AXPWQ Axion Power International Inc (CE)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

These unaudited consolidated financial statements of Axion Power International, Inc., a Delaware corporation, include the operations of its wholly owned subsidiary, Axion Power Battery Manufacturing, Inc., a Pennsylvania corporation, and its two inactive wholly owned subsidiaries, Axion Power Corporation, a Canadian Federal corporation, and C & T Co. Inc., an Ontario corporation (collectively, the “Company”).

In the opinion of management the accompanying unaudited consolidated financial statements contain all adjustments (which include normal recurring adjustments) necessary to present fairly the financial position, statements of income and comprehensive income and cash flows for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been condensed or omitted pursuant to the rules and regulations of the United States Securities and Exchange Commission (SEC). These consolidated financial statements should be read in conjunction with the audited financial statements and footnotes thereto in the Annual Report on Form 10-K for the year ended December 31, 2015. The results of income and comprehensive income for the three and nine month periods ended September 30, 2016 are not necessarily indicative of results of income and comprehensive income for the Company’s 2016 calendar year.

As approved by our board of directors and shareholders, we effected a 1-for-35 stock split of our common shares and Series A warrants on July 14, 2015. During 2015, there were 1,457 true-up rounding shares issued due to the above mentioned reverse stock split.

As approved by our board of directors and shareholders, we effected a 1-for-400 stock split of our common shares effective July 15, 2016. We did not effect a reverse split of any of our warrants and instead, each warrant is exercisable into 1/400th of a share of our common stock. All share related and per share information was adjusted to give effect to the reverse stock split from the beginning of the earliest period presented.

We have again sought approval from our shareholders to effect a reverse split of our common stock in a range of 1-for-100 to 1-for-400 as set forth in our Definitive Proxy Statement on Schedule 14A filed with the SEC on October 17, 2016. As stated in the 14A, we have asked our shareholders for their consent no later than November 14, 2016. This reverse split is to increase our stock price and to make shares available for conversion for satisfaction of our November 2015 notes.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, assumptions and judgments that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statement and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). ASU 2016-15 reduces the existing diversity in practice in financial reporting across all industries by clarifying certain existing principles in ASC 230, Statement of Cash Flows, including providing additional guidance on how and what an entity should consider in determining the classification of certain cash flows. ASU 2016-15 will be effective for the reporting periods beginning after December 15, 2017, and early adoption is permitted. The Company is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to employee share-based payment accounting, which includes provisions intended to simplify various aspects related to how share-based compensation payments are accounted for and presented in the financial statements. This amendment will be effective prospectively for reporting periods beginning on or after December 15, 2016, and early adoption is permitted. The Company is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize the lease assets and lease liabilities classified as operating leases on the balance sheet. The amendment will be effective for reporting periods beginning on or after December 15, 2018, and early adoption is permitted. The Company is evaluating the impact that the new accounting guidance will have on its consolidated financial statements and related disclosures.

On November 20, 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. The guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. The guidance does not change the existing requirement that only permits offsetting within a jurisdiction. The new guidance will be effective for public business entities in fiscal years beginning after December 15, 2016, including interim periods within those years (i.e., in the first quarter of 2017 for calendar year-end companies). Early adoption is permitted for all entities as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact, if any, of the adoption of this newly issued guidance to its consolidated financial statements.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory , that simplifies the measurement of inventory for all entities. The amendment applies to all inventories that are measured using first-in, first-out or average cost. The guidance requires an entity to measure inventory at the lower of cost and net realizable value. The guidance must be applied prospectively and will be effective for interim and annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the expected impact, if any, of the adoption of the newly issued guidance to the consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Topic 225-20): Simplifying the Presentation of Debt Issue Costs , that simplifies the presentation of debt issuance costs. The guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by these amendments. This guidance should be applied on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company elected early adoption of this newly issued guidance, and there was no impact on the Company’s consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidations (Topic 225-20): Amendments to the Consolidation Analysis , which affects current consolidation guidance. The guidance changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. This guidance must be applied using one of two retrospective application methods and is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. The Company has adopted this new guidance, and there was no impact on the Company’s consolidated financial statements.

In January 2015, the FASB issued ASU 2015-01, Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items , which changed the requirements for reporting extraordinary and unusual items in the income statement. The update eliminates the concept of extraordinary items. The presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and will be expanded to include items that are both unusual in nature and infrequently occurring. A reporting entity may apply the amendments prospectively or retrospectively to all periods presented in the financial statements. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this newly issued guidance did not have an impact to the Company’s consolidated financial statements.

Inventory is recorded at the lower of cost or market value, and adjusted as appropriate for decreases in valuation and obsolescence. Adjustments to the valuation and obsolescence reserves are made after analyzing market conditions, historical sales activity, inventory costs and inventory composition to determine appropriate reserve levels. Cost is determined using the first-in first-out (FIFO) method. Many components and raw materials we purchase have minimum order quantities. 

A summary of inventory at September 30, 2016 and December 31, 2015 is as follows:

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

Warrants consist of the following:

As of September 30, 2016, there were no Series B warrants classified as derivative liabilities. On April 27, 2016, 10,000 Series B warrants were exercised resulting in the issuance of 29 shares of the Company’s common stock. The remaining 24,521 Series B warrants expired on April 29, 2016. In addition, as of September 30, 2016, there were 11,967,716 warrants also classified as derivative liabilities relating to the November 2015 private placement of senior convertible notes and warrants. We effected a 1-for-400 reverse split of our common stock on July 15, 2016 (as contractually required as a result of needing shares for conversions of our November 2015 notes); however, the number of warrants was not split and instead each warrant is exercisable or convertible into 1/400th of a share of our common stock.

The Company adopted ASC 718 “ Compensation – Stock Compensation " whereby employee-compensation expense related to stock based payments is recorded over the requisite service period based on the grant date fair value of the awards. The Company’s accounting policy for equity instruments issued to consultants and vendors in exchange for goods and services follows the provisions of ASC 505-50 “ Equity-Based Payments to Non-Employees” .  The measurement date for fair value of the equity instruments is determined by the earlier of (i) the date at which commitment for performance by the vendor or consultant is reached, or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.

The stock based compensation expense for the nine months ended September 30, 2016 and 2015 was $35,955 and $244,771 of which $0 and $112,793 was for independent directors’ compensation in lieu of cash, respectively. In May 2016, the Board of Directors chose to forgive the previously reported $19,719 owed in Director’s fees for the fourth quarter of 2015, as well as forgive the $15,000 stock compensation for consulting services also reported for the fourth quarter of 2015.

Outstanding compensatory options consist of the following based on grant date:

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

Non-vested compensatory options consist of the following based on grant date:

As of September 30, 2016, there was $46,620 of unrecognized compensation related to non-vested options granted under the plans. The Company expects to recognize this expense over a weighted average period of 1.25 years. We have not granted any options in 2016.

Basic loss per share is computed by dividing loss available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) for the period. Diluted earnings per share are computed by assuming that any dilutive convertible securities outstanding were converted, with related preferred stock dividend requirements and outstanding common shares adjusted accordingly. It also assumes that outstanding common shares were increased by shares issuable upon exercise of those stock options for which the market price exceeds the exercise price, less shares which could have been purchased by us with the related proceeds. In periods of losses, diluted loss per share is computed on the same basis as basic loss per share as the inclusion of any other potential shares outstanding would be anti-dilutive.

If the Company had generated earnings during the nine months ended September 30, 2016 and 2015, the Company would have added 482,659,713 and 68 respectively, of common equivalent shares to the weighted average shares outstanding to compute the diluted weighted average shares outstanding. The Company had unexercised Series B warrants of 34,521 outstanding as of September 30, 2015. The remaining unexercised outstanding 34,521 Series B warrants would have added 98 common shares as permitted by the Amendment to the original warrant agreement.

For the nine months ended September 30, 2016, the Company recognized $31,576 in other income. The Company sold various pieces of zero value equipment.

At December 31, 2015, the Company had a balance of $237,600 in notes with its landlords for its two New Castle facilities, which was settled as of September 30, 2016. As per the note agreement the Company made payments of $25,000 per month to Becan Development and the final payment due in April was reduced by the original $19,297 lease deposit. In addition to the principal payments, Becan Development also received $2,300 in interest. As per the note agreement with S&S Partnership, the Company made monthly installment payments of $17,200 for a total of $137,600 in principal payments. The Company also paid $12,592 of accrued interest. As of April 1, 2016, the Company has moved from the Greenridge facility as planned and consolidated to the Clover Lane facility.

At September 30, 2016 there is no principal or remaining interest outstanding.

During 2013 , the Company sold $1,000,000 principal amount of its Subordinated Convertible Notes (the “Subordinated Notes”) to investors consisting of management and directors of the Company and one individual accredited investor. The sale of the Subordinated Notes did not carry any additional fees and expenses, so the Company received the entire $1 million in proceeds from the Subordinated Notes at closing. The Subordinated Notes are subordinated in right of repayment to the Company’s now expired 2013 Senior Notes and were to mature 91 days subsequent to the maturity date of the 2013 Senior Notes. The Subordinated Notes bear interest at the rate of 8% per year. The Subordinated Notes may be converted and/or prepaid in cash. The conversion price for the Subordinated Notes is $184,800 per share. The holders of the Subordinated Convertible Notes were issued five year warrants to purchase 1,097 shares of Company common stock (“Subordinated Warrants”).  Each Subordinated Warrant has an exercise price of $528.50 and is convertible into 1/400 of a share.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

The fair value of the warrants, issued in connection with the Subordinated Notes is $304,000 in the aggregate and was calculated using the Black-Scholes-Merton option pricing model with the following assumptions: (i) expected life of 5 years, (ii) volatility of 80%, (iii) risk free interest rate of 0.75% and (iv) dividend yield of zero.

The outstanding principal balance at September 30, 2016 and December 31, 2015, related to the Subordinated Notes is $65,000. The subordinated notes remain outstanding as a result of a verbal agreement with the noteholders to continue to extend the maturity thereof.

Effective October 29, 2014, the Company consummated an underwritten public offering consisting of 53,572 shares of common stock ("Common Stock"), together with Series A warrants to purchase 53,572 shares of its Common Stock ("Series A Warrants") and Series B warrants to purchase 1,875,000 shares of its Common Stock (“Series B Warrants”) for gross proceeds to the Company of approximately $6.1 million and net proceeds of $5.5 million. The public offering price for each share of Common Stock, together with one Series A Warrant and one Series B Warrant, was $113.75.  The Series A Warrants may be exercised for a period of five years and have an exercise price of $113.75 per share of Common Stock. The Series B Warrants were originally exercisable for a period of 15 months from the date of closing and expired on April 29, 2016 (due to an extension) and had an exercise price of $113.75 per share of Common Stock. In connection with the offering, the Company granted to the underwriter a 45-day option to acquire up to 8,036 additional shares of Common Stock and/or up to 8,036 additional Series A Warrants and/or up to 281,250 additional Series B Warrants. The Company has also closed on the underwriter’s exercise of the over-allotment option on the Series A Warrants and the Series B Warrants. The Company’s common stock and Series A Warrants are now listed on the OTCQB Capital Market under the symbols “AXPW” and “AXPWW”, respectively. On June 15, 2015, as the result of an agreement with the holders of our Series A warrants and Series B warrants, we adjusted the terms of our Series A warrants so that the exercise price was reduced to $.50, which number was changed to $17.50 as a result of our July 14, 2015 1-for -35 reverse stock split. The Series A warrants were not further reverse-split as a result of our July 2016 1:400 reverse split and instead each warrant is exercisable into 1/400 ^th of a share of our common stock. The Series B warrants were not subject to the 1-for-35 reverse split.

On April 26, 2016, 10,000 Series B warrants were exercised and 29 shares of the Company’s common stock were issued. As of September 30, 2016 there are no Series B warrants. The remaining 24,521 unexercised Series B warrants expired on April 29, 2016.

Accounting for the Series B warrants

Pursuant to ASC 815-40, due to the net settlement terms included in the Series B warrants, which requires an increased number of shares to be issued if the price of the Company’s common stock falls, the Company determined that the Series B warrants were not indexed to the Company’s own stock and must be recognized separately as a derivative liability in the consolidated balance sheet, measured at fair value and marked to market each reporting period.

As of September 30, 2016 and December 31, 2015, the fair value of the Series B warrants was estimated to be $0 and $35,764, respectively.

The change in the fair value of the Series B warrant liability for the nine months ended September 30, 2016 is as follows: 

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

The change in fair value of the Series B warrant liability for the nine months ended September 30, 2015 is a follows:

Fair Value Disclosure

The Company has two Level 3 financial instruments. Prior to the expiration of the Series B warrants on April 29, 2016 there were three Level 3 financial instruments.

On November 4, 2015, we entered into a financing transaction for the sale of convertible notes and warrants issued by us with gross proceeds of $9,000,000 to us. Upon closing of the sale of the notes and warrants, which occurred on November 5, 2015, we received cash proceeds of $1.85 million and deposited an additional $7,150,000 into a series of control accounts in our name. Under the original terms of the notes, we are permitted to withdraw funds from our control accounts (i) in connection with certain conversions of the notes or (ii) otherwise, as follows: $1 million on each 30-day anniversary of the commencing on the 30 ^th day after the effective date of a registration statement being filed in connection with the transaction until there are no more funds in the control accounts, subject in each instance to equity conditions set forth in the convertible notes. As a result of the January 28, 2016 amendments to the notes, another $1.8 million was released on that date, and the balance of $5.35 million was to be released in 8 equal monthly installments commencing on May 2, 2016 (subsequently amended to be May 6, 2016), subject to terms and conditions set forth in the notes.

We received approximately $1,790,000 in net proceeds at closing, which occurred on November 5, 2015, after deducting our placement agent’s legal fee of $60,000. Offering expenses, including our placement agent’s fee, were approximately $183,750, which were paid out of operating cash at Closing. At each release of funds starting on May 6, 2016, we were to receive approximately $620,000 in net proceeds, after deducting our placement agent’s fee of $50,000, if equity conditions (certain stock price and volume and other conditions set forth in the loan documents from our November 5, 2015) were met. As a result of a further waiver and amendment entered into on May 1, 2016, the equity conditions were waived with respect to a release of $310,000 to us on May 6, 2016. Further, the waiver and amendment (i) waives equity conditions for our ability to make all installment and preinstallment payments in stock through May 6, 2017, and (ii) reduces the preinstallment and installment conversion prices to 75% of an average vwap price over the five trading days preceding the date of issuance. In June of 2016 an additional $355,000 was released.

In the third quarter of 2016 and subsequently, we received the following releases from the control accounts as follows: July $668,866, August $305,889, September $305,889 and October $288,889.

The initial conversion price of the notes was $492.00 per share (for optional conversions only and not Company amortization payments), and the initial exercise price of the 10,975,608 warrants was $1.29 per share (and post reverse split, each warrant is exercisable into 1/400th of a share of our common stock).

As a result of the “rollover” of $363,530 of principal amount and accrued and unpaid interest of our August 2015 Bridge Notes, on November 10, 2015, an additional note in the principal amount of $363,530 and an additional 443,328 warrants were issued to replace the rolled over Bridge Notes. 

The outstanding principal bears interest at 9% per annum and shall be repaid or converted at monthly installment dates over a 14-month period. Additionally, the notes are convertible by the holder at any time after issuance. Pursuant to the optional conversion feature of these notes (as opposed to the monthly Company conversions which are at a discount formula as set forth below), the Company would deliver the number of shares of common stock equal to the outstanding principal amount, accrued interest amount, and a make whole amount equal to the interest that would be accrued on the conversion amount until maturity, divided by the fixed conversion price of $492.00. Additionally, a portion of the outstanding amount would have been exchanged for common shares at each Monthly Installment Date at a conversion price equal to the lower of the conversion price in effect and 85% of the fair value of the common shares the trading day prior to the installment date (now 75%). On the 23 ^rd date prior to any installment date, shares to be delivered based upon the conversion price formula for the installment amount, and then on the installment date in question, the amount of shares to be delivered is recalculated for the conversion price formula on that installment date, and if the conversion price is lower on the installment date than on the preinstallment date, a number of shares equal to the number to be delivered on the installment date less the number of shares delivered on the preinstallment date is delivered to the investor. The number of common shares deliverable under the contract is limited by a beneficial ownership cap of 4.99% for any single investor (except for one investor which has a cap of 9.99%), so shares may be deemed issued but held in abeyance by the transfer agent until the investor is able to accept further shares without exceeding the beneficial ownership cap.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

As the Company was required to separate the conversion option in the notes under ASC 815, Derivatives and Hedging, the Company recorded the bifurcated conversion option valued at $1.33 million as a derivative liability, which creates additional discount on the debt. The derivative liability is marked to market through the income statement each reporting period, while the discount created on the convertible notes is accreted as interest expense over the maturity period of the debt. Additionally, the convertible notes were issued to the investors in a basket transaction with warrants that are classified as derivative liabilities. These warrants, initially valued at $725,111 ($691,861 as discount on the debt and $33,250 as issuance costs for compensation to the underwriter), are also marked through the income statement each reporting period, while further discount is created on the convertible notes, and is accreted as interest expense using the effective interest method over the life of the debt.

At inception, the warrants were valued by calibrating the aggregate fair value of the notes and warrants to the transaction price, as required by ASC 820. Calibrating the valuation model to ensure that the model is consistent with the fair value at initial recognition provides a basis for estimating the inputs required in the analysis that are not directly observable. For each subsequent reporting date, the warrants are valued based on the payoff structure, considering the change in assumptions between the inception and the subsequent reporting date.

The conversion feature fair value is determined at inception and for each reporting date using a “with” and “without” analysis, based on the payoff structure of the notes. The same key assumptions utilized in the warrants valuation were considered in the conversion feature fair value,

Using the Calibration model, to calculate the mark to market value at September 30, 2016, the following key assumptions were utilized in both the valuations of the notes and warrants as follows: (i) risk free interest rate 0.29%, (ii) credit spread 125%, (iii) volatility 41.57%, and (iv) stock price $0.01.

Derivative liability relating to the 2015 Private Placement

The change in the fair value of the 2015 Private Placement derivative liability is as follows: 

Securities Purchase Agreement

The notes and warrants were issued pursuant to the terms of a Securities Purchase Agreement among us and the investors named therein. The Purchase Agreement provided for the sale of the notes and warrants for gross proceeds of $9,000,000 to us.

Ranking

The notes are senior unsecured obligations of us.

Maturity Date

Unless earlier converted or redeemed, the notes mature 14 months from the Closing, subject to the right of the investors to extend the date (i) if an event of default under the notes has occurred and is continuing or any event shall have occurred and be continuing that with the passage of time and the failure to cure would result in an event of default under the Notes and (ii) for a period of 20 business days after the consummation of a fundamental transaction if certain events occur.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(unaudited)

Interest

The notes bear interest at the rate of 9% per annum and are compounded4 monthly, on the first calendar day of each calendar month. The interest rate will increase to 18% per annum upon the occurrence and continuance of an event of default (as described below). Interest on the notes is payable in arrears on each installment date (as defined below). If a holder elects to convert or redeem all or any portion of a note prior to the maturity date, all accrued and unpaid interest on the amount being converted or redeemed will also be payable. If we elect to redeem all or any portion of a note prior to the maturity date, all accrued and unpaid interest on the amount being redeemed will also be payable. The amount of interest due at any time is the amount of any interest that, but for any conversion, installment conversion, acceleration or redemption hereunder on such given date, would have accrued with respect to the conversion amount or installment amount being converted or redeemed under the note at the interest rate for the period from such given date through the maturity date of the note.

Optional Conversion

All amounts due under the notes are convertible at any time, in whole or in part, at the option of the holders into shares of our common stock at a fixed conversion price, which is subject to adjustment as described below. The notes are initially convertible into shares of our common stock at the initial price of $492.00 per share. This conversion price is subject to adjustment for stock splits, combinations or similar events and “full ratchet” antidilution provisions.

Payment of Principal and Interest

We have agreed to make amortization payments with respect to the principal amount of each note in shares of our common stock, subject to the satisfaction of certain equity conditions, or at our option, in cash on each of the following installment dates: the twenty-first trading day after the earlier of (x) the initial effective date of a registration statement filed in connection with this offering or (y) May 2, 2016; the first trading day of the calendar month immediately following the initial installment date (or if such date is less than twenty trading days after the initial installment date, the second calendar month immediately following the initial installment date to the extent); and then each month through and including the Maturity Date, each in an amount equal to 1/11 of the principal amount of each note. Payment in stock was originally at 85% of the market price based upon a variable weighted average price formula.

As a result of the amendment agreements entered into by us with each selling stockholder on January 28, 2016, an additional $1,800,000 was released from the controlled accounts on January 28, 2016, starting on May 2, 2016, and continuing for seven consecutive months thereafter on the 1 ^st business day of each such month $667,500 would have been released in total from the controlled accounts. As a result of a further waiver and amendment entered into on May 1, 2016, the equity conditions were waived with respect to a release of $310,000 to us on May 6, 2016. Further, the waiver and amendment (i) waives equity conditions for our ability to make all installment and preinstallment payments in stock through May 6, 2017, and (ii) reduces the preinstallment and installment conversion prices to 75% of an average vwap price over the five trading days preceding the date of issuance. An additional $355,000 was released in June 2016. In the third quarter of 2016 and subsequently, we received the following releases from the control accounts as follows: July $ 668,866, August $ 305,889, September $305,889 and October $288,889.

On August 10, 2016, $3,464,124 from the restricted cash accounts was released from the control accounts and returned to the investors on a pro rata basis based upon the original principal amount of the notes issued to each investor. Of the funds released, $3,299,166 was applied against the $9,363,530 notes and the additional $164,957 was applied as a 5% redemption premium to the investors. The placement agent fees have been reduced by an amount of $247,437 due to the cash repayment on the senior convertible notes. In addition, the debt discount recorded on the senior convertible notes was reduced by $339,458 as a result of the cash payment made.

Acceleration and Deferral of Amortization Amounts

During each period after an installment date and prior to the immediately subsequent installment date, a holder may elect to accelerate the amortization of the note at the applicable amortization conversion price for such prior installment date with respect to any given installment period, the holder may not elect to effect any acceleration during such installment period if either (x) in the aggregate, all the accelerations in such installment period exceeds the sum of two (2) other installment amounts, or (y) accelerations have been consummated in four (4) prior installment periods.  

The holder of a note may, at the holder’s election by giving notice to us, defer the payment of the installment amount due on any installment dates, in whole or in part, to another installment date, in which case the amount deferred will become part of such subsequent installment date and will continue to accrue interest.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

September 30, 2016

(unaudited)

Events of Default

The notes contain standard and customary events of default including but not limited: (i) failure to register our common stock within certain time periods; (ii) failure to make payments when due under the Notes; and (iii) bankruptcy or insolvency of us.

If an event of default occurs, each holder may require us to redeem all or any portion of the notes (including all accrued and unpaid interest thereon), in cash, at a price equal to the greater of (i) up to 125% of the amount being redeemed, depending on the nature of the default, and (ii) the intrinsic value of the shares of common stock then issuable upon conversion of the note.

Fundamental Transactions

The notes prohibit us from entering into specified transactions involving a change of control, unless the successor entity assumes in writing all of our obligations under the notes under a written agreement.

In the event of transactions involving a change of control, the holder of a note will have the right to require us to redeem all or any portion of the Note it holds (including all accrued and unpaid interest thereon) at a price equal to the greater 125% of the amount of the Note being redeemed and the intrinsic value of the shares of common stock then issuable upon conversion of the note being redeemed.

Limitations on Conversion and Issuance

A note may not be converted and shares of common stock may not be issued under the notes if, after giving effect to the conversion or issuance, the holder together with its affiliates would beneficially own in excess of 4.99% of our outstanding shares of common stock. At each holder’s option, the note blocker may be raised or lowered to any other percentage not in excess of 9.99%.

As a result of the January 28, 2016 amendment agreements, there is no exchange cap in this transaction.

January 28, 2016 Amendment Agreements

On January 28, 2016, we entered into amendment agreements with each of the selling stockholders with respect to the November 5, 2015 private placement exempt from securities registration under Section 4(a)(2) of the Securities Act of 1933 and Rule 506(b) of Regulation D. On or about November 20, 2015, we filed a registration statement on Form S-1 to register the Registrable Securities, and as a result of comments received from the SEC, we withdrew this original S-1 on January 21, 2016. Subsequent to the withdrawal of the original S-1, we sought to make certain amendments to the terms of the securities purchase agreement and registration rights agreement, entered into in connection with the sale of the senior secured convertible notes, as well as to the notes. The amendments are embodied in the amendment agreements with each of the buyers.

Changes to the securities purchase agreement are as follows:

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

September 30, 2016

(unaudited)

Changes to the notes are as follows:

Changes to the registration rights agreement are as follows:

May 1, 2016 Waiver and Amendment

The Company has entered into a Waiver and Amendment (“Waiver”) with each of the buyers listed on the Schedule of Buyers attached to the securities purchase agreement. In each Waiver, the Company and the Buyer agreed as follows:

“as of any Conversion Date or other date of determination, a price per share equal to the lowest of (x) $492.00, subject to adjustment as provided in this Note (the price set forth in this clause (x), the "Fixed Conversion Price"), (y) 75% of the arithmetic average of the Weighted Average Prices of the Common Stock during the five (5) consecutive Trading Day period ending immediately preceding the time of delivery of the applicable Conversion Notice, and (z) 75% of the Weighted Average Price of the Common Stock on the Trading Day of the delivery of the applicable Conversion Notice. For the avoidance of doubt, all such foregoing determinations to be appropriately adjusted for any stock dividend, stock split, stock combination, reclassification or similar transaction during the applicable calculation period.”

“Notwithstanding anything to the contrary in this paragraph 4, the Company and the Buyers hereby acknowledge that the Equity Conditions for the Controlled Account Release Event on May 6, 2016 are not, and are deemed not to be, satisfied, and the Buyers hereby waive the Equity Conditions for the Controlled Account Release Event on May 6, 2016, for an aggregate release of $310,000, to be released proportionately among the Buyers based upon the pro rata share as a result of the original principal amounts of the Notes.”

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

September 30, 2016

(unaudited)

August 8, 2016 Waiver and Amendment to the November 2015 Notes

The Company has entered into a Waiver and Amendment (“Waiver”) with each of the buyers (“Holders”) listed on the Schedule of Buyers attached to that certain Securities Purchase Agreement (“SPA”), dated November 5, 2015, among the Company and the Holders (each capitalized term used below is used as defined in the SPA and notes entered into in conjunction with the SPA, “Notes”). In each Waiver, the Company and the Holders agreed as follows:

The Waivers became effective on August 8, 2016 upon entry into waivers by all of the Holders, individually, with the Company.

During the nine months ended September 30, 2016, the Company has issued 37,509,851 shares of its common stock to convert $3,573,412 of principal. In addition on September 30, 2016, the Company issued 4,453,568 shares of common stock for $272,046 interest and 1,133,546 shares of common stock for $171,613 make whole interest. The Company will be required to issue additional true-up shares which cannot be calculated at this time. During the nine months ended September 30, 2016, the Company recognized an extinguishment loss of $2,043,797 on the conversions of the senior convertible notes. The loss is determined based on the difference between the conversion price as calculated on the installment date versus the previously calculated price on the notice date.

As of November 11, 2016 86,638,138 shares of our common stock have been issued as a result of the conversion of principal, interest, make-whole and true ups related to the November 2015 Senior Convertible Notes which shall be applied consistent with the conversion notices and for Pre-installment shares, calculation and application of the applicable Installment price and true-up arising therefrom. Until and unless we are able to make more shares available for conversion of the notes, we will be unable to meet our obligations to repay the notes, and we will likely be unable to obtain the remaining $321,889 in the control accounts.

During the first nine months of 2016, the Company engaged the services of a marketing firm to provide branding and web site development at a cost of $138,338. We engaged the firm to further provide sales and marketing services for the full year at an estimated cost of $115,000. The principal of this firm is our Chief Executive Officer’s brother in law; however, neither our Chief Executive Officer nor his immediate family has any direct or indirect interest in the marketing firm. At September 30, 2016, the balance owed to this firm was $13,750 which is included in the Company’s accounts payable balance.

At September 30, 2016, the Company’s accounts payable balance included $76,540 as a result of related party transactions. Of those transactions, $59,593 was for consulting fees associated with the previous CEO, $13,750 was for marketing services of which the principal of the firm is our Chief Executive Officer's' brother in law, however, neither our Chief Executive Officer nor his immediate family has any direct or indirect interest in the marketing firm, and $3,197 was for employee related travel expense reimbursement. At September 30, 2015, the Company’s accounts payable balance included $64,976 in related party transactions. Of those transactions $59,593, was for fees associated with the previous CEO, $623 was for director related meeting fees, and $4,760 was for employee related travel expense reimbursement.

At September 30, 2016, the subordinated notes, all held by related parties had a balance of $65,000. Accrued interest payable on the subordinated was approximately $18,000.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

September 30, 2016

(unaudited)

The accompanying unaudited consolidated financial statements have been prepared assuming that the Company will continue as a going concern. At September 30, 2016 the Company’s working capital was $(3,723) million. The financial resources of the Company will not provide sufficient funds for the Company’s operations beyond the fourth quarter of 2016, as those operations currently exist. Subsequent funding will be required to fund the Company’s ongoing operations, working capital, and capital expenditures beyond the fourth quarter of 2016. No assurances can be given that the Company will be successful in arranging the further funds needed to continue the execution of its business plan, which includes the development and commercialization of new products, or even if further funding is available, upon what terms. Failure to obtain such funds on terms acceptable to the Company’s management will require management to substantially curtail, if not cease, operations, which will result in a material adverse effect on the financial position and results of operations of the Company. The unaudited consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that might occur if the Company is unable to continue as a going concern.

Resignation of Auditor  

On October 11, 2016, the Company was advised by its independent registered accounting firm, Mayer Hoffman McCann P.C. (“Mayer Hoffman”), of its intention to not seek re-appointment as the Company’s independent registered public accounting firm for the year ending December 31, 2016 and to cease serving as the Company’s independent registered public accounting firm upon completion of the review of the Company’s unaudited financial statements for the quarter ended September 30, 2016.

Mayer Hoffman’s reports on the financial statements of the Company for each of the past two fiscal years have neither contained an adverse opinion or a disclaimer of opinion, nor been qualified or modified as to uncertainty, audit scope or accounting principles, except that, the reports included an explanatory paragraph with respect to the uncertainty as to the Company’s ability to continue as a going concern. During the past two fiscal years and in the subsequent interim period through October 11, 2016, there were (i) no disagreements with Mayer Hoffman on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Mayer Hoffman, would have caused it to make reference to the subject matter of the disagreements in connection with its reports, and (ii) there were no reportable events (as that term is defined in Item 304(a)(1)(v) of Regulation S-K).

Shareholder Approval Sought for Reverse Split

On October 17, 2016, we filed a Definitive Proxy Statement on Schedule 14A seeking approval from our shareholders for another reverse split of our common stock in a ratio of at least 1-for-100 but not to exceed 1-for-400 (with the final ratio to be determined by our Board). The deadline for shareholder approval of this reverse stock split was November 14, 2016; however, as of November 9, 2016, we had not received the requisite number of votes for a Quorum of shares under Delaware law to approve or not approve the reverse split proposal, so we, have extended the solicitation period until November 30, 2016, at 5:00 pm EST. If our shareholders do not approve the reverse split, we will be required to further seek approval consistent with our contractual obligations. Without this reverse split we are unable to provide additional shares of our common stock for issuance upon conversion notes issued in the November 2015 private placement.

AXION POWER INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

September 30, 2016

(unaudited)

Execution of Non Binding Letter Of Intent

Effective on November 1, 2016, Axion Power International, Inc. entered into a non binding Tri-Party Letter of Intent with Fengfan Co. Ltd. of Baoding, China (SH. 600482) and LCB International Inc. of BVI, regarding the sale of Axion’s PbC technology in China, Taiwan, Hong Kong and Macau to Fengfan and LCB, along with non-exclusive licensing rights in North America. The IP package includes the sale of Axion’s five PbC patents in China; nonexclusive license to its 15 PbC patents in the United States; and will give Fengfan and LCB access to all of Axion’s intellectual property rights to PbC technology for use in a wide variety of applications, from automotive to energy storage.

The Letter of Intent, calls for a $5 million cash infusion into Axion over a 24-month period. As a result of the signing of this Letter of Intent, Fengfan will make an initial cash down payment of $250,000 to Axion by December 1, 2016 upon receiving regulatory approvals.

Concurrent with the signing of this Letter of Intent and the receipt of the $250,000, the three parties are targeting a definitive Tri-Party Agreement by the end of January 2017. Once finalized, quarterly payments to Axion are anticipated to begin in the first quarter of 2017. Then, starting one year following achievement of agreed-upon PbC volume production goals, or agreed-to PbC battery performance and cost objectives, Axion will receive a royalty of two percent of Fengfan’s net sales of PbC batteries in Greater China and North America, with a guaranteed annual minimum of $1 million.