years.

The
fair value of the 10% Note Warrants was estimated as of the issue date using a lattice
pricing model, with the following assumptions: common stock based on a closing market
price of $0.95 per share, exercise price of $0.55, zero dividends, expected volatility of
71.73%, risk free interest rate of 3.15% and contractual life of three years. The gross
proceeds of the 10% convertible debt were allocated to the 10% Notes and the 10% Note
Warrants. The fair value of the 10% Note Warrants of $5,897,680 resulted in a discount to
the face value of 10% Notes that has been recorded as additional paid in capital and is
being amortized over the term of the 10% Notes as additional interest expense on a
straight line basis.

In
accordance with EITF 98-5 and 00-27, the Company has evaluated the conversion feature
embedded in the 10% Note and concluded that a beneficial conversion feature exists since
the effective conversion price of the shares was less than the stock price at the
commitment date. The Company determined the value of the beneficial conversion feature to
be $12,102,320, which resulted in a discount to the face value of the 10% Notes that has
been recorded as additional paid in capital and is being amortized over the term of the
10% Notes as additional interest expense on a straight line basis.

The
Company evaluated the provisions of EITF 00-19 Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Companys Own Stock(EITF
00-19), and determined that the conversion option embedded in the 10% Notes and the
10% Note Warrants should be classified as equity in the accompanying consolidated financial
statements.

The Company issued warrants (the
Placement Agent Warrants) to purchase 2,618,181 shares of the Companys
common stock to the placement agent in connection with the issuance of the 10% Notes. The
fair value of the Placement Agent Warrants was estimated as of the issue date using a
lattice pricing model, with the following assumptions: common stock based on a closing
market price of $0.95 per share, exercise price of $0.55, zero dividends, expected
volatility of 71.73%, risk free interest rate of 3.15% and contractual life of three
years. The fair value of the Placement Agent Warrants of $630,981 has been recorded as
deferred financing cost and is being amortized over the term of the 10% Notes.

The
Company incurred financing costs of $1,387,389 which have been recorded as deferred
financing costs and are being amortized over the term of the 10% Notes.

Interest
expense on the 10% Notes amounted to $123,288 for the year ended December 31, 2007. The
amortization of the deferred debt discount and deferred financing costs recorded in
connection with the 10% Notes and the 10% Note Warrants amounted to $236,453 and $33,640,
respectively, for the year ended December 31, 2007.

NOTE 8  Commitments
and Contingencies

Operating Leases                The
Company conducts its operations from three leased facilities. The Colorado Springs,
Colorado operating lease expires in March 2009 and requires minimum monthly payments of
$23,875. On September 28, 2006, EaglePicher Technologies, LLC granted the Company the
option to terminate the Colorado Springs lease after December 31, 2006 with 90 days
notice. On May 4, 2006, the Company signed a lease agreement for the Danbury, Connecticut
location to extend the term for one year commencing August 1, 2006 for $9,071 per month.
On May 17, 2007, the Company signed a lease agreement for the Danbury, Connecticut
location to extend the term for one year commencing August 1, 2007 for $9,253 per month.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

On
April 5, 2006, the Company entered into various six year agreements, expiring in April
2012, to lease 200,000 square feet of industrial space in three buildings in Alachua,
Florida, which require minimum monthly payments of $19,583 from January 2007 through
April 2007, $37,917 from May 2007 through April 2008, $56,250 from May 2008 through April
2011 and $92,917 from May 2011 through February 2012.. In connection with the lease
agreements, and in addition to rental payments, the Company issued a four-year warrant to
purchase 1,000,000 shares of the Companys common stock at an exercise price of
$7.00 per share. The value of the warrants issued in connection with the lease agreements
of $1,043,959 is recorded as deferred lease costs and is being amortized over the lease
term. Amortization on account of deferred lease costs amounted to $173,993 and $130,495
for the year ended December 31, 2007 and 2006, respectively. The fair value of the
warrants was estimated as of the issue date using a Black-Scholes pricing model, with the
following assumptions: common stock based on a closing market price of $3.70 per share,
exercise price of $7.00, zero dividends, expected volatility of 53.7%, risk free interest
rate of 4.79% and contractual life of 4 years. Furthermore, the Company reserved 68,354
shares of its common stock as security in connection with the leases. In April 2006, the
Company paid a security deposit of $185,833 representing the last two months rent.

Rental
expense related to facilities under operating leases amounted to $1,002,607 and $863,818
for the years ended December 31, 2007 and 2006, respectively.

Future
minimum rental payments under the above noncancelable operating leases are as follows:

|For the Year Ending December 31, |  
|-------------------------------- | -
|                                 |  
|2008                             | $
|2009                             |  
|2010                             |  
|2011                             |  
|2012                             |  
|                                 |  
|Total payments                   | $
|                                 |  

Deferred
rent consists of the following as of December 31, 2007:

|Facility:                              |  
|-------------------------------------- | -
|Colorado Springs, Colorado             | $
|Alachua, Florida - rental payments     |  
|                                       |  
|Total deferred rent                    |  
|Less: current portion of deferred rent |  
|                                       |  
|Deferred rent, net of current portion  | $
|                                       |  

The
term of certain of the Companys lease obligations provide for scheduled escalations
in the monthly rent. In accordance with SFAS 13 Accounting for Leases
the non-contingent rent increases are being amortized over the term of the leases on a
straight line basis. Deferred rent of $583,938 represents the unamortized rent adjustment
amount at December 31, 2007 and is reflected as deferred rent obligations in the
consolidated balance sheet.

Capital Lease                The
Company entered into a capital lease for certain machinery and equipment at its Alachua,
Florida facility in November 2006. Accordingly, the Company has recorded property and
equipment and recognized a corresponding liability in the principal amount of the lease
of $45,958. The lease requires minimum monthly payments of $1,137 through October 2010.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Future
minimum lease payments under the above capital lease are as follows:

|For the Year Ending December 31               |   | Amount  
|--------------------------------------------- | - | --------
|                                              |   |         
|2008                                          | $ | 13,646  
|2009                                          |   | 13,646  
|2010                                          |   | 11,371  
|                                              |   |         
|Total payments                                |   | 38,663  
|Less: interest                                |   | (4,506) 
|Current portion                               |   | (11,110)
|                                              |   |         
|Long term capital lease, less current portion | $ | 23,047  
|                                              |   |         

Off Balance Sheet
Arrangements                At
December 31, 2007, a non-revocable standby letter of credit in the amount of $10,000 was
outstanding as security for the Companys electric utility account for its Alachua,
Florida manufacturing facility.

The
value of the beneficial conversion of the Series B Preferred Stock is considered a deemed
dividend and is being accreted monthly as a preferred stock dividend from the issuance
date of the Series B Preferred Stock through the date of first possible conversion. At
December 31, 2007, the unaccreted balance of the deemed dividend was $594,805.

Supply Agreement                The
Company was party to a five-year agreement to supply EaglePicher with certain products at
agreed-upon prices. Under the agreement, the Company is the sole source supplier for
components for battery power systems used in military satellites and military aircraft.
Pricing under the agreement was fixed, subject to possible adjustment under periodic
value engineering reviews and based on material cost escalations. On October 22, 2007,
the parties agreed to terminate the supply agreement. Net sales to EaglePicher
represented approximately 14% and 24% of total sales for the years ended December 31,
2007 and 2006, respectively. Accounts receivable from EaglePicher amounted to $14,165 at
December 31, 2007.

Licensing Agreements                The
Company is party to a ten year, non-exclusive, worldwide technology license agreement for
the use of certain technologies and processes involving the use and sale of nickel plaque
and the manufacture and sale of vented NiCd and sealed NiCd batteries. Under the license
agreement, the Company is obligated to pay a royalty to EaglePicher ranging from 0.5% to
3% of revenue as defined in the agreement. During the years ended December 31, 2007 and
2006, the Company did not incur any liability for payments under this agreement.

On
June 11, 2007, the Company entered into an exclusive worldwide technology agreement for
the use of certain commercial truck anti-idling technologies. Under the terms of the
agreement, as amended, the Company paid an initial License fee of $150,000 with additional
licensing payments of $25,000 per month. In addition, the Company is obligated to pay a
royalty to Enertek Corporation ranging from 3% to 5% of revenue as defined in the
agreement. The agreement is cancellable upon 30 days written notice. During the year ended
December 31, 2007, the Company incurred $175,000 for licensing fees pursuant to this
agreement. During the years ended December 31, 2007, the Company did not incur any
liability for royalty payments under this agreement.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

On
July 31, 2007, the Company entered into a five year exclusive worldwide technology
agreement for the use of certain smart battery system technologies with two five year
renewal options. Under the terms of the agreement the Company is obligated to pay a
licensing fee of $300,000, of which $100,000 was incurred on July 31, 2007 and the remainder
of which is due in monthly installments of $10,000. In addition, the Company is obligated
to pay a royalty to Falcon Systems Engineering Corporation of 3% of revenue as defined in
the agreement. During the year ended December 31, 2007, the Company incurred $150,000 for
licensing fees pursuant to this agreement. During the years ended December 31, 2007, the
Company did not incur any liability for royalty payments under this agreement.

Employment Agreements                On September 12, 2007, the
Company entered into long-term employment agreements with Michael E. Reed and Timothy E.
Coyne. Effective as of September 12, 2007, Mr. Reed will continue to serve as
Chief Executive Officer of the Company and Mr. Coyne was named Vice President of Finance,
in addition to continuing in his current role of Chief Financial Officer. The agreements
are for a term of three years and are subject to renewal or termination for cause, or
not-for-cause, including in the event of an acquisition of the Company or other change of
control. Under the terms of the agreements, both officers are subject to non-competition,
non-solicitation and confidentiality provisions. Both officers are also eligible for
grants of stock based upon any improved market capitalization of the Company. Mr.
Reeds agreement contains provisions providing for unpaid compensation for his past
services to the Company as Chief Operating Officer and, later, as Chief Executive Officer,
including equity-based grants and a portion of base salary. Mr. Reed is entitled to an
annual base salary of $240,000 and Mr. Coyne is entitled to an annual base salary of
$170,000. Each is eligible for an annual year-end bonus opportunity. During the year ended
December 31, 2007, the Company accrued $70,965 for Mr. Reed and $43,350 for Mr. Coyne on
account of such bonus opportunity. Mr. Coyne and Mr. Reed are also entitled to annual
grants of 100,000 and 200,000 stock options, respectively, with vesting over four years.
In the event of termination without cause or resignation for good reason, Messrs. Reed and
Coyne are each entitled to twelve months of base salary, a pro-rated bonus and
acceleration of unvested options. In the event of termination without cause within twelve
months after an acquisition of the Company, or other change in control, Mr. Reed and Mr.
Coyne are entitled to 24 months base salary, prorated bonus and acceleration of unvested
stock options.

Stock Purchase Agreement                On October 17, 2005, the Company
entered into a Stock Purchase Agreement with In-Q-Tel, pursuant to which In-Q-Tel has
agreed to purchase 241,692 shares of unregistered common stock of the Company along with
three-year warrants to purchase 75,829 shares of unregistered common stock of the Company
at an exercise price of $3.11 per share. The total purchase price for the stock and
warrants was $800,000 to be paid over the course of 14 months following the closing,
conditioned upon the Company achieving certain development milestones. As of December 31,
2007, the Company completed the program and in the aggregate has received $800,000 and
issued 241,692 shares of unregistered common stock and 75,829 warrants in connection with
this agreement. During the year ended December 31, 2007, the Company received $500,000 and
issued 151,060 shares of unregistered common stock and warrants to purchase 47,395 shares
of common stock in connection with this agreement. During the year ended December 31,
2006, the Company received $200,000 and issued 60,424 shares of unregistered common stock
and warrants to purchase 18,958 shares of common stock in connection with this agreement.

Legal Proceedings                Electro
Energy, Inc. is engaged in litigation with LNAH and Phoenix Commercial Park, LLLP (Phoenix)
in a state court proceeding in Alachua County, Florida regarding entitlement to assets
purchased and leased pursuant to the Asset Purchase Agreement, Site Agreement, leases,
and in conjunction with the Bankruptcy Order and Letter of Intent with LNAH. LNAH sold
certain real estate and assets to Phoenix which infringe on Electro Energy asset
ownership and leasehold rights. The litigation is styled as an action seeking a
declaratory judgment. EEI was provided injunctive relief by the Circuit Court to protect
its assets and leasehold interests. EEI and Phoenix have entered into an abatement
agreement to pursue settlement discussions. LNAH has filed a motion to return the
litigation to Bankruptcy Court. The Company is engaged in active settlement negotiations with
LNAH and Phoenix and believes that a settlement is likely.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

On
April 6, 2007, the Company provided LNAH notice of certain claims the Company is asserting
against LNAH for breach of contract and indemnification under the provisions of the Asset
Purchase Agreement and real property lease agreements.

At this time, an evaluation of the ultimate  outcome and estimate of potential  loss, if any, is unable to
be determined for these issues.

On
or about January 31, 2007, Audra Mace, the Companys former Chief Financial Officer,
filed an administrative discrimination case against the Company with the Connecticut
Commission on Human Rights and Opportunities (the CHRO). The Complaint
alleges that she was constructively discharged based on her gender and
because of an alleged hostile work environment. Ms. Mace claims loss of income and
emotional distress as a result of her alleged treatment by the Company and her alleged
constructive discharge. The Company believes that the complaint has no merit
and will vigorously defend the claims set forth therein. Such defense will include a
statement that Ms. Mace left her position voluntarily. Ms. Mace has rejected the Companys
attempts to settle these issues in a No Fault Conciliation process administered by the
CHRO. The resolution of this complaint is not expected to have a material effect on the
Company.

The
Company is not aware of any other pending or threatened litigation related to the
Company, the Companys business or the Companys officers and directors.

NOTE 9 
Stockholders Equity

Preferred Stock                The
Company has authorized 10,000 shares of preferred stock, par value $0.001 per share. As
of December 31, 2007, 160 shares of Series A Preferred Stock (the Series A Preferred)
are outstanding. Each share of Series A Preferred is convertible at the option of the
holder and automatically upon the occurrence of certain events, as defined in the Series
A Preferred Stock Certificate of Designation (the Series A Certificate), into
400 shares of the Companys common stock and has a liquidation preference of $1,000
per share. The conversion rate and liquidation preference are subject to adjustment as
specified in the Series A Certificate. Each share of Series A Preferred is entitled to
votes equal to the number of shares of common stock it is convertible into at the time of
the voting. During the year ended December 31, 2006, 20 shares of Series A Preferred were
converted into 8,000 shares of common stock.

As
of December 31, 2007, 5,401 shares of Series B Preferred Stock (the Series B
Preferred) are outstanding. Each share of Series B Preferred is convertible after
December 6, 2008 at the option of the holder into shares of common stock and has a
liquidation preference of $275 per share.. Each share of Series B Preferred shall
initially be convertible into common stock at the Conversion Rate of 500 shares of common
stock for each share of Series B Preferred, subject to adjustments. After the date of the
first issuance of any shares of Series B Preferred, the conversion rate for each share of
Series B Preferred shall equal the fraction whose numerator is the liquidation preference
of such share of Series B Preferred and the denominator is the greater of (A) 70% of the
volume weighted average price of the Companys common stock for the ten business day
period prior to the conversion date, or (B) $0.25. Holders of the Series B Preferred shall
not be entitled to vote on any matters submitted to a vote of the shareholders holding any
other class of stock of the Company.

Each
holder of the Series B Preferred shall be entitled to an annual cash dividend equal to 2%
of the outstanding principal amount of the Series B Preferred held by such holder (subject
to adjustment in the event that such Series B Preferred is held for less than one year)
payable in cash on January 1, April 1, July 1 and October 1. No dividends or other
distributions shall be declared or paid with respect to the common stock of the Company or
stock of any other class or series of junior securities unless at the same time an
equivalent dividend or distribution is declared or paid on all outstanding shares of the
Series B Preferred. As of December 31, 2007, the Company accrued $1,980 in dividends
relating to the Series B Preferred.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

During
the year ended December 31, 2007, the Company issued 5,401 shares of Series B Preferred in
connection with the redemption of the 8.5% Notes (see Note 7).

Common Stock                The
Company has authorized 250,000,000 shares of common stock, par value $0.001. During the year ended December 31, 2007, there were no exercises of any options or
warrants. During the year ended December 31, 2006, the Company issued 72,297 shares of
common stock in connection with the exercise of employee stock options for proceeds of
$39,101. During the year ended December 31, 2006, warrants were exercised for proceeds of
$175,000 in exchange for 92,687 shares of common stock.

On
October 17, 2005, the Company entered into a Stock Purchase Agreement with In-Q-Tel (See
Note 10). During the years ended December 31, 2007 and 2006, the Company issued 151,060
and 60,424 shares of unregistered common stock for proceeds of $500,000 and $200,000,
respectively pursuant to the Stock Purchase Agreement.

On
April 5, 2006, the Company entered into the Asset Purchase issuing 5,750,000 shares of
common stock in exchange for manufacturing equipment (See Note 4).

On
April 5, 2006, in connection with the Asset Purchase, the Company entered in to a lease
agreement for industrial space (See Note 4) and has reserved 68,354 shares of common
stock for future issuance as a contingent security deposit.

On
March 2, 2007, the Company issued an aggregate of 765,769 shares of the Companys
common stock to the holders of the 8.5% Notes, representing the initial number of shares
required to pay the interest and late registration penalties under the Notes. On April 9,
2007, the Company issued an aggregate of 90,872 shares of the Companys common stock
to the holders of the 8.5% Notes, representing the additional number of shares required to
pay the interest and late registration penalties under the 8.5% Notes.

On
August 3, 2007, the Company issued an aggregate of 1,229,973 shares of the Companys
common stock to the holders of the 8.5% Notes, representing 894,309 shares required to pay
the August 1, 2007 put right, plus 335,664 shares required to pay accrued and unpaid
interest.

On
September 18, 2007, the Companys Board of Directors voted to issue 101,695 shares
of the Companys common stock to the Companys Chief Executive Officer as
compensation for services previously rendered. Such shares were valued at $60,000 based
upon the market price of such shares.

On
September 21, 2007, the Company issued an aggregate of 730,994 shares of the
Companys common stock to the holders of the 8.5% Notes, representing the initial
number of shares required to pay the interest under the 8.5% Notes.

On
October 3, 2007, the Company issued an aggregate of 658,308 shares of the Companys
common stock to the holders of the 8.5% Notes, representing the additional number of
shares required to pay the September 30, 2007 interest payment interest under the 8.5%
Notes.

On
October 25, 2007, the Company entered into a Common Stock and Warrant Purchase Agreement
(the KIT Stock Purchase Agreement) with KIT Financial, Inc. (KIT)
for the purchase of 2,500,000 shares of the Companys common stock for the purchase
price of $750,000. In connection with the KIT Stock Purchase Agreement, the Company also
entered into a Registration Rights Agreement that requires the Company to file a shelf
registration statement with the SEC under the Securities Act of 1933, as amended (the
Securities Act) no later than 30 days after the date of the KIT Stock Purchase
Agreement. Such registration statement was filed and declared effective by the SEC on
December 10, 2007.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Stock Options                The
purpose of the Companys stock compensation plans is to enable the Company to
attract, retain and motivate key employees, directors and, on occasion, consultants. As of
December 31, 2007 and 2006, the Company had reserved 3,000,000 shares of common stock for
issuance under the 1993 Plan and 3,000,000 shares of common stock for issuance under the
2005 Plan. Stock options granted under the 2005 Plan may be either incentive stock
options, as defined in Section 422A of the Internal Revenue Code of 1986, or non-qualified
stock options. Options vest ratably over a four-year period and are exercisable up to 10
years from the date of grant.

On
January 1, 2006, the Company adopted SFAS 123R. SFAS 123R requires companies to estimate
the fair value of share-based payment awards on the date of grant. The value of stock
options granted to employees and directors is estimated using an option-pricing model.
The value of the portion of the award that is ultimately expected to vest is recognized
as expense over the requisite service periods.

The
Company has selected the Black-Scholes method of valuation for share-based compensation
and has adopted the modified prospective transition method under SFAS 123R, which requires
that compensation cost be recorded, as earned, for all unvested stock options outstanding
as the beginning of the first quarter of adoption of SFAS 123R. As permitted by SFAS 123R,
prior periods have not been restated. Compensation expense is generally recognized on a
straight-line basis over the remaining service period after the adoption date based on the
options original estimate of fair values.

Stock-based
compensation expense recognized in the Companys Consolidated Statements of
Operations for the year ended December 31, 2007 includes compensation expense for all
share-based payment awards granted prior to, but not yet vested as of January 1, 2006,
based upon the grant date fair value estimated in accordance with the pro forma provision
of SFAS 123, and compensation expense for the share-based payment awards granted
subsequent to January 1, 2006, based upon the grant date fair value estimated in
accordance with the provisions of SFAS 123R. The Company recognizes compensation expense
for stock option awards on a straight-line basis over the requisite service period of the
award. As stock-based compensation expense recognized in the year ended December 31, 2007
is based upon awards ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and
such estimates are revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates.

The
Company recorded $835,725 of employee stock option compensation in the year ended
December 31, 2007. The remaining balance of unamortized employee stock compensation as of
December 31, 2007 was $1,129,619 and will be fully amortized through 2011.

During
the year ended December 31, 2007, the Company recorded an adjustment of $8,525 to
remeasure and amortize stock compensation expense in connection with 100,000 stock
options issued to consultants. The remaining balance of the stock compensation as of
December 31, 2007 was $45,910 and will be amortized through March 2011.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Stock
option activity under the 1993 and 2005 Plans for the years ended December 31, 2007 and
2006 are as follows:

| |                           | Numberof Options |           | WeightedAverageExercisePrice
| | ------------------------- | ---------------- | --------- | ----------------------------
| |                           |                  |           |                             
| | Balance January 1, 2006   |                  | 1,317,353 |                             
| | Granted                   |                  | 375,000   |                             
| | Exercised                 |                  | (72,297)  |                             
| | Forfeited                 |                  | (152,148) |                             
| |                           |                  |           |                             
| | Balance December 31, 2006 |                  | 1,467,908 |                             
| |                           |                  |           |                             
| | Granted                   |                  | 790,000   |                             
| | Exercised                 |                  | -         |                             
| | Forfeited                 |                  | (210,950) |                             
| |                           |                  |           |                             
| | Balance December 31, 2007 |                  | 2,046,958 |                             
| |                           |                  |           |                             

Of
the 790,000 stock options granted during the year ended December 31, 2007, Mr. Reed was
granted 400,000 and Mr. Coyne was granted 100,000.

The
weighted average fair value of the options at date of grant using the Black Scholes
option-pricing model is estimated at $0.29 and $0.73 per option for options granted in
the years ended December 31, 2007 and 2006, respectively.

Stock
options outstanding and exercisable, by price range, as of December 31, 2007 are as
follows:

|  | Exercise Price | Options Outstanding | WeightedAverageRemainingContractualLife inYears |   | WeightedAverageExercisePrice | OptionsExercisable
|- | -------------- | ------------------- | ----------------------------------------------- | - | ---------------------------- | ------------------
|  |               
|$ | 0.26           | 25,487              | 0.1                                             | $ | 0.26                         | 25,487            
|$ | 0.59           | 500,000             | 9.8                                             | $ | 0.59                         | -                 
|$ | 0.67           | 25,000              | 9.8                                             | $ | 0.67                         | -                 
|$ | 1.12           | 65,000              | 9.6                                             | $ | 1.12                         | -                 
|$ | 1.16           | 406,471             | 5.1                                             | $ | 1.16                         | 361,347           
|$ | 1.18           | 200,000             | 9.3                                             | $ | 1.18                         | -                 
|$ | 1.52           | 250,000             | 8.9                                             | $ | 1.52                         | 62,500            
|$ | 2.14           | 25,000              | 8.7                                             | $ | 2.14                         | 6,250             
|$ | 3.94           | 200,000             | 8.0                                             | $ | 3.94                         | 100,000           
|$ | 6.76           | 350,000             | 7.5                                             | $ | 6.76                         | 175,000           
|  |               
|  |                | 2,046,958           | 8.0                                             | $ | 2.29                         | 730,584           
|  |                |                    

The
aggregate intrinsic values of the outstanding and exercisable options at December 31, 2007
and were $226,524 and $18,524, respectively.

The
total fair value of shares vested during the year ended December 31, 2007 was $725,539.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Warrants                Warrant
activity for the years ended December 31, 2007 and 2006 is as follows:

|                          | Number
                                       of Warrants |           | Weighted
                                                           Average
                                                         Exercise Price |     
|------------------------- | --------------------------------------------------------- | --------- | --------------------------------------------------------------------------------------------------------------------------------------------------- | ----
|                          |                                                           |           |                                                                                                                                                     |     
|Balance January 1, 2006   |                                                           | 1,225,333 | $                                                                                                                                                   | 2.09
|Granted                   |                                                           | 3,597,905 | $                                                                                                                                                   | 6.46
|Exercised                 |                                                           | (92,687)  | $                                                                                                                                                   | 1.89
|Cancelled                 |                                                           | (9,643)   | $                                                                                                                                                   | 1.71
|                          |                                                           |           |                                                                                                                                                     |     
|Balance December 31, 2006 |                                                           | 4,720,908 | $                                                                                                                                                   | 5.43

|Granted                   |  | 43,292,849 | $ | 0.54 | 
|------------------------- |  | ---------- | - | ---- | 
|                          |  |            |   |     
|Balance December 31, 2007 |  | 48,013,757 | $ | 1.02 | 
|                          |  |            |   |     

On
December 7, 2007, the Company issued warrants to purchase 32,727,273 shares  common stock to
Quercus and 2,618,181 warrants to purchase common stock to the placement agent in
connection with the issuance of the 10% Notes. On December 7, 2007, the Company issued
warrants to purchase 5,400,000 shares of common stock and reduced the exercise price of the 578,947
outstanding 8.5% Note Warrants from $3.80 per share to $0.55 per share in connection with
the extinguishment of the 8.5% Notes (See Note 7).

On
October 25, 2007, pursuant to the KIT Stock Purchase Agreement, the Company issued to KIT
a warrant for the purchase of up to 2,500,000 shares of Common Stock, subject to certain
limitations contained in the KIT Stock Purchase Agreement, at an exercise price of $0.30
per share, exercisable within three years of any issuance of shares of the Companys
common stock or securities exercisable, convertible or exchangeable into the
Companys common stock, to future third-party investors, that occurs on or before
October 25, 2009. In no event shall the total amount of common stock issuable under the
warrant exceed the lesser of (i) that number of shares, which when added to (x) 2.815
million plus (y) any additional shares of common stock issued to KIT pursuant to the KIT
Stock Purchase Agreement, exceed 9.98% of the total outstanding common stock of EEI at the
time of exercise or (ii) 2.5 million shares.

The
Company has a Stock Purchase Agreement with In-Q-Tel (See Note 10). During the years
ended December 31, 2007 and 2006, the Company issued 47,395 and 18,958 warrants,
respectively, in connection with this agreement.

On
May 10, 2007, the Board of Directors of the Company extended the expiration date of
712,450 warrants with an exercise price of $2.50 from July 16, 2007 to July 16, 2008. The
warrants were issued in connection with the Series A Convertible Preferred Stock offering
during the year ended December 31, 2004 and recorded as a cost of the offering.

During
the year ended December 31, 2006, the Company issued warrants to purchase 1,000,000 shares
of common stock in connection with its lease agreements (See Note 4), contingent warrants
to purchase 2,000,000 shares of common stock in connection with its asset purchase (See
Note 4), and warrants to purchase 578,947 shares of common stock in connection with its
issuance of the 8.5% Senior Secured Convertible Notes (See Note 7).

During
the year ended December 31, 2006, warrants were exercised for proceeds of $175,000 in
exchange for 92,687 shares of common stock.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

As
of December 31, 2007, warrants to purchase 48,013,757 shares of common stock are outstanding with expiration dates ranging
from July 16, 2008 through October 25, 2012 and exercise prices ranging from $0.30 to
$9.06. The weighted average exercise price of the outstanding warrants is $1.02.

NOTE 10  Related
Parties

Consulting Services                On
July 5, 2007 the Company entered into a consulting agreement (the Klein Consulting
Agreement) with Mr. Martin Klein, the Chairman of the Board of Directors of the
Company. The Klein Consulting Agreement provides that Mr. Klein will consult with the
Company on an ongoing basis. Under the terms of the Klein Consulting Agreement, Mr. Klein
will be compensated at the rate of $1,000 per day as well as reasonable out-of-pocket
expenses, and he has agreed not to engage in or conduct any business which competes with
the business conducted by the Company during the term of the Klein Consulting Agreement.
The Klein Consulting Agreement will expire on July 5, 2008, and shall be automatically
renewed for additional successive one year periods unless earlier terminated in accordance
with the agreement.

On
August 1, 2006, the Company entered into a consulting agreement (the Hamlen
Consulting Agreement) with Dr. Robert Hamlen, a member of the Board of Directors of
the Company. The Hamlen Consulting Agreement provides that Dr. Hamlen will consult with
the Company on an ongoing basis. Under the terms of the Hamlen Consulting Agreement, Dr.
Hamlen will be compensated at the rate of $1,500 per month, plus additional compensation
for extra work at a rate of $1,000 per day as well as reasonable out-of-pocket expenses,
and he has agreed not to engage in or conduct any business which competes with the
business conducted by the Company during the term of the Hamlen Consulting Agreement. The
Hamlen Consulting Agreement will continue until terminated by either party with thirty
days advance written notice.

On
August 1, 2006, the Company entered into a consulting agreement (the Wylam
Consulting Agreement) with Mr. William Wylam, who was appointed a member of the
Board of Directors of the Company, effective as of August 14, 2006. The Wylam Consulting
Agreement provides that Mr. Wylam will consult with the Company on an ongoing basis.
Under the terms of the Wylam Consulting Agreement, Mr. Wylam will be compensated at the
rate of $1,500 per month, plus additional compensation for extra work at a rate of $1,000
per day as well as reasonable out-of-pocket expenses, and he has agreed not to engage in
or conduct any business which competes with the business conducted by the Company during
the term of the Wylam Consulting Agreement. The Wylam Consulting Agreement will continue
until terminated by either party with thirty days advance written notice.

Certain
stockholders, parties related to stockholders and directors have provided consulting
services to the Company for various technical and general and administrative services.
Consulting fees incurred amounted to $213,272 and $152,973 for the years ended December
31, 2007 and 2006, respectively. No amounts were payable to these parties as of December
31, 2007.

Stock Purchase Agreement                On October 17, 2005, the Company
entered into a Stock Purchase Agreement with In-Q-Tel, pursuant to which In-Q-Tel has
agreed to purchase 241,692 shares of unregistered common stock of the Company along with
three-year warrants to purchase 75,829 shares of unregistered common stock of the Company
at an exercise price of $3.11 per share. The total purchase price for the stock and
warrants was $800,000 to be paid over the course of 14 months following the closing,
conditioned upon the Company achieving certain development milestones. As of December 31,
2007, the Company completed the program and in the aggregate has received $800,000 and
issued 241,692 shares of unregistered common stock and 75,829 warrants in connection with
this agreement. During the year ended December 31, 2007, the Company received $500,000 and
issued 151,060 shares of unregistered common stock and warrants to purchase 47,395 shares
of common stock in connection with this agreement. During the year ended December 31,
2006, the Company received $200,000 and issued 60,424 shares of unregistered common stock
and warrants to purchase 18,958 of common stock in connection with this agreement.

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Development Agreement                On
March 31, 2005, the Company entered into a development agreement to receive a total of
$450,000 in cash funding from In-Q-Tel, a shareholder of the Companys common stock,
for intended use in the research and development of certain battery technologies. The
contract provides for scheduled payments to the Company if it performs certain research
and development activities over a 24-month period. The Company has entered into a
sub-contract agreement with Rutgers University to perform certain of these activities for
$350,000. In connection with this development agreement, the Company issued warrants
containing certain cashless provisions to purchase up to 15,000 shares of the Companys
common stock upon exercise. The warrants are exercisable at $9.06 per share over a
four-year period expiring in March 2009. The weighted average fair value of the warrants
at the date of issuance using the Black Scholes option-pricing model is estimated at
$5.58 per warrant. The total estimated value of the warrants, amounting to $83,767, was
recorded as cost of services-related parties expense and other accrued liability.
Further, a deferred contract cost and additional paid-in capital was recorded as of the
date of issuance. The number of warrants that are exercisable are directly proportional
to the amount of the scheduled payments that are received by the Company for performance
of the development agreement. As of December 31, 2007, the Company has received the
$450,000 of cash funding and the estimated value of the warrants has been fully
amortized.

NOTE 11  Income
Taxes

The
Company has net operating loss carryforwards (NOLs) of approximately
$23,600,000 as of December 31, 2007 that will be available to offset future taxable
income. The Company has recorded a full valuation allowance against the deferred tax
assets as it has concluded that the utilization of the deferred tax asset is not more
likely than not to be utilized. For the years ended December 31, 2007 and 2006, the valuation allowance has increased by $5,305,700 and
$2,227,000, respectively. The deferred tax asset as of December 31, 2007 consists
of the following:

|Deferred tax asset              |   |            
|------------------------------- | - | -----------
|Net operating loss carryforward | $ | 8,738,300  
|Deferred rent                   |   | 194,400    
|Stock based compensation        |   | 753,200    
|                                |   |            
|Total deferred tax asset        |   | 9,685,900  
|Less valuation allowance        |   | (9,685,900)
|                                |   |            
|Total net deferred tax asset    | $ | -          
|                                |   |            

The
expiration of the companys NOLs is as follows:

|For the Year Ended December 31, |   | Amount    
|------------------------------- | - | ----------
|                                |   |           
|2023                            | $ | 1,422,288 
|2024                            |   | 1,130,731 
|2025                            |   | 2,979,497 
|2026                            |   | 4,222,130 
|2027                            |   | 13,862,180
|                                |   |           
|Total                           | $ | 23,616,826
|                                |   |           

---



ELECTRO ENERGY INC. AND SUBSIDIARIESNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

Under
Internal Revenue Code Section 382, certain significant changes in ownership may restrict
the utilization of these loss carry forwards. More specifically, should the holder of the
10% Notes decide to convert the entire principal balance, the potential for the holder to
have a majority control in the Company would be more likely than not to occur, causing a
significant change in ownership and restriction or loss of the utilization of the NOLs.

The
reconciliation of the statutory U.S. Federal income tax rate to the Companys
effective income tax rate for the years ended December 31, 2007 and 2006 is as follows:

|                                              |  | For the years ended December 31,
|--------------------------------------------- |  | --------------------------------
|                                              |  |                                 
|                                              |  | 2007                            
|                                              |  |                                 
|Tax benefit at statutory rate                 |  | 34.00%                          
|State and local taxes, net of federal benefit |  | 2.89%                           
|Permanent differences                         |  | (5.91)%                         
|Change in valuation allowance                 |  | (30.98)%                        
|                                              |  |                                 
|Effective income tax rate                     |  | 0.00%                           
|                                              |  |                                 

NOTE 12  Defined
Contribution Plan

The
Company has a defined contribution 401(k) Savings Plan covering substantially all
eligible employees. Contributions to the plan are at the discretion of the Board of
Directors. The Company did not make any contributions to the plan during the years ended
December 31, 2007 and 2006. As of December 31, 2007, accounts payable and accrued
expenses included a liability of $62,333 for the Companys matching contribution to
be made in 2008 on account of 2007 employee contributions.

NOTE 13  Subsequent
Events

On
March 5, 2008, the Company issued 455,000 options to purchase common stock to employees
under the 2005 Stock Plan.

On
April 1, 2008, the Company issued 1,150,515 shares of the Companys common stock to
the holder of the 10% Notes, representing the number of shares required to pay the March
31, 2008 interest payment under the 10% Notes.

In compliance with NASDAQ Marketplace
Rules requiring shareholder approval of transactions whereby the potential issuance of
securities of 20% or more of the outstanding common stock at a price lees than the greater
of the book value or market value of the common stock, the Company was obligated to obtain
shareholder approval for the December 7, 2007 financing transactions (See Note 7). On
March 5, 2008, the shareholders of the Company voted to approve the December 7, 2007
financing transactions.

---



# Item 8. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

We
have not had any disagreements, whether or not resolved, with our accountants on
accounting and financial disclosures, nor have we had any other changes in our
accountants during our two most recent fiscal years.

# Item 8A. CONTROLS AND
PROCEDURES

Managements Annual
Report on Internal Control over Financial Reporting

Management
is responsible for establishing and maintaining adequate internal control over financial
reporting, which is defined in Securities Exchange Act Rules 13a-15(f) and 15d-15(f) as a
process designed by, or under the supervision of, a companys principal executive and
principal financial officers, effected by a companys board of directors, management
and other personnel and to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles and includes those policies and
procedures that: (1) pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the assets of the
issuer; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the issuer are being made
only in accordance with authorizations of management and directors of the issuer; and (3)
provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the issuersassets that could have a
material effect on the financial statements.

We
do not expect that our disclosure controls and procedures will prevent all errors or
fraud. A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must take into account resource constraints and
the benefits of controls must be considered relative to their costs. Projections of any
evaluation of the effectiveness of controls to future periods are subject to the risk that
controls may become inadequate because of changes in conditions or that the degree of
compliance with the policies or procedures may deteriorate. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected.

Our
Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness
of our disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e)
of the Securities Exchange Act of 1934) as of the end of the period reported in this
annual report (the Evaluation Date) using the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control  Integrated Framework, concluded that our disclosure controls and
procedures were appropriately designed and operating effectively based on those criteria.

This
annual report does not include an attestation report of our registered public accounting
firm regarding internal control over financial reporting pursuant to temporary rules of
the SEC that permit us to provide only managements report in this annual report.

Changes in Internal
Controls

There
were no significant changes in our disclosure controls and procedures during the fourth
quarter of the year ended December 31, 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.

# Item 8B. OTHER
INFORMATION

Not
applicable.

---



# PART III

# Item 9. DIRECTORS,
 EXECUTIVE OFFICERS,  PROMOTERS AND CONTROL PERSONS AND CORPORATE  GOVERNANCE;
 COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Directors, Executive
Officers, Promoters and Control Persons

The
following table sets forth information regarding the members of our Board of Directors,
executive officers and significant employees. The directors listed below will serve until
the next annual meeting of our stockholders in the years indicated.

|Name                 | Age | Position                                                                 | Term Expires
|-------------------- | --- | ------------------------------------------------------------------------ | ------------
|Bruce L. Lev         | 64  | Chairman of the Board of Directors                                       | 2008        
|Martin G. Klein      | 70  | Founder, Member of the Board of Directors and Chief Technologist         | 2008        
|Michael E. Reed      | 58  | President and Chief Executive Officer, Member of  the Board of Directors | 2009        
|Robert P. Hamlen     | 78  | Member of the Board of Directors                                         | 2009        
|William B. Wylam     | 72  | Member of the Board of Directors                                         | 2009        
|Lawrence G. Schafran | 68  | Member of the Board of Directors                                         | 2008        
|Jeffrey Auerbach     | 37  | Member of the Board of Directors                                         | 2008        
|Timothy E. Coyne     | 53  | Chief Financial Officer                                                  | N/A         

The
principal occupations for the past five years (and, in some instances, for prior years)
of each of our directors, officers and significant employees are as follows:

Bruce
L. Lev has served as a director since June 5, 2007. Mr. Lev is a Managing Director of
Loeb Partners Corp., New York City. Prior thereto he was Vice Chairman and a Director of
USCO Logistics, a world leader in providing integrated logistics services. From 1995
through early 2000 Mr. Lev was Executive Vice President of Corporate and Legal Affairs of
Micro Warehouse Inc., a $2.5 billion direct marketer of brand name personal computers and
accessories to commercial and consumer markets. He also served on the Micro Warehouse
four-person Executive Committee with global responsibility for legal and regulatory
affairs, human resources, corporate communications, risk management and facilities. From
1995 through 2002 he was also a member of the Board of Directors of the Roper Organization
and served on the Board of the Direct Marketing Association. Prior to 1995, Mr. Lev
engaged in the private practice of law. During this time he was instrumental in the
acquisition of USCO Logistics division of Uniroyal by a group of private investors and the
initial formation of Micro Warehouse. He is a 1965 graduate of Wesleyan University and a
1968 graduate of the University of Virginia School of Law. Mr. Lev is a member of the
Connecticut, Virginia and Supreme Court bars and serves on the boards of directors of
AirDat, LLC, Flagler Construction Co, LLC, and Open Labs, LLC.

Martin
G. Kleinhas been the Chairman of our Board of Directors since 1992 and our Chief
Executive Officer from 1992 to 2006. Mr. Klein is the founder of EEI and currently is our
Chief Technologist. He has over 40 years of experience in the advanced battery field. In
1970, prior to forming EEI, Mr. Klein was one of the founding principals of Energy
Research Corporation (now Fuel Cell Energy Inc.) and served as its Executive Vice
President through 1990 and as a director through 1992. Mr. Klein has developed and worked
on several battery chemistries and fuel cell systems. Prior to his association with
Energy Research Corporation, he held positions in the battery field at U.S. Army Signal
Corps, Yardney Electric Corp., Electrochimica Corp., and Electro Optical Systems. Mr.
Klein, considered an expert in the field of electrochemistry, has contributed to many of
the fundamental reference books on the subject and has authored numerous technical
papers. Mr. Klein provided consulting services and served as an assistant professor at
Rutgers University from 1990 to 1992. Mr. Klein holds more than 15 patents in the field
of advanced electrochemical systems and has a bachelors degree in Chemical
Engineering.

---



Michael
E. Reed has served as the President and Chief Executive Officer since May 2006. He
also serves as the President and Chief Operating Officer of EEI Technologies, Inc., a
position he has held since May 2005. Prior thereto he served as the Chief Operating
Officer of EaglePicher Horizon Batteries, LLC since 2003. Additionally, since 2002, Mr.
Reed has been the Principal of Reed Ventures, a consulting company focused on assisting
technology start-up companies with securing capital funds. Prior thereto, from 2000
through 2002, Mr. Reed was the Vice President, Manufacturing and Distribution for Pearle
Vision, an autonomous $700 million business unit of retailer Cole National. Before
joining Pearle Vision, Mr. Reed held several management positions within Johnson
Controls, Inc., Exide Corporation and Delco Remy Division of General Motors Corporation.
Mr. Reed holds a BSChE in Chemical Engineering from Purdue University and an M.B.A. from
Indiana University.

Robert
P. Hamlen has served as a Director since 2005. His extensive commercial and
government career spans many high-profile organizations including General Electric,
EXXON, ALCAN and the U.S. Army Communications-Electronics R&D Center at Fort
Monmouth, N.J., and Ft. Belvoir, Va., where he was the Chief of Army Power Division. Dr.
Hamlen holds over 20 patents, has a B.S. from Lafayette College, a Ph.D. in Physical
Chemistry from Johns Hopkins and completed the Advanced Management Program at the Harvard
Business School.

William
B. Wylamhas served as a director since August 2006. He was Chief Engineer-Batteries,
Director of International Manufacturing, and Director of Technology Development for the
Delco Remy Division of General Motors Corporation. He led the development of many
electric and hybrid-electric powertrain systems including the motor and battery system
for the GM EV1 electric vehicle. Since 1998 he was Corporate Director-Technology for
Delco Remy International until his retirement in 2005. Dr. Wylam has a degree in
Materials Science Engineering and an Honorary Doctor of Engineering from Purdue
University.

Lawrence
G. Schafran has served as director since November 2006. He currently is a Managing
General Partner of Providence Recovery Partners, a New York-based investment fund. Mr.
Schafran is also a director of PubliCARD, Inc. (OTCBB: CARD.OB), Tarragon Corporation
(NASDAQ: TARR) and RemoteMDx, Inc. (OTCBB: RMDX) and has extensive experience in the
financial markets and corporate governance.

Jeffrey
Auerbachhas served as a director since March 2008. He currently is a Senior Vice
President of the Private Client Group of vFinance Investments, Inc. Prior to that, Mr.
Auerbach was the Senior Vice President of Retail Sales at Ehrenkrantz King Nussbaum from
2001 to 2003. From 1998 to 2001, Mr. Auerbach was Vice President of Retail Sales at Dalton
Kent Securities.

Timothy
E. Coynehas served as the Chief Financial Officer since November 2006. Prior thereto
he was the Chief Financial Officer, Vice President and Corporate Controller of Imagistics
International Inc., the Office Systems Division of Pitney Bowes Inc. spun-off in December
2001, where he was responsible for Accounting, Finance, Treasury, Budgeting,
Reporting/Control, Audit, Tax and Investor Relations. Prior to joining Imagistics, he
spent five years as Chief Financial Officer, Vice President and Corporate Controller of
TransPro, Inc., a $250 million NYSE-listed manufacturer of heat transfer components and
systems for automotive and original equipment automotive, truck, specialty vehicle and
industrial applications spun-off from the Allen Group.

Code of Ethics

The
Company has adopted a Code of Ethics that applies to its directors, officers and
employees, including its principal executive officer, principal financial officer and
principal accounting officer. The Company publicizes the Code of Ethics through posting
the policy on its website, http://www.electroenergyinc.com. The Company will disclose on
its website any waivers of, or amendments to, our Code of Ethics.

---



Corporate Governance

We
have a standing Compensation Committee, Corporate Governance and Nominating Committee and
Audit and Finance Committee. Our Compensation Committee is comprised of William Wylam,
Chair, Robert Hamlen and Bruce Lev, each an independent director. Our Corporate
Governance and Nominating Committee is comprised of Robert Hamlen, Chair, Lawrence
Schafran and Jeffrey Auerbach, each an independent director. Currently, we do not have
any procedures by which security holders may recommend nominees to our Board of
Directors. Our Audit and Finance Committee is comprised of Bruce Lev, Chair, Lawrence
Schafran and Robert Hamlen, each an independent director. The Board of Directors has
determined that Messrs. Lev and Schafran qualify as audit committee financial
experts as that term is defined in Item 401(e) of Regulation S-B.

Section 16(a) Beneficial
Ownership Reporting Compliance

Based
upon a review of Forms 3 and 4 and amendments thereto furnished to us during the fiscal
year ended December 31, 2007, Forms 5 and amendments thereto furnished to us with respect
to the fiscal year ended December 31, 2007, and written representations furnished to us,
all required Forms were timely filed.

# Item 10. EXECUTIVE
COMPENSATION

The
following Summary Compensation Table sets forth all compensation earned, in all
capacities, during the fiscal years ended December 31, 2007, and 2006 by the Companys
(i) Principal Executive Officer, and (ii) the next two highest paid executive officers.

SUMMARY COMPENSATION TABLE

|Name and Principal Position         | Year |   | Salary  |   | Bonus   |   | Stock Awards |   | Option Awards (1) |   | Non-Equity Incentive Plan Compensation |   | Nonqualified Deferred Compensation Earnings |   | All Other Compensation |   | Total  
|----------------------------------- | ---- | - | ------- | - | ------- | - | ------------ | - | ----------------- | - | -------------------------------------- | - | ------------------------------------------- | - | ---------------------- | - | -------
|                                   
|Michael E. Reed (2)                 | 2007 | $ | 214,038 | $ | 130,965 | $ | 60,000       | $ | 336,465           | $ | -                                      | $ | -                                           | $ | 1,568                  | $ | 743,036
|Principal Executive Officer         | 2006 | $ | 190,000 | $ | -       | $ | -            | $ | 329,329           | $ | -                                      | $ | -                                           | $ | -                      | $ | 519,329
|                                    |      |   |         |   |         |   |              |  
|Martin G. Klein (3)                 | 2007 | $ | -       | $ | -       | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | -      
|Chairman                            | 2006 | $ | 75,000  | $ | -       | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | 75,000 
|                                    |      |   |         |   |         |   |              |  
|Timothy E. Coyne (4)                | 2007 | $ | 156,000 | $ | 43,350  | $ | -            | $ | 26,909            | $ | -                                      | $ | -                                           | $ | -                      | $ | 26,259 
|Chief Financial Officer &
Secretary | 2006 | $ | 17,308  | $ | -       | $ | -            | $ | 1,826             | $ | -                                      | $ | -                                           | $ | -                      | $ | 19,134 
|                                    |      |   |         |   |         |   |              |  
|Audra J. Mace (5)                   | 2007 | $ | -       | $ | -       | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | -      
|Chief Financial Officer &
Secretary | 2006 | $ | 85,153  | $ | -       | $ | -            | $ | 145,186           | $ | -                                      | $ | -                                           | $ | 4,673                  | $ | 235,012

|(1) | Represents
the compensation cost of awards recognized during the year as stock
               compensation expense in accordance with FASB 123R. The cost of pre-2006
awards                that have not yet been fully recognized are reported using the
modified                prospective transition method under FAS 123R.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Mr.
Reed was appointed President & Chief Executive Officer effective May 30,
               2006. He received an automobile allowance of $1,568 in 2007.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Mr.
Klein was replaced as President and Chief Executive Officer by Mr. Reed
               effective May 30, 2006.
|--- | ------------------------------------------------------------------------------------------------------------------

|(4) | Mr.
Coyne was appointed Chief Financial Officer                effective November 20, 2006.
|--- | -------------------------------------------------------------------------------------------

|(5) | Ms.
Mace resigned as Chief Financial Officer                effective August 8, 2006. She was
paid accrued vacation of $4,673 in 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------

---



Outstanding Equity Awards
at Fiscal Year End

|                 | Option Awards                                                                      | Stock Awards
|---------------- | ---------------------------------------------------------------------------------- | ------------
|                 |                                                                                    |             
|Name             | Number of
    Securities
    Underlying
   Unexercised
     Options
   Exercisable |             
|                
|Michael E. Reed  | 100,000                                                                            |             
|                 | 50,000                                                                             |             
|                 | -                                                                                  |             
|                 |                                                                                    |             
|Timothy E. Coyne | 37,500                                                                             |             
|                 | -                                                                                  |             

Director Compensation

|Name                             |   | Fees Earned
     or Paid
     in Cash |   | Stock
   Awards |   | Option
   Awards |   | Non-Equity
     Incentive
        Plan
    Compensation |   | Non-qualified
     Deferred
    Compensation
     Earnings |   | All Other
    Compensation |   | Total  |  | Aggregate
    Number of
      Stock
     Awards
   Outstanding
    at Fiscal
    Year End |  | Aggregate
    Number of
     Option
     Awards
   Outstanding
    at Fiscal
    Year End
|-------------------------------- | - | ------------------------------------- | - | --------------- | - | ---------------- | - | ------------------------------------------------------- | - | ---------------------------------------------------------- | - | -------------------------- | - | ------ |  | ----------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------
|                                
|Martin G. Klein                  | $ | 5,500                                 | $ | -               | $ | -                | $ | -                                                       | $ | -                                                          | $ | 48,000                     | $ | 53,500 |  | -                                                                                         |  | -                                                                                        
|Bruce L. Lev                     | $ | 5,000                                 | $ | -               | $ | 2,133            | $ | -                                                       | $ | -                                                          | $ | -                          | $ | 7,133  |  | -                                                                                         |  | 50,000                                                                                   
|Robert P. Hamlen                 | $ | 7,500                                 | $ | -               | $ | 21,151           | $ | -                                                       | $ | -                                                          | $ | 23,000                     | $ | 51,651 |  | -                                                                                         |  | 50,000                                                                                   
|William B. Wylam                 | $ | 7,000                                 | $ | -               | $ | 8,365            | $ | -                                                       | $ | -                                                          | $ | 46,900                     | $ | 62,265 |  | -                                                                                         |  | 50,000                                                                                   
|Lawrence G. Schafran             | $ | 8,000                                 | $ | -               | $ | 8,375            | $ | -                                                       | $ | -                                                          | $ | -                          | $ | 16,375 |  | -                                                                                         |  | 50,000                                                                                   
|Jeffrey Auerbach                 | $ | -                                     | $ | -               | $ | -                | $ | -                                                       | $ | -                                                          | $ | -                          | $ | -      |  | -                                                                                         |  | -                                                                                        
|Warren D. Bagatelle              | $ | 4,500                                 | $ | -               | $ | 83,891           | $ | -                                                       | $ | -                                                          | $ | -                          | $ | 88,391 |  | -                                                                                         |  | 75,000                                                                                   
|Joseph            F. Engelberger | $ | 4,000                                 | $ | -               | $ | -                | $ | -                                                       | $ | -                                                          | $ | -                          | $ | 4,000  |  | -                                                                                         |  | -                                                                                        
|Farhad Assari                    | $ | 1,500                                 | $ | -               | $ | 41,495           | $ | -                                                       | $ | -                                                          | $ | -                          | $ | 43,445 |  | -                                                                                         |  | 37,500                                                                                   

Outside
directors are paid a fixed sum for attendance at each meeting of the directors and are
reimbursed for their expenses for attending each meeting of the directors. No payment
precludes any director from serving our company in any other capacity and being
compensated for the service. Members of special or standing committees may be allowed like
compensation and expense reimbursement for attending committee meetings. The Company
records an expense and assumes a liability on the date meetings are held.

# Item 11. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Security Ownership of
Certain Beneficial Owners and Management

The
following table sets forth information regarding the number of shares of our common stock
beneficially owned on January 25, 2008, by:

 each
person who is known by us to beneficially own 5% or more of our common stock,                  each
of our directors and executive officers, and  
 all of our directors and executive
officers, as a group.

Unless
otherwise indicated, the address of each of the persons listed below is Electro Energy
Inc., 30 Shelter Rock Road, Danbury, Connecticut 06810.

---



|Name and Address ofBeneficial Owner                                              |  |  | Number of Shares BeneficiallyOwned (1) |      | Percentage of Shares BeneficiallyOwned (2)
|-------------------------------------------------------------------------------- |  |  | -------------------------------------- | ---- | ------------------------------------------
|                                                                                 |  |  |                                        |      |                                           
|5% or Greater Stockholders                                                       |  |  |                                        |      |                                           
|                                                                                 |  |  |                                        |      |                                           
|Lithium Nickel Asset Holding Company I7 South Jersey Ave.East Setauket, NY 11733 |  |  | 8,750,000                              | (3)  |                                           
|                                                                                 |  |  |                                        |      |                                           
|KIT Financial, Inc.610 Anacapa Street, Suite D-11Santa Barbara, CA 93101         |  |  | 2,715,000                              | (5)  |                                           
|                                                                                 |  |  |                                        |      |                                           
|Context Capital Management4365 Executive Drive, Suite 850San Diego, CA 92121     |  |  | 4,192,363                              | (7)  |                                           
|                                                                                 |  |  |                                        |      |                                           
|Executive Officers and Directors                                                 |  |  |                                        |      |                                           
|                                                                                 |  |  |                                        |      |                                           
|Martin G. Klein                                                                  |  |  | 6,379,782                              | (9)  |                                           
|Bruce L. Lev                                                                     |  |  | 1,089,278                              | (10) |                                           
|Robert Hamlen                                                                    |  |  | 18,750                                 | (12) |                                           
|William Wylam                                                                    |  |  | 12,500                                 | (14) |                                           
|Lawrence Schafran                                                                |  |  | 12,500                                 | (16) |                                           
|Michael E. Reed                                                                  |  |  | 341,495                                | (18) |                                           
|Timothy E. Coyne                                                                 |  |  | 37,500                                 | (20) |                                           
|Directors and executive officers as a group(seven persons)                       |  |  | 7,891,805                              |      |                                           

|(1) | Unless
otherwise indicated, includes shares owned by a spouse, minor children,
                    by relatives sharing the same home and entities owned or controlled
by the named                     person. Also includes shares if the named person has the
right to acquire such                     shares within 60 days after January 25, 2008,
by the exercise of any warrant,                     stock option or other right. Unless
otherwise noted, shares are owned of record                     and beneficially by the
named person. Does not include (i) 493,707 shares of                     common stock
issued to, (ii) 85,950 shares of common stock issuable upon the
                    exercise of warrants held by and (iii) 31,250 shares of common stock
issuable                     upon the exercise of options formerly held by Mr. Bagatelle.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Unless
otherwise indicated, based upon 28,811,797 shares of common stock
                    outstanding on January 25, 2008; does not include 64,000 shares of
common stock                     issuable upon conversion of series A convertible
preferred stock.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes
(i) 5,750,000 shares of common stock outstanding and (ii) 3,000,000
                    shares of common stock issuable upon the exercise of warrants held by
Lithium                     Nickel Asset Holding Company I.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Based
upon (i) 28,811,797 shares of common stock outstanding, plus (ii)
                    3,000,000 shares of common stock issuable upon the exercise of
warrants.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes
(i) 2,500,000 shares of common stock outstanding and (ii) 215,000
                    shares of common stock outstanding held by an affiliate of KIT
Financial, Inc.                     Does not include 2,500,000 shares of common stock
issuable upon the exercise of                     the warrant held by KIT Financial, Inc.
(the KIT Warrant), which has                     an exercise price of $0.30
per share and is exercisable within three years of                     any issuance of
shares of common stock or securities exercisable, convertible or
                    exchangeable into common stock, to future third-party investors, that
occurs on                     or before October 25, 2009. In no event shall the total
amount of common stock                     issuable under the KIT Warrant exceed the
lesser of (i) that number of shares,                     which when added to (x) 2.815
million plus (y) any additional shares of common                     stock issued to KIT
Financial, Inc. pursuant to the Stock and Warrant Purchase                     Agreement
entered into between KIT Financial, Inc. and the Company, exceed 9.98%
                    of the total outstanding common stock of EEI at the time of exercise
or (ii) 2.5                     million shares.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Based
upon (i) 28,811,797 shares of common stock outstanding, plus (ii)
                    2,500,000 shares of common stock issuable upon the exercise of
warrants.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Includes
1,747,987 shares of common stock outstanding, 814,054 shares of common
                    stock issuable upon conversion of series B convertible preferred
stock and                     1,630,322 shares of common stock issuable upon the exercise
of warrants held by                     Context Capital Management.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Based upon
(i) 28,811,797 shares of common stock outstanding, plus (ii) 814,054 shares of common
stock issuable upon conversion of series B convertible preferred stock and (iii)
1,630,322 shares of common stock issuable upon the exercise of warrants.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) | Includes
(i) 4,874,912 shares of common stock outstanding held by Mr. Klein,
                    (ii) 250,000 shares of common stock outstanding held by Susan Klein,
(iii)                     627,435 shares of common stock outstanding held by Michael
Klein and (iv)                     627,435 shares of common stock outstanding held by
Alison Klein & Stephen                     Okinow. Mr. Klein expressly disclaims
beneficial ownership of the common stock                     owned or acquirable by the
other investors.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



|(10) | Includes
(i) 428,689 shares of common stock outstanding, 20,000 shares of common
                    stock issuable upon conversion of series A convertible preferred
stock and                     95,950 shares of common stock issuable upon the exercise of
warrants held by the                     Trust FBO Thomas L. Kempner and (ii) 428,689
shares of common stock outstanding,                     20,000 shares of common stock
issuable upon conversion of series A convertible                     preferred stock and
95,950 shares of common stock issuable upon the exercise of                     warrants
held by the Trust FBO of Alan H. Kempner.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) | Based
upon (i) 28,811,797 shares of common stock outstanding, plus (ii) 40,000
                    shares of common stock issuable upon conversion of series A
convertible                     preferred stock and 191,900 shares of common stock
issuable upon the exercise of                     warrants.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) | Includes
18,750 shares of common stock issuable upon the exercise of options
                    held by Mr. Hamlen.
|---- | --------------------------------------------------------------------------------------------------------------------

|(13) | Based
upon (i) 28,811,797 shares of common stock                     outstanding, plus (ii)
18,750 shares of common stock issuable upon the exercise of options.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) | Includes
12,500 shares of common stock issuable upon the exercise of options           held by Mr.
Wylam.
|---- | ---------------------------------------------------------------------------------------------------------

|(15) | Based
upon (i) 28,811,797 shares of common stock           outstanding, plus (ii) 12,500 shares
of common stock issuable upon the exercise of options.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(16) | Includes
12,500 shares of common stock issuable upon the exercise of options           held by Mr.
Schafran.
|---- | ------------------------------------------------------------------------------------------------------------

|(17) | Based
upon (i) 28,811,797 shares of common stock           outstanding, plus (ii) 12,500 shares
of common stock issuable upon the exercise of options.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(18) | Includes
191,495 shares of common stock outstanding and 150,000 shares of common
                    stock issuable upon the exercise of options held by Mr. Reed.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(19) | Based
upon (i) 28,811,797 shares of common stock outstanding, plus (ii) 150,000
                    shares of common stock issuable upon the exercise of options.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(20) | Includes
37,500 shares of common stock issuable upon the exercise of options
                    held by Mr. Coyne.
|---- | -------------------------------------------------------------------------------------------------------------------

|(21) | Based
upon (i) 28,811,797 shares of common stock                     outstanding, plus (ii)
37,500 shares of common stock issuable upon the exercise of options.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(22) | Based
upon (i) 28,811,797 shares of common stock outstanding, plus (ii) 40,000
                    shares of common stock issuable upon conversion of series A
convertible                     preferred stock, plus (iii) 191,900 shares of common
stock issuable upon the                     exercise of warrants, plus (iv) 231,250
shares of common stock issuable upon                     exercise of options.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

No other person or group has reported
that it is the beneficial owner of more than 5% of the outstanding Common Stock of the
Company.

# Item 12. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

Related Party Transactions

The
Company has agreements with certain related parties who provide consulting services to
the Company. Related party services of an administrative nature were included in S,G&A
in the amount of $213,272 for the year ended December 31, 2007 compared with $152,973 in
2006. The owner of E.F.S. Management Systems and Maryann Phillips, shareholders of the
Companys common stock, provide accounting services to the Company. The Company has
agreements with Martin Klein, a shareholder of the Companys common stock and member
of the Companys Board of Directors, and Robert Hamlen and William Wylam, members of
the Companys Board of Directors, to provide consulting services.

On
March 31, 2005, the Company entered into a development agreement to receive a total of
$450,000 in cash funding from In-Q-Tel, a shareholder of the Companys common stock,
for intended use in the research and development of certain battery technologies. The
contract provides for scheduled payments to the Company if it performs certain research
and development activities over a 24-month period. The Company has entered into a
sub-contract agreement with Rutgers University to perform certain of these activities for
$350,000. In connection with this development agreement, the Company issued warrants
containing certain cashless provisions to purchase up to 15,000 shares of the Companys
common stock. The warrants are exercisable at $9.06 per share over a four-year period
expiring in March 2009. The weighted average fair value of the warrants at the date of
issuance using the Black Scholes option-pricing model was estimated at $5.58 per warrant
and the total estimated value of the warrants, amounting to $83,767, was recorded as cost
of services-related parties expense and other accrued liability. Further, a deferred
contract cost and additional paid-in capital was recorded as of the date of issuance. The
number of warrants that are exercisable are directly proportional to the amount of the
scheduled payments that are received by the Company for performance of the development
agreement. As of December 31, 2007, the Company has received the $450,000 of cash funding
and the estimated value of the warrants has been fully amortized.

---



On
October 17, 2005, the Company entered into a Stock Purchase Agreement with In-Q-Tel,
pursuant to which In-Q-Tel has agreed to purchase 241,692 shares of unregistered common
stock of the Company along with three-year warrants to purchase 75,829 shares of
unregistered common stock of the Company at an exercise price of $3.11 per share. The
total purchase price for the stock and warrants was $800,000 to be paid over the course of
14 months following the closing, conditioned upon the Company achieving certain
development milestones. As of December 31, 2007, the Company completed the program and has
received $800,000 and issued 241,692 shares of unregistered common stock and 75,829
warrants in connection with this agreement. During the year ended December 31, 2007, the
Company received $500,000 and issued 151,060 shares of unregistered common stock and
47,395 warrants in connection with this agreement. During the year ended December 31,
2006, the Company received $200,000 and issued 60,424 shares of unregistered common stock
and 18,958 warrants in connection with this agreement.

On
July 5, 2007 the Company entered into a consulting agreement (the Klein Consulting
Agreement) with Mr. Martin Klein, a stockholder and member of the Board of Directors
of the Company. The Klein Consulting Agreement provides that Mr. Klein will consult with
the Company on an ongoing basis. Under the terms of the Klein Consulting Agreement, Mr.
Klein will be compensated at the rate of $1,000 per day as well as reasonable
out-of-pocket expenses, and he has agreed not to engage in or conduct any business which
competes with the business conducted by the Company during the term of the Klein
Consulting Agreement. The Klein Consulting Agreement will expire on July 5, 2008, and
shall be automatically renewed for additional successive one year periods unless earlier
terminated in accordance with the Klein Consulting Agreement.

On
August 1, 2006, the Company entered into a consulting agreement (the Hamlen
Consulting Agreement) with Dr. Robert Hamlen, a member of the Board of Directors of
the Company. The Hamlen Consulting Agreement provides that Dr. Hamlen will consult with
the Company on an ongoing basis. Under the terms of the Hamlen Consulting Agreement, Dr.
Hamlen will be compensated at the rate of $1,500 per month, plus additional compensation
for extra work at a rate of $1,000 per day as well as reasonable out-of-pocket expenses,
and he has agreed not to engage in or conduct any business which competes with the
business conducted by the Company during the term of the Hamlen Consulting Agreement. The
Hamlen Consulting Agreement will continue until terminated by either party with thirty
days advance written notice.

On
August 1, 2006, the Company entered into a consulting agreement (the Wylam
Consulting Agreement) with Mr. William Wylam, who was appointed a member of the
Board of Directors of the Company, effective as of August 14, 2006. The Wylam Consulting
Agreement provides that Mr. Wylam will consult with the Company on an ongoing basis.
Under the terms of the Wylam Consulting Agreement, Mr. Wylam will be compensated at the
rate of $1,500 per month, plus additional compensation for extra work at a rate of $1,000
per day as well as reasonable out-of-pocket expenses, and he has agreed not to engage in
or conduct any business which competes with the business conducted by the Company during
the term of the Wylam Consulting Agreement. The Wylam Consulting Agreement will continue
until terminated by either party with thirty days advance written notice.

Promoters and Control
Persons

Matrix
USA, LLC (Matrix), a co-finder in the private placement of the 10% Senior
Secured Convertible Debenture consummated on December 7, 2007, received cash in the
amount of $248,400 and 33,636 warrants to purchase shares of common stock in connection
with such private placement. Shari Popkin Fleischer, the Chairperson of Matrix and a
shareholder of the Company, received 280,000 warrants in connection with such private
placement.

vFinance
Investments, Inc., a co-finder in the private placement of the 10% Senior Secured
Convertible Debenture consummated on December 7, 2007, received cash in the amount of
$993,600 and 348,217 warrants to purchase shares of common stock in connection with such
private placement. Jeffrey Auerbach, Senior Vice President of the Private Client Group of
vFinance Investments, Inc., a director of the Company, received 634,978 warrants in
connection with such private placement.

Director Independence

Currently,
Robert Hamlen, Bruce Lev, Lawrence Schafran and William Wylam would be considered independent as
that term is used in Item 7(d)(3)(iv) of schedule 14A under the Securities Exchange Act
of 1934.

---



# Item 13. EXHIBITS

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

|2.1 |  | Agreement
of Merger and Plan of  Reorganization  among MCG  Diversified,  Inc., EEI  Acquisition
          Corp. and Electro Energy, Inc., dated May 7, 2004.(1)
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|2.2 |  | Asset
 Purchase  Agreement,  dated  as of  March  31,  2006,  among  Electro  Energy  Inc.,
 EEI           Acquisition Co., LLC and Lithium Nickel Asset Holding Company I, Inc. (2)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.1 |  | Articles
of Incorporation of MCG Diversified, Inc.(3)
|--- |  | -----------------------------------------------------

|3.2 |  | Amended
and Restated Articles of Incorporation of MCG Diversified, Inc.(3)
|--- |  | --------------------------------------------------------------------------

|3.3 |  | Bylaws
of MCG Diversified, Inc.(1)
|--- |  | ----------------------------------

|3.4 |  | Articles
of Amendment to the Amended and Restated  Articles of Incorporation of MCG Diversified,
          Inc.(4)
|--- |  | ------------------------------------------------------------------------------------------------------------------

|3.5 |  | Articles
of Amendment  Designating  Series A  Convertible  Preferred  Stock of MCG  Diversified,
          Inc.(1)
|--- |  | ------------------------------------------------------------------------------------------------------------------

|3.6 |  | Articles
of Amendment to the Amended and Restated  Articles of Incorporation of MCG Diversified,
          Inc. changing the name of the company to Electro Energy, Inc.(1)
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.7 |  | Articles
of Amendment Designating Series B Convertible Preferred Stock (7)
|--- |  | --------------------------------------------------------------------------

|4.1 |  | Note
and Warrant  Purchase  Agreement,  dated as of March 31, 2006,  between Electro Energy
Inc.           and each of the purchasers whose name appears on the signature pages
thereto. (2)
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2 |  | Form
of 8.5%  Senior  Secured  Convertible  Note  due  2010 by  Electro  Energy  Inc.  for
 each           purchaser. (2)
|--- |  | -------------------------------------------------------------------------------------------------------------------------

|4.3 |  | Form
of Warrant to Purchase Common Stock by Electro Energy Inc. for each purchaser. (2)
|--- |  | ---------------------------------------------------------------------------------------

|4.4 |  | Registration
 Rights Agreement,  dated as of March 31, 2006, between Electro Energy Inc. and the
persons and entities listed on Exhibit A attached thereto. (2)
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Security
 Agreement,  dated as of March 31, 2006, among Electro Energy Inc. and its Subsidiaries
          in favor of Context Capital Management,  LLC, as collateral agent for the
ratable benefit of the           investors under the Note and Warrant Purchase Agreement.
(2)
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.6 |  | Guaranty
 Agreement,  dated as of March 31, 2006,  among the Subsidiaries of Electro Energy Inc.
          in favor of Context Capital Management,  LLC, as collateral agent for the
ratable benefit of the           investors under the Note and Warrant Purchase Agreement.
(2)
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Escrow
Deposit  Agreement,  dated as of March 30, 2006,  among Electro Energy Inc.,  each of the
          purchasers of the notes listed on Schedule I attached  thereto,  and  Signature
 Bank, as escrow           agent. (2)
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.1 |  | Lease,
 dated as of April 5, 2006,  between Lithium Nickel Asset Holding Company I, Inc. and EEI
          Acquisition Co., LLC for the lithium-ion building and improvements. (2)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 |  | Lease,
 dated as of April 5, 2006,  between Lithium Nickel Asset Holding Company I, Inc. and EEI
          Acquisition Co., LLC for the sintering building and improvements.  (2)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.3 |  | Lease,
 dated as of April 5, 2006,  between Lithium Nickel Asset Holding Company I, Inc. and EEI
          Acquisition Co., LLC for the bulk chemical,  water treatment and storage
 facility  building and           improvements. (2)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.4 |  | Employment
Agreement, dated September 14, 2007, between the Company and Timothy E. Coyne.(5)
|---- |  | --------------------------------------------------------------------------------------------

|10.5 |  | Employment
Agreement, dated September 14, 2007, between the Company and Michael E. Reed.(5)
|---- |  | -------------------------------------------------------------------------------------------

|10.6 |  | Common
Stock and Warrant Purchase Agreement dated October 25, 2007 by and among the Registrant
and KIT Financial, Inc. (6)
|---- |  | --------------------------------------------------------------------------------------------------------------------------

|10.7 |  | Note
Sale and Preferred Stock and Warrant Purchase Agreement (7)
|---- |  | ----------------------------------------------------------------

|10.8 |  | Debenture
and Warrant Purchase Agreement (7)
|---- |  | --------------------------------------------

|21.1 |  | Subsidiaries
of the Company.(8)
|---- |  | -------------------------------

|31.1 |  | Section
302 Certification of Chief Executive Officer.(8)
|---- |  | --------------------------------------------------------

|31.2 |  | Section
302 Certification of Chief Financial Officer.(8)
|---- |  | --------------------------------------------------------

|32.1 |  | Section
906 Certification of Chief Executive Officer.(8)
|---- |  | --------------------------------------------------------

|32.2 |  | Section
906 Certification of Chief Financial Officer.(8)
|---- |  | --------------------------------------------------------

---



|(1) | Incorporated
by reference to the Companys Current Report on Form 8-K filed                with
the Securities and Exchange Commission on June 24, 2004.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated
by reference to the Companys Current Report on Form 8-K filed                with
the Securities and Exchange Commission on April 6, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated
by reference to the Companys Registration Statement on Form                SB-2
filed with the Securities and Exchange Commission on June 17, 2002.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated
by reference to the Companys Quarterly Report on Form 10-QSB                for the
quarterly period ended September 30, 2004.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated
by reference to the Companys Current Report on Form 8-K filed                with
the Securities and Exchange Commission on September 17, 2007.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated
by reference to the Companys Current Report on Form 8-K filed                with
the Securities and Exchange Commission on October 31, 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated
by reference to the Companys Current Report on Form 8-K filed                with
the Securities and Exchange Commission on December 13, 2007.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Filed
herewith.
|--- | ---------------

# Item 14. PRINCIPAL
ACCOUNTANT FEES AND SERVICES

# Audit and Non Audit Fees

The
following table presents fees for professional audit services rendered by Marcum &Kliegman,
LLP (M&K) for the audit of Electro Energys annual financial
statements for the years ended December 31, 2007 and 2006, and fees billed for other
services rendered by Marcum & Kliegman, LLP.

| |                        |   | 2007    |  |   | 2006    | 
| | ---------------------- | - | ------- |  | - | ------- | 
| | Audit Fees (1)         | $ | 235,095 |  | $ | 150,316 | 
| | Audit-Related Fees (2) | $ | -0-     |  | $ | 96,496  | 
| | Tax Services (3)       | $ | -0-     |  | $ | -0-     | 
| | All Other Fees         | $ | -0-     |  | $ | -0-     | 

|(1) | Audit
fees consist of fees for professional services rendered for the audit of
                    Electro Energy Inc.s consolidated financial statements and
review of                     consolidated financial statements included in Electro
Energy Inc.s                     quarterly reports.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Audit-related
fees are fees principally for professional services rendered in
                    connection with accounting consultations related to corporate
acquisitions,                     consultations concerning the initial adoption or
consideration of new financial                     accounting and reporting standards and
consultations regarding SEC reporting and                     disclosure matters
pertaining to the Companys annual form 10-KSB filing.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Tax
service fees consist of compliance fees for the preparation of original tax
                    returns as well as tax consulting and planning related fees.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

Each
of the permitted non-audit services has been pre-approved by the Audit Committee or the
Audit Committees Chairman pursuant to delegated authority by the Audit Committee,
other than de minimus non-audit services for which the pre-approval requirements are
waived in accordance with the rules and regulations of the SEC.

# Audit Committee
Pre-Approval Policies and Procedures

The
Audit Committee charter provides that the Audit Committee will pre-approve the fees and
other significant compensation to be paid to the independent auditors.

# SIGNATURES

In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.

| |       |                | ELECTRO ENERGY INC.
| | ----- | -------------- | -------------------
| |       |                |                    
| |       |                | By:                
| |       |                |                    
| | Date: | April 15, 2008 |                    

---



In
accordance with the Exchange Act, this report has been signed below by the following
persons on behalf of the registrant and in the capacities and on the dates indicated.

| |       |                |  | /s/ Bruce L. Lev  
| | ----- | -------------- |  | ------------------
| |       |                |  | Name: Bruce L. Lev
| | Date: | April 15, 2008 |  | Title: Chairman   

| |       |                |  | /s/ Michael E. Reed                         
| | ----- | -------------- |  | --------------------------------------------
| |       |                |  | Name: Michael E. Reed                       
| | Date: | April 15, 2008 |  | Title: President and Chief Executive Officer

| |       |                |  | /s/ Timothy E. Coyne          
| | ----- | -------------- |  | ------------------------------
| |       |                |  | Name: Timothy E. Coyne        
| | Date: | April 15, 2008 |  | Title: Chief Financial Officer

| |       |                |  | /s/ Martin G. Klein  
| | ----- | -------------- |  | ---------------------
| |       |                |  | Name: Martin G. Klein
| | Date: | April 15, 2008 |  | Title: Director      

| |       |                |  | /s/ Robert P. Hamlen  
| | ----- | -------------- |  | ----------------------
| |       |                |  | Name: Robert P. Hamlen
| | Date: | April 15, 2008 |  | Title: Director       

| |       |                |  | /s/ William B. Wylam  
| | ----- | -------------- |  | ----------------------
| |       |                |  | Name: William B. Wylam
| | Date: | April 15, 2008 |  | Title: Director       

| |       |                |  | /s/ Lawrence G. Schafran  
| | ----- | -------------- |  | --------------------------
| |       |                |  | Name: Lawrence G. Schafran
| | Date: | April 15, 2008 |  | Title: Director           

| |       |                |  | /s/ William Wylam  
| | ----- | -------------- |  | -------------------
| |       |                |  | Name: William Wylam
| | Date: | April 15, 2008 |  | Title: Director    

| |       |                |  | /s/ Lawrence Schafran  
| | ----- | -------------- |  | -----------------------
| |       |                |  | Name: Lawrence Schafran
| | Date: | April 15, 2008 |  | Title: Director        

| |       |                |  | /s/ Jeffrey Auerbach  
| | ----- | -------------- |  | ----------------------
| |       |                |  | Name: Jeffrey Auerbach
| | Date: | April 15, 2008 |  | Title: Director       

---