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, 2006 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: $4,666,737.

The aggregate  market value of the voting  common equity held by  non-affiliates
was $18,327,512  based upon the closing sales price of Common Stock on March 27,
2007 of $1.18 per share.

As of March 27, 2007, 23,348,896 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                                                                                                              | F-1       
|Item 8     |  | Changes In and Disagreements With
        Accountants on Accounting and Financial Disclosure                                      | 20        
|Item 8A    |  | Controls
        and Procedures                                                                                                   | 20        
|Item 8B    |  | Other Information                                                                                                                 | 20        
|           |  |                                                                                                                                   |           
|Part III   |  |                                                                                                                                   |           
|Item 9     |  | Directors, Executive Officers, Promoters and Control Persons; Compliance with Section
                  16(a) of the Exchange Act | 21        
|Item 10    |  | Executive Compensation                                                                                                            | 24        
|Item 11    |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
                  Matters                  | 27        
|Item 12    |  | Certain Relationships and Related Transactions                                                                                    | 29        
|Item 13    |  | Exhibits                                                                                                                          | 30        
|Item 14    |  | Principal Accountant Fees and Services                                                                                            | 31        
|           |  |                                                                                                                                   |           
|Signatures |  |                                                                                                                                   | 32        

---



# 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: (i)
the Companys plans, strategies, objectives, expectations and intentions are subject
to change at any time at the discretion of the Company; (ii) the Companys plans and
results of operations will be affected by the Companys ability to manage its growth;
and (iii) 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. (Old EEI) was incorporated in Delaware in 1992. 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 exchange for a note payable
amounting to $450,000 plus the assumption of $138,482 in accounts payable and accrued
liabilities and incurred acquisition costs of $158,903. The fair value of the net assets
acquired was $567,390. The power systems operations had been established by EaglePicher in
1976 to manufacture specialty nickel-cadmium batteries for satellites and aircraft
applications. 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
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. MCG issued 9,497,557 unregistered shares of common stock,
stock options to purchase 2,332,121 shares of common stock and warrants to purchase
526,444 shares of common stock to the former security holders of Old EEI in exchange for
100% of the outstanding capital stock, options and warrants of Old EEI. Pursuant to the
Merger Agreement, Merger Sub merged with and into Old EEI, with Old EEI remaining as the
surviving corporation (the Merger). Although MCG acquired Old EEI as a result
of the Merger, the stockholders of Old EEI hold a majority of the voting interest in the
combined enterprise. Immediately prior to the Merger, Old EEI had 23 stockholders.
Additionally, the Merger resulted in Old EEIs management and Board of Directors
assuming operational control of MCG. 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) and to increase the authorized number of
shares of capital stock to 50,010,000 shares, consisting of 50,000,000 shares of Common
Stock, $.001 par value per share and 10,000 shares of Preferred Stock, $.001 par value per
share. At the conclusion of the Merger, MCGs stockholders owned approximately 22% of
the issued and outstanding shares of EEI common stock, based on 12,197,453 shares
outstanding after the Merger. 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
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), 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 require 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.

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
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 Technologies, LLC (EaglePicher) in Colorado Springs. The operation
was established by EaglePicher in 1976 and has been primarily engaged in the manufacture
of specialty nickel-cadmium (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 in connection with a
five year supply agreement with EaglePicher as well as custom orders from government
agencies.

In
April 2006, EEI acquired 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 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

Under
a five year supply agreement with EaglePicher expiring in 2008, EEI is the sole source
supplier for components for battery power systems used in military and commercial
satellite applications. Pricing under the supply agreement is fixed, subject to possible
adjustment under periodic value engineering reviews and based on material cost
escalations. At its expiration, the agreement is renewable annually upon the mutual
consent of the parties.

EEI
also entered into 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, 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 NiMH battery. The
construction of the bipolar 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 should not become a supply issue. 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 2006. Net sales to
the Companys four major customers, U.S. Air Force, Sandia National Laboratories,
Defense Finance and Accounting System and EaglePicher Technologies, LLC represented
approximately 88.9% in 2006. Accounts receivable from these customers amounted to $846,943
at December 31, 2006. The Company had three customers with sales of 10% or more of total
sales in 2005. Net sales to such customers, U.S. Air Force, Sandia National Laboratories
and EaglePicher Technologies, LLC, represented approximately 64.2% in 2005. Accounts
receivable from these customers amounted to $185,418 at December 31, 2005.

On
April 11, 2005, Eagle Picher, Inc. and its affiliates announced its voluntary Chapter 11
bankruptcy filing. Eagle Picher, Inc.s public releases stated they were in the
process of reorganizing, and certain assets would be liquidated to meet financial
obligations. In 2005, revenue from EaglePicher declined $2.3 million, or 79% compared to
2004. 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. 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 eight issued United States patents, which expire beginning in 2012 and ending in
2022. We also hold four 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 battery.

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

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, 2006 was approximately $2,429,806 compared with backlog of
approximately $3,189,861 as of December 31, 2005. 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, 2006, we had 52 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 five 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 2007                                 | 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 Lithium Nickel Asset Holding Company I
(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. At this juncture, the case is vigorously contested, and out of court settlement is
likely to occur upon a declaration from the Court establishing the entitlements and rights
of the assets and property in question. At this time, an evaluation of the likelihood of
outcome and estimate of potential loss is unable to be determined.

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. The Company has entered into 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

There
were no matters 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, 2006.

# 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, 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    

| | Year Ended December 31, 2005 |  | High    |  | Low     
| | ---------------------------- |  | ------- |  | --------
| |                              |  |         |  |         
| | First Quarter                |  | $ 12.70 |  | $   7.55
| | Second Quarter               |  | 10.00   |  | 4.84    
| | Third Quarter                |  | 6.97    |  | 3.20    
| | Fourth Quarter               |  | 5.23    |  | 2.75    

As
of December 31, 2006, there were 22,583,127 shares of the Companys common stock
issued and outstanding.

As
of February 28, 2007, there were approximately 180 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
3,600 beneficial shareholders.

The
Company did not pay cash dividends on its common stock in 2006, 2005 and 2004. 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.

The
following table sets forth, as of the year ended December 31, 2006, 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,warrants and rights | Weighted-averageexercise price ofoutstandingoptions, warrantsand rights | Number of securities
                                        remaining available for
                                        future issuance
|---------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ----------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------
|                                                          
|                                                           | (a)                                                                                      | (b)                                                                     | (c)                                                                                                                                         
|                                                          
|Equity compensation plans approved by security holders     |                                                                                          |                                                                         |                                                                                                                                             
|1993 Stock Compensation Plan                               | 517,908                                                                                  | $  1.12                                                                 | 693,717                                                                                                                                     
|2005 Stock Compensation Plan                               | 950,000                                                                                  | $  4.15                                                                 | 2,050,000                                                                                                                                   
|Equity compensation plans not approved by security holders | N/A                                                                                      | N/A                                                                     | N/A                                                                                                                                         
|                                                          
|Total                                                      | 1,467,908                                                                                | $  3.08                                                                 | 2,743,717                                                                                                                                   

---



# 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,
2006 Compared to Year Ended December 31, 2005

Net Revenue

Consolidated
net revenue for the year ended December 31, 2006 was $4,666,737 compared with $3,861,650
for the year ended December 31, 2005, an increase of $805,087 or 21%. Revenues of
$2,724,028 from service operations declined $257,035 or 9% as a result of the completion
of several contracts during 2006 and a delay in US Department of Energy and Department of
Defense contracts for funds appropriated in the 2006 federal budget. During 2006, service
revenues accounted for 58% of total revenues compared with 77% of total revenues in 2005.
The service contract backlog as of December 31, 2006 was approximately $2,343,762.

Revenues
of $1,942,709 from product manufacturing operations increased $1,062,122 or 121% as a
result of a resumption of sales to EaglePicher under our supply agreement after their
emergence from bankruptcy in August 2006 and a contract to supply batteries to the U.S.
Army for the Apache helicopter. During 2006, product revenues accounted for 42% of total
revenues compared with 23% of total revenues in 2005. The product order backlog was
approximately $86,044 as of December 31, 2006 and is expected to be shipped and invoiced
during the first quarter of 2007.

The
underlying government and commercial contracts pertaining to net revenue from services for
the periods mentioned are primarily with the U.S. Air Force, U.S. Army, U.S. Navy,
Department of Energy, and commercial customers with performance periods that commenced May
15, 2003 and continue through November 5, 2007 requiring 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 (PO). At the completion of
each contract and after all contract requirements have been met, a final invoice is
submitted, audited, and satisfied. In past history, the Company has received substantially
all contract funding on awards as agreed.

Gross Profit (Loss)

The
consolidated gross profit for the year ended December 31, 2006 was $105,991 or 2.3% of net
revenue compared with a consolidated gross loss of $(753,667) or (19.5)% in 2005. The
improvement to gross profit in 2006 from a gross loss in 2005 was mainly a result of the
shift to product revenue, which carries a higher gross profit, from service revenues,
which carry a lower gross profit.

Gross
loss from services for the year ended December 31, 2006 was $(190,260) or (7.0)% of net
service revenue compared with $(150,785) or (5.1)% of net service revenue in 2005. 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 driven by
overhead maintained in anticipation of contracts from the US government and its agencies.

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.

---



Gross
profit from products for the year ended December 31, 2006 was $296,251 or 15.2% of net
product revenue compared with a gross loss from products of $(602,882) or (68.5)% of net
product revenue in 2005 The primary reason for the increase in product gross profit
resulted from an increase in order volume pursuant to our supply agreement with
EaglePicher.

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,
2006 were $3,855,315 or 82.6% of total net revenue compared with $1,866,478 or 48.3% of
total net revenue in 2005, an increase of $1,988,837 or 107%. The increase in SG&A was
a result of $1,287,848 of operating and start-up costs associated with the Florida
manufacturing facility and an increase of $780,642 in stock-based compensation expense.

Research and Development
Expenses

Research
and development (R&D) expenses for the year ended December 31, 2006 were
$972,977 or 20.8%% of total net revenue compared with $688,114 or 17.8% of total net
revenue in 2005, an increase of $284,863 or 41%. 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. R&D conducted in
applying the Companys patented bipolar design to lithium ion batteries is in
connection with a development agreement with a venture capital firm. The venture capital
firm will make direct equity investments over a 14 month period in exchange for the
Companys common stock under a stock purchase agreement.

Other (Income) Expense

Interest
expense for the year ended December 31, 2006 was $1,093,744 compared to interest expense
of $22,013 in 2005. The primary reason for the increase in interest expense is the
interest expense associated with the 8.5% senior secured convertible notes, which were issued
in April 2006. Interest and dividend income was $239,261 for the year ended December 31,
2006 compared with $39,592 in 2005. This increase was primarily as a result of interest
and dividend income on the significantly higher cash balances, including the restricted
cash. For the year ended December 31, 2006, the amortization of deferred debt discount
relating to the 8.5% senior secured convertible notes was $256,152 and the amortization of
deferred financing costs relating to 8.5% senior secured notes was $228,777. 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.

Net Loss

Net
loss for the year ended December 31, 2006 was $(5,961,713) or $(0.28) per basic and
diluted share compared with $(3,290,680) or $(0.23) per share in 2005.

---



# 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 $152,973 for the year ended December 31, 2006 compared with $44,779 in 2005. The
Company has an agreement with the owner of E.F.S. Management Systems, a shareholder of the
Companys common stock, to provide accounting services. The Company has agreements
with Martin Klein, Robert Hamlen, William Wylam, Jack Brown and Maryann Phillips,
shareholders of the Companys common stock, 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 a private venture capital firm, 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.

At
December 31, 2005, the weighted average fair value of the warrants using the Black Scholes
option-pricing model was $3.06 per warrant. Accordingly, the total estimated value of the
warrants was reduced by $42,057 to $41,710. The amount was recorded as a reduction of cost
of services-related parties expense and other accrued liability. Further, a reduction of
deferred contract cost and additional paid-in capital was recorded. During the year ended
December 31, 2005, the Company received an installment of cash funding and recognized
$150,000 of gross revenue from services rendered related to this development agreement.
The relative value of the warrants of $13,903 was recorded as a reduction to cost of
services-related parties expense and other accrued liability. In addition, a discount to
revenue and a reduction in deferred contract costs was recorded. As of December 31, 2005
the remaining deferred contract cost was $27,807.

The
weighted average fair value of the warrants using the Black Scholes option-pricing model
was revalued on December 31, 2006 at $0.35 per warrant. Accordingly, the total estimated
value of the warrants was reduced by $36,461 to $5,250. This amount was recorded as a
reduction of cost of services-related parties expense and other accrued liability.
Further, a reduction of deferred contract cost and additional paid-in capital was
recorded. During the year ended December 31, 2006, the Company received an installment of
cash funding and recognized $100,000 of gross revenue from services rendered related to
this development agreement. An adjustment to the relative value of the warrants of $2,916
was recorded as an increase to cost of services-related parties expense and other accrued
liability. In addition, a discount to revenue and an increase in deferred contract costs
was recorded. As of December 31, 2006 the remaining deferred contract cost was $2,333.

# Financial Condition

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

|                               | December 31,2006 |  | December 31,2005
|------------------------------ | ---------------- |  | ----------------
|Working capital                | $5,423,982       |  | $1,428,795      
|Current ratio                  | 4.18             |  | 3.06            
|Long-term debt to equity ratio | 46.04            |  | 4.45            

---



Note and Warrant Purchase
Agreement and Asset Purchase                On
March 31, 2006, the Company entered into a Note and Warrant Purchase Agreement (the
Note and Warrant Purchase Agreement) with seven institutional accredited
investors (the Investors) and, on April 5, 2006, the Company completed the
note purchase transaction, pursuant to which the Company issued and sold to the Investors
$11,000,000 in aggregate principal amount of 8.5% Senior Secured Convertible Notes due
2010 (the Notes) and issued 578,947 warrants to purchase common stock that are
exercisable until March 31, 2010 at an exercise price of $3.80 per share. The Notes are
senior secured debt with all assets of the Company, except inventory and accounts
receivable, pledged as security. The Notes convert into shares of the Companys
common stock at any time and from time to time on or before March 31, 2010 at the holders
option, initially at a conversion price of $3.80 per share (equivalent to an initial
conversion rate of approximately 263 shares of common stock per $1,000 in principal amount
of notes), which could potentially be adjusted in accordance with a 24-month reset
provision and certain anti-dilution adjustments. At the initial conversion price, the
Notes would convert into an aggregate of 2,894,737 shares of the Companys common
stock. The Company incurred financing costs of $1,222,852 in connection with issuing the
Notes which included placement agent and professional fees. Also, $2,970,000 of the
proceeds from the issuance of the Notes were placed in escrow to pay the first two years
of interest, as well as payment for the holders first put right. The balance of the
escrow account, including interest income, was $2,564,021 as of December 31, 2006.

At
any time after June 1, 2006, upon the investors converting their Notes to common stock,
the investors will receive all accrued interest through the conversion date, plus the
present value of any interest payments that would have been paid through the third
anniversary of closing. This additional interest will be paid at the Companys option
in cash or in common stock at a 10% discount to the market value as described in the Note
and Warrant Purchase Agreement.

Interest
will be paid semiannually on September 30 and March 31 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 Note and Warrant Purchase Agreement. On March 9, 2007, the Company paid the semiannual
interest due on March 31, 2007 in 394,487 shares of common stock. The Notes may be
redeemed by the Company after August 1, 2007 based on certain conditions. Holders of the
Notes have put rights on August 1, 2007, April 1, 2008, December 1, 2008, and August 3,
2009 for the greater of 10% of the aggregate principal amount, or $1,000,000.

In
connection with the Note and Warrant Purchase Agreement, the Company entered into a
Registration Rights Agreement (the Registration Rights Agreement), dated as of
March 31, 2006, by and among the Company and the purchasers of the Notes. The Registration
Rights Agreement required the Company to file a shelf registration statement (the
Shelf Registration Statement) with the Securities and Exchange Commission
(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 Registration Rights Agreement. Failure to do so would trigger interest penalties of
$110,000 (representing 1.0% of the principal amount of the Notes) for each month beyond
the 180 day period that the Shelf Registration Statement remains not having been declared
effective, up to a maximum of $550,000 per year. The SEC declared the 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
interest penalties are payable on March 31 in cash or, at the Companys option, in
common stock at a 10% discount to the market value. The Company paid the interest
penalties on March 9, 2007 in 371,282 shares of common stock.

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 $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 convertible debt were allocated to the Notes and the warrants. The fair value of
the warrants of $906,415 resulted in a discount to the face value of the Notes that has
been recorded as additional paid in capital and is being amortized over the term of the
Notes as additional interest expense. The yield to maturity is 11.11%.

---



In
accordance with EITF 98-5 and 00-27, the Company has evaluated the conversion feature
embedded in the debt instrument and concluded that a beneficial conversion feature exists
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 Notes and the warrants. The beneficial conversion feature of $607,895
resulted in a discount to the face value of the Notes that has been recorded as additional
paid in capital and is being amortized over the term of the Notes as additional interest
expense. However, the contingent reset provision provides that on April 1, 2008, the
conversion price be reset to the lower of the $3.80 conversion price or 115% of the volume
weighted average price of the common stock for the ten trading days preceding and
including the reset date, provided that in no event will the conversion price be less than
$2.50 per share. The reset provision will be eliminated in the event the common stock
trades at or above $5.70 for 20 of 30 trading days prior to April 1, 2008, the Shelf
Registration Statement has been effective for such 30-day trading period and the note
holders would not otherwise be restricted from selling the underlying shares pursuant to
such Shelf Registration Statement. In the event the reset provision is triggered at the
minimum reset conversion price of $2.50, the notes would convert into an aggregate of
4,400,000 shares of the Companys common stock, a potential maximum number of
additional shares of 1,505,263.

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 embedded conversion option and warrants should be
classified as equity in the accompanying financial statements.

Interest
expense on the Notes, including $330,000 of late registration penalties, amounted to
$1,087,625 for the year ended December 31, 2006. The amortization of the deferred debt
discount and deferred financing costs recorded in connection with the Notes and warrants
amounted to $256,152 and $228,777, respectively, for the year ended December 31, 2006.

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 (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 1,000,000 warrants 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 purchased assets
require further improvements in order to become operational.

---



The
Company is using the acquired assets and the simultaneous financing 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 are
required and are in progress. Additional assets specifically for bipolar cell manufacturing will be installed
in the Florida location.

In
addition 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 may
include advanced lithium ion cells in 18650 and 26650 industry standard sizes.

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. Sample products are being developed for submission to target
customers and potential strategic partners. 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 over the next 6 to 15 months. 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.

As
of December 31, 2006, the current maturities of long term debt are $61,193 and relate to
the note payable to Connecticut Innovations, Incorporated (CII). Interest at a
fixed rate of 5% is paid with the annual installment payment on December 31st
and the final installment will be made on December 31, 2007. Interest expense related to
the CII note amounted to $6,119 and $9,179 for the years ended December 31, 2006 and 2005,
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. Accretion of the discount related to the EaglePicher note amounted to $5,979 and
$12,834 for the years ended December 31, 2006 and 2005, respectively.

On
October 17, 2005, the Company entered into a Stock Purchase Agreement with a venture
capital firm, pursuant to which the venture capital firm has agreed to purchase 241,692
shares of unregistered common stock of the Company and 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 is $800,000 and is expected to be paid
over the course of 14 months following the closing, conditioned upon the Company achieving
certain development milestones. 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. During the year ended December 31, 2005, the
Company received $100,000 and issued 30,208 shares of unregistered common stock and 9,476
warrants in connection with this agreement. The Company and the venture capital firm have agreed to complete the development project. The Company is using the proceeds for research
and development of its bipolar Li-ion battery technology.

---



On
March 31, 2005, the Company entered into a development agreement to receive a total of
$450,000 in cash funding from a private venture capital firm, 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.

At
 December 31, 2005,  the weighted  average fair value of the warrants using the Black
Scholes option-pricing model was $3.06 per warrant. Accordingly, the total estimated
value of the warrants was reduced by $42,057 to $41,710. The amount was recorded as a
reduction of cost of services-related parties expense and other accrued liability.
Further, a reduction of deferred contract cost and additional paid-in capital was
recorded. During the year ended December 31, 2005, the Company received an installment of
cash funding and recognized $150,000 of gross revenue from services rendered related to
this development agreement. The relative value of the warrants of $13,903 was recorded as
a reduction to cost of services-related parties expense and other accrued liability. In
addition, a discount to revenue and a reduction in deferred contract costs was recorded.
As of December 31, 2005 the remaining deferred contract cost was $27,807.

The
weighted average fair value of the warrants using the Black Scholes option-pricing model
was revalued on December 31, 2006 at $0.35 per warrant. Accordingly, the total estimated
value of the warrants was reduced by $36,461 to $5,250. This amount was recorded as a
reduction of cost of services-related parties expense and other accrued liability.
Further, a reduction of deferred contract cost and additional paid-in capital was
recorded. During the year ended December 31, 2006, the Company received an installment of
cash funding and recognized $100,000 of gross revenue from services rendered related to
this development agreement. An adjustment to the relative value of the warrants of $2,916
was recorded as an increase to cost of services-related parties expense and other accrued
liability. In addition, a discount to revenue and an increase in deferred contract costs
was recorded. As of December 31, 2006 the remaining deferred contract cost was $2,333.

During
the years ended December 31, 2006 and 2005, warrants were exercised for proceeds of
$175,000 and $730,528 in exchange for 92,687 and 826,079 shares of common stock,
respectively. As of December 31, 2006, 4,720,908 warrants are outstanding with expiration
dates ranging from July 16, 2007 through March 31, 2010 and exercise prices ranging from
$1.00 to $9.06. The weighted average exercise price of the outstanding warrants is $5.43.

During
the years ended December 31, 2006 and 2005, the Company issued 72,297 and 1,387,579 shares
of common stock in connection with the exercise of employee stock options for proceeds of
$39,101 and $607,524, respectively. As of December 31, 2006, 1,467,908 options are
outstanding with expiration dates ranging from February 27, 2010 through November 20, 2016
and exercise prices ranging from $0.26 to $6.76. The weighted average exercise price of
the outstanding options is $3.08. The maximum potential future proceeds from the exercise
of the options vested and in-the-money as of December 31, 2006 is $433,370.

Net
cash used in operating activities totaled $3,474,504 and $3,211,595 for the years ended
December 31, 2006 and 2005, respectively. The Company invested $622,109 and $946,086 in
equipment during the years ended December 31, 2006 and 2005, 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. The Company made payments towards security deposits of $219,693 during the year ended
December 31, 2006. These payments relate primarily to the leases in Alachua, Florida.

---



The  Company expects to invest additional  amounts
in capital expenditures in the next twelve months to facilitate the operating
capabilities of the acquired assets. The Company anticipates that cash generated
from operating activities, together with funds available from the proceeds of
the 8.5% senior secured convertible notes described above, additional proceeds
from the Stock Purchase Agreement described above, the release of restricted
cash for working capital purposes as a result of the payment of interest on the
8.5% senior secured convertible notes with the Company's common stock and
additional common stock issuances, under current conditions, will be sufficient
to finance the Company's planned operations over the next twelve months. As of
December 31, 2006, the Company has cash and cash equivalents of $3,789,780. In
addition, the Company has $2,564,021 of restricted cash held in escrow for
future interest and redemption payments in connection with the 8.5% senior
secured convertible notes.

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.

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, 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.

# Application of Critical
Accounting Policies

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 using the
modified prospective method and the Black Scholes option pricing model and the effect of
implementing resulted in stock based compensation expense of $986,003 for the year ended
December 31, 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, 2006, there was no
allowance for doubtful accounts and as of December 31, 2005, the allowance for doubtful
accounts was $5,652.

---



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.

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                               On
February 15, 2007, the FASB issued Statement of Financial Accounting Standards (SFAS)
No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. 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 is 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 our consolidated
financial position, results of operations or cash flows.

In
December 2006, the FASB issued FASB Staff Position EITF 00-19-2 Accounting for
Registration Payment Arrangements, which specifies that the contingent
obligation to make future payments or otherwise transfer consideration under a
registration payment arrangement should be separately recognized and measured in
accordance with SFAS No. 5, Accounting for Contingencies. Adoption of
EITF 00-19-2 is required for fiscal years beginning after December 15, 2006. We are
currently evaluating the impact of the adoption of EITF 00-19-2 on our consolidated
financial position, results of operations or cash flows.

In
September 2006, the FASB issued SFAS No. 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 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007. We are in the
process of evaluating the impact of the adoption of SFAS 157 on our consolidated
financial position, results of operations or cash flows.

In
September 2006, the staff of the 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 becomes effective in fiscal 2007. Adoption of SAB 108 is not
expected to have a material impact on our consolidated financial position, results of
operations or cash flows.

---



In
July 2006, the FASB released FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109(FIN
48). FIN 48 clarifies the accounting and reporting for uncertainties in income tax
law and prescribes a comprehensive model for the financial statement recognition,
measurement, presentation and disclosure of uncertain tax positions taken or expected to
be taken in income tax returns. FIN 48 shall be effective for fiscal years beginning
after December 15, 2006. Earlier adoption is permitted as of the beginning of an
enterprises fiscal year, provided the enterprise has not yet issued financial
statements, including financial statements for any interim period for that fiscal year.
The cumulative effects, if any, of applying this Interpretation will be recorded as an
adjustment to retained earnings as of the beginning of the period of adoption. The
adoption of FIN 48 is not expected to have a material effect on our consolidated
financial position, results of operations or cash flows.

In
March 2006, the FASB issued Statement SFAS No. 156, Accounting for Servicing of
Financial Assets (SFAS 156), which requires all separately
recognized servicing assets and servicing liabilities be initially measured at fair
value. SFAS 156 permits, but does not require, the subsequent measurement of servicing
assets and servicing liabilities at fair value. Adoption is required as of the beginning
of the first fiscal year that begins after September 15, 2006. Early adoption is
permitted. The adoption of SFAS 156 is not expected to have a material effect on our
consolidated financial position, results of operations or cash flows.

In
February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments (SFAS 155), which eliminates the exemption
from applying SFAS 133 to interests in securitized financial assets so that similar
instruments are accounted for similarly regardless of the form of the instruments. SFAS
155 also allows the election of fair value measurement at acquisition, at issuance, or
when a previously recognized financial instrument is subject to a remeasurement event.
Adoption is effective for all financial instruments acquired or issued after the
beginning of the first fiscal year that begins after September 15, 2006. Early adoption
is permitted. The adoption of SFAS 155 is not expected to have a material effect on our
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    | F-2
|---------------------------------------------------------- | ---
|Consolidated Balance Sheets                                | F-3
|Consolidated Statements of Operations                      | F-4
|Consolidated Statements of Changes in Stockholders' Equity | F-5
|Consolidated Statements of Cash Flows                      | F-6
|Notes to Consolidated Financial Statements                 | F-8

---



REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and
StockholdersElectro Energy Inc. and Subsidiaries

We have audited the accompanying
consolidated balance sheets of Electro Energy Inc. and the Subsidiaries (the
Company) as of December 31, 2006 and 2005 and the related consolidated
statements of operations, changes in stockholders equity, and cash flows for the
years then ended. 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 consolidated financial statements, assessing the
accounting principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of Electro Energy Inc. and Subsidiaries as of December 31, 2006 and
2005, and the results of their operations and their cash flows for the years then ended,
in conformity with accounting principles generally accepted in the United States of
America.

/s/ Marcum & Kliegman
LLPMarch 22, 2007New York, New York

---



|ELECTRO ENERGY INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSFOR THE YEARS ENDED DECEMBER 31,                                                                                                                                                                                                                                  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                 
|ASSETS                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                 
|Current Assets                                                                                                                                                                                                                                                                                                                   
|Cash and cash equivalents                                                                                                                                                                                                                                                                                                        
|Current portion of restricted cash                                                                                                                                                                                                                                                                                               
|Accounts receivable, net of allowance for doubtful accounts of $0   and $5,652 at December 31, 2006 and 2005, respectively                                                                                                                                                                                                       
|Inventories                                                                                                                                                                                                                                                                                                                      
|Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                 
|Total Current Assets                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                 
|Property and equipment, net of accumulated depreciation                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                 
|Other Assets                                                                                                                                                                                                                                                                                                                     
|Restricted cash, less current portion                                                                                                                                                                                                                                                                                            
|Deferred financing costs                                                                                                                                                                                                                                                                                                         
|Security deposits                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                 
|Total Other Assets                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                 
|Total Assets                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                 
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                                                                                                                                                                                             
|Current Liabilities                                                                                                                                                                                                                                                                                                              
|Current maturities of long term debt                                                                                                                                                                                                                                                                                             
|Current portion of senior secured convertible notes,
         net of deferred debt discount of $359,489                                                                                                                                                                                                                          
|Accounts payable and accrued expenses                                                                                                                                                                                                                                                                                            
|Current portion of capital lease                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                 
|Total Current Liabilities                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                 
|Other Liabilities                                                                                                                                                                                                                                                                                                                
|Long term debt, less current maturities                                                                                                                                                                                                                                                                                          
|Senior secured convertible notes, net of current portion and
         deferred debt discount of $898,669                                                                                                                                                                                                                         
|Deferred rent, less current portion                                                                                                                                                                                                                                                                                              
|Capital lease, less current portion                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                 
|Total Other Liabilities                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                 
|Total Liabilities                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                 
|Commitments and Contingencies                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                 
|Stockholders' Equity                                                                                                                                                                                                                                                                                                             
|Preferred stock, $0.0001 par value, 10,000 shares authorized;
      Series A preferred stock, 5,600 shares designated;
      5,501 shares issued, 160 and 180 outstanding at
      December 31, 2006 and 2005, respectively;
      $160,000 and $180,000 liquidation preference
      at December 31, 2006 and 2005, respectively
|Common stock, $0.01 par value, 50,000,000 shares authorized;
      22,583,127 and 16,599,719 shares outstanding at
      December 31, 2006 and 2005, respectively                                                                                                                                                                
|Additional paid in capital                                                                                                                                                                                                                                                                                                       
|Deferred contract costs                                                                                                                                                                                                                                                                                                          
|Deferred lease costs, net of amortization                                                                                                                                                                                                                                                                                        
|Deferred compensation expense                                                                                                                                                                                                                                                                                                    
|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,                                                                                    
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|Net Revenue                                                                                                                                                                                  
|Services                                                                                                                                                                                     
|Products                                                                                                                                                                                     
|                                                                                                                                                                                             
|Total Net Revenue                                                                                                                                                                            
|                                                                                                                                                                                             
|Cost of Revenue                                                                                                                                                                              
|Service                                                                                                                                                                                      
|Product                                                                                                                                                                                      
|                                                                                                                                                                                             
|Total Cost of Revenue                                                                                                                                                                        
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|Gross Profit (Loss)                                                                                                                                                                          
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|Operating Expenses                                                                                                                                                                           
|Selling, General and Administrative Expenses (including  non-cash             compensation of $986,003 and $205,361 for the years ended             December 31, 2006 and 2005, respectively)
|Research and Development                                                                                                                                                                     
|                                                                                                                                                                                             
|Total Operating Expenses                                                                                                                                                                     
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|Operating Loss                                                                                                                                                                               
|                                                                                                                                                                                             
|                                                                                                                                                                                             
|Other Expense (Income)                                                                                                                                                                       
|Interest Expense                                                                                                                                                                             
|Interest and Dividend Income                                                                                                                                                                 
|Amortization of deferred debt discount                                                                                                                                                       
|Amortization of deferred financing costs                                                                                                                                                     
|Forgiveness of debt                                                                                                                                                                          
|                                                                                                                                                                                             
|Total Other Expense (Income)                                                                                                                                                                 
|                                                                                                                                                                                             
|Net Loss                                                                                                                                                                                     
|                                                                                                                                                                                             
|Net Loss per 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 STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITYFOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
|--------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                            
|                                                                                                                                            
|                                                                                                                                            
|                                                                                                                                            
|Balance January 1, 2005                                                                                                                     
|Proceeds from exercise of employee
      stock options                                                                                      
|Forfeiture of stock options issued
      to employees                                                                                       
|Amortization of deferred
      compensation expense                                                                                         
|Issuance of stock options                                                                                                                   
|Issuance and amortization of warrants                                                                                                       
|Proceeds from issuance of
      common stock                                                                                                
|Proceeds from warrant subscription
      receivable                                                                                         
|Conversion of preferred stock into
      common stock                                                                                       
|Proceeds from exercise of warrants                                                                                                          
|Net loss                                                                                                                                    
|                                                                                                                                            
|Balance December 31, 2005                                                                                                                   
|                                                                                                                                            
|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
      Secured Convertible Note                                                                      
|Beneficial conversion feature of Secured
      Convertible Notes                                                                            
|Amortization of deferred lease costs                                                                                                        
|Net loss                                                                                                                                    
|                                                                                                                                            
|Balance December 31, 2006                                                                                                                   
|                                                                                                                                            
|                                                                                                                                            
|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,
|---------------------------------------------------------------------------------------------------------
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Cash Flows From Operating Activities                                                                     
|Net loss                                                                                                 
|Adjustments to reconcile net loss to net cash used in operating activities:                              
|Depreciation and amortization                                                                            
|Stock compensation expense                                                                               
|Deferred rent                                                                                            
|Interest accretion                                                                                       
|Amortization of deferred financing costs                                                                 
|Amortization of deferred debt discount                                                                   
|Amortization of deferred lease costs                                                                     
|Amortization of deferred contract costs                                                                  
|Loss on disposal of fixed assets                                                                         
|Forgiveness of debt                                                                                      
|Changes in:                                                                                              
|Accounts receivable                                                                                      
|Inventories                                                                                              
|Prepaid expenses and other current assets                                                                
|Accounts payable and accrued expenses                                                                    
|                                                                                                         
|Net Cash Used In Operating Activities                                                                    
|                                                                                                         
|Cash Flows From Investing Activities                                                                     
|Purchases of property and equipment                                                                      
|Acquisition costs in connection with asset purchase                                                      
|Payment of security deposits                                                                             
|                                                                                                         
|Net Cash Used In Investing Activities                                                                    
|                                                                                                         
|Cash Flows From Financing Activities                                                                     
|Restricted cash                                                                                          
|Repayment of long term debt                                                                              
|Proceeds from issuance of common stock                                                                   
|Proceeds from issuance of senior secured convertible notes                                               
|Financing costs related to senior secured convertible notes                                              
|Proceeds from exercise of employee stock options                                                         
|Proceeds from exercise of warrants                                                                       
|Proceeds from warrant subscription receivable                                                            
|Repayment of capital lease                                                                               
|                                                                                                         
|Net Cash Provided By Financing Activities                                                                
|                                                                                                         
|Net Increase (Decrease) In Cash and Cash Equivalents                                                     
|                                                                                                         
|Cash and Cash Equivalents - Beginning                                                                    
|                                                                                                         
|Cash and Cash Equivalents - Ending                                                                       
|                                                                                                         
|                                                                                                         
|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,
|---------------------------------------------------------------------------------------------------------
|                                                                                                         
|                                                                                                         
|                                                                                                         
|Supplemental Disclosures of Cash Flow Information                                                        
|Cash paid for:                                                                                           
|Interest                                                                                                 
|Income taxes                                                                                             
|                                                                                                         
|Supplemental Disclosures of Non-Cash Activities                                                          
|Issuance of warrants for deferred contract costs                                                         
|Stock issued in connection with Asset Purchase                                                           
|Warrants issued for lease agreements                                                                     
|Warrants issued in connection with senior secured convertible notes                                      
|Beneficial conversion feature of senior secured convertible notes                                        
|Acquisition of Property and Equipment under capital lease obligation                                     
|Conversion of preferred stock into common stock                                                          
|Revaluation of warrants issued for contract costs                                                        
|Revaluation of options issued for compensation costs                                                     
|                                                                                                         
|The accompanying notes are an integral part of these consolidated financial statements.                  

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1  The Company

Organization                Electro
Energy, Inc. (Old EEI) was incorporated in Delaware in 1992. 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 in December 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.

Managements
Liquidity Plans                 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 total purchase consideration for the assets
consisted of 5,750,000 unregistered shares of EEI common stock and a six-year 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. (See Note 4).
On April 5, 2006, the Company issued 8.5% senior secured convertible notes due 2010 in the
aggregate principal amount of $11,000,000 secured by certain assets of the Company to
finance its plans to commercialize its patented bipolar battery design technology. (See
Note 7).

As
of December 31, 2006, the Company had working capital of $5,423,982, including
unrestricted cash and cash equivalents of $3,789,780 and the current portion of restricted
cash of $1,935,000. The Company held cash in escrow of $2,564,021, consisting of the
current portion of restricted cash of $1,935,000 and the non-current portion of restricted
cash of $629,021, whose use is restricted for semi-annual interest payments through March
31, 2008 and the August 1, 2007 periodic put right under the 8.5% Senior Secured
Convertible Notes. The Company incurred a loss from operations of $4,722,301 for the year
ended December 31, 2006.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The  Company expects to invest additional  amounts
in capital  expenditures  in the next  twelve  months to  facilitate  the  operating  capabilities  of the
acquired  assets.  The Company  anticipates that cash generated from operating  activities,  together with
funds available from the proceeds of the 8.5% senior secured  convertible notes,  additional proceeds from
the Stock Purchase  Agreement,  the release of restricted cash for working capital purposes as a result of
the payment of interest on the 8.5% senior  secured  convertible  notes in the Companys  common stock and
additional common stock issuances,  under current conditions,  will be sufficient to finance the Companys
planned  operations  over the next twelve  months.  As of December 31, 2006, the Company has cash and cash
equivalents of $3,789,780.  In addition,  the Company has $2,564,021 of restricted cash held in escrow for
future interest and redemption payments in connection with the 8.5% senior secured convertible notes.

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.

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, 2006, the Company had cash balances in excess of federally insured limits of
$6,362,160.

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. However, one
of the Companys private entity customers represented approximately 34% of accounts
receivable at December 31, 2006.

As
of December 31, 2006, 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, 2006,
there was no allowance for doubtful accounts and as of December 31, 2005, the allowance
for doubtful accounts was $5,652.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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.

Deferred Financing Costs                 
         The costs incurred in connection with the issuance of the 8.5% senior secured
 convertible  notes (see Note 4) was  capitalized  as deferred  financing  costs and is
being  amortized  over the term of the notes.

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 2006. Net sales to the Company's four major customers, U.S. Air Force, Sandia
National Laboratories, Defense Finance and Accounting System and EaglePicher Technologies, LLC,
represented approximately 19%, 22%, 23% and 24%, respectively, of total net sales in 2006. The Company
had three customers with sales of 10% or more of total sales in 2005. Net sales to three major
customers, U.S. Air Force, Sandia National Laboratories, and EaglePicher Technologies, LLC, represented
approximately 31%, 17% and 16%, respectively, of total net sales in 2005. Accounts receivable from these
customers amounted to $846,943 and $185,418 at December 31, 2006 and 2005, respectively.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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. As of December 31, 2006, 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.

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). In March 2005, the Securities and Exchange
Commission issued Staff Accounting Bulleting No. 107 (SAB 107) relating to
SFAS 123R. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R
and recorded total stock-based compensation of $986,003 during this period.

For
 the year  ended  December  31,  2005,  as was permitted under SFAS No. 148, Accounting
for Stock-Based Compensation  Transition and Disclosure, which amended
SFAS 123, the Company elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation arrangements as defined by APB 25
and related interpretations including Financial Accounting Standards Board (FASB)
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB No. 25. For the year ended December 31,
2005, the Company recorded total stock-based compensation expense of $195,203 related to
stock options granted to employees. The following table illustrates the effect on net
loss per share as if the Company had applied the fair value recognition provisions of
SFAS 123 to stock-based employee compensation for the year ended December 31, 2005:

| | Net loss attributable to common stockholders as reported                                                                             | $ | (3,290,680) |  |  | 
| | ------------------------------------------------------------------------------------------------------------------------------------ | - | ----------- |  |  | 
| | Add stock-based employee compensation    expense included in reported loss                                                           |   | 195,203     |  |  | 
| | Deduct total stock-based employee compensation    expense determined
      under fair and minimumvalue-based methods for all options |   | (750,103)   |  |  | 
| |                                                                                                                                      |   |             |  |  | 
| | Proforma net loss attributable to common stockholders                                                                                | $ | (3,845,580) |  |  | 
| |                                                                                                                                      |   |             |  |  | 
| | Proforma net loss per share attributable to commonstockholders -
      basic and diluted                                             | $ | (0.26)      |  |  | 
| |                                                                                                                                      |   |             |  |  | 

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

| |                          | 2006 |        | 2005
| | ------------------------ | ---- | ------ | ----
| |                          |      |        |     
| | Expected life (years)    |      | 4      |     
| | Interest rate            |      | 4.63%  |     
| | Annual rate of dividends |      | 0.00%  |     
| | Volatility               |      | 50.82% |     

The
weighted average fair value of the options at date of grant using the Black Scholes
option-pricing model is estimated at $0.73 and $4.44 per option for the years ended
December 31, 2006 and 2005, respectively.

Research and Development                Research
and development expenses are incurred to develop our battery technologies. They are self
funded and expensed as incurred. Research and development expenses for the years ended
December 31, 2006 and 2005 were $972,977 and $688,114, 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
preferred stock, 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
antidilutive.

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, 2006 and 2005:

| |                                               | 2006 |           | 2005
| | --------------------------------------------- | ---- | --------- | ----
| |                                               |      |           |     
| |                                               |      |           |     
| | Preferred stock convertible into common stock |      | 64,000    |     
| | Warrants to purchase common stock             |      | 4,720,908 |     
| | Options to purchase common stock              |      | 1,467,908 |     
| | Senior secured convertible note               |      | 2,894,737 |     
| |                                               |      |           |     
| | Total potential common shares                 |      | 9,147,553 |     
| |                                               |      |           |     

Recent Accounting
Pronouncements                On
February 15, 2007, the FASB issued
Statement of Financial Accounting Standards (SFAS) No. 159, The Fair
Value Option for Financial Assets and Financial Liabilities. The guidance in
SFAS No. 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 No. 159 are applicable to all reporting entities and is 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
December 2006, the FASB issued FASB Staff Position EITF 00-19-2 Accounting for
Registration Payment Arrangements, which specifies that the contingent
obligation to make future payments or otherwise transfer consideration under a
registration payment arrangement should be separately recognized and measured in
accordance with SFAS No. 5, Accounting for Contingencies.Adoption of
EITF 00-19-2 is required for fiscal years beginning after December 15, 2006. The Company
is currently evaluating the impact of the adoption of EITF 00-19-2 on the Companys
consolidated financial position, results of operations, and cash flows.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In
September 2006, the FASB issued Statement of Financial Accounting Standard 157,
Fair Value Measurements (SFAS 157). SFAS No. 157 defines
fair value, establishes a framework for measuring fair value and expands disclosure of
fair value measurements. SFAS No. 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 becomes effective in fiscal 2007. Adoption of SAB 108 is not
expected to have a material impact on the Companys consolidated financial position,
results of operations or cash flows.

In
July 2006, the FASB released FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
(FIN 48). FIN 48 clarifies the accounting and reporting for uncertainties in
income tax law and prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions taken or
expected to be taken in income tax returns. FIN 48 shall be effective for fiscal years
beginning after December 15, 2006. Earlier adoption is permitted as of the beginning of an
enterprises fiscal year, provided the enterprise has not yet issued financial
statements, including financial statements for any interim period for that fiscal year.
The cumulative effects, if any, of applying this Interpretation will be recorded as an
adjustment to retained earnings as of the beginning of the period of adoption. The
adoption of FIN 48 is not expected to have a material effect on our consolidated financial position,
results of operations or cash flows.

In
March 2006, the FASB issued Statement of Financial Accounting Standard 156,
Accounting for Servicing of FinancialAssets (SFAS 156),
which requires all separately recognized servicing assets and servicing liabilities be
initially measured at fair value. SFAS 156 permits, but does not require, the subsequent
measurement of servicing assets and servicing liabilities at fair value. Adoption is
required as of the beginning of the first fiscal year that begins after September 15,
2006. Early adoption is permitted. The adoption of SFAS 156 is not expected to have a
material effect on our consolidated financial position, results of operations or cash flows.

In
February 2006, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard 155, Accounting for Certain Hybrid
Financial Instruments (SFAS 155), which eliminates the exemption
from applying SFAS 133 to interests in securitized financial assets so that similar
instruments are accounted for similarly regardless of the form of the instruments. SFAS
155 also allows the election of fair value measurement at acquisition, at issuance, or
when a previously recognized financial instrument is subject to a remeasurement event.
Adoption is effective for all financial instruments acquired or issued after the beginning
of the first fiscal year that begins after September 15, 2006. Early adoption is
permitted. The adoption of SFAS 155 is not expected to have a material effect on our consolidated
financial position, results of operations or cash flows.

NOTE 3  Inventories

Inventories
consist of the following as of December 31, 2006 and 2005:

| |                   | 2006 |         | 2005
| | ----------------- | ---- | ------- | ----
| |                   |      |         |     
| | Raw materials     | $    | 229,360 |     
| | Work in progress  |      | 79,367  |     
| |                   |      |         |     
| | Total inventories | $    | 308,727 |     
| |                   |      |         |     

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 (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 1,000,000 warrants 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. The purchased assets require further improvements in order to become
operational.

NOTE 5  Property
and Equipment

Property
and equipment consists of the following as of December 31, 2006 and 2005:

| |                                                | 2006 |            | 2005 |   | Useful Lives
| | ---------------------------------------------- | ---- | ---------- | ---- | - | ------------
| |                                                |      |            |      |   |             
| | Equipment                                      | $    | 22,810,216 |      | $ | 1,652,276   
| | Leasehold improvements                         |      | 223,170    |      |   | 30,359      
| |                                                |      |            |      |   |             
| |                                                |      | 23,033,386 |      |   | 1,682,635   
| |                                                |      |            |      |   |             
| | Less accumulated depreciation and amortization |      | 362,673    |      |   | 308,013     
| |                                                |      |            |      |   |             
| | Property and equipment, net                    | $    | 22,670,713 |      | $ | 1,374,622   
| |                                                |      |            |      |   |             

Included    in   property    and    equipment   is
$22,266,409 of construction  in progress,  including  $21,050,841 of equipment and leasehold  improvements
from the Asset  Purchase  (see Note 4),  which has not been placed in service as of December  31, 2006 and
therefore  not  depreciated  during the year then ended.  As of December 31, 2005,  property and equipment
included  construction  in progress of $868,809  which had not been placed in service and 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, 2006.

Depreciation
and amortization expense for the years ended December 31, 2006 and 2005 was $112,512 and
$104,737, respectively.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6  Long-Term
Debt

Long-term
debt consists of the following as of December 31, 2006 and 2005:

| |                                                                                                                                                                                                                                                  |                                                                  |   | 2006   |        | 2005
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------- | - | ------ | ------ | ----
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     
| | Note payable to Connecticut Innovations, Incorporated ("CII") commencing
December 2004 and maturing December 2007 with interest at 5% and annual
installments of $61,193                                                                         |                                                                  | $ | 61,193 |        | $   
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     
| | Non-interest bearing note payable to EaglePicher Technologies, LLC requiring
three annual installments of $150,000 commencing in October 2004 secured by
assets acquired in connection with the purchase of its Colorado Springs
energy business |                                                                  |   |        |        |     
| |                                                                                                                                                                                                                                                  | Face value                                                       |   |        | -      |     
| |                                                                                                                                                                                                                                                  | Remaining discount to fair value (effective interest rate of 5%) |   |        | -      |     
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     
| |                                                                                                                                                                                                                                                  | Fair value                                                       |   |        | -      |     
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     
| |                                                                                                                                                                                                                                                  | Total long term debt                                             |   |        | 61,193 |     
| |                                                                                                                                                                                                                                                  | Less current maturities                                          |   |        | 61,193 |     
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     
| |                                                                                                                                                                                                                                                  | Long term debt, less current maturities                          |   | $      | -      |     
| |                                                                                                                                                                                                                                                  |                                                                  |   |        |        |     

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).

Interest
expense related to the long-term debt of CII amounted to $6,119 and $9,179 for the years
ended December 31, 2006 and 2005, respectively.

Accretion
of the discount related to the long-term debt of EaglePicher Technologies, LLC amounted to
$5,979 and $12,834 for the years ended December 31, 2006 and 2005, respectively.

NOTE 7  Senior
Secured Convertible Note

Senior
secured convertible note consists of the following at December 31, 2006:

|Face value                                    | $ | 11,000,000 |  
|--------------------------------------------- | - | ---------- | -
|Remaining discount to fair value              |   | (1,258,157 | )
|                                              |  
|Fair value of senior secured convertible note |   | 9,741,843  |  
|Less: Current portion                         |   | (640,511   | )
|                                              |  
|                                              | $ | 9,101,332  |  
|                                              |  

On March
31, 2006, the Company entered into a Note and Warrant Purchase Agreement (the Note
and Warrant Purchase Agreement) with seven institutional accredited investors (the
Investors) and, on April 5, 2006, the Company issued and sold to the Investors
$11,000,000 in aggregate principal amount of 8.5% Senior Secured Convertible Notes due
2010 (the Notes) and issued 578,947 warrants to purchase common stock that are
exercisable until March 31, 2010 at an exercise price of $3.80 per share. The Notes are
senior secured debt with all assets of the Company, except inventory and accounts
receivable, pledged as security. The Notes convert into shares of the Companys
common stock at any time and from time to time on or before March 31, 2010 at the holders
option, initially at a conversion price of $3.80 per share (equivalent to an initial
conversion rate of approximately 263 shares of common stock per $1,000 in principal amount
of notes), which could potentially be adjusted in accordance with a 24-month reset
provision and certain anti-dilution adjustments. At the initial conversion price, the
Notes would convert into an aggregate of 2,894,737 shares of the Companys common
stock. The Company incurred financing costs of $1,222,852 in connection with issuing the
Notes which included placement agent and professional fees. Also, $2,970,000 of the
proceeds from the issuance of the Notes were placed in escrow to pay the first two years
of interest, as well as payment for the holders first put right. The balance of the
escrow account, including interest income, was $2,564,021 as of December 31, 2006.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At
any time after June 1, 2006, upon the investors converting their Notes to common stock,
the investors will receive all accrued interest through the conversion date, plus the
present value of any interest payments that would have been paid through the third
anniversary of closing. This additional interest will be paid at the Companys option
in cash or in common stock at a 10% discount to the market value as described in the Note
and Warrant Purchase Agreement.

Interest
will be paid semiannually on September 30 and March 31 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 Note and Warrant Purchase Agreement. At December 31, 2006, accrued interest payable of
$257,125 on account of the semi-annual interest payment, including the 10% discount to
market for payment in stock, was included in accounts payable and accrued expenses. On
March 9, 2007, the Company paid the semiannual interest due on March 31, 2007 in 394,487
shares of common stock. The Notes may be redeemed by the Company after August 1, 2007
based on certain conditions. Holders of the Notes have put rights on August 1, 2007, April
1, 2008, December 1, 2008, and August 3, 2009 for the greater of 10% of the aggregate
principal amount, or $1,000,000.

In
connection with the Note and Warrant Purchase Agreement, the Company entered into a
Registration Rights Agreement (the Registration Rights Agreement), dated as of
March 31, 2006, by and among the Company and the purchasers of the Notes. The Registration
Rights Agreement required the Company to file a shelf registration statement (the
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 Registration Rights Agreement. Failure to do so would trigger interest penalties of
$110,000 (representing 1.0% of the principal amount of the Notes) for each month beyond
the 180 day period that the Shelf Registration Statement remains not having been declared
effective, up to a maximum of $550,000 per year. The SEC declared the 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
interest penalties are payable on March 31 in cash or, at the Companys option, in
common stock at a 10% discount to the market value as described in the Note and Warrant
Purchase Agreement. At December 31, 2006, accrued interest payable of $363,000 on account
of the late registration penalty, including the 10% discount to market for payment in
stock, was included in accounts payable and accrued expenses. The Company paid the
interest penalties on March 9, 2007 with 371,282 shares of common stock.

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 $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 convertible debt were allocated to the Notes and the warrants. The fair value of
the warrants of $906,415 resulted in a discount to the face value of the Notes that has
been recorded as additional paid in capital and is being amortized over the term of the
Notes as additional interest expense. The effective rate of interest is 11.11%.

In
accordance with EITF 98-5 and 00-27, the Company has evaluated the conversion feature
embedded in the debt instrument and concluded that a beneficial conversion feature exists
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 Notes and the warrants. The beneficial conversion featured of $607,895
resulted in a discount to the face value of the Notes that has been recorded as additional
paid in capital and is being amortized over the term of the Notes as additional interest
expense. However, the contingent reset provision provides that on April 1, 2008, the
conversion price be reset to the lower of the $3.80 conversion price or 115% of the volume
weighted average price of the common stock for the ten trading days preceding and
including the reset date, provided that in no event will the conversion price be less than
$2.50 per share. The reset provision will be eliminated in the event the common stock
trades at or above $5.70 for 20 of 30 trading days prior to April 1, 2008, the Shelf
Registration Statement has been effective for such 30-day trading period and the note
holders would not otherwise be restricted from selling the underlying shares pursuant to
such Shelf Registration Statement. In the event the reset provision is triggered at the
minimum reset conversion price of $2.50, the notes would convert into an aggregate of
4,400,000 shares of the Companys common stock, a potential maximum number of
additional shares of 1,505,263.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 embedded conversion option and warrants should be
classified as equity in the accompanying financial statements.

Interest
expense on the Notes, including $330,000 of late registration penalties, amounted to
$1,087,625 for the year ended December 31, 2006. The amortization of the deferred debt
discount and deferred financing costs recorded in connection with the Notes and warrants
amounted to $256,152 and $228,777, respectively, for the year ended December 31, 2006.

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, the Company reached a settlement with EaglePicher
Technologies, LLC to have the option to terminate the Colorado Springs lease after
December 31, 2006 with 90 days notice as described below. 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 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 $130,495 for
the year ended December 31, 2006.  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 $863,818 and $372,528 for
the years ended December 31, 2006 and 2005, respectively.

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

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|For the Year EndingDecember 31, | Amount
|------------------------------- | ------
|                                |       
|2007                            | $     
|2008                            |       
|2009                            |       
|2010                            |       
|2011                            |       
|Thereafter                      |       
|                                |       
|                                | $     
|                                |       

Deferred
rent consists of the following as of December 31, 2006 and December 31, 2005:

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

| |                                         |  |   | 2006     |  | 2005
| | --------------------------------------- |  | - | -------- |  | ----
| |                                         |  |   |          |  |     
| |                                         |  |   |          |  |     
| | Facility:                               |  |   |          |  |     
| | Colorado Springs, Colorado              |  | $ | 58,620   |  | $   
| | Alachua, Florida  rental payments      |  |   | 305,111  |  |     
| |                                         |  |   |          |  |     
| | Total deferred rent                     |  |   | 363,731  |  |     
| | Less:  current portion of deferred rent |  |   | (58,620) |  |     
| |                                         |  |   |          |  |     
| | Deferred rent, net of current portion   |  | $ | 305,111  |  | $   
| |                                         |  |   |          |  |     

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 $363,731 and $84,660 represents the unamortized
rent adjustment amount at December 31, 2006 and 2005, respectively, and is reflected as
deferred rent obligations in the consolidated balance sheets.

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.

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

|For the Year EndingDecember 31,              | Amount
|-------------------------------------------- | ------
|                                             |       
|2007                                         | $     
|2008                                         |       
|2009                                         |       
|2010                                         |       
|                                             |       
|                                             |       
|Less: Interest                               |       
|Current portion                              |       
|                                             |       
|Long term capital lease,less current portion | $     
|                                             |       

Off Balance Sheet Arrangements               At December  31,  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.

Supply Agreement                 The
Company has entered into 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 is fixed, subject to possible adjustment under periodic value
engineering reviews and based on material cost escalations. The agreement is renewable
upon the mutual consent of the parties. The agreement expires September 2008 with renewal
options annually thereafter. Net sales to EaglePicher represented approximately 24% and
16% of total sales for the years ended December 31, 2006 and 2005, respectively. Accounts
receivable from EaglePicher amounted to $294,110 and $14,165 at December 31, 2006
and 2005, respectively. On April 11, 2005 Eagle Picher, Inc. and its affiliates announced
its voluntary Chapter 11 bankruptcy filing. On August 1, 2006, pursuant to their 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, the Company and EPCs subsidiary EaglePicher
Technologies, LLC (EPT) entered into an agreement pursuant to which (i) the Company shall
continue to supply certain products to EPT under the terms of the existing supply
agreement, (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 the Company the option to terminate the
Colorado Springs lease after December 31, 2006 with 90 days notice and (iv) the Company
agreed to terminate its right of first refusal on buying the EPT nickel hydrogen battery
business.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The
  Company   also  entered  into  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% as defined in the agreement.

Employment Agreement                Effective
May 2, 2005 (Effective Date), the Company entered into an employment agreement
(the Agreement) with Michael E. Reed, pursuant to which Mr. Reed will serve as
the Companys President and Chief Operating Officer. Mr. Reeds employment will
be at-will, and will carry an annual base salary of $190,000. Mr. Reed will be eligible
for an annual bonus based on goals and objectives set by the Board of Directors in
consultation with him. On May 30, 2006 the Company executed an addendum to the Agreement
that added the position of Chief Executive Officer on the same terms and conditions.

Stock Purchase Agreement                On
October 17, 2005, the Company entered into a Stock Purchase Agreement with a venture
capital firm, pursuant to which the venture capital firm has agreed to purchase 241,692
shares of unregistered common stock of the Company and 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 is $800,000 and is expected to be paid
over the course of 14 months following the closing, conditioned upon the Company achieving
certain development milestones. 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. During the year ended December 31, 2005, the
Company received $100,000 and issued 30,208 shares of unregistered common stock and 9,476
warrants in connection with this agreement. The Company and the venture capital firm have
agreed to complete the development project.

Legal Proceedings                Electro
Energy, Inc. is engaged in litigation with Lithium Nickel Asset Holding Company I
(LNAH) and Phoenix Commercial Park, LLP (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. At this juncture, the case is vigorously contested, and out of court settlement is
likely to occur upon a declaration from the Court establishing the entitlements and rights
of the assets and property in question. At this time, an evaluation of the likelihood of
outcome and estimate of potential loss is unable to be determined.

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. The Company has entered into 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.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9 
Stockholders Equity

Preferred Stock                 The
Company has authorized 10,000 shares of preferred stock, par value $0.001 per share, of
which 5,600, are designated as Series A Convertible Preferred Stock (Series A
Preferred) as specified in the Certificate of Designation (the
Certificate).

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 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
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, 2004, the Company issued 5,501 shares of Series A Preferred in a
private placement.

During
the year ended December 31, 2006 and 2005, 20 and 4,771 shares of Series A Preferred were
converted into 8,000 and 1,908,400 shares of common stock, respectively.

Common Stock                 The
Company has authorized 50,000,000 shares of common stock, par value $0.001. During the
years ended December 31, 2006 and 2005, the Company issued 72,297 and 1,387,579 shares of
common stock in connection with the exercise of employee stock options for proceeds of
$39,101 and $607,524, respectively.

During
the years ended December 31, 2006 and 2005, warrants were exercised for proceeds of
$175,000 and $730,528 in exchange for 92,687 and 826,079 shares of common stock,
respectively.

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
October 17, 2005, the Company entered into a Stock Purchase Agreement with a venture
capital firm (See Note 10). During the years ended December 31, 2006 and 2005, the Company
issued 60,424 and 30,208 shares of unregistered common stock for proceeds of $ $200,000
and $100,000, respectively.

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, 2006 and 2005, the Company had reserved 3,000,000 shares of common stock for
issuance under its 1993 Stock Compensation Plan (the 1993 Plan) and 3,000,000
shares of common stock for issuance under its 2005 Stock Compensation Plan (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.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Stock-based
compensation expense recognized in the Companys Consolidated Statements of
Operations for the year ended December 31, 2006 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, 2006
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
revised, if necessary, in subsequent periods if actual forfeitures differ from those
estimates.

The
Company recorded $994,025 of employee stock option compensation in the year ended December
31, 2006. The remaining balance of unamortized employee stock compensation as of December
31, 2006 was $1,892,331 and will be fully amortized through 2010.

During
the year ended December 31, 2006, the Company recorded an adjustment of $8,022 to
remeasure and amortize stock compensation expense in connection with 175,000 stock options
issued to consultants. The remaining balance of the stock compensation as of December 31,
2006 was $128,467 and will be amortized through June 2010.

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

| |                           | Numberof Options |             | Weighted Average Exercise Price
| | ------------------------- | ---------------- | ----------- | -------------------------------
| |                           |                  |             |                                
| | Balance January 1, 2005   |                  | 2,332,121   |                                
| | Granted                   |                  | 700,000     |                                
| | Exercised                 |                  | (1,387,579) |                                
| | Forfeited                 |                  | (327,189)   |                                
| |                           |                  |             |                                
| | Balance December 31, 2005 |                  | 1,317,353   |                                
| |                           |                  |             |                                
| | Granted                   |                  | 375,000     |                                
| | Exercised                 |                  | (72,297)    |                                
| | Forfeited                 |                  | (152,148)   |                                
| |                           |                  |             |                                
| | Balance December 31, 2006 |                  | 1,467,908   |                                
| |                           |                  |             |                                

The
weighted average grant date fair value of the options at date of grant using the Black Scholes
option-pricing model is estimated at $0.73 and $4.44 per option for the years ended
December 31, 2006 and 2005, respectively.

Stock
options outstanding and exercisable, by price range, as of December 31, 2006 are as
follows:

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

| | Exercise Price | Number    | WeightedAverageRemainingContractualLife inYears | WeightedAverageExercisePrice | AmountExercisable
| | -------------- | --------- | ----------------------------------------------- | ---------------------------- | -----------------
| |                |           |                                                 |                              |                  
| | $0.26          | 25,487    | 3.2                                             | $0.26                        | 25,487           
| | $1.16          | 492,421   | 6.7                                             | $1.16                        | 359,197          
| | $1.52          | 250,000   | 9.9                                             | $1.52                        | 0                
| | $1.82          | 100,000   | 9.8                                             | $1.82                        | 0                
| | $2.14          | 25,000    | 9.6                                             | $2.14                        | 0                
| | $3.94          | 200,000   | 8.9                                             | $3.94                        | 50,000           
| | $6.76          | 375,000   | 8.4                                             | $6.76                        | 93,750           
| |                |           |                                                 |                              |                  
| |                | 1,467,908 | 8.2                                             | $3.08                        | 528,434          
| |                |           |                                                 |                              |                  

The
total intrinsic value of options exercised during 2006 was $152,901.

The
aggregate intrinsic values of the outstanding and exercisable options at December 31,
2006 were $160,988 and $125,479, respectively.

A
summary of the option activity of nonvested options at December 31 2006, and changes
during the year ended December 31, 2006 is presented below:

|                          | 2006 | Weighted
                                                                                               Average
                                                                                                Grant
                                                                                                Date
                                                                                                Fair
                                                                                            Value
|------------------------- | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                          |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Nonvested at January 1,   |      | 1,012,934                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Vested                    |      | (308,812                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Issued                    |      | 375,000                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Forfeited                 |      | (139,648                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                          |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Nonvested at December 31, |      | 939,474                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                          |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

The
total fair value of shares vested during the year ended December 31, 2006 was $961,446.

Warrants                 The
Company has a Stock Purchase Agreement with a venture capital firm (See Note 10). During
the years ended December 31, 2006 and 2005, the Company issued 18,958 and 9,476 warrants,
respectively, in connection with this agreement.

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

On
March 31, 2005, the Company issued warrants to purchase 15,000 shares of the
Companys common stock in connection with a contract to receive a total of $450,000
in cash funding from a venture capital firm for intended use in the research and
development of certain battery technologies. (See Note 10)

During
the years ended December 31, 2006 and 2005, warrants were exercised for proceeds of
$175,000 and $730,528 in exchange for 92,687 and 826,079 shares of common stock,
respectively. As of December 31, 2006, 4,720,908 warrants are outstanding with expiration
dates ranging from July 16, 2007 through March 31, 2010 and exercise prices ranging from
$1.00 to $9.06. The weighted average exercise price of the outstanding warrants is $5.43.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10  Related
Parties

Consulting Services                 On
July 5, 2006, the Company entered into a consulting agreement (the Klein Consulting
Agreement) with Martin G. Klein, the Chairman of the Board of Directors of the
Company and its former Chief Executive Officer. The Klein Consulting Agreement provides
that Mr. Klein will consult with the Company on an ongoing basis as the Companys
Chief Technologist. Under the terms of the Klein Consulting Agreement, Mr. Klein will be
compensated at the rate of $8,000 per month, plus additional compensation at a rate of
$1,000 per day for extra work 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 from the date of the Klein Consulting Agreement until three years after the
termination or expiration of the Klein Consulting Agreement. The Klein Consulting
Agreement will expire on July 5, 2007, 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.

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 $152,973 and $44,779 for the years ended December 31,
2006 and 2005, respectively. Amounts due to these related parties as of December 31, 2006
and 2005 were $18,267 and $6,735, respectively.

Stock Purchase Agreement                On
October 17, 2005, the Company entered into a Stock Purchase Agreement with a venture
capital firm, pursuant to which the venture capital firm has agreed to purchase 241,692
shares of unregistered common stock of the Company and 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 is $800,000 and is expected to be paid
over the course of 14 months following the closing, conditioned upon the Company achieving
certain development milestones. 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. During the year ended December 31, 2005, the
Company received $100,000 and issued 30,208 shares of unregistered common stock and 9,476
warrants in connection with this agreement.

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Development Agreement                On
March 31, 2005, the Company entered into a development agreement to receive a total of
$450,000 in cash funding from a private venture capital firm, 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.

At
December 31, 2005, the weighted average fair value of the warrants using the Black Scholes
option-pricing model was $3.06 per warrant. Accordingly, the total estimated value of the
warrants was reduced by $42,057 to $41,710. The amount was recorded as a reduction of cost
of services-related parties expense and other accrued liability. Further, a reduction of
deferred contract cost and additional paid-in capital was recorded. During the year ended
December 31, 2005, the Company received an installment of cash funding and recognized
$150,000 of gross revenue from services rendered related to this development agreement.
The relative value of the warrants of $13,903 was recorded as a reduction to cost of
services-related parties expense and other accrued liability. In addition, a discount to
revenue and a reduction in deferred contract costs was recorded. As of December 31, 2005
the remaining deferred contract cost was $27,807.

The
weighted average fair value of the warrants using the Black Scholes option-pricing model
was revalued on December 31, 2006 at $0.35 per warrant. Accordingly, the total estimated
value of the warrants was reduced by $36,461 to $5,250. This amount was recorded as a
reduction of cost of services-related parties expense and other accrued liability.
Further, a reduction of deferred contract cost and additional paid-in capital was
recorded. During the year ended December 31, 2006, the Company received an installment of
cash funding and recognized $100,000 of gross revenue from services rendered related to
this development agreement. An adjustment to the relative value of the warrants of $2,916
was recorded as an increase to cost of services-related parties expense and other accrued
liability. In addition, a discount to revenue and an increase in deferred contract costs
was recorded. As of December 31, 2006 the remaining deferred contract cost was $2,333.

NOTE 11  Income
Taxes

The
Company has net operating loss carryforwards (NOLs) of approximately
$9,971,589 as of December 31, 2006 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. The deferred tax asset as of December 31, 2006 and 2005
consists of the following:

| |                                 | 2006 |             | 2005 |  
| | ------------------------------- | ---- | ----------- | ---- | -
| |                                 |      |             |      |  
| | Deferred tax asset              |      |             |      |  
| | Net operating loss carryforward | $    | 3,789,300   |      | $
| | Deferred rent                   |      | 138,200     |      |  
| | Stock based compensation        |      | 452,700     |      |  
| |                                 |      |             |      |  
| | Total deferred tax asset        |      | 4,380,200   |      |  
| | Less valuation allowance        |      | (4,380,200) |      |  
| |                                 |      |             |      |  
| | Total net deferred tax asset    |      | -           |      |  
| |                                 |      |             |      |  

---



ELECTRO ENERGY INC. AND
SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

|For the Year EndedDecember 31, | Amount
|------------------------------ | ------
|                               |       
|2023                           | $     
|2024                           |       
|2025                           |       
|2026                           |       
|                               |       
|Total                          | $     
|                               |       

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, 2006 and 2005 is as follows:

| |                                               | 2006 |          | 2005
| | --------------------------------------------- | ---- | -------- | ----
| |                                               |      |          |     
| |                                               |      |          |     
| | Tax benefit at statutory rate                 |      | 34.00%   |     
| | State and local taxes, net of federal benefit |      | 3.41%    |     
| | Permanent differences                         |      | (1.50)%  |     
| | Change in valuation allowance                 |      | (35.91)% |     
| |                                               |      |          |     
| | 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 contribute to the plan for the years ended December 31, 2006 and 2005.

NOTE 13  Subsequent
Events

The
Company has elected to pay the semi-annual interest and late registration penalties due on
March 31, 2007 related to the 8.5% senior secured convertible notes (the
Notes) in shares of the Companys common stock. According to the Note and
Warrant Purchase Agreement, 20 trading days prior to the interest payment due date, the
Company is obligated to 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. The number of shares the Company is obligated to issue is based upon the then
current interest conversion rate as described in the Note and Warrant Purchase Agreement.
In addition, the Company is required to give the note holders 15 trading days advance
notice of the Companys election to pay the interest and late registration penalties
payment amount in shares of the Companys common stock. Accordingly, on March 2,
2007, the Company, pursuant to the Note and Warrant Purchase Agreement, delivered an
aggregate of 765,769 shares of the Companys common stock to the note holders
accounts with The Depository Trust Company, representing the number of shares required to
pay the interest and late registration penalties under the Notes, which satisfies the
interest and late registration penalties owed as of March 31, 2007.

On
March 9, 2007, the Company, pursuant to the Note and Warrant Purchase Agreement, provided
notice to the note holders that the Company had elected to pay the interest and late
registration penalties due on March 31, 2007 under the Notes entirely in shares of the
Companys common stock.

---



# 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

Evaluation of Disclosure
Controls and Procedures

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), concluded that our disclosure controls and
procedures were appropriately designed and operating effectively to ensure that material
information relating to the Company is accumulated and would be made known to them by
others as appropriate to allow timely decisions regarding required disclosures.

Changes in Internal
Controls

Effective
August 8, 2006, Audra J. Mace resigned as Chief Financial Officer and Corporate Secretary
of Electro Energy, Inc. and its subsidiaries. Ms. Mace was not subject to an employment
agreement with the Company, and no contractual obligations remain between the Company and
Ms. Mace. Michael E. Reed, the Companys President and Chief Executive Officer, was
appointed interim Chief Financial Officer of the Company by the Board of Directors,
effective as of August 8, 2006, while the Company conducted a search for Ms. Maces
successor. Effective November 21, 2007, the Board of Directors appointed Timothy E. Coyne
as Chief Financial Officer replacing Mr. Reed. With the exception of Mr. Coynes
appointment, there were no other changes in internal controls over financial reporting
that occurred during the period covered by this report that have materially affected, or
are reasonably likely to materially effect, our internal control over financial
reporting.

We
do not believe that there are significant deficiencies in the design or operation of our
disclosure controls and procedures that could adversely affect our ability to record,
process, summarize and report financial data. Although there were no significant changes
in our disclosure controls and procedures or in other factors that could significantly
affect those controls subsequent to the Evaluation Date, our senior management, in
conjunction with the Board of Directors, continuously reviews overall company policies and
improves the documentation and procedures related to internal control matters and
financial reporting.

Limitations on the
Effectiveness of Controls

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. Because of the
inherent limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.

# 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.

|Name                  | Age | Position                                                               
|--------------------- | --- | -----------------------------------------------------------------------
|                      |     |                                                                        
|Martin G. Klein       | 69  | Founder, Chairman of the Board of Directors and Chief Technologist     
|Michael E. Reed       | 57  | President and Chief Executive Officer, Member of the Board of Directors
|Joseph F. Engelberger | 80  | Member of the Board of Directors                                       
|Warren D. Bagatelle   | 67  | Member of the Board of Directors                                       
|Farhad Assari         | 45  | Member of the Board of Directors                                       
|Robert P. Hamlen      | 77  | Member of the Board of Directors                                       
|William B. Wylam      | 71  | Member of the Board of Directors                                       
|Lawrence G. Schafran  | 68  | Member of the Board of Directors                                       
|Timothy E. Coyne      | 52  | Chief Financial Officer                                                
|                      |     |                                                                        

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:

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.

Joseph
F. Engelberger has served as a Director since 1992, also serving as a member of the
Audit and Corporate Governance and Nominating Committees since 2004. Mr. Engelberger has
over 50 years of experience as an entrepreneur/engineer and has participated in the
founding and start-up of a number of high technology companies. He founded the first
industrial robot company Unimation, Inc. in 1961 later sold to Westinghouse in 1983.
Thereafter, he founded HelpMate Robotics Inc, developing the first successful service
robot, HelpMate®, a robotic hospital courier, later merged with a subsidiary of
Cardinal Health in 1999. Mr. Engelberger retired as CEO of Helpmate in 1992.

---



Warren
D. Bagatellehas served as a Director since 2004, also serving as Chairman of the
Audit and Corporate Governance and Nominating Committees. He has been a Managing Director
of Loeb Partners Corporation, an investment banking firm, and a director of Fuel Cell
Energy, Inc. (NASDAQ: FCEL), a world leader in the development of high temperature
hydrogen fuel cells for clean electric power generation, since 1988. Mr. Bagatelle is also
the Chairman of the Board of VirtualScopics, Inc. (OTCBB:VSCP), a medical imaging services
company.

Farhad
Assari has served as a Director since 2004, also serving as a member of the Audit and
Corporate Governance and Nominating Committees. Mr. Assari has been involved in the
international investment management business for the past twenty years. He has held senior
executive positions at global financial institutions such as Citibank where he was
responsible for the investment management business throughout Europe, Middle East and
Africa. He is currently the managing director in private banking for a global financial
institution in Europe. Since 2004, Mr. Assari has been a principal of Investrust LLC, a
company that invests in growth companies. From 2001 to 2003, Mr. Assari built the Miami
offices of Neuberger Berman. Prior to that, from 1995 to 2000, he was a Regional Director
at Citibank. Mr. Assari received his Bachelor of Science from New York University (magna
cum laude) and completed his Masters of Business Administration at the Wharton School with
distinction.

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.

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, Nominating and Governance Committee and Audit and
Finance Committee. Our Compensation Committee is comprised of Joseph Engelberger, Robert
Hamlen and William Wylam, each an independent director. Our Nominating and Governance
Committee is comprised of Robert Hamlen, Warren Bagatelle and Martin Klein. Messrs. Hamlen
and Bagatelle are independent directors. 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 Warren Bagatelle, Lawrence Schafran and Joseph Engelberger. The
Board of Directors has determined that Messrs. Bagatelle 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, 2006, Forms 5 and amendments thereto furnished to us with respect
to the fiscal year ended December 31, 2006, 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, 2006, and 2005 by the
Companys (i) Principal Executive Officer, and (ii) the next two highest paid
executive officers as determined by Regulation S-B, Item 402.

---



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)                    | 2006 | $ | 190,000 | $ | -     | $ | -            | $ | 329,329           | $ | -                                      | $ | -                                           | $ | -                      | $ | 519,329
|Principal Executive Officer           | 2005 | $ | 127,890 | $ | -     | $ | -            | $ | 168,957           | $ | -                                      | $ | -                                           | $ | 73,315                 | $ | 370,162
|                                      |      |   |         |   |       |   |              |  
|Martin G. Klein(3)                    | 2006 | $ | 75,000  | $ | -     | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | 75,000 
|Chairman                              | 2005 | $ | 150,001 | $ | -     | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | 150,001
|                                      |      |   |         |   |       |   |              |  
|Timothy E. Coyne(4)                   | 2006 | $ | 17,308  | $ | -     | $ | -            | $ | 1,826             | $ | -                                      | $ | -                                           | $ | -                      | $ | 19,134 
|Chief Financial Officer               | 2005 | $ | -       | $ | -     | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | -      
|                                      |      |   |         |   |       |   |              |  
|Michael D. Eskra(5)                   | 2006 | $ | -       | $ | -     | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | -      
|President and Chief Operating Officer | 2005 | $ | 50,615  | $ | -     | $ | -            | $ | 72,678            | $ | -                                      | $ | -                                           | $ | 35,250                 | $ | 158,543
|                                      |      |   |         |   |       |   |              |  
|J. Albert Estrada(6)                  | 2006 | $ | -       | $ | -     | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | -      
|Vice President - Sales and Marketing  | 2005 | $ | 109,659 | $ | -     | $ | -            | $ | -                 | $ | -                                      | $ | -                                           | $ | -                      | $ | 109,659
|                                      |      |   |         |   |       |   |              |  
|Audra J. Mace(7)                      | 2006 | $ | 85,153  | $ | -     | $ | -            | $ | 145,186           | $ | -                                      | $ | -                                           | $ | 4,673                  | $ | 235,012
|Chief Financial Officer & Secretary   | 2005 | $ | 130,200 | $ | -     | $ | -            | $ | 139,484           | $ | -                                      | $ | -                                           | $ | -                      | $ | 269,684

|(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 was
paid relocation compensation of $73,315 in 2005.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(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) |  | Mr.
Eskra resigned as President and Chief Operating Officer effective March 22, 2005.  He was
paid severance of $19,885 and accrued vacation of $15,365.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Mr.
Estrada resigned as Vice President  Sales and Marketing as of October 31, 2005.
|--- |  | ------------------------------------------------------------------------------------

|(7) |  | Ms.
Mace resigned as Chief Financial Officer effective August 8, 2006.  She was paid accrued
vacation of $4,673.
|--- |  | ----------------------------------------------------------------------------------------------------------------

---



# Outstanding Equity
Awards at Fiscal Year End

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

# Director Compensation

|Name                  |   | Fees Earned
     or Paid
     in Cash |   | Stock
   Awards |   | Option
   Awards |   | Non-Equity
     Incentive
        Plan
    Compensation |   | Nonqualified
     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       | $ | 1,500                                 | $ | -               | $ | -                | $ | -                                                       | $ | -                                                         | $ | 48,000                     | $ | 49,500 |  | -                                                                                         |  | -                                                                                        
|Joseph F. Engelberger | $ | 4,500                                 | $ | -               | $ | -                | $ | -                                                       | $ | -                                                         | $ | -                          | $ | 4,500  |  | -                                                                                         |  | -                                                                                        
|Warren D. Bagatelle   | $ | 4,000                                 | $ | -               | $ | 83,891           | $ | -                                                       | $ | -                                                         | $ | -                          | $ | 87,891 |  | -                                                                                         |  | 75,000                                                                                   
|Farhad Assari         | $ | 2,500                                 | $ | -               | $ | 41,945           | $ | -                                                       | $ | -                                                         | $ | -                          | $ | 44,445 |  | -                                                                                         |  | 37,500                                                                                   
|Robert P. Hamlen      | $ | 3,000                                 | $ | -               | $ | 18,973           | $ | -                                                       | $ | -                                                         | $ | 8,000                      | $ | 29,973 |  | -                                                                                         |  | 25,000                                                                                   
|William B. Wylam      | $ | 1,000                                 | $ | -               | $ | 1,730            | $ | -                                                       | $ | -                                                         | $ | 23,000                     | $ | 25,730 |  | -                                                                                         |  | 25,000                                                                                   
|Lawrence G. Schafran  | $ | 500                                   | $ | -               | $ | 609              | $ | -                                                       | $ | -                                                         | $ | -                          | $ | 1,109  |  | -                                                                                         |  | 50,000                                                                                   

---



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 February 28, 2007, 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% Stockholders                                                                   |                                        |      |                                           
|                                                                                  |                                        |      |                                           
|Lithium Nickel Asset Holding Company I7 South Jersey Ave.East Setauket, NY  11733 | 8,750,000                              | (3)  |                                           
|                                                                                  |                                        |      |                                           
|Executive Officers and Directors                                                  |                                        |      |                                           
|Martin G. Klein                                                                   | 6,379,782                              | (5)  |                                           
|Warren D. Bagatelle                                                               | 1,267,407                              | (6)  |                                           
|Joseph Engelberger                                                                | 313,717                                |      |                                           
|Farhad Assari                                                                     | 83,575                                 | (8)  |                                           
|Robert Hamlen                                                                     | 6,250                                  | (10) |                                           
|William Wylam                                                                     | --                                     |      |                                           
|Lawrence Schafran                                                                 | --                                     |      |                                           
|Michael E. Reed                                                                   | 89,050                                 | (12) |                                           
|Timothy E. Coyne                                                                  | --                                     |      |                                           
|Directors and executive officers as a group(seven persons)                        | 8,139,781                              |      |                                           

|(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 February 28, 2007, 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.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



|(2) |  | Unless
otherwise indicated, based upon 22,583,127 shares of common stock           outstanding
on February 28, 2007; 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 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) 22,583,127 shares of common stock outstanding, plus (ii)           3,000,000
shares of common stock issuable upon the exercise of warrants.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | 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.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) |  | Includes
(i) 493,707 shares of common stock outstanding, 85,950 shares of common           stock
issuable upon the exercise of warrants and 18,750 shares of common stock
          issuable upon the exercise of options held by Mr. Bagatelle, (ii) 428,689
shares           of common stock outstanding and 115,950 shares of common stock issuable
upon the           conversion of shares of series A convertible preferred stock and the
exercise of           warrants held by the Trust FBO Thomas L. Kempner, (iv) 114,115
shares of common           stock outstanding held by Shari Popkin Fleischer, and (v)
10,246 shares of           common stock outstanding held by Matrix USA, LLC. Mr.
Bagatelle expressly           disclaims beneficial ownership of the common stock owned or
acquirable by the           other investors.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) |  | Based
upon (i) 22,583,127 shares of common stock outstanding, plus (ii) 20,000           shares
of common stock issuable upon conversion of series A convertible           preferred
stock, plus (iii) 181,900 shares of common stock issuable upon the           exercise of
warrants and (iv) 18,750 shares of common stock issuable upon the           exercise of
options.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | Includes
(i) 20,000 shares of common stock outstanding and 9,375 shares of           common stock
issuable upon the exercise of options held by Mr. Assari and (ii)           42,800 shares
of common stock outstanding and 11,400 shares of common stock           issuable upon the
exercise of warrants held by Merkantil 7, Inc., an affiliate           of Mr. Assari.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) |  | Based
upon (i) 22,583,127 shares of common stock outstanding, plus (ii) 11,400           shares
of common stock issuable upon the exercise of warrants and (iii) 9,375           shares
of common stock issuable upon the exercise of options.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | Includes
6,250 shares of common stock issuable upon the exercise of options held           by Mr.
Hamlen.
|---- |  | ---------------------------------------------------------------------------------------------------------

|(11) |  | Based
upon (i) 22,583,127 shares of common stock outstanding, plus (ii) 6,250           shares
of common stock issuable upon the exercise of options.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------

|(12) |  | Includes
14,050 shares of common stock outstanding and 75,000 shares of common           stock
issuable upon the exercise of options held by Mr. Reed.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) |  | Based
upon (i) 22,583,127 shares of common stock outstanding, plus (ii) 75,000           shares
of common stock issuable upon the exercise of options.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(14) |  | Based
upon (i) 22,583,127 shares of common stock outstanding, plus (ii) 20,000           shares
of common stock issuable upon conversion of series A convertible           preferred
stock, plus (iii) 193,300 shares of common stock issuable upon the           exercise of
warrants, plus (iv) 105,775 shares of common stock issuable upon           exercise of
options.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

---



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

Related Party Transactions

On
July 5, 2006, the Company entered into a consulting agreement (the Klein Consulting
Agreement) with Martin G. Klein, the Chairman of the Board of Directors of the
Company and its former Chief Executive Officer. The Klein Consulting Agreement provides
that Mr. Klein will consult with the Company on an ongoing basis as the Companys
Chief Technologist. Under the terms of the Klein Consulting Agreement, Mr. Klein will be
compensated at the rate of $8,000 per month, plus additional compensation at a rate of
$1,000 per day for extra work 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 from the date of the Klein Consulting Agreement until three years after the
termination or expiration of the Klein Consulting Agreement. The Klein Consulting
Agreement will expire on July 5, 2007, 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.

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 $152,973 and $44,779 for the years ended December 31,
2006 and 2005, respectively. Amounts due to these related parties as of December 31, 2006
and 2005 were $18,267 and $6,735, respectively.

Promoters and Control
Persons

Mr.         Bagatelle
and his spouse currently hold non-controlling interests in Matrix USA,           LLC (Matrix),
a finder in the private placement consummated in July           2004. Matrix received
cash in the amount of $128,500 and equity-based           compensation of $61,000 in the
form of Series A Convertible Preferred Stock and           112,500 warrants to purchase
shares of common stock in connection with the           private placement. Shari Popkin
Fleischer, the Chairperson of Matrix is a           current shareholder of the Company.

Director Independence

Currently,
Warren Bagatelle, Joseph Engelberger, Farhad Assari, Robert Hamlen, William Wylam and
Lawrence Schafran 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)
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|21.1 |  | Subsidiaries
of the Company. (5)
|---- |  | --------------------------------

|31.1 |  | Section
302 Certification of Chief Executive Officer.((5))
|---- |  | ----------------------------------------------------------

|31.2 |  | Section
302 Certification of Chief Financial Officer.((5))
|---- |  | ----------------------------------------------------------

|32.1 |  | Section
906 Certification of Chief Executive Officer.((5))
|---- |  | ----------------------------------------------------------

|32.2 |  | Section
906 Certification of Chief Financial Officer.((5))
|---- |  | ----------------------------------------------------------

|(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) |  | 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, 2006 and 2005, and fees billed for
other services rendered by Marcum & Kliegman, LLP.

| |                        |   | 2006    |  |   | 2005    | 
| | ---------------------- | - | ------- |  | - | ------- | 
| | Audit Fees (1)         | $ | 150,316 |  | $ | 105,500 | 
| | Audit-Related Fees (2) | $ | 96,496  |  | $ | 72,390  | 
| | Tax Services (3)       | $ | -0-     |  | $ | -0-     | 
| | All Other Fees         | $ | -0-     |  | $ | 14,504  | 

| |  | (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 2, 2007 |                    

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/ Martin G. Klein  
| | ----- | ------------- |  | ---------------------
| |       |               |  | Name: Martin G. Klein
| | Date: | April 2, 2007 |  | Title: Chairman      

| |       |               |  | /s/ Michael E. Reed                         
| | ----- | ------------- |  | --------------------------------------------
| |       |               |  | Name: Michael E. Reed                       
| | Date: | April 2, 2007 |  | Title: President and Chief Executive Officer

| |       |               |  | /s/ Timothy E. Coyne          
| | ----- | ------------- |  | ------------------------------
| |       |               |  | Name: Timothy E. Coyne        
| | Date: | April 2, 2007 |  | Title: Chief Financial Officer

| |       |               |  | /s/ Joseph Engelberger  
| | ----- | ------------- |  | ------------------------
| |       |               |  | Name: Joseph Engelberger
| | Date: | April 2, 2007 |  | Title: Director         

| |       |               |  | /s/ Warren D. Bagatelle  
| | ----- | ------------- |  | -------------------------
| |       |               |  | Name: Warren D. Bagatelle
| | Date: | April 2, 2007 |  | Title: Director          

| |       |               |  | /s/ Farhad Assari  
| | ----- | ------------- |  | -------------------
| |       |               |  | Name: Farhad Assari
| | Date: | April 2, 2007 |  | Title: Director    

| |       |               |  | /s/ Robert Hamlen  
| | ----- | ------------- |  | -------------------
| |       |               |  | Name: Robert Hamlen
| | Date: | April 2, 2007 |  | Title: Director    

---



| |       |               |  | /s/ William Wylam  
| | ----- | ------------- |  | -------------------
| |       |               |  | Name: William Wylam
| | Date: | April 2, 2007 |  | Title: Director    

| |       |               |  | /s/ Lawrence Schafran  
| | ----- | ------------- |  | -----------------------
| |       |               |  | Name: Lawrence Schafran
| | Date: | April 2, 2007 |  | Title: Director        

---