Summary of ZBB ENERGY CORP

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The following information should be read in conjunction with the financial statements and notes thereto in Part I, Item 1 of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-KSB for the year ended June 30, 2008.

Forward-Looking and Cautionary Statements

Information provided by us or statements made by our employees may, from time to time, contain "forward-looking" information that involves risks and uncertainties. In particular, statements contained in this Quarterly Report that are not historical facts constitute forward-looking statements and are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve substantial risks and uncertainties. You can identify these statements by forward-looking words such as "may", "expect", "anticipate", "believe", "estimate", "continue", and similar words. You should read and use our forward-looking statements carefully because they:
(1) discuss our future expectations; (2) contain projections of our future operating results or financial condition; or (3) state other "forward-looking" information. Various factors described below, as well as any other instances of cautionary language in this Quarterly Report, refer to or provide examples of risks, uncertainties and events that may cause our actual results to be materially different than the expectations described in our forward-looking statements. You should be aware that the occurrence of any of the events or factors described below and elsewhere in this Quarterly Report could materially and adversely affect our business. All forward-looking statements included in this Quarterly Report are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.

In addition to the risks and uncertainties faced generally by participants in the renewable energy industry, we face the following risks and uncertainties:

· We have incurred losses and anticipate incurring continuing losses.

· Our initial customer focus is utilities and renewable energy companies which are generally slow to react to new technologies or make substantial financial commitments.

· The market for our products is new and evolving and a viable market may never develop or may take longer to develop than we anticipate.

· Undetected and unanticipated defects in our energy storage systems could increase our costs and harm our reputation.

· We will be required to regularly devote capital to updating, refining and expanding our energy storage systems technology and there is no assurance that we will be able to make improvements to remain competitive with new technologies.

· Our products must compete against both existing and newly developed technologies.

· We face competition from larger, more well-established companies.

· We may not be able to protect important intellectual property.

· We face risks associated with our plans to market, distribute and service our products internationally.

· Sales of our common stock by a major stockholder may have an adverse effect on the market price of our common stock.

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Overview

Company Background

We design, develop, manufacture and distribute energy storage systems under the recently trademarked names, ZESS 50 and ZESS 500. Our ZESS systems are built using a proprietary process based upon our zinc-bromide rechargeable electrical energy storage technology. The modular nature of our zinc-bromide regenerative fuel cells allows it to be sized and packaged into fully customized, large format energy storage systems. Our systems combine these modules with computer hardware and software that interface with a customer's power source to recharge during off peak times and discharge power as needed.

Since our inception in 1981, and through 2006, we have been primarily 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 currently remains limited, though we expect the delivery of new production equipment by December 2008 that will significantly increase capacity. Since our IPO we have commenced implementation of our business plan including the repayment of certain indebtedness, initiating manufacturing commercialization and capacity increases, and commenced initial commercial marketing of our products into target markets.

Our products reflect a newer 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.

We are currently working in the California energy market, in association with the CEC, Pacific Gas & Electric and the US Department of Energy amongst others, to install products into the local transmission and distribution network. In addition we are currently addressing numerous opportunities in the renewable energy markets within the United States and Australia along with a diverse international marketplace with the intention of introducing products and services into these markets.

Results of Operations

Three months ended September 30, 2008 and 2007:

Revenue and Other income:

Our revenues for the three months ended September 30, 2008 and 2007 were $291,697 and $386,422, respectively, a decrease of $94,725. This was result of a decrease in revenues of $108,937 from the CEC contract which was completed in March 2007, offset by a $14,212 increase in revenues resulting from the Australian AEST project as compared to the three month period ending September 30, 2008. Revenues include estimates based on the percentage-of-completion method of accounting for long-term contracts.

Other income for the three months ended September 30, 2008 represents interest income of $53,952 compared to $191,362 in the three months ended September 30, 2007, which also included $12,500 of rental income. The decrease of $137,410 in the three months ended September 30, 2008 resulted from the rental income and a significant decrease in interest income from the investment of proceeds from the Company's U.S. public offering in June 2007. Interest income is expected to continue 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.

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Cost and Expenses and Other expense:

Total costs and expenses for the three months ended September 30, 2008 and 2007 were $1,724,123 and $1,128,484, respectively. The increase of $595,639 in the three months ended September 30, 2008 was primarily due to the Australian (AEST) contract activities which began in July 2007 incurring increased levels of expenses of $338,094 compared to the three month period ended September 30, 2007. Increases in product engineering and development costs of $83,852, selling, general, and administrative costs of $169,719, and $3,974 in depreciation expense comprised the balance of the increase in costs and expenses.

Other expenses for the three months ended September 30, 2008 and 2007 were $42,531 and $105,607, respectively. The decrease of $63,076 in other expenses for three month period ending September 30, 2008 was primarily due to the decrease in finance costs as compared to costs incurred during the first quarter of the prior fiscal year which included a significant reduction of the Company's debt. Also, decreases in interest rates in the period ending September 30, 2008 resulting in $25,421 less interest expense than was incurred in the three months ended September 30, 2007.

Cost of product sales. Our cost of contracts for three months ended September 30, 2008 and 2007 were $-0- and $89,413, respectively. The decrease in expense in the three month period ended September 30, 2008 was due to the completion of the CEC sales contract which expired March 31, 2008.

Selling, General and Administrative. Our selling, general and administrative expense for the three months ended September 30, 2008 and 2007 was $785,081 and $615,362, respectively. The expense during the current three month period reflected an increase of $169,719 compared to the three month period ending September 30, 2007. This was primarily result of establishing a sales and marketing department, increased investor and public relations costs, additional financial and administrative personnel, and overall cost increases.

Travel costs were approximately $67,000 and $92,000 for the three month periods ending September 2008 and 2007, respectively. The prior period included travel costs related to installation and testing of energy storage systems sold in California. We expect overall travel related to marketing and business development to increase as our sales efforts and installations increase, but decrease as a percentage of sales.

Insurance costs include insurance benefits for employees of $26,336, general insurance of $9,191, and directors and officers insurance of $10,125.

Advanced engineering and development. Our engineering and development costs for the three months ended September 30, 2008 and 2007 were $737,145 and $352,782, respectively. The increase during the three month period ending September 30, 2008 of $384,363 from the comparable 2007 period was primary due to the increase in engineering and materials costs incurred under the AEST project contract which commenced in July 2007. Expenses were partially offset by $126,997 received from the Australian government during the three months ended September 30, 2008 as tax concession funding for research and development expenditures.

The materials component of the AEST contract, which requires delivery of a 500kWh storage system, has not been separately charged or disclosed under cost of product sales resulting in a materials increase of $203,647 over the three months ending September 30, 2007. This project will continue to affect expenditures through June 2010 to the extent the costs are required or allowable under the AEST contract. Also directly related to the AEST contract were engineering consultants and scientists which resulted in increases of $115,477 over the July 2007 period. Other increases of $62,568, net of $126,997 received in government concessions received during the period, were primarily due to a reallocation of engineering staffing and other resources subsequent to the completion of the CEC contract to further the development and improvements of the energy storage systems and manufacturing capacity, quality control, and cost improvement processes.

Net Loss. Our net loss for the three months ended September 30, 2008 and 2007 was $1,294,009 and $656,307, respectively, resulting in a $637,702 increase in net loss as compared to the three months ended September 30, 2007.

Liquidity and Capital Resources

Since our inception, our research, advanced engineering and development, and operations were primarily financed through debt and equity financings, government grants and joint ventures. Total paid in capital as of September 30, 2008 was $45,220,869. We had a cumulative deficit of $33,020,804 as of September 30, 2008 compared to a cumulative deficit of $31,726,795 as of June 30, 2008. At September 30, 2008 we had a working capital surplus of $7,198,738 and as of June 30, 2008 a working capital surplus of $8,611,872. Our shareholders' equity as of September 30, 2008 and June 30, 2008 was $10,603,384 and $12,016,118, respectively.

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As a result of consummation of our initial U.S. public offering and our receipt of $18,410,000 proceeds (net of underwriter's costs) on June 20, 2007, our working capital increased by $17,267,365 (net proceeds less $1,142,635 in capital raising costs).

Additional funding continues to be generated with funding from the AEST agreement entered into on June 29, 2007 by ZBB Technologies, Ltd, our subsidiary based in Western Australia, and the Commonwealth of Australia (administered by the Department of Environment and Water Resources), whereby, among other things, the Department has agreed to provide funding to us for the development and delivery of an energy storage system to be used to store and supply renewable energy generated from photovoltaic solar panels and wind turbines already operational at the Commonwealth Scientific and Industrial Research Organization's Newcastle Energy Centre in New South Wales.

The AEST agreement provided for $2.5 million (A$3.1 million) in project funding through June 2010 totaling $1.3 million in year one, $1.0 million in year two and $0.2 million in year three, as certain development progress "milestones" are met by us. The AEST project has total budgeted expenditure for operating and capital items of approximately $4.8 million (A$5.9 million) exclusive of any Australian taxes. The Company's contribution of approximately $2.3 million (A$2.8 million) is the value of any cash and in-kind contributions to be provided to the project by the Company (balance remaining in Company contributions is approximately $1.5 million as of September 30, 2008) in undertaking the project activities.

We believe that we will have sufficient capital necessary to meet our operating and capital commitments through at least December 2009. This is based on a conservative business plan that does not include any new sales contracts and a rate of expenditure that supports our current operations, including product development and production readiness without additional funding from project financing or equity transactions. However, if sales do increase substantially, we believe additional capital is required in order to expand our production capacity and inventory levels. Conversely, under current economic conditions and absent a substantial increase in new orders, the board of directors has requested that management implement increased cost containment measures.

Material Commitments for Capital Expenditures

From the proceeds of our June 2007 United States initial public offering, we retired an aggregate of $4,523,060 in indebtedness in July and August 2007. In addition to investing in plant improvements and increased capacity, we intend to apply approximately $1,100,000 towards the acquisition of new vibration welding and production equipment ($750,000), infra-red welding equipment ($150,000) and other production line tools and sundry equipment ($200,000) over the next twelve months.

Operating Activities

For the three months ended September 30, 2008, net cash used in operations was $1,180,192. Cash used in operations resulted primarily from a net loss of $1,294,009. Changes in working capital impacted cash used in operations with a net $287,408 in additional cash used in operations from decreases in accrued expenses of 35,667; deferred revenues of $244,862; increase to inventory of $131,125; increase in accounts receivable of $2,223; and prepaid and other current assets of $27,275. This was offset by increases in accounts payable of $146,869 and a reduction in interest receivable of $6,875.Other non-cash adjustments to cash included long-term assets of $210,855 expensed to costs of engineering and development, $50,000 of non-cash consulting fees, $54,471 of stock options compensation expense, a $11,000 change in inventory allowance, and $74,901 of depreciation expense.

For the three months ended September 30, 2007, net cash used in operations was $1,395,243 after adding back non-cash items of $70,927 of depreciation and other non-cash sources of $50,000. Cash used in operations resulted from decreases in accounts payable of $408,129; accrued expenses of $91,574; deferred revenues of $102,937; and increase to inventory of $187,016; prepaid and other current assets of $110,614. Cash provided from operations was generated from a decrease in accounts receivable of $40,408.

Investing Activities

For the three months ended September 30, 2008, net cash used in investing activities was $407,207. All of the net cash used in investing activities related to purchases of property and equipment.

For the three months ended September 30, 2007, net cash used in investing activities was $89,669 due to purchases of manufacturing equipment and computer hardware.

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Financing Activities

For the three months ended September 30, 2008, net cash used in financing activities was $42,447 consisting of repayments of principal on notes payable.

For the three months ended September 30, 2007, net cash used in financing activities was $4,170,470 consisting primarily of $4,047,822 in repayments of principal on notes payable, additional public offering costs of $100,000 and $22,647 reduction in principal on bank loans. Additional conversion of $475,237 in notes payable for shares of the Company's common stock resulted in only the bank loan debt remaining at September 30, 2007.

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 continue 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 "Company Background" 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.

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Our systems compete with both traditional energy storage technologies, such as lead acid batteries, as well as emerging energy storage technologies, such as vanadium redox and sodium sulfur batteries. For our target markets, we believe our product has a significant advantage over competing products and technologies in terms of:

• Superior technical attributes in terms of the amount of energy that can be stored in a system of a given weight and size or "energy density" (sometimes measured in Watt Hours per Kilogram or Wh/kg), recharge cycle and overall cycle life

• Competitive cost, based on dollars per Kilowatt Hours (kWh), as well as life of the module components

• Demonstrated commercial manufacturing capability of functioning product in the United States

• Modular construction allowing portable applications of varying size, as compared to the large scale, fixed site emerging alternatives.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.