Summary of ZBB ENERGY CORP

Item 6. Management's Discussion and Analysis or Plan of Operation

WE URGE YOU TO READ THE FOLLOWING DISCUSSION IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO BEGINNING ON PAGE 29. THIS DISCUSSION MAY CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS COULD DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY THE FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF FACTORS, INCLUDING BUT NOT LIMITED TO THE RISKS AND UNCERTAINTIES DISCUSSED UNDER THE HEADING "RISK FACTORS" IN THIS FORM 10K-SB AND IN OUR OTHER FILINGS WITH THE SEC. SEE "CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS."

Company Background

Since our inception in 1981, and through 2004, we have been a research and development company with little or no revenues. We have historically funded our operations primarily through debt and equity financings, government grants and joint ventures.

The company completed a public offering on the Australian Stock Exchange (the "ASX") in March of 2005. Our securities traded on the ASX from March 2005 to August 9, 2007 when they were delisted in connection with our United States public offering.

In 2005 we began production under a contract with the Department of Energy and the California Energy Commission ("CEC") to produce our first commercial energy storage system.

On June 18, 2007, in connection with our initial United States public offering of 3,333,333 shares of our common stock at an initial offering price of $6.00 per share, our shares began trading on the American Stock Exchange under the symbol "ZBB".

Our production capacity remains limited even after completion of our United States public offering. Since the IPO we have commenced implementation of our business plan including the repayment of certain indebtedness, initiating manufacturing commercialization and capacity increases, and securing and implementing our project with the Commonwealth of Australia. We also commenced initial commercial marketing of our products into target markets.

Our business model involves marketing primarily to large utility companies and renewable energy customers. In order for these customers to make the most efficient use of our products in their electricity production and delivery operations, they would likely purchase our energy storage systems in quantities that could exceed our current production capacity. If our sales are successful, we may be required to get additional financing to meet demand.

Our products reflect a new technology that has not yet attained commercial acceptance in the market. Additionally, we intend to compete with the existing lead-acid storage system and other technologies which have attained market acceptance.

Results of Operations

Year ended June 30, 2008 as compared to the year ended June 30, 2007:

Revenue and Other income:

Our revenues for the year ended June 30, 2008 were $1,279,599 which reflected an increase of $695,780 from $583,819 for the year ended June 30, 2007. This increase was primarily attributable to $976,536 from our contract with the Commonwealth of Australia, and a $280,756 reduction in revenues from the contract with the California Energy Commission which was completed in March 2008. Revenues include estimates based on the percentage-of-completion method of accounting for long-term contracts.

Other income for the year ended June 30, 2008 was $547,340, which reflected an increase of $429,050 from $118,290 for the year ended June 30, 2007. This resulted from a $447,851 increase in interest income from the investment of proceeds from the Company's U.S. public offering in June 2007. Interest income is expected to decrease in future periods as proceeds from the public offering are utilized for capital expenditures and operational purposes and from lower interest rates on the funds invested, based on current market rates. The increase was partially offset by an $18,801 decrease in rental revenues. We also expect rental income to decrease in future periods as the facility in Wisconsin is expanded into commercial manufacturing and distribution activities.

Costs and Expenses and Other Expense:

Total operating expenses for the year ended June 30, 2008 were $6,525,444, which represents an increase of $1,685,334 from expenses of $4,840,110 for the year ended June 30, 2007.

The total operating expense increase was due increases in selling, general and administrative expense of $567,297; advanced engineering and development cost increases of $1,309,370; and depreciation expense of $56,272; and a decrease of $247,605 in cost of contracts.

Other expenses for the year ended June 30, 2008 were $206,158 which represents a decrease of $5,285,573 from expenses of $5,491,731 in the year ended June 30, 2007.

The decrease in other expenses was primarily due to the significant financing costs during the year ended June 30, 2007 and leading up to the initial US public offering which closed on June 20, 2007. These costs included $910,096 in interest expense (see below), $583,258 in amortization of deferred financing fees, $3,133,665 in finance charges (including $1,430,000 in amortization of beneficial conversion benefits on notes, $1,205,603 in Bushido loan warrants issued, and $498,062 in amortizations of debt, warrant, and option discounts), and $864,712 in debt extinguishment expenses resulting from the early retirement of debt issued in 2006 and 2007 (Bushido lenders and Montgomery notes) and repaid and/or converted into Company shares during June, July and August 2007.

During the year ended June 30, 2008, except for the building and equipment bank loans, all debt was converted to shares of our common stock or repaid which has significantly reduced interest expense.

Cost of Product Sales. Our cost of contracts for the year ended June 30, 2008 was $300,751, which represented a decrease of $247,605 from the comparable 2007 period expense of $548,356. The decrease resulted directly from the completion of the long-term CEC contract in March 2008. Cost of product sales includes allocations and estimates based on the percentage-of-completion method of accounting for long-term contracts. Costs in the current year related to the AEST advanced engineering contract in Australia were classified as "advanced engineering and development costs" and not included in the "cost of contracts".

Selling, General and Administrative. Our selling, general and administrative expenses for the year ended June 30, 2008 was $3,350,330, which represented an increase of $567,297 from the same expenses in the comparable 2007 period of $2,783,033. Included were increases of approximately $300,000 in costs directly related to our initial U.S. public offering, Australian Stock Exchange de-listing, and compliance costs. The remaining balance of the increase is mostly attributable to additional investor and public relations costs; management, financial and administrative personnel; the establishment of a sales and marketing department; and overall cost increases.

We also began multiple compliance and quality related initiatives and expect to continue to incur these "one time" expenses in the upcoming year to implement and improve our environmental, employee health and safety, obtaining UL certification from Underwriter Laboratories, Inc. and ISO 9001 certification, Sarbanes-Oxley, and other "best practices" processes.

We expect our advertising and marketing expenses to increase as a result of attending and exhibiting our products at energy trade shows and an overall expansion of our sales and marketing efforts. However, we expect that these expenses will decrease as a percentage of sales if we are successful in expanding our business.

Travel costs were $296,341 and $237,649 for the years ended in June 30, 2008 and June 30, 2007, respectively, due to installation and maintenance of our product sold to the California Energy Commission and significant increases in our sales and marketing efforts. We expect travel related to marketing and business development to increase as our sales efforts and installations increase.

Insurance costs include insurance benefits for employees of $120,822 and general liability insurance of $64,819. We acquired a $5,000,000 Directors and Officers policy in July 2007 costing $39,500 annually.

Advanced Engineering and Development. Our engineering and development costs for the year ended June 30, 2008 were $2,558,423 which represented an increase of $1,309,370 from the comparable 2007 period expenses of $1,249,053. The increase from the comparable 2007 period was primary due to an additional $1,012,068 in engineering staffing and materials costs incurred related to the Australian AEST project contract, as well as further development and improvements to the energy storage system manufacturing capacity, quality control, and cost improvement processes. This project will affect future expenditures through the term of the contract to the extent the costs are allowable under the contract. We intend to maintain our Australian staff and facility for the purposes of facilitating further marketing in Australia and Asia and for advanced engineering and development projects as needed.

Net Loss. Our net loss for the year ended June 30, 2008 and 2007 was $4,904,663 and $9,629,732, respectively. The $4,725,069 reduction in net loss was the result of a $5,285,573 decrease of in other expense, an increase in other income of $429,050, which was offset by an increase of $989,554 in loss from operations.

Known Trends, Market Opportunities and Challenges

We believe that there are specific existing and rapidly emerging market opportunities for the Company's energy storage products.

We believe that in North America the electric utilities markets' increasing energy demands on an increasingly fragile transmission and distribution network is forcing both utilities and commercial and industrial customers to adopt distributed storage and delivery systems to increase the reliability and the capacity of the electrical grid. Network reliability depends on both energy storage systems, and delivery products that are lower in cost, have greater life span and are lower in emission with minimal disposal costs. We have designed our products to meet these needs in that they can be combined for use in larger storage applications and we believe that our products will cost less with competing products, based on a life of product basis and on energy density and delivery. We believe that the increasing importance of renewable energy generating sources for future energy supply is now being enhanced with Federal and State Government initiatives to lessen the United States greenhouse gas emissions and dependency on oil. Increasing concerns surrounding CO2 emissions are also driving this market sector. We believe that solar and wind energy has grown over the past five years and will continue to grow for so long as fossil fuel prices are increasing. Because both solar and wind are intermittent primary energy sources, both grid connected and off-grid installations require energy storage devices to optimize their capabilities.

We continues to advance the sales and marketing process in the areas of sales network structure, direct key accounts, strategic relationships, marketing and industry/policy involvement.

We continue to build a direct market pipeline of opportunities which include several electric utilities; various oil companies involved in renewable energy; large renewable energy integrators involved in on-grid and off-grid applications, government facilities and other commercial and industrial opportunities such as "big box" store chains.

We have advanced the ZBB presence and awareness in the market through increased involvement in various market conferences (energy storage, wind, and solar, electric utility), increased direct marketing, advancing the marketing materials and web content, as well as continued efforts in media channels and highly visible applications such as the Future House USA installation at the Beijing Olympic Games in China and the LifeVillage project with Envision Solar International for the purpose of transporting village power systems to remote areas in Central and West Africa. ZBB is in the process of furthering these marketing and networking efforts with additional marketing activities that will continue to raise the profile of ZBB and the ZESS brands.

We continue to work in the California energy and utility markets through the CEC (under a new May 2008 agreement), and pursue opportunities with Pacific Gas & Electric and the U.S. Department of Energy amongst others, to install products into the local transmission and distribution network. In addition we are currently addressing opportunities in the renewable energy markets in both the United States, Australia, and Africa with the intention of introducing products and services into these markets.

Our recent efforts also include a collaborative project (Advanced Electricity Storage Technologies project) with the Commonwealth of Australia which commenced July 2007 and running through July 2010, which includes the payment to the Company of $2.7 million for future development costs and which includes the production and delivery of one 500kWh energy storage system for installation into a renewable energy site in Australia.

In addition to the other risk factors stated above, and other information relating to our business as referenced in our "Business" section, we believe that some of the biggest challenges we face will be gaining market acceptance for our newer products and reaching the utility and renewable energy companies that we target. In order to be successful we must also develop a reputation of reliability and quality service.

Issuance of Stock Options

1998 Key Employee Stock Option Plan

In 1998 the Company adopted a Key Employee Stock Option Plan (the "KESOP") pursuant to which up to 268,927 shares of common stock were authorized for grants of options, rights, and stock awards. The exercise price of all options granted under the Plan was determined by the Board of Directors at an amount no less than the estimated fair value of the Company's common stock at the date of grant. No options were exercised and 4,413 options expired during the twelve months ended June 30, 2008. As of June 30, 2008 there were no options or other awards outstanding under the KESOP and there were no additional shares available for grant.

1998 Outside (Non-Executive) Directors Stock Option Plan

In 1998 the Company adopted an Outside (Non-Executive) Directors Stock Option Plan (the "ODSOP") whereby 67,231 options were issued to Non-Executive Directors over a five year period commencing on January 2, 1999. As of June 30, 2008, all ODSOP options had been granted. During fiscal 2007, 9,882 ODSOP options were exercised. No options were exercised and 8,470 options expired during the twelve months ended June 30, 2008. As of June 30, 2008 there were no options outstanding under the ODSOP.

2002 Stock Option Plan

In 2002 the Company established the 2002 Stock Option Plan ("SOP") whereby a stock option committee was given the discretion to grant up to 882,353 options to key employees of the Company at exercise prices and dates to be determined by the directors. During the year ended June 30, 2008 400,000 options were granted to employees and directors exercisable at $3.59 (110% of the market closing price on June 6, 2008) based on vesting terms of June 2008 through January 2009, and exercisable at various dates through June 2014. No options were exercised and 93,028 options expired during the twelve months ended June 30, 2008. At June 30, 2008 there remain 504,700 options outstanding with exercise prices of not less than $3.59 and exercise dates up to June 30, 2014. A further 74,407 options are available to be issued under the SOP.

2005 Employee Option Scheme

During 2005 the Company established an Employee Stock Option Scheme (the "2005 Plan") that authorizes the board of directors or a committee thereof, to grant options to employees and directors of the Company or any affiliate of the Company. The maximum number of options that may be granted in aggregate at any time under this option scheme or under any other employee option or share plan is the number equivalent to 5% of the total number of issued shares of the Company including all shares underlying options under the KESOP, the ODSOP and the SOP. Options issued expire five years after the vesting date. During the year ended June 30, 2007 250,000 options were granted. No options have been exercised in fiscal 2007 or fiscal 2008. At June 30, 2008, 250,000 options with an exercise price of $3.82 and an expiration date of June 12, 2012 remain outstanding. A further 205,838 are available to be issued under this plan.

2007 Equity Incentive Plan

During 2007 the Company established the 2007 Equity Incentive Plan (the "2007 Plan") that authorizes the board of directors or a committee thereof, to grant up to a maximum of 1,500,000 options to employees and directors of the Company at exercise prices to be determined by the administrator but not less than 100% (110% for a 10% shareholder) of the market value on the date granted. The maximum number of shares subject to options granted to any one employee during any fiscal year shall not exceed 300,000. During the year ended June 30, 2008 275,000 options were granted to employees and directors exercisable at $3.59 (110% of the market closing price on June 6, 2008) based on vesting terms of June 2008 through January 2011, and exercisable at various dates through January 2016. A further 1,225,000 options are available to be issued under the 2007 plan.

In aggregate for all plans, at June 30, 2008, the Company has a total of 1,029,700 options outstanding and 1,505,245 options available for future grant under the SOP, the Employee Stock Option Scheme, 2005 and the 2007 Plans.

Broker Options issued in connection with public offering in Australia

In connection with our initial public offering on the ASX in March of 2005, we issued to the brokers selling our securities options to acquire 314,176 shares of our common stock at an exercise price of A$8.50 (US$6.46) per share. These options expired on December 15, 2007. None of the options have been exercised.

Options issued to convertible note holders prior to public offering in Australia

In connection with our public offering in Australia on the ASX in March of 2005, including convertible note holders who converted their notes into common stock, an additional 286,765 options to purchase common stock at an exercise price of $7.65 per share. These options expired in December 2007. None of these options have been exercised.

Options issued in connection with financings

In connection with financings of the Company in 2006 and 2007, we also issued options or warrants or convertible notes to acquire shares of common stock, as follows:

� 120,023 warrants have been issued to Empire Financial Group, Inc., one of the managing underwriters of our recently completed underwritten public offering, and certain of its affiliates in connection with their assistance with our capital raising activities. These warrants are exercisable at $3.23 per share and expire on September 30, 2011 and were subject to a lock-up agreement through December 20 of 2007.

� 50,000 underwriters warrants exercisable at $7.20 per share and expire on June 20, 2012 were issued to Empire Financial Group, Inc. as part of the underwriting compensation in connection with their acting as managing underwriter of our United States initial public offering in June of 2007.

� 195,800 warrants issued to Strategic Growth International in connection with their assistance with capital raising activities leading up to and including the June 2007 public offering. These warrants are $3.75 and $7.20 per share and expire between March 2011 and June 2012.

� In addition, warrants have been issued under the Bushido Loan and the Montgomery Loan along with convertible notes to acquire shares as described under Recent Sales of Unregistered Securities. These warrants and loans have been exercised or repaid during the June 2007 public offering or shortly thereafter.

Liquidity and Capital Resources

Since our inception, our research and development and operations were primarily financed through debt and equity financings, government grants and joint ventures. Total paid in capital as at June 30, 2008 and June 30, 2007 was $45,724,731 and $45,095,204, respectively. We had a cumulative deficit of $31,726,795 through June 30, 2008 and a cumulative deficit of $26,822,131 through June 30, 2007. As of June 30, 2008 we had a working capital surplus of $8,611,872 and as of June 30, 2007 a working capital surplus of $11,617,425, respectively, and our net worth as of June 30, 2008 and June 30, 2007 was $12,016,118 and $15,918,203, respectively.

As a result of consummation of our initial United States public offering and our receipt of $18,410,000 (net of underwriters' costs) proceeds on June 20, 2007, our working capital increased by $17,267,365 (net proceeds less $1,142,635 in capital raising costs) during the year ended June 30, 2007.

Additional funding will continue to be generated from an agreement entered into on June 29, 2007 by ZBB Technologies, Ltd, our subsidiary based in Western Australia, and the Commonwealth of Australia, and which commenced in July 2007 whereby the Company commenced engineering and product development activities pursuant to a collaborative project entitled the Advanced Electricity Storage Technologies ("AEST") project, through July 2010. The terms of the project provide for the receipt of $2.7 million by the Company of which $1.3 million has been received as of June 30, 2008.

We believe that we will have sufficient capital necessary to meet our operating and capital commitments for at least the next eighteen months. However, if product sales increase substantially, we will require additional capital in order to expand our production capacity.

Material Commitments for Capital Expenditures

From the proceeds of our June 2007 United States initial public offering, we retired an aggregate of $4.5 million in indebtedness (including conversions of debt) in July and August 2007. The use of proceeds also included approximately $3.7 million towards the acquisition of new vibration welding and production equipment of which approximately $1.4 million has been either acquired or committed during fiscal 2008.

Operating Activities

For the year ended June 30, 2008, net cash used in operations was $4,379,777 after adding back non-cash items of $888,230 consisting primarily of depreciation, stock based compensation, and equipment used in operations. Sources of cash provided by operations resulted from a decrease in accounts receivable of $188,602; and increases in accrued expenses of $45,603 and deferred revenues of 308,395. Cash used in operations resulted from increases in inventory of $40,318, prepaid and other current assets of $235,485, and interest receivable of $44,227; and decreases in accounts payable of $228,664 and accrued loss on contracts of $357,250.

For the year ended June 30, 2007, net cash used in operations was $3,401,618 after adding back non-cash items of $5,759,414 consisting primarily of depreciation, issuances and amortizations of financial assets, deferred finance fees and discounts, debt extinguishment expenses and increases in accrued interest expense. Sources of cash provided by operations resulted from increases in accounts payable of $546,041; accrued expenses of $26,061; and decreases in inventory of $155,845; prepaid and other current assets of $106,192. Cash used in operations resulted from increases in accounts receivable of $28,670 and a decrease in deferred revenues of $336,768.

Investing Activities

For the year ended June 30, 2008, net cash used in investing activities was $721,468 due to increases in capital expenditures for manufacturing and testing equipment, building improvements, and computer software and hardware.

For the year ended June 30, 2007, net cash used in investing activities was $201,667 due to purchases of manufacturing equipment and computer hardware.

Financing Activities

For the year ended June 30, 2008, net cash used by financing activities was $4,270,457. Cash was used in the repayment of $1,882,634 in bank loans and notes payable of $4,047,823, and additional costs related to the June 2007 public offering of $100,000. Financing sources were provided from the refinancing of a bank loan in the amount of $1,760,000.

For the year ended June 30, 2007, net cash provided from financing activities was $20,693,671 consisting primarily of $18,410,000 of proceeds from our initial U.S. public offering less financing and other capital raising charges related to the offering of $1,142,635. Other sources included debt and convertible notes issued of $2,260,000, bank loans of $117,223, and $1,155,333 from exercise of stock options and warrants, less $106,250 in additional deferred finance fees.

$1,000,000 Montgomery Capital Partners LP Convertible Loan Financing

On February 28, 2006 the Company borrowed $1,000,000 from Montgomery Capital Partners L.P. ("Montgomery"), and entered into a convertible loan and warrant agreement (the "Montgomery Facility"). Interest on the Montgomery Facility accrued at 10% per annum compounded monthly and became payable in full on the earliest to occur of the consummation by the Company of any major financing, a default, or February 28, 2008.

On July 11, 2007, subsequent to the Company's public offering, the Company repaid the Montgomery Facility in full, an aggregate of $1,295,239 representing $890,000 of the outstanding principal amount of the Montgomery Facility, $124,918 in accrued interest, $178,000 as the contractual prepayment premium, and $102,321 in certain loan deferral fees all of which were accrued and expensed during the year ended June 30, 2007. Under the terms of the Montgomery Facility, the Company was also required to issue to Montgomery a number of shares of common stock equal to 50% of the amount required to be repaid under the Montgomery Facility, divided by the conversion price then in effect. Based on the application of above formula, Montgomery was issued an aggregate of 202,674 shares of common stock.

The Montgomery Facility also provided that Montgomery would receive up to 117,647 warrants to purchase common stock, the exercise price of which was to set at the time subscription notice was given with respect to such warrants. On July 11, 2007, the Company issued an aggregate of 63,263 shares of common stock in respect of the cashless exercise of Montgomery's warrants.

There are no outstanding obligations under the Montgomery Facility or to Montgomery at June 30, 2008.

$2,226,666 Bushido Loan

On June 14, 2006 the Company entered into a Note Purchase Agreement with Bushido Capital Master Fund, L.P.; ABS SOS-Plus Partners, Ltd ("ABS-SOS"); and Pierce Diversified Strategy Master Fund ("Pierce"), (the "Bushido Lenders") pursuant to which the Company issued an aggregate of $2,226,667 face amount of secured promissory notes at a 25% original issue discount (the "Bushido Loan") and warrants to purchase the Company's common stock (the "Bushido Warrants"). Interest on the Bushido Loan accrued at 8%, payable quarterly on 75% of the face amount of the notes. The Bushido Loan was due in full on July 14, 2008.

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