The following discussion should be read in conjunction with the consolidated financial statements and the related notes that are set forth in our financial statements elsewhere in this annual report.

Overview

We are a development stage company that was formed in September 2003 to acquire and develop certain innovative battery technology. Since inception, APC has been engaged in R&D of the new technology for the production of lead-acid-carbon energy storage devices that we refer to as our proprietary lead/carbon ("PbC") devices. As of December 31, 2003, APC engaged in a reverse acquisition with Tamboril, a public shell company. Tamboril was originally incorporated in Delaware in January 1997, operated a wholesale cigar business until December 1998 and was an inactive public shell thereafter until December 2003. The information presented herein relates to the operations of APC, the accounting acquirer. Tamboril, the legal acquirer, changed its name to Axion Power International, Inc. We formed a new corporation, Axion Power Battery Manufacturing Inc., which purchased the foreclosed assets of a failed battery manufacturing plant and now conducts our manufacture of specialty batteries.

At December 31, 2008, we have incurred cumulative net losses of approximately $49.1 million applicable to the common shareholder. This includes approximately $2.1 million in interest of which $1.3 million relates to discount on notes. We have an additional $13.6 million in accumulated preferred stock dividends. We had approximately $6.9 million in current assets and $1.5 million in current liabilities at December 31, 2008, which left a net working capital surplus of approximately $5.4 million. As discussed below, we received an aggregate amount of $16.5 million, net of offering costs, in long term equity financing on January 14, 2008, April 7, 2008, and June 30, 2008 from Quercus Trust. Management believes those funds will support operations through 2009.

On July 3, 2008 we moved from the Pink Sheets back to the OTCBB. We lost our OTCBB listing and moved to the Pink Sheets in October of 2006 when our filings became delinquent due to the restatements of our financial statements for the years 2003, 2004 and 2005. Our financial reporting became current at the beginning of the second quarter of 2008, and it is our intention to remain current on a going forward basis.

During the third quarter of 2008, we fabricated several different types of lead acid batteries to prepare for the testing of those products by another company under a purchase order. At the end of September 2008, we were released to begin production on three of eleven items covered by the order. On November 3, 2008, the Company received the first purchase order in what will be a series of "confirming purchase orders and delivery releases" pursuant to the original agreement. We have devoted time and financial resources to upgrading, and where necessary replacing, existing battery manufacturing equipment as part of our long range business plan. In the future, a large portion of this upgraded equipment will be used to manufacture our proprietary PbC lead carbon product. The Quercus Trust investment of $4 million in April allowed us to move this upgrade forward. Likewise the Quercus $10 million investment that we received on June 30th has allowed us to continue to pursue automated fabrication equipment, which will be used in the manufacture of the PbC carbon electrode device in commercialization quantities.

Key Performance Indicators

Because of our early stage of development the usual financial measures are not particularly relevant or helpful in the assessment of company operations.

We do not use non-financial measures to evaluate our performance other than the degree of success of our R&D and demonstration projects. Our demonstration projects entail extended periods of time to assess our energy devices over multiple charge and deep discharge cycles. Further, the results of our demonstration projects do not lend themselves to simple measurement and presentation.

The single most significant financial metric for us is the adequacy of working capital in order to continue to fund our research and development efforts. Capital is also necessary to fund the equipment and methods required to progress from demonstration projects to a state of prepared readiness for commercial deployment. We believe we can maintain operations and fund R&D through 2009 without further capital infusions.

We believe we need to continue to characterize and perfect our products in house and through a limited number of demonstration projects before moving into mass production. While the results of this work are promising to date, we cannot assure you that the products will be successful in their present design or that further research and development will not be needed. The successful completion of present and future characterization and demonstration projects are critical to the development and acceptance of our technology.

We must devise methodologies to manufacture our energy storage devices in commercial quantities. While we have assembled an engineering team that we believe can accomplish this goal, and are adding to it as we go forward, there is no assurance that we will be able to successfully mass produce our product.

If we successfully complete our characterization and demonstration projects, we must present sufficiently compelling evidence to prospective users of energy storage devices in order to persuade them to purchase our technology.

Material Trends and Uncertainties

We will continue to require substantial funds for R&D. Even with adequate funding there is no assurance our new technology can be successfully commercialized. While we intend to continue to manufacture specialty batteries and commence contract manufacturing there is no assurance of profits or whether those profits will be sufficient to sustain us as we continue to develop our new technology.

Recent Financing Activities

Bridge Loan Financing In November of 2007 we structured short term secured bridge loan arrangements in increments of $100,000 (the "Bridge Loans") with certain of our directors, officers and significant investors, such loans to bear interest at the rate of 14% and were secured by all of our assets, including our intellectual property and all of the equipment and inventory assets of our wholly-owned subsidiary, Axion Power Battery Manufacturing Inc. Total funding received under the Bridge Loans was approximately $2,640,000, of which $100,000 was received in 2008.

The Bridge Loans had an original maturity date of March 31, 2008, with three extensions of the maturity date at the option of the Company, with higher interest rates to apply to each such extension. On March 31, 2008, we sent notice to the investors of our intention to extend the loan until April 30, 2008. In accordance with the option terms contained in the loan agreement, three of the investors chose to convert a total of $328,984 into equity under the same terms offered to Quercus. One of these investors later rescinded his election, opting for repayment. This resulted in a net conversion of $276,484 into equity under the same terms offered to Quercus. The extension entitled the remaining investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 15%. On April 29, 2008, we sent notice to the investors of our intention to extend the loan until May 31, 2008. The extension entitled investors to earn an additional 1% extension fee based on the original loan amount and interest at the annual rate of 16%. On May 29, 2008, a related party converted $4,200 of his Bridge Loan into equity under the same terms offered to Quercus, with the balance repaid under the terms of the note for the Bridge Loan. On May 30, 2008, we sent notice to the remaining investors of our intention to extend the Loans until June 30, 2008. The interest rate during the extension period increased to 18% with an extension fee equal to 2% of the original loan and an extension fee of 2% of the original loan was paid to the holders of the Bridge Loans. A loan origination fee was paid equal to 8% of the original principal amount of the Loan. The origination fee decreased by one-half percent each week after December 15, 2007 until the loan closed on January 7, 2008. Warrants exercisable at $2.35 until December 31, 2012 are included. For each $100,000 increment of the Bridge Loan, the investors were issued warrants as follows: 3,405 warrants upon occurrence of the secured bridge loan: 851 additional warrants upon the extension of the loan to April 30, 2008; 1,276 additional warrants upon extension of the loan to May 31, 2008 and 2,128 additional warrants upon extension of the loan to June 30, 2008. Typical anti-dilution provisions apply to the warrants as do piggyback registration rights.

On June 30, 2008, a director, exercising his rights to convert under the same terms converted $800,000 of indebtedness under the Bridge Loans into 380,952 shares of common stock and warrants to purchase 380,952 shares of common stock at an exercise price of $2.60 per share, such warrants will expire on June 29, 2013. The remaining balance due, $1,235,028, of indebtedness from the Bridge Loans was repaid as of July 1, 2008 with a portion of the proceeds from the Final Quercus Investment (as described below). The Bridge Loans have been fully repaid or converted, and there is no remaining indebtedness under these instruments.

The Quercus Investment On January 14, 2008, we entered into the Securities Purchase Agreement with Quercus, pursuant to which we agreed to issue to Quercus up to 8,571,429 shares of our common stock, together with a five year common stock purchase warrants that will entitle the holder to purchase up to 10,000,000 additional shares of our common stock.

At the initial closing on January 14, 2008, Quercus invested $4.0 million in exchange for 1,904,762 shares and warrants to purchase an additional 2,857,143 shares at an exercise price of $2.60 per share. At the second closing on April 17, 2008, Quercus invested an additional $4.0 million in exchange for 1,904,762 shares of our common stock and warrant to purchase an additional 2,380,953 shares of at an exercise price of $2.60 per share.

On June 30, 2008, the Company completed the third and final tranche of the Quercus investment, whereby Quercus invested $10.0 million in exchange for 4,761,905 shares of our common stock and warrants to purchase an additional 4,761,905 shares of stock at an exercise price of $2.60 per share. All of the warrants issued to Quercus expire by June 29, 2013. A portion of the proceeds of the June 30, 2008 financing were used to retire the remainder of the $2,640,000 December 2007 Bridge Loan that the Company had previously entered into. By June 30, certain of the bridge lenders had converted $1,080,684 into 514,611 shares of common stock and warrants to purchase 580,940 shares of common stock at an exercise price of $2.60 per share. The warrant expires on June 29, 2013 and the entire conversion was under the same terms as the Quercus investment. As a result of conversion and repayment, the December 2007 Bridge Loans have been completely retired, extinguishing all indebtedness under those instruments as of July 1, 2008

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

Grant Activities

On October 6, 2008, the Company received notice that it was the recipient of a federal grant for the development of new lightweight, high-powered batteries for use in vehicles operated by the U.S. Marine Corps. The first year, of an anticipated ongoing three year grant, provides $1,200,000 to us for the project. In December of 2006 and January of 2007, the Company presented its unique technology to branches of the Armed Forces. In February of 2007, after receiving a letter of support from the Office of Naval Research, the Company submitted a proposal to the Department of Defense. The proposal to further study the applicability of the Company's PbC technology for use in military assault vehicles was sponsored by a U.S. Congressman. The grant was not approved in the 2008 federal budget, but was resubmitted and approved in the 2009 budget, and the Company received formal notice on October 6, 2008. The potential three year $5,000,000 grant has an initial year funding of $1,200,000 expected to be received in 2009. Under the grant program, the Company and the Navy and Marine Corps will study the feasibility of utilizing one of the Company's PbC products in their assault and silent watch vehicles. The next phase is the joint development and testing of the product, which is expected to be lighter in weight and more powerful in discharge than some of the existing products in use.

On February 5, 2009, the Company received a pair of grants from the Advanced Lead-Acid Battery Consortium, the leading industry association made up in part by the largest companies supplying the world's battery market. The pair of grants totals approximately $380,000 and will help support research into two key areas. (1) The first grant seeks to identify the mechanism by which the optimum specification of carbon, when included in the negative active material of a valve-regulated lead-acid battery, provides protection against accumulation of lead sulfate during high-rate partial-state-of-charge operation. (2) The second grant seeks simply to characterize Axion's proprietary PbC™ battery in hybrid electric vehicle (HEV) type duty-cycle testing. The grants are administered through the Durham, NC-based International Lead Zinc Research Organization acting on behalf of the ALABC. The research work is expected to be completed in 2009.

On February 9, 2009, the Company received notice that it is the recipient a grant from the Pennsylvania Alternative Fuels Incentive Grant program. The $800,000 first-year grant, which was announced by Governor Edward Rendell on January 29th, is part of Pennsylvania's overall effort to invest in businesses that are creating important and innovative clean energy and bio-fuels technologies. The award proceeds will be used to demonstrate the advantages the Axion proprietary PbC battery technology provides in a variety of electric vehicle types including: hybrids (HEVs), such as the popular Toyota Prius; "plug-ins" (PHEVs) used in commuter, delivery and other vehicles; and in electric vehicles (EV's) and converted (from combustion engine operation) EV's. The grant proceeds are expected to be received in 2009.

A summary of awarded grants expected to be received in 2009 are summarized as follows:

DOD Office of Naval Research                   $ 1,200,000
ALABC                                              380,000
PA Alternative Fuels Incentive Grant Program       800,000

                                               $ 2,380,000

Results of Operations

The comparative data below presents our results of operations for the year ended December 31, 2007 and 2008. While certain of the data is not strictly comparable because some line items are positive and some negative, the provided percentages demonstrate the relative significance of the individual line items and also the relative changes from year to year.

· Our primary operations in our current development stage consist of research and development efforts for advanced battery applications and PbC carbon electrode devices. Revenues are for specialty collector and racing car, uninterruptable power supply (UPS) and flooded batteries sold to customers. Cost of goods sold represent the raw materials, components, labor and manufacturing overhead absorbed in producing batteries sold to customers.

· Selling, general and administrative expenses include substantial non-recurring legal, auditing, accounting and other costs associated with becoming current with our public filings, investor and public relations, registration and litigation costs and also one time employee costs in relation to restructuring of employment agreements.

· Research & development expenses are incurred to design, develop and test advanced batteries and an energy storage product based on our patented lead carbon technology (PbC). These costs include engineering and research and development employee labor and expenses, materials and components consumed in production for pilot products, demonstration projects, testing and prototypes. These costs also include manufacturing costs incurred for research and development activities including the creation, testing and improvement of plant production processes needed for production of our proprietary technologies.

· Interest expense was incurred for the bridge loan financing offered during the fourth quarter of 2007. The bridge loans were retired as of July 1, 2008.

                                                                    Years Ended
                                                                   December 31,
                                                              % of net                           % of
Statements of Operations                       2008             loss            2007           net loss

Revenues                                   $     679,559                    $     533,911
Cost of goods sold                               368,922                          283,357
Gross profit                                     310,637           -2.9 %         250,554           -1.7 %

Expenses
Selling, general & administrative              4,846,189           45.6 %       3,720,632           26.0 %
Research & development                         3,960,909           37.3 %       2,155,873           15.1 %
Interest expense - related party               1,137,436           10.7 %         276,651            1.9 %
Derivative revaluation                            (2,844 )          0.0 %         (72,236 )         -0.5 %
Interest & other income, net                     (57,224 )         -0.5 %         (47,708 )         -0.3 %
Net loss before income taxes                  (9,573,829 )         90.2 %      (5,782,658 )         40.5 %

Income Taxes Expense (Benefit)                   (79,170 )         -0.7 %          83,469            0.6 %
Deficit accumulated during development
stage                                         (9,494,659 )         89.5 %      (5,886,127 )         41.1 %

Less preferred stock dividends and
beneficial conversion feature                 (1,117,699 )         10.5 %      (8,417,955 )         58.9 %
Net loss applicable to common
shareholders                               $ (10,612,358 )        100.0 %   $ (14,284,082 )        100.0 %

Basic and diluted net loss per share       $       (0.46 )                  $       (0.88 )

Weighted average common shares
outstanding                                   22,826,187                       16,247,299

Summary of Consolidated Results for the Year Ended December 31, 2008 compared with the Year Ended December 31, 2007

Revenue

Revenues for year ended December 31, 2008 were approximately $0.7 million compared to revenues of approximately $0.5 million for the same period in 2007. This represents an increase of 27% in revenues reported during 2008 over the same period in 2007. This increase is primarily due to another year of exposure, especially in the race car and classic car industries, increased sales of uninterruptable power supply (UPS) batteries and the sale of flooded lead-acid batteries to a large battery manufacturer under our manufacturing subcontract agreement. We have one customer that accounted for approximately 10% of revenue or the year ended December 31, 2008 and another customer accounted for 12.5% of revenue for the same period in 2007. Our relatively low revenue is indicative of our predominant development stage activities.

Cost of Goods Sold

Costs of goods sold represent costs for batteries sold to customers and include various raw materials with lead being the most prominent and costly. We also use components such as plastic battery cases and covers as well as separators and acid. The cost of lead during 2008 decreased from the historical highs of 2007 similar to other industrial-grade metals partially as a result of the global economic slowdown. We also incur manufacturing labor and overhead costs as well as costs for packaging and shipping. Costs of goods sold increased by approximately $.10 million for the year ended December 31, 2008, as compared to the same time period last year. 2008 costs are 30% higher than that the 2007 respective period consistent with our increase in revenue.

Selling, General & Administrative Expenses

Selling, general and administrative expenses include compensation for employees and contractors, legal and accounting fees, and costs incurred for investor relations and activities associated with fund raising and shareholder awareness. Selling, general and administrative costs for year ended December 31, 2008 were approximately $4.8 million compared to $3.7 million, respectively, for the same period in 2007. This represents a 30% increase in spending over the same period during 2007. Cost increases are primarily due to substantial non-recurring legal, auditing, accounting and other costs associated with becoming current with our public filings, investor and public relations, registration and litigation costs and also one-time employee costs with respect to restructuring of employment agreements.

Research & Development Expenses

Research and development expenses include compensation for employees and contractors, as well as small test equipment, supplies and overhead. These costs also include manufacturing employee compensation, manufacturing facility and overhead costs attributed to research and development activities. Research and development also includes prototype production and testing costs. Research and development expenses for the year ended December 31, 2008 were approximately $4.0 million compared to $2.2 million for the same periods in 2007, representing an increase in spending of 46% as compared to the same period in 2007. The increase is due to increased costs associated with additional efforts incurred to design, develop and test advanced batteries and energy storage products based on our patented lead carbon battery (PbC) including manufacturing activities to prepare the plant for future PbC production, pilot product production and demonstration project production activities. In 2008, we increased our R&D staff by approximately 50% and signed them to long term contracts. We also restructured existing R&D employment contracts to ensure long term continuity. The expense of all of these measures is reflected in the increased R&D expenditures for 2008.

Interest Expense - Related Party

Interest expense - related party represents interest costs incurred primarily for the bridge loan financing offered during the fourth quarter of 2007. Related party interest expense includes the coupon value of interest on debt, as well as the debt discount on detachable warrants and origination fees. Expenses incurred during the year ended December 31, 2008 were approximately $1.14 million as compared to $.28 million, for the same period in 2007. Whereas 2007 financing was sustained through the issuance of the Series A preferred offering, 2007 did not have a comparable level of interest expense as was recognized during 2008. The 2007 bridge loans were completely retired as of July 1, 2008.

Derivative Revaluation

Derivative revaluations are recognized whenever the Company incurs a liability to issue an equity instrument. The instrument is revalued quarterly until the point in time that the liability is settled. Derivative revaluation expense for the year ended December 31, 2008 resulted in a credit of $(.003) million compared with a credit of $(.072) million for the same period ended in 2007. During 2007, the Company funded its capital needs with debt that offered detachable warrants. These warrants were not settled until March 2008, at which point the Company's stock values were lower, giving rise to the nominal credit in 2008. There are no new obligations as of December 31, 2008.

Net Loss

For the fiscal year ended December 31, 2008, our net loss before income taxes increased $3.8 million, or 65%, to $9.6 million on revenue of $.7 million, from an operating loss of approximately $5.8 million on revenue of $.6million for the fiscal year ended December 31, 2007. As discussed above, the factors primarily affecting this increase in operating loss were increased selling, general and administrative costs, increased research and development costs and increased interest expense of related party debt.

The net loss applicable to common shareholders of $10.6 million for the year ended December 31, 2008 compared to a loss of $14.3 million for the year ended December 31, 2007 reflects a decrease of approximately 26%. The loss includes non-cash charges related to preferred stock dividends and beneficial conversion feature of $1.1 million in 2008 compared with $8.4 million in 2007.

Liquidity and Capital Resources

Our primary source of liquidity has historically been cash generated from issuances of our equity or debt securities. From inception through fiscal year ended December 31, 2008, we generated insignificant revenue from operations. We believe we had sufficient funds on December 31, 2008 to conduct our operations through 2009, which were primarily the result of the closings of financing with the Quercus Trust. If we do not significantly increase our revenues, obtain additional government grants or raise more money through sale of equity during 2009 we will likely be unable to implement our business plan, fund our liquidity needs or even continue our operations after this period. Any equity or debt financings, if available at all, may be on terms which are not favorable to us and, in the case of equity financings, most likely will result in dilution to our stockholders.

Cash, Cash Equivalents, Short Term Investments and Working Capital

At December 31, 2008, we had approximately $3.1 million of cash and cash
equivalents compared to approximately $0.7 million at December 31, 2007. At
December 31, 2008 working capital was $5.4 million compared to a working capital
deficit of $(2.9) million at December 31, 2007. Cash equivalents consist of
short-term liquid investments with original maturities of no more than three
months and are readily convertible into cash and consisted of the following at
December 31, 2008:

                                            Coupon /                December 31,
                                             Yield      Maturity        2008

     United States Treasury Bills                        Feb-09    $      999,840
     Fidelity Institutional Money Market         2.08 %   n/a      $    1,756,105

At December 31, 2008, we had the following short term investments of $2,193,920 consisting of short-term liquid investments with original maturities that exceed three months at December 31, 2008:

. . .