UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
DC 20549
  ______________
  FORM
10-K
  ANNUAL
REPORT
 PURSUANT
TO SECTION 13 OR 15(d) OF THE
 SECURITIES
EXCHANGE ACT OF 1934
  For
the fiscal year ended December 31, 2008
  Commission
file number:  0-30391
   MEDIS
TECHNOLOGIES LTD.
 (Exact
name of registrant as specified in its charter)
  Delaware
                  (State
      of incorporation)
                
                13-3669062
                  (I.R.S.
      Employer Identification No.)
 805
Third Avenue
 New
York, New York 10022
 (Address
of principal executive offices, including zip code)
  (212) 935-8484
 (Registrant’s
telephone number, including area code)
  Securities
registered pursuant to Section 12(b) of the Exchange Act:
  Title of Each Class
              Name of Each Exchange on Which
      RegisteredCommon
      Stock, $.01 Par Value per Share
              The
      NASDAQ Stock Market LLC
  Securities
registered pursuant to Section 12(g) of the Exchange Act: None
  Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes  [   ] 
No  [X]
  Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Exchange Act.Yes [   ]No  [X]
  Indicate
by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) had been subject to such filing requirements
for the past 90 days.  Yes  [X]  No  [  
]
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  [   ]
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company”  in Rule 12b-2 of the Exchange
Act.
  Large
accelerated filer  [   ]   Accelerated
filer  [X] Non-accelerated
filer  [   ]   Smaller reporting
company  [   ]
  Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).  Yes  [   ] 
No  [X]
  As of
June 30, 2008, the aggregate market value of the registrant’s common stock held
by non-affiliates of the registrant was approximately $133,839,600
  As of
March 27, 2009, there were outstanding 46,349,555 shares of the registrant’s
common stock.
  DOCUMENTS
INCORPORATED BY REFERENCE
  Portions
of the Registrant’s Proxy Statement for the 2009 Annual Meeting of Stockholders
are incorporated by reference into Items 10, 11, 12, 13 and 14 of
Part III.
 
 
 TABLE
OF CONTENTS
   PART
    I
              
              1Item
      1.
              Business
              1Item
      1A.
              Risk
      Factors
              11Item
      1B.
              Unresolved Staff
      Comments
              23Item
      2.
              Properties
              23Item
      3.
              Legal
      Proceedings
              23Item
      4.
              Submission of
      Matters to a Vote of Security Holders
              23PART
    II
              
              24Item
    5.
              Market For
      Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
              24Item
    6.
              Selected Financial
      Data
              25Item
    7.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              27Item
    7A.
              Quantitative and
      Qualitative Disclosures About Market Risk
              43Item
    8.
              Financial Statements
      and Supplementary Data
              44Item
    9.
              Changes in and
      Disagreements with Accountants on Accounting and Financial
      Disclosure
              44Item
    9A.
              Controls and
      Procedures
              44Item
    9B.
              Other
      Information
              46PART
    III
              
              46Item
    10.
              Directors, Executive
      Officers and Corporate Governance
              46Item
    11.
              Executive
      Compensation
              46Item
    12.
              Security Ownership
      of Certain Beneficial Owners and Management and Related Stockholder
      Matters
              46Item
    13.
              Certain
      Relationships and Related Transactions, and Director
      Independence
              46Item
    14.
              Principal Accounting
      Fees and Services
              46PART
    IV
              
              47Item
    15.
              Exhibits and
      Financial Statement Schedules
              47
  References
in this annual report to “we,” “us,” or “our” are to Medis Technologies Ltd. and
its direct and indirect subsidiaries, unless the context specifies or requires
otherwise.
  
 SOURCES
OF INFORMATION
  Information
contained in this annual report concerning the commercial and military portable
electronics market, our general expectations concerning these industries and
these markets, and our position within these industries are based on market
research, industry publications, other publicly available information and on
assumptions made by us based on this information and our knowledge of these
industries and these markets, which we believe to be reasonable. Although we
believe that the market research, industry publications and other publicly
available information are reliable, including the sources that we cite in this
annual report, they have not been independently verified by us and, accordingly,
we cannot assure you that such information is accurate in all material respects.
Our estimates, particularly as they relate to our general expectations
concerning the portable electronics market, involve risks and uncertainties and
are subject to change based on various factors, including those discussed under
‘‘Risk Factors.’’
  All
dollar amounts are in U.S. dollars unless otherwise noted.
  FORWARD-LOOKING
STATEMENTS
  This
annual report includes forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. Words such as “will,”
“may,” ‘‘expects,’’ ‘‘anticipates,’’ ‘‘approximates,’’ ‘‘believes,’’
‘‘estimates,’’ ‘‘intends’’ and ‘‘hopes’’ and variations of such words and
similar expressions are intended to identify such forward-looking statements. We
have based these statements on our current expectations and projections about
future events. These forward-looking statements are not guarantees of future
performance and are subject to risks and uncertainties that could cause actual
results to differ materially from those projected in these statements. These
risks and uncertainties include those set forth under ‘‘Risk Factors.’’ The
forward-looking statements contained in this annual report include, among
others, statements about:
  ·
              the
      development and commercialization schedule for our fuel cell technology
      and products;
  ·
              our
      financial condition;
  ·
              the
      expected cost competitiveness of our fuel cell technology and
      products;
  ·
              rapid
      technological change;
  ·
              our
      intellectual property;
  ·
              the
      timing and availability of our
products;
  ·
              our
      business strategy; and
  ·
              general
      economic conditions.
  Except
for our ongoing obligations to disclose material information under the federal
securities laws, we are not obligated to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this annual report might not
occur.
 
 PART
I
  Item
1. Business
  Introduction
  We
design, develop and market an innovative fuel cell technology that provides
portable  electricity for retail, commercial and military
applications.  A fuel cell is a device that converts the chemical energy of
a fuel directly into electricity.  To our knowledge we are the only company
ever to have manufactured working portable fuel cells in production
quantities.  Our intellectual property portfolio consists of
37 United States and international patents.
  Our
technologies provide solutions for remote and off-grid power. Unlike batteries,
our products do not store power; they generate fresh power on the spot as
needed, which we believe makes our technology ideal for military applications.
It also means that we can power devices in the complete absence of electricity
from the grid – during blackouts, in battlefield conditions, in subway
tunnels or mine shafts, or at other remote or unmanned
locations.
  Our fuel
cells do not generate significant heat, are DOT approved and UL listed, and are
recyclable. Most other fuel-cell developers that we are aware of use a
methane or hydrogen-based chemistry.  Our fuel cells are based on sodium
borohydride, which we believe is a superior and more
stable fuel.
  Our first
commercial product is our “24/7 Power Pack,” commercially introduced in late
2008. It is a recyclable hand-held power generator that can  power
advanced portable electronic devices, such as mobile handsets, smart phones, MP3
players, gaming and other devices useful in emergencies such as flashlights,
radios and GPS devices.We believe that the
24/7 Power Pack is the first commercially available, portable fuel cell ever
sold. Subsequent to the introduction of the 24/7 Power Pack, we introduced
our XtremeTM Power Pack Emergency Kit, which provides light in any emergency
situations where light is needed for survival or escape. Because it
generates its own power when needed, it can provide instant light as well as
energy to power portable electronic devices on demand.
  We also
are majority owners of a separately operated subsidiary that is also traded
publicly: Lod, Israel-based Cell Kinetics Ltd. (OTC BB: CKNTF). Cell
Kinetics is seeking to exploit commercially a unique cell carrier under its
CKChipTM product
line, which can accommodate large quantities of living cells, each in individual
wells, for measuring their reactions while in a static state over
time.
  We
require additional financing in order to continue to fund our current
operations, and pay existing and future liabilities and other obligations. We
can give no assurances that we will be successful in raising funds through the
sale of our securities, through the divestiture of assets or through any other
alternative. Any inability to so obtain additional financing will materially
adversely affect us, including requiring us to significantly further curtail or
cease business operations altogether.
  We are
a Delaware corporation organized in April 1992. Our executive offices
are located at 805 Third Avenue, New York, New York 10022.
Our telephone number is (212) 935-8484. Our website is located
at www.medistechnologies.com. We make available free of charge through our
website our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after we have
filed such material electronically with, or
furnished it to, the Securities and Exchange Commission. The information on our
website is not part of this annual report.
 
 New
Management
  When our
original management determined that, after many years of trial-and-error product
development, that our first commercial product was ready to ship in December
2008, our Board of Directors began to bring in an entirely new management team
to put in place second-generation professional management, whose charge is to
commercialize our technologies. Our new management team has since
then:
  ·
              evaluated
      the viability of the existing operational, financial and technological
      infrastructure of our company;
  ·
              developed
      a plan and seeded actions which we believe will help us address the
      immediate recessionary conditions in the market today that relate to our
      company’s structure and performance;
and
  ·
              defined
      a strategy that we hope will guide us to where we need to be going
      forward.
  Through
the second quarter of 2009, our new management team is focused on the following
priorities:
  ·
              Driving
      down our cost structure to a market sustainable
  level;
  ·
              Enhancing
      our financial profile by significantly reducing our fixed costs
      basis;
  ·
              Commercializing
      our current product offerings;
  ·
              Exploring
      co-development opportunities in the military and government markets;
      and
  ·
              Arranging
      definitive financing agreements.
  Strategy
  We have
achieved what we believe to be an historic breakthrough in commercializing a
technology that has resisted the best efforts of science and industry for
approximately 170 years.  To date, we have manufactured approximately
200,000 portable fuel cells on our fully-automated manufacturing line
in Ireland. We believe that these are the first portable fuel cells to
have been manufactured in production quantities. Our product assets
include:
  ·
              The
      first portable commercial fuel
cell;
  ·
              A
      strong intellectual property
portfolio;
  ·
              Green
      credentials;
  ·
              The
      ability to manufacture in quantity;
and
  ·
              The
      ability to recruit distributors, to package and ship products to retail
      locations.
  Our
strategy is to commercialize our power generation technologies for three market
segments: (1) retail, (2) industrial/business, and (3) governments and military
forces.  We believe that our accomplishment to date position us as a prime
greentech, alternative-energy developer and supplier, and one of the leading
portable fuel-cell companies in the world.  We also intend to develop a
licensing program to broaden the use of our technologies beyond our own
manufacturing and product-development plans.  All of these activities are
conditioned upon our obtaining additional funding, of which we can give no
assurance.
 2
 Although
we continue with our research and development, we are now in the early stages of
commercial roll-out of our 24/7 Power Pack and Emergency Kit through on-line
channels.
  Commercialization
  It is our
goal to commercialize our fuel cell technology through providing power sources
to different end markets and applications. To date we have focused on a
commercially viable solution for the portable electronics charging market, and
more recently, the emergency kit market. To this end, we are working to
establish relationships with key customers and distributors who will provide
online, on-shelf and catalogue retail space for our products. As part of our
commercialization and marketing program, we have produced thousands of our Power
Packs for testing, marketing and promotional purposes, including distribution to
potential key customers.
  We have
received Underwriters’ Laboratories (UL) listing of our 24/7 Power Pack, and
having been notified by UL that we have successfully completed the initial
production inspection of our fully automated production line located in Galway,
Ireland, we are authorized to apply the UL mark to our Power Pack products
produced on that line. UL is an internationally recognized, independent,
not-for-profit product safety certification organization involved in testing
products and writing standards for safety. TUV Rheinland Group, an independent
international service company that documents product safety and quality, has
confirmed that our 24/7 Power Pack also meets the requirements needed to carry
the CE mark, including the IEC 62282-6-1 standard for micro fuel cell power
systems, demonstrating that the 24/7 Power Pack is compliant with the directives
and standards required by the European Union. Furthermore, we have received a
special permit from the U.S. Department of Transportation, which authorizes
aircraft passengers and crew members to carry up to three 24/7 Power Pack micro
fuel cell devices for personal use aboard aircraft on one’s person or in
carry-on baggage without being subject to the Hazardous Materials Regulations,
subject to limitations, conditions, regulations and specific labeling
requirements set forth in the permit.
  Target
End Users
  We are
currently targeting the following specific applications for the use of our
current fuel cell product offerings:
  ·
              Emergency Kit Users.
      This market includes users requiring backup power during emergency
      situations such as natural disasters and blackouts as well as those users
      who want to be prepared for such emergencies by having power available for
      use at some future time.  Our Emergency Kit provides three very
      important functions in an emergency: light via the included flashlight,
      communication with the outside world by powering your cell phone, and
      information via portable radios.
  ·
              Consumers of Content on
      Portable Devices. Mobile phone operators and content providers are
      increasing the ability of consumers to access multimedia and online
      content such as music, video, social networks, search services and GPS.
      These type of applications require significantly more power consumption
      than traditional services which pushes the envelope on the battery
      servicing capability of today’s portable device market.  As the
      power demands on mobile phone and other portable electronics products
      increase, we anticipate that consumers will be interested in having the
      24/7 Power Pack to provide them access to continuous power when
      conventional power sources are not available or
    inaccessible.
  ·
                Off Grid Business Travelers to
      Mountain Hikers:Today, we are a world on the move pursuing a
      business deal or adventuring deep into the wilds of land and
      sea.  These pursuits of business or pleasure are ever more
      dependent on portable devices to make them possible.  Just to
      name one of many hundreds of examples, we believe frequent travelers who
      utilize cell phones and other portable electronic devices who are
      forever in search of an A/C outlet will be interested in using our
      24/7 Power Pack to keep their devices charged while
    traveling.
  3
  Product
Offering
  In order
to address the market opportunity of our different target end markets we have
decided to initially focus on the following product offering:
  24/7 Power Pack.Our 24/7
Power Pack is a recyclable, portable power source that allows the continued use
of a portable electronic device whose battery is depleted, while at the same
time charging the battery. The 24/7 Power Pack provides sufficient energy to
provide multiple charges to a range of portable electronic devices on the market
today. Our 24/7 Power Pack comes in two versions - a 1 watt version and a more
powerful 4 watt version designed for smart phones that charges devices in a
shorter time frame.
  Xtreme Power Pack Emergency Kit.Our Xtreme Power Pack Emergency Kit offering was introduced to customers
and distributors in January 2009. The Emergency Kit is built around our fuel
cell technology, delivering emergency power when a user needs it most.  It
is a power alternative that does not require mechanical or solar energy to power
mobile phones, flashlights or radios. The Emergency Kit can be used as an
instant power source for charging the user’s cell phone, to power an included
14-LED flashlight, as well as to power portable radios and other electronic
devices. The kit is intended to be used in the event of power outages due to
natural disasters or other situations when access to conventional electricity is
not available such as, for instance, when a car breaks down on the road, or when
one is enjoying an off grid adventure such as hiking in remote
areas.
  A
New Generation of Products
  While we
continue to pursue the commercialization of our current products, our management
team is also concentrating efforts on a second generation of products designed
for specific target market niches. Overall, we expect to add significant
improvements in performance, design and marketability. One important step
forward will be the introduction of a solid fuel, replacing the liquid/paste
fuel format used in the first products. The solid fuel is expected to
increase energy density and may allow us to design a cartridge-refillable
product.
  Our new
management team is currently defining what we believe to be the most significant
areas of opportunity to apply our technology and where the most value exists.
Subject to market validation and our future financial situation, we intend to
pursue the following opportunities:
  ·
              Consumer Products.A multi-use,
      cartridge-based charger for portable electronic devices that is expected
      to be approximately one-third smaller and generate approximately twice the
      energy of our current 24/7 Power
Pack.
  ·
              Military Products. A
      range of products in development, including a 10-30W product leading to a
      replacement cell product for military radio applications and a “Future
      Soldier” power system. Furthermore, we may explore products
      specifically designed for military Unmanned Aerial
    Vehicles.
  Additionally,
depending on the success of our other products, we may pursue development of a
back-up power system for small offices and homes, with power capabilities up to
5kw.
 4
 Production
  Manufacturing
fuel cells has been and continues to be a challenge that demands extremely tight
control of critical variables. We believe it is one of the most substantial
barriers to commercialization of a fuel cell product – even products whose
underlying technology has been proven in the lab.
  Our fully
automated production line is at the Galway, Ireland facilities of our contract
manufacturer, Celestica Ireland Ltd.  It is designed to produce at
full capacity 1.5 million Power Packs per month, and also includes a fuel
production facility. We have recently suspended our production operations in an
effort to cut costs and preserve cash while we focus on sales and marketing
activities, and are currently evaluating our existing manufacturing capacity as
it relates to our short and long-term expectations of product
demand.  Our semi-automated production line, located in our facilities
in Lod, Israel, is expected to be used for the foreseeable future primarily for
research and development, and prototype and low rate initial production
purposes.
  Competition
  General
  We expect
our portable energy sources to compete against other portable fuel cell
developers as well as against other advanced battery technologies. Our primary
competitors are:
  ·
              Battery manufacturers who
      utilize existing battery technologies (both rechargeable and
      non-rechargeable). Existing battery technologies have the
      significant advantages of having commercially available products today and
      are familiar to most consumers, and are backed by companies who are
      continuously investing in marketing and further research and
      development.
  ·
              Companies developing small
      fuel cells or other alternative power sources for the portable electronics
      market. We compete with companies such as Mechanical Technology
      Inc., Poly Fuel, Inc., Angstrom Power, Tekion Inc., Lilliputian Systems,
      Inc., Neah Power Systems, Inc, iGo, and others. We believe other large
      cell phone and portable electronic device companies are also developing
      fuel cells for the portable electronics
market.
  ·
              Companies competing in the
      emergency kit market, which can provide portable light sources such as
      flashlights, emergency warnings lights, etc.In the
      emergency kit end market we compete with companies that offer flashlights,
      portable lighting and electronics solutions to consumers that value
      emergency preparedness. The emergency kit market has different products
      which package radios, flashlights and cell phone chargers that can be
      powered through solar, self-powered and hand-crank
    mechanisms.
  We expect
competition to intensify greatly as the need for new energy alternatives becomes
more apparent and continues to increase. Many of our competitors are well
established and have substantially greater managerial, technical, financial,
marketing and product development resources. We cannot give any assurance that
current and future competitors will not be more successful in the markets in
which we compete, or that we will be successful in such a competitive
environment.
 5
 Competitive
Advantages
  Leading-Edge, Disruptive
Technology. We believe that our products have multiple competitive
advantages, including:
  ·
              instantaneous,
      continuous power source – little or no pre-charging
  needed;
  ·
              lower heat
      emission;
  ·
              significantly
      less flammable or toxic than other fuel cell alternatives that we are
      aware of;
  ·
              significantly
      greater efficiency with a high energy density when compared to battery or
      fuel cell alternatives we are aware
of;
  ·
              cost
      advantage relative to other fuel cell
  competitors;
  ·
              ability
      to operate in a broad range of ambient
  temperatures;
  ·
              relative
      size – small, portable solution;
  ·
              more
      environmentally friendly ‘‘green’’ solution relative to other battery or
      fuel cell alternatives; and
  ·
                both
      UL listed for safety and DOT approved for use on
  airplanes.
 World’s First Commercial Portable
Fuel Cell Solution. We believe that we have the only commercially
available portable fuel cell solution. We believe that other portable fuel cell
solutions are primarily in prototype stages and have not been widely
commercialized. Our fuel cell is not based on the traditional proton exchange
membrane (PEM) technology or methanol based fuels utilized by many other fuel
cell developers. Therefore, we do not face issues such as the emission of
significant heat and water, high production costs, and the flammable and toxic
nature of their respective fuels. Our 24/7 Power Pack provides a competitive,
portable fuel cell solution today.
  Significant Intellectual Property
and Technological Know-how. We have been issued 37 United States and
international patents relating to our fuel cell technologies. Furthermore, we
have several other patents pending which we are pursuing, and we continue to
prepare new patent applications when we think it appropriate to protect our
intellectual property. We also have trade secrets pertaining to our fuel cell
technology and production process which we believe will create substantial
barriers to market entry and protect us from reverse engineering.
  Barriers
to Entry
  In
addition to our competitive advantage related to our technology and intellectual
property, we believe that we have also created significant barriers to entry for
other fuel cell companies that directly or indirectly compete with us. Such
barriers include the following:
  ·
              Production.We
      haveefficiencies and
      learning associated with automated production technology and quality
      control (assembly, fuel blending, framing, electrode and catalyst
      production).
  ·
              Manufacturing Ability.We believe that we are the only company to have manufactured
      thousands of working fuel cell units for the portable electronics
      market.
  ·
              Value Chain.We have
      developed and are continuing to develop supplier and distributor
      networks.
  ·
              Standards/Regulations.We believe that we are the only company to have received all
      necessary regulatory approvals for sale of our fuel cell products in the
      markets in which we compete.
  6
 Military
Opportunity
  We
believe that the military market offers us a significant opportunity for
profitable  margin sales based on evolving our current technology, and
would be one of our key focus areas going forward. Our belief is premised on the
following factors:
  ·
              Heavy
      Consumption of Batteries.  A conservative estimate of
      worldwide military battery sales totals $500 million, with spikes for
      active conflicts. Batteries are currently used by militaries around the
      world for manpack and handheld applications, including radio,
      surveillance, telemetry, remote control, sensors and lasers, and for
      unmanned vehicles and unattended stations, which are dependent on power
      but remote from any grid. According to National Defense Magazine, in Iraq
      in 2003, consumption of BA-5590 batteries for the combined U.S. forces
      reached 125,000 per month.
  ·
              Dissatisfaction
      with Battery Power.Military planners are
      actively looking for ways to reduce weight and minimize health and
      environmental risks for combat
soldiers.
  ·
              Future
      Soldier Initiatives.  “Future Soldier” is shorthand for
      the many initiatives by militaries worldwide to equip ground-based combat
      soldiers with an integrated set of high-technology uniforms and equipment,
      linked to an array of battlefield information resources. These systems are
      increasingly power-dependent, driving the demand for new sources of safe,
      clean, reliable and lower
weight power.
  ·
              High Volume
      and Repeat Sales Potential.Once
      field-proven and accepted by any military, we believe that fuel cells will
      be ordered and re-ordered in large
quantities.
  ·
              Sustained
      Market Growth.  We believe
      that worldwide military spending on portable power systems will remain
      steady or increase in the future.
  ·
              Leveraging
      Existing Technology.The
      military opportunity leverages our technology
  platform.
 
 Cell
Kinetics - CKChipTM
  Through
Cell Kinetics, we are seeking to commercially exploit an improved Cell Carrier
under the CKChipTM product line. This unique CKChipTM can accommodate up to 10,000
cells, each in individual wells, for measuring reactions of living cells over
time. Our CKChipTM is a platform static cytometry technology that enables the
simultaneous examination of many individual live cells using simple imaging
methods such as fluorescence microscopy. Whereas until now cells were fixed and
stained for microscopic examination, broken down for examination of their
contents, or held alive in groups on micro-plates, the CKChipTM enables the
dispersion of a group of living cells, each into its own micro-well for
individual scrutiny over time. We believe that our proprietary CKChipTM platform
will address the need for cell-based assays that are simple to use, providing
continuous recording of cellular activities with high sensitivity, reliability
and medium to high content kinetic analysis.
  Monitoring
of cells held on the CKChipTM is performed by means of fluorescence emission
detected microscopically, using an upright or inverted microscope, in
conjunction with common imaging software. As fluorescence imaging microscopes
are common in most life science and medical laboratories, anyone interested in
using the CKChipTM may be able to do so without having to invest in purchasing a
monitoring device.
 7
 Advantages
of the CKChipTM
  We
believe the CKChipTM has the following distinct advantages:
  ·
              ability
      to capture and register living cells at specific
  addresses;
  ·
              ability
      to monitor identifiable individual cells and rare
  events;
  ·
              ability
      to repeatedly monitor cells for acquisition of kinetic
    data;
  ·
              simultaneous
      and sequential monitoring of up to 10,000 cells by conventional fluoresces
      microscopy;
  ·
              enables
      characterization of specific cells within a heterogeneous cell
      population;
  ·
              manipulation
      and analysis of adherent and non-adherent living cells;
  and
  ·
              adding
      and rinsing reagents from living cells under
  observation.
  Potential
CKChipTM Applications
  Advances
in cell biology and medical research are driving the growing need for
technologies that enable the examination of dynamic molecular and physiological
processes in individual living cells over time.
  Scientists
today recognize that in order to advance the understanding of biological
processes and to carry out tests on them, it is necessary to integrate separate
functions into one complex modulus.  The smallest living unit, the
cell, plays a central role as a functional system model for such tests. We
believe that detailed quantitative understanding of single cell functions and
integration of various aspects of cellular events become important tools for
cell function analysis.
  We
believe that the CKChipTM technology could be used for research purposes in
various scientific fields including:
  ·
              immunology;
  ·
              cell
      biology;
  ·
              genetic
      engineering;
  ·
              systems
      biology;
  ·
              stem
      cell research;
  ·
              cancer
      research; and
  ·
              drug
      discovery.
  While it
was our intention to develop a medical device incubator, we have decided to
accord priority to the development and commercialization of our CKChip
technology and successive generations of CKChip applications and products.
Accordingly, we do not expect at the current time to develop and expand a
diverse partner company portfolio, and we will be delaying implementing our
plans for additional investments in new early stage medical device enterprises
to a later date, if at all.
 
 To
explore the feasibility of such initiative, in 2007 we invested in Scorpion
Surgical Technologies, Ltd. (“Scorpion”), a start-up company in the field of
orthopedic surgical instrumentation, with particular emphasis upon spinal
stabilization systems. Scorpion’s technology is intended to enhance implant
stability, increase implant strength as well as resistance to pull-out, and
improve bone implant
 8
 interaction.
We are currently assessing the advisability of moving forward with additional
investment in Scorpion, which would be based on availability of funds and
approval of the Board of Directors of  Cell Kinetics.
  During
2008 we initiated sales and marketing activities in Israel, the United States
and Europe.
  Cell
Kinetics is a foreign private issuer registered under the Securities Exchange
Act of 1934, as amended.  It files Annual Reports on Form 20-F and
makes other periodic filings with the SEC.
  Research
And Development
  Our
research and development programs are generally pursued by scientists employed
by us in Israel on a full-time basis or hired as consultants.  We are
also working with subcontractors in developing specific components and/or
processes for use in our technologies.
  The
primary objectives of our research and development programs are to advance the
development of our direct liquid fuel cell technology, including next generation
fuel cells for commercial and military products, and to enhance the commercial
value of our products and technology, as well as to continue the development of
our Cell Carrier technology and CKChipTM products.
  We have
incurred research and development costs of approximately $18,057,000,
$25,705,000 and $21,527,000 for the years ended December 31, 2006, 2007 and
2008, respectively.
  Government
Regulation
  In
addition to regulations we encounter that are common to all businesses, such as
employment legislation, implied warranty laws, and environmental, health and
safety standards, in the United States, Israel and Ireland, in each case, to the
extent applicable.  We also encounter and expect to continue and
further encounter in the future industry-specific government regulations that
would govern our fuel cell products, such as transportation, performance,
safety, and environmental regulations for each region in which we would seek to
sell or transport our products, as well as regulations that would govern our
cell carrier related technology. We have received a special permit from the U.S.
Department of Transportation, which authorizes aircraft passengers and crew
members to carry up to three 24/7 Power Pack micro fuel cell devices for
personal use aboard aircraft on one’s person or in carry-on baggage without
being subject to the Hazardous Materials Regulations, subject to limitations,
conditions, regulations and specific labeling requirements set forth in the
permit.
  It may
become the case that other regulatory approvals will be required for the design
and manufacture of our fuel cells and the use of our proprietary fuel, and other
components of the fuel cell such as the electrolyte. Furthermore, we must obtain
from the State of Israel and Ireland permits to work with certain chemicals used
to make our fuel cells. To the extent that there are delays in gaining
regulatory approval, our development and growth may be materially
affected.
  Intellectual
Property
  As
mentioned above, we have been issued nine United States patents relating to our
fuel cell technologies, four of which pertain to our liquid fuel. Furthermore,
we have several other patents pending and we continue to prepare new patent
applications in the United States with respect to various aspects of our fuel
cell technology, including our fuel, electrodes, cartridge system, power
management system and fuel cells.
 9
 Corresponding
applications have been filed or are intended to be filed under the Patent
Cooperation Treaty, which allows us limited protection in member countries for
periods ranging from 20-30 months from the initial filing date, during which
time patent applications can be filed in such countries. Patents have been
issued in 13 foreign countries, including Japan, China, Korea, Russia, Israel
and Mexico. Patent applications filed in foreign countries are subject to laws,
rules and procedures which differ from those of the United States, and even if
foreign patent applications issue, some foreign countries provide significantly
less patent protection than the United States.
  Cell
Kinetics, as the successor to our CellScan and Cell Carrier business, is the
exclusive worldwide licensee of Bar-Ilan University’s proprietary rights
relating to the CellScan. We were required to pay Bar-Ilan a royalty through
2005 at the rate of 6.5% of proceeds of sales, after deducting sales commissions
and other customary charges, and 4.5% of any fees received on account of the
grant of territorial rights, and for the ensuing ten years a royalty of 3.5% of
all revenues, whether from sales or fees. In addition, we are required to pay
$100,000 to Bar-Ilan during the first year in which our post-tax profits
relating to the CellScan exceed $300,000. The license contains provisions
relating to the joint protection of the licensed patent rights and other
provisions customary in such instruments. We do not believe that Bar Ilan’s
patent rights with respect to the CellScan, will be of material value to us in
our future efforts to commercialize and protect our CellScan and our Cell
Carrier technology as the underlying patents and attendant proprietary rights
have either expired or will shortly expire by their respective
terms.
  Cell
Kinetics holds a U.S. patent relating to its Cell Carrier and has filed and
continues to file patent applications for its new Cell Carrier development. Cell
Kinetics has also filed applications under the Patent Cooperation Treaty to seek
proprietary protection for that technology world wide. Furthermore, three
provisional patent applications covering unique features related to the Cell
Carrier technology and test kit have been submitted, thereby affording Cell
Kinetics up to an additional 12 months from the submission date to apply for
patent protection in the United States.
  In
addition to patent protection, we rely on the laws of unfair competition and
trade secrets to protect our licensed or proprietary rights. We attempt to
protect our trade secrets and other proprietary information through agreements
with our collaborators, through confidentiality agreements with employees,
consultants, potential joint ventures and licensees and through other security
measures.
  Employees
  As of
December 31, 2008, we had 140 full time employees, of which approximately 89
were engineers, scientists and degreed professionals, 35 were technical,
administrative and manufacturing support personnel and 15 were production
employees. There were also approximately 12 engineers, scientists, degreed
professionals and other personnel who worked with us as consultants in
researching and developing and marketing our technologies and products. All
except 10 of such employees and consultants are in Israel.
  As part
of our recently announced comprehensive cost rationalization plan designed to
reduce operating costs and enhance operational efficiencies, the employment of
approximately 50 employees from the our Israeli office was
terminated.  These positions are directly and indirectly related to
our operations and general administration.
 10
  Item 1A. Risk
Factors
  We
have incurred losses and anticipate continued losses and negative cash flow; our
financial statements are subject to a going concern qualification from the
Independent Registered Public Accounting Firm that performed our
audit.
  We have
generated net losses since inception and expect to continue to incur net losses
and generate negative cash flow until we can produce sufficient revenues to
cover our costs through the production and sale of our 24/7 Power Packs and
other anticipated fuel cell products.
  We
incurred a net loss of approximately $148,422,000, $38,200,000 and
$33,047,000 during the years ended December 31, 2008, 2007 and 2006,
respectively. We have recently suspended our production operations and curtailed
our development programs in an effort to cut costs and preserve cash while we
focus on sales and marketing activities. Our inability to become profitable may
force us to further curtail or discontinue our research and development programs
and manufacturing operations and our other day-to-day operations. Furthermore,
there can be no assurance that profitability, if achieved, can be sustained on
an ongoing basis. As of December 31, 2008, we had an accumulated deficit of
approximately $371,697,000. We may continue to generate net losses for the
foreseeable future and cannot predict when we will achieve profitability, if
ever.
  In order
for us to remain a going concern, we will need to obtain substantial additional
financing to continue our operations and to meet our cash flow needs. In view of
our financial situation and current market and economic conditions, we do not
know if additional financing will be available to us on commercially reasonable
terms, or at all. Moreover, if we raise additional capital through borrowing or
other debt financing, we would incur substantial interest expense. Sales of
additional equity securities, including upon the exercise of convertible
securities, will dilute on a pro rata basis the percentage ownership of all
holders of common stock. Any inability to obtain additional financing will
materially adversely affect us, including possibly requiring us to significantly
further curtail or cease business operations altogether.
  We
require additional funding in order to complete the commercialization of our
24/7 Power Pack, to be competitive, to establish a stronger financial position
and to continue our operations.
  Since
inception, we have incurred operating losses and have used cash in our
operations. We have relied principally on the sale of our securities to fund our
research and development activities and operations. Unless we are able to
successfully market our 24/7 Power Pack or any of our other technologies and
products, we believe this dependence will continue. We will need additional
funding in order to successfully market our 24/7 Power Pack, to be competitive,
to establish a stronger financial position and to continue our operations. In
addition, we will need additional funding if cost overruns relating to the
implementation of our manufacturing lines occur, if our suppliers require us to
provide additional funding, if we do not achieve our current commercialization
targets, or if we determine to expend additional funds on marketing and
advertising our 24/7 Power Pack or other products. We can offer no assurance
that we will be able to secure additional funding, or funding on terms
acceptable to us, to meet our financial obligations, if necessary, or that a
third party will be willing to make such funds available. Our failure to raise
additional funds could require us to delay or curtail our marketing and
production programs and research and product development efforts, or force us to
cease business operations entirely. Additionally, our failure to successfully
develop or market our fuel cell products or products derived from any of our
other technologies may materially adversely affect our ability to raise
additional funds. In any event, it is not possible to make any reliable estimate
of the funds required to
 11
 complete
the development of any of our other technologies or successfully market and
produce our fuel cell products
  A
commercially acceptable market for our fuel cell products may never develop or
may take longer to develop than we anticipate.
  Although
we have developed our business plans assuming a consumer demand for our 24/7
Power Pack and future generations of our fuel cell products, as well as military
demand, a commercially acceptable market may never develop for our fuel cell
products or Cell Kinetic’s cell carrier products, or may develop more slowly
than we anticipate. Our fuel cell products represent a new technology and market
category, and we do not know with certainty to what extent, if any, end-users
will want to purchase and use them. The development of a commercially acceptable
market for our fuel cell products may be affected by many factors, some of which
are out of our control, including:
  ·
              the
      level to which the capabilities of our 24/7 Power Pack, and any other of
      our fuel cell products, have advanced in performance, shelf-life, stand-by
      time, time of use, size, weight, cost and other factors that determine
      consumer acceptance;
  ·
              the
      emergence of newer, more competitive technologies and
      products;
  ·
              improvements
      to existing technologies, including existing rechargeable battery
      technology or the chips used in the electronic devices that allow the
      batteries to operate more efficiently or allow the devices to run for
      longer periods of time;
  ·
              the
      future cost of sodium or potassium borohydrides, alkalines, glycerol, or
      any other hydrogen-based fuels, the catalysts used in our fuel cell
      products which may require costly metals or other chemicals used for
      powering our fuel cell products and plastics and nickel used in the
      products;
  ·
              regulations
      that affect or limit the use of the components in our fuel cells or our
      fuel cells in general or regulations regarding
  recycling;
  ·
              consumer
      perceptions of the safety of our products;
and
  ·
              consumer
      reluctance to try a new product.
  If a
market fails to develop or develops more slowly than we anticipate, we may be
unable to recover the losses we will have incurred in the development of our
products and may never achieve profitability or positive cash
flows.
  We
may not meet our product development and commercialization milestones and time
tables.
  We
establish milestones and time tables based upon our expectations regarding our
technologies, plans and programs at that time, which we use to assess our
progress toward developing and delivering into the market place commercially
acceptable fuel cell products. These milestones relate to technology and design
improvements as well as to dates for achieving production and marketing goals.
If our products exhibit technical defects or are unable to meet cost or
performance goals, including levels and stability of power output for our 24/7
Power Pack, useful life and reliability or if our production goals cannot be
achieved in time or the costs exceed our expectations, our commercialization
schedule could be delayed and third parties who are collaborating with us to
manufacture or market our fuel cell products may
decline to continue that collaboration. Furthermore, potential purchasers of our
initial commercial products may lose interest or may opt to purchase alternative
technologies.
 12
 We can
give no assurance that our commercialization schedule – including production and
sales time tables – will be met as we further develop, produce and sell our fuel
cell products.
  We
may be unsuccessful in developing additional fuel cell products or future
generations of our 24/7 Power Pack or any of our other
technologies.
  In tandem
with the commercialization of our first products and subject to available funds,
we are developing other fuel cell products as well as future generations of our
24/7 Power Pack, including a solid fuel, refuelable Power Pack product and
specialized products for military use. Developing any technology into a
marketable product that a consumer will desire to purchase is a risky, time
consuming and expensive process. We may encounter setbacks or discrepancies
requiring time consuming and costly redesigns and changes. There also is the
possibility of outright failure. Furthermore, we contemplate moving forward with
the development of certain of our fuel cell technologies only if we are able to
find strategic investors or other joint venture partners or otherwise obtain
additional financing. Additionally, we continue to seek to improve our 24/7
Power Pack and our fuel cell technologies in general, particularly in the areas
of energy capacity, power density, operating time, shelf life, working life and
flexibility of use, as well as the temperature conditions under which they can
operate. We also seek to reduce the component costs and costs of the final
product, and continue to seek to improve its power management system and each
element of the power management system and to improve the efficiency of our
manufacturing processes. We can give no assurance that we will be successful in
improving our technologies or reducing costs. Generally, we can give no
assurance as to when or whether we will successfully develop any of our other
planned fuel cell products into commercially successful products.
  We
have limited experience manufacturing our products on a large scale commercial
basis.
  Prior to
2008, we manufactured a limited number of our fuel cell products on our
semi-automated production line at our facility in Lod, Israel. In 2008, we
shifted our manufacturing efforts to our fully automated production line located
at the facilities of our contract manufacturer, Celestica Ireland Ltd., in
Galway, Ireland.  We can offer no assurance that either we, our
contract manufacturer or any other party we have engaged to build a fully
automated line production for volume-production of our products have developed
production processes that are satisfactorily designed and sufficiently efficient
to provide for automated, low-cost manufacturing capabilities and processes to
meet the quality, price, engineering, design and production standards or
production volumes required to successfully mass market our fuel cell products.
Furthermore, our manufacturing process is complicated and we rely on a number of
subcontracts for the production of various subassemblies. Even if we or our
contract manufacturer and our subcontractors are successful in developing such
manufacturing capability and processes, we do not know whether we or they will
be timely in meeting our product commercialization schedule or the product,
production and delivery requirements of potential customers. A failure to
develop such manufacturing processes and capabilities or to timely meet such
requirements could cause us to lose customers and could have a material adverse
effect on our business and financial results.
  Customers
will be unlikely to buy our fuel cell or CKChipTM products unless we can
demonstrate that they can be produced for sale to customers and users at
attractive prices.
  The price
of our fuel cell products and CKChip products is dependent largely on material
and other manufacturing costs. We are unable to offer any assurance that either
we or a contract manufacturer will be able to reduce costs to a level which will
allow production of a competitive product that the consumer finds attractive or
that any product produced using lower cost materials and manufacturing
 13
 processes
will not suffer from a reduction in performance, reliability and longevity. In
any event, we can give no assurance that the pricing schedules for our products
will be attractive to any of our distributors, representatives or
customers.
  We have
developed an estimated pricing structure for our CKChipTM that we believe would
be commercially acceptable. However, we can give no assurance that potential
CKChipTM customers would respond affirmatively to our pricing
structure.
  We
will be unable to market or sell our fuel cell or CKChipTM products if we are
unsuccessful in entering into, amending and maintaining sales agreements,
arrangements, alliances, joint ventures or licensing agreements with third
parties.
  Our
ability to market, manufacture and sell our fuel cell technologies or CKChipTM
products is wholly dependent on our entry into manufacturing, sales or
distributing arrangements, sales agreements, strategic alliances, joint ventures
or licensing agreements with third parties possessing such capabilities.
Although to date we have been successful in entering into certain of such
arrangements, we can give no assurance that in the future we will be successful
in amending such arrangements to take into account new pricing schedules and
products or other reasons, or in entering into additional arrangements,
alliances, joint ventures or agreements or that the terms of which will be
entirely beneficial to us or that existing agreements will result in substantial
revenue. Failure to enter into, or amend the terms of, such arrangements with
regard to our products could materially and adversely affect our
commercialization plans and, therefore, our business, prospects, results of
operations and financial condition. Furthermore, even if we were successful in
entering into such arrangements or amending the terms of any such arrangements,
any failure to successfully support our products through advertising or
marketing programs, whether due to the costs involved or otherwise, or generally
any failure by potential end users to purchase our products, could cause those
third parties to decline to extend their relationship with us or order
additional products from us.
  We
depend on relationships with strategic partners, and many of the terms of these
relationships are not certain.
  We have
entered into agreements with strategic partners for the distribution of our 24/7
Power Pack. The terms and conditions of many of these agreements allow for
immediate termination, in part or in whole, by the partners in their discretion,
or only provide for a commitment on the part of the partners upon the happening
of certain milestone events. We can give no assurance that we will meet any of
these milestones. Our inability to meet any of the aforementioned milestones, or
the termination of any of these agreements by the strategic partner, could
adversely affect our ability to distribute our 24/7 Power Pack to the
marketplace and, therefore, our business, prospects, results of operations and
financial condition. Furthermore, our agreement with Celestica to manage and
operate our high volume production line and fuel production facility may be
terminated by us, by Celestica, or by mutual agreement at the end of its current
term in September 2009, or any consecutive one-year term, by providing the other
party six-months prior notice.
  We are
evaluating whether to terminate the agreement with Celestica at the end of the
current term. While we believe that we will be able to adequately replace
Celestica to manage and operate our production,  our inability to do
so in a timely manner and on an cost-effective basis, could adversely affect our
ability to manufacture our products and, consequently, our ability to bring our
products to market.
  Although
we have received or expect to receive purchase orders pursuant to some of these
distribution agreements, various factors, including that the market for our
products continues to evolve,
 14
 have
impacted those agreements and purchase orders. Any new product we develop would
likely require changes in or additions to the distribution agreements and
purchase orders. Accordingly, we are now working with our existing distributors
and representatives, with whom we are developing new pricing schedules
for our products and introducing our new and existing products. We can give
no assurance that any of our distributors or representatives will continue to
cooperate with us on the roll-out of our products on the terms and based on the
pricing schedules we believe are appropriate. Any such failure to cooperate
could adversely affect our ability to distribute our 24/7 Power Pack and
emergency kit to the marketplace and, therefore, our business, prospects,
results of operations and financial condition.
  We
are and will continue to be dependent on third party suppliers and
subcontractors for the supply of key materials and components for our
products.
  We rely
upon third party suppliers and subcontractors to provide requisite materials and
components, including the power management system of our 24/7 Power Pack
product. A supplier’s or subcontractor’s failure to supply materials or
components in a timely manner, or to supply materials and components that meet
our quality, quantity or cost requirements, or our inability to obtain
substitute sources for these materials and components in a timely manner or on
terms acceptable to us, could negatively affect our ability to manufacture our
fuel cell products on a timely basis or meet our cost targets or
commercialization schedule. We or our contract manufacturers, manufacturing,
strategic alliance or joint venture partners may be unable to obtain comparable
materials or components from alternative suppliers, and that could adversely
affect our ability to produce viable fuel cells or significantly raise the cost
of producing fuel cells or fuel cell products.
  Platinum
is a scarce natural resource and, to the extent it remains a component of the
electrode, we will be dependent upon a sufficient supply of this commodity at a
cost that allows us to meet our cost targets for any future fuel cell products.
Any shortages in the supply of platinum could raise our cost of producing our
fuel cell products beyond our targeted cost, thus lowering our profit margins or
adversely affecting our ability to produce fuel cell products at prices
consumers would be willing to pay.
  Problems
or delays in our collaboration efforts with third parties to develop or market
our fuel cell products could hurt our reputation and the reputation of our
products.
  We have
entered into agreements with third parties who have agreed to assist us in
developing or marketing our fuel cell products, producing and supplying
components of our fuel cell products or producing the manufacturing line for our
fuel cell products. We are in discussions with other third parties and may enter
into similar agreements with such other parties or others in the future, of
which we can give no assurances of success. Some of these collaboration
agreements contemplate that these third parties will work with our scientists
and employees to test various aspects of, assist in developing components of, or
market, our fuel cells or fuel cell products. Such tests or development efforts
may encounter problems and delays for a number of reasons, including, without
limitation, the failure of our technology, the failure of the technology of
others, the failure to combine these technologies properly and the failure to
maintain and service any test prototypes properly. Many of these potential
problems and delays are beyond our control. In addition, collaborative efforts,
by their nature, often create problems due to miscommunications and disparate
expectations and priorities among the parties involved and may result in
unexpected modifications and delays in developing or marketing our fuel cell
technologies or impact the cost of making and delivering our fuel cell products.
Any such problems or perceived problems with these collaborative efforts could
hurt our reputation and the reputation of our products and
technologies.
 15
 Product
liability or defects could negatively impact our results of
operations.
  Any
liability for damages resulting from malfunctions or design defects could be
substantial and could materially adversely affect our business, financial
condition, results of operations and prospects. In addition, a well publicized
actual or perceived problem could adversely affect the market’s perception of
our products, resulting in a decline in demand for our products and could divert
the attention of our management, which may materially and adversely affect our
business, financial condition, results of operations and prospects.
  Our
business depends on our intellectual property. We may not be successful in
protecting our intellectual property, which could hinder our growth and
success.
  We regard
our patents, trade secrets, copyrights and other intellectual property rights as
essential to our growth and success. We rely upon a combination of patent,
copyright and trademark laws, trade secret protection, confidentiality and
non-disclosure agreements and contractual provisions with employees and with
third parties to establish and protect our proprietary rights. We own, directly
or indirectly through subsidiaries, patents for certain technologies and are
currently applying for additional patents. We can offer no assurance that we
will succeed in receiving patent and other proprietary protection in all markets
we enter, or, if successful, that such protection will be sufficient. If we
successfully develop and market our fuel cells or any of our other technologies,
we expect to face efforts by larger companies and other organizations or
authorities to undermine our patents by challenging or copying our intellectual
property. Moreover, intellectual property rights are not protected in certain
parts of the world. We intend to vigorously defend our material intellectual
property against any challenges that may arise. However, any infringement action
initiated by us may be very costly and require the diversion of substantial
funds from our operations and may require management to expend efforts that
might otherwise be devoted to our operations.
  Claims
by third parties that our technology infringes upon their patents may, if
successful, prevent us from further developing or selling our
technologies.
  Although
we do not believe our business activities infringe upon the rights of others,
nor are we aware of any pending or contemplated actions to such effect, we can
give no assurance that our business activities will not infringe upon the
proprietary rights of others, or that other parties will not assert infringement
claims against us.
  We
currently face and will continue to face significant competition.
  We expect
our portable energy sources to compete against other portable fuel cell
developers as well as against other advanced battery technologies. Our primary
competitors are:
  ·
              Battery manufacturers who
      utilize existing battery technologies (both rechargeable and
      non-rechargeable). Existing battery technologies have the
      significant advantages of having commercially available products today and
      are familiar to most consumers, and are backed by companies who are
      continuously investing in marketing and further research and
      development.
  ·
              Companies developing small
      fuel cells or other alternative power sources for the portable electronics
      market. We compete with companies such as Mechanical Technology
      Inc., Poly Fuel, Inc., Angstrom Power, Tekion Inc., Lilliputian Systems,
      Inc., Neah Power Systems, Inc, iGo, and others. We believe other large
      cell phone and portable electronic device companies are also developing
      fuel cells for the portable electronics
market.
  16
 ·
              Companies competing in the
      emergency kit market, which can provide portable light sources such as
      flashlights, emergency warnings lights, etc.In the
      emergency kit end market we compete with companies that offer flashlights,
      portable lighting and electronics solutions to consumers that value
      emergency preparedness. The emergency kit market has different products
      which package radios, flashlights and cell phone chargers that can be
      powered through solar, self-powered and hand-crank
    mechanisms.
  We expect
competition to intensify greatly as the need for new energy alternatives becomes
more apparent and continues to increase. Many of our competitors are well
established and have substantially greater managerial, technical, financial,
marketing and product development resources. We cannot give any assurance that
current and future competitors will not be more successful in the markets in
which we compete, or that we will be successful in such a competitive
environment.
  Our
business depends on key members of our management. If we were to lose our senior
technical talent or members of senior management, our business could be
adversely affected.
  The
success of our fuel cell program depends to a significant extent upon Gennadi
Finkelshtain, our Chief Technical Officer, and other scientists, engineers and
technicians on our staff. Our success further depends on our highly skilled and
experienced management, including Jose Mejia, our President and Chief Executive
Officer, Thomas Finn, our Executive Vice President and John Giere, our Executive
Vice President and Chief Commercialization Officer, as well as certain other
officers and employees that develop and market our products and technologies.
The loss of the services of Mr. Finkelshtain, or certain of our other technical
talent or of Messrs. Mejia, Finn or Giere could have a material adverse effect
on our ability to develop our fuel cell products into successful commercial
products or any of our other technologies into commercial products. We possess
key-person life insurance of $3,000,000 on Mr. Finkelshtain. Although to date we
have been successful in recruiting executive, managerial and technical
personnel, and with limited exceptions we have been able to retain key
personnel, we may not be able to continue to attract and retain the qualified
personnel needed for our business. The failure to attract or retain qualified
personnel could have a material adverse effect on our business.
  We do not
believe that the transition from our former management team to our recently
appointed management team has caused any material adverse effect on our
business.
  During
the year ended December 31, 2008, we have recorded significant impairment
charges related to the goodwill and property, plant and equipment that we carry
on our balance sheet, which has significantly increased our losses for the
year.
  In
accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,”
goodwill is subject to at least an annual assessment for impairment. In general,
a write down is required if the carrying value exceeds the fair value of the
reporting unit. Upon completion of such assessment for the year ended December
31, 2008, we determined that the entire goodwill balance of $55,993,000
allocated to our fuel cell reporting unit is impaired, and,
accordingly, recorded a charge in the amount of $55,993,000, which is
included within impairment charges on goodwill and property and equipment
in the statement of operations, for the year ended December 31,
2008.
  In
accordance with SFAS No. 144, “Accounting for Impairment and Disposal of
Long-Lived Assets, in the event that any one or combination of factors indicate
that there is an impairment of an entity’s long-lived assets, such long lived
assets are to be reviewed to determined if their carrying value exceed their
fair value.  For the year ended December 31, 2008, we reviewed our
long-lived assets for impairment and determined that the carrying value of our
fuel cell property and equipment exceeded its fair value by
approximately $30,508,000 and, accordingly, we recorded a charge in
such amount to impairment charges on goodwill and property and equipment in the
statement of operations, for the year ended December 31, 2008.
 17
 Furthermore,
we can give no assurance that we will not be required to record additional
impairment charges on our assets in the future, especially considering the stage
of commercialization of our products and current economic and market
conditions.
  We
may be affected by environmental and other governmental
regulations.
  Our
business is subject to numerous federal, state and local laws and regulations
that govern environmental protection and human health and safety. These laws and
regulations have changed frequently in the past and it is reasonable to expect
additional and more stringent changes in the future. Our operations may not be
in compliance with any such future changes in laws and regulations, which could
require us to make significant unanticipated capital and operating expenditures.
If we fail to comply with any such changes, we may be subject to fines and
penalties or we may have existing permits revoked or not subject to renewal.
Furthermore, private parties in such circumstances could seek damages from us.
Under any of those circumstances, we might be required to curtail or cease
operations, conduct site remediation or other corrective action or pay
substantial damage claims.
  As we
begin to commercialize our 24/7 Power Pack, we and our suppliers expect to be
subject to an increasing number of environmental regulations in Israel, Ireland
and other jurisdictions where we develop, produce and assemble our products.
Some of these regulations may require us and/or our suppliers to apply for and
obtain permits prior to any such development, production or assembly, of which
we can give no assurance we or they can obtain at minimal cost or at all. In
addition, it is possible that industry specific laws and regulations will be
adopted in any of these or other jurisdictions covering matters relating to our
fuel cell products or our other products. Such laws or regulations could limit
the growth of our products or increase our commercialization, manufacturing or
distribution costs and, therefore, the price of our products so affected.
Accordingly, compliance with existing or future laws and regulations as we begin
our commercialization efforts could have a material adverse effect on our
business, prospects, results of operations and financial condition.
  We
could be liable for damages resulting from the storage and use of large
quantities of chemicals during the manufacturing process of our fuel cell
products.
  The
storage and use of large quantities of chemicals used as components of our fuel
cells could expose us to the risk that such chemicals may escape into the
environment, resulting in damage to natural resources or property, or injury or
loss of life. Depending on the nature of the claim, our current insurance
policies may not adequately, if at all, reimburse us for costs incurred to
litigate or settle any such claims.
  Our
results of operations and capital costs have been and may continue to be
negatively affected by potential fluctuations in foreign currency exchange
rates.
  A portion
of our costs and expenses are denominated in foreign currencies. The principal
foreign currencies applicable to our business are the New Israeli Shekel, the
Euro and the Swiss Franc. As a result, we have exposure to foreign currency
exchange fluctuations. Recently, the U.S. dollar has been volatile and has
declined in relation to these foreign currencies, when compared to historical
levels. Foreign currency fluctuations, including a weaker U.S. dollar, have
adversely affected our costs, including the costs of the raw materials that make
up our fuel cells, and have caused us to reevaluate our pricing structure and
seek to increase the prices for our products to maintain projected
profitability. Any such increase could negatively impact our sales to
distributors or potential customers. Conversely, maintaining
our current pricing structure could significantly harm our cash flow and results
of operations, as well as our ability to achieve and maintain profitability as
we continue to grow our business.
 18
 We
are likely to continue to incur costs related to depreciation, production and
facility capacity, including costs related to excess production
capacity.
  During
the year ended December 31, 2008, we incurred costs aggregating approximately
$28,223,000 with respect to depreciation, production and facility costs,
including costs related to capacity in excess of that which we have utilized and
materials and components. Unless and until such time as we are able to more
fully and efficiently utilize our production facilities through the production
and sale of our fuel cell products, we will continue to incur such
charges.
  Risks
associated with conducting operations in Israel could materially adversely
affect our ability to complete the development of our fuel cell technology or
our cell carrier technology.
  Our
research and development facilities, certain manufacturing and semi-automated
assembly facility for our 24/7 Power Pack, as well as some of our executive
offices and back-office functions, are located in the State of Israel and we
have key personnel and their families residing in Israel. We are, therefore,
directly affected by the political, economic and military conditions in Israel.
Any major hostilities involving Israel or the interruption or curtailment of
trade between Israel and any other country, whether due to the
Israeli-Palestinian conflict, conflicts with Iran, or America’s war against
terrorism, among others, could have a material adverse effect on our ability to
complete the development of any of our fuel cell products, our technologies or
our ability to supply our technology to contract manufacturers, development
partners, customers or vendors. Furthermore, any interruption or curtailment of
trade between Israel and any other country in which we have strategic
relationships could similarly adversely affect such relationships. In addition,
currently all adult permanent residents of Israel under the age of 45 to 50,
depending on military rank, unless exempt, are obligated to perform up to an
average of 18-28 days, depending on the military rank, of military reserve duty
annually and are subject to being called to active duty at any time under
emergency circumstances. Some of our employees are currently obligated to
perform annual reserve duty. We are unable to assess what impact, if any, these
factors may have upon our future operations.
  In
addition, historically, Israel has suffered from high inflation and the
devaluation of its currency, the New Israeli Shekel, or NIS, compared to the
U.S. dollar. Future inflation or further devaluations of the NIS may have a
negative impact on our NIS-based obligations over time upon substantial price
increases caused by inflation. Similarly, a further weakening of the U.S. dollar
as against the NIS could continue to raise certain of our costs of operating in
Israel.
  It
may be difficult to serve process on or enforce a judgment against our Israeli
officers and directors, making it difficult to bring a successful lawsuit
against us, or our officers and directors, individually or in the
aggregate.
  Service
of process upon our directors and officers, many of whom reside outside the
United States, may be difficult to obtain within the United States. Furthermore,
any judgment obtained in the United States against us may not be collectible
within the United States to the extent our assets are located outside the United
States. This could limit the ability of our stockholders to sue us based upon an
alleged breach of duty or other cause of action. We have been informed by our
Israeli legal counsel that it may be difficult to assert U.S. Securities law
claims in original actions instituted in Israel. However, subject to limitation,
Israeli courts may enforce United States final executory judgments for
liquidated amounts in civil matters, obtained after a trial before a court of
competent jurisdiction, according to the rules of private international law
currently prevailing in Israel, which enforce similar Israeli judgments,
provided that:
   19
  ·
              due
      service of process has been effected and the defendant was given a
      reasonable opportunity to defend;
  ·
              the
      obligation imposed by the judgment is enforceable according to the rules
      relating to the enforceability of judgments in Israel and the substance of
      the judgment is not contrary to public
  policy;
  ·
              such
      judgments were not obtained by fraud and do not conflict with any other
      valid judgments in the same manner between the same parties;
      and
  ·
              an
      action between the same parties in the same matter is not pending in any
      Israeli court at the time the lawsuit is instituted in the foreign
      court.
  Foreign
judgments enforced by Israeli courts generally will be payable in Israeli
currency, which can then be converted into United States dollars and transferred
out of Israel. The judgment debtor may also pay in dollars. Judgment creditors
must bear the risk of unfavorable exchange rates.
  The
declining value of stocks, bonds and other investments during the current world
economic downturn could require us to write-down the value of our severance pay
fund, which could have a material adverse effect on our results of
operations.
  Under
Israeli law, we must provide severance for all our employees in Israel. We fund
the severance through monthly deposits in externally managed funds, invested
mostly in conservative investments such as government and corporate bonds. In
the current capital markets downturn, the value of these assets has declined,
and they may lose additional value in the future. These funds are recorded at
fair value on our balance sheet. The magnitude of the future potential loss is
unpredictable, as it is based on the market value of investments at a future
date. If the value of the investments falls, we would be required to write down
the value of the severance pay fund asset on our balance sheet. Such a
write-down could result in a significant expense on our income statement,
materially adversely affecting our results of operations.
  We
do not expect to pay dividends to holders of our common stock and recently have
not declared dividends on our preferred stock.
  We have
not paid any dividends on our common stock to date and do not anticipate
declaring any dividends on our common stock in the foreseeable future. We are
required under the certificate of designation relating to our Series A preferred
stock to accumulate dividends to holders of our Series A preferred stock at a
rate initially equivalent to $725 per share annually. We did not declare the
dividend on our preferred stock for the first quarter of 2009 and do not expect
to declare the dividend on our preferred stock for the second quarter of 2009.
No dividends may be paid upon our common stock unless all accumulated and unpaid
dividends have been paid on the Series A preferred stock. Our board presently
intends to retain all earnings, if any, for use in our business
operations.
  The
issuance of our common stock upon a fundamental change of our Series A
preferred stock would have a dilutive effect on the then holders of our common
stock.
  Upon the
occurrence of a fundamental change (as defined in the certificate of designation
of our Series A preferred stock) holders of our Series A preferred stock will
have the right to require us to purchase all of their respective shares of our
Series A preferred stock. We will have the option to pay for those shares either
in cash or in our common stock valued at a discount of 5% from the market price
of our
common stock. The issuance of our common stock at a discount to the market price
of our common stock would have a dilutive effect on the then holders of our
common stock.
    20
 The right
of holders to cause us to repurchase shares of our Series A preferred stock upon
a fundamental change may be subject to our obligation to repay or repurchase any
future indebtedness, such as credit facilities or debt securities.
  Future
sales of substantial amounts of our common stock could affect the market price
of our common stock.
  Future
sales of substantial amounts of our common stock, or securities convertible or
exchangeable into shares of our common stock, into the public market, including
shares of common stock issued upon exercise of options or warrants or conversion
of the Series A preferred stock, or perceptions that those sales and/or
conversions could occur, could adversely affect the prevailing market price of
our common stock and our ability to raise capital in the future. At the present
time, we expect that we will require substantial amounts of outside funding to
finance our operations.
  Our
stock price has declined significantly since its closing high during 2008 of
$15.15 per share and may not rise and may decline further, which could cause our
stock to be delisted from trading on the Nasdaq Global Market.
  Since its
closing high during 2008 of $15.15 per share, our common stock has declined
significantly. The last reported closing sale price of our shares on March 27,
2009 was $0.48 per share. Our stock has traded below $1.00 per share since at or
around November 17, 2008. Under Nasdaq’s continued listing standards, if the
closing bid price of our common stock is under $1.00 per share for 30
consecutive trading days or if our market capitalization is less than $75
million, Nasdaq may notify us that it intends to delist our common stock from
the Nasdaq Global Market. If the closing bid price of our common stock does not
thereafter regain compliance for a minimum of ten consecutive trading days
during the 180-days following notification by Nasdaq, Nasdaq may delist our
common stock from trading on the Nasdaq Global Market. While Nasdaq has
suspended the minimum bid price and market value requirements until July 20,
2009, there can be no assurance that Nasdaq will extend the suspension or that
our common stock will remain eligible for trading on the Nasdaq Global Market.
If our stock were delisted, the ability of our stockholders to sell any of our
common stock at all would be severely, if not completely, limited, causing our
stock price to continue to decline. Furthermore, a delisting from Nasdaq could
trigger a fundamental change under the Certificate of Designations governing our
preferred stock, which would allow the holders of our preferred stock to sell
back to us all outstanding shares of our preferred stock.
  Our
issuance of additional common stock or preferred stock may cause our common
stock price to decline, which may negatively impact your
investment.
  Issuances
of a substantial number of additional shares of our common or preferred stock,
or the perception that such issuances could occur, may cause prevailing market
prices for our common stock to decline. In addition, our board of directors is
authorized to issue additional series of shares of preferred stock without any
action on the part of our stockholders. Our board of directors also has the
power, without stockholder approval, to set the terms of any such series of
shares of preferred stock that may be issued, including voting rights,
conversion rights, dividend rights, preferences over our common stock or our
Series A preferred stock with respect to dividends or if we liquidate, dissolve
or wind up our business and other terms. If we issue cumulative preferred stock
in the future that has preference over our common stock with respect to the
payment of dividends or upon our liquidation, dissolution or winding up, or if
we issue
preferred stock with voting rights that dilute the voting power of our common
stock, the market price of our common stock could decrease.
   21
 Our
stock price has been and could remain volatile and has recently declined
substantially.
  The
market price for our common stock has been and may continue to be volatile and
subject to extreme price and volume limitations in response to market and other
factors. As the price of our common stock on The Nasdaq Global Market constantly
changes, it is impossible to predict whether the price of our common stock or
interest rates will rise or fall. Trading prices of our common stock will be
influenced by our operating results and prospects and by economic, financial and
other factors. In addition, general market conditions, including the level of,
and fluctuations in, the trading prices of stocks generally, and sales of
substantial amounts of common stock by us in the market, or the perception that
such sales could occur, could affect the price of shares of our common
stock.
  Our
investment in Cell Kinetics, our majority owned indirect subsidiary, has a
number of risks associated with it.
  Our
investment in Cell Kinetics, our majority owned indirect subsidiary, has a
number of risks associated with it, including, among others, the
following:
  ·
              a
      history of operating losses, with no assurance of future revenues or
      operating profits;
  ·
              very
      limited manufacturing, marketing, distribution and sales
      capabilities;
  ·
              competition
      from both public and private companies and academic collaborators, many of
      which have significantly greater experience and financial
      resources;
  ·
              acceptance
      by the life sciences research and diagnostic communities is not
      assured;
  ·
              commercial
      development of its CKChipTM technology and proposed product lines is not
      assured;
  ·
              an
      inability to manufacture, market or sell its proposed products if it is
      unsuccessful in entering into strategic alliances or joint ventures with
      third parties; and
  ·
              reliance
      on the activities of non-employee consultants and research institutions,
      whose activities are not wholly within its control, may lead to delays in
      development of its proposed
products.
  Further,
Cell Kinetics’ efforts to source, vet and invest in early stage Israeli-based
medical device companies give rise to additional risks including, among
others:
  ·
              insufficient
      cash resources to fund its partner companies or to acquire interests in
      more than a limited number of partner
companies;
  ·
              management
      may fail to identify early stage medical device companies in which to
      acquire interests or to complete these acquisition
      transactions;
  ·
              limited
      experience in actively managing, operating or promoting medical device
      companies;
  ·
              partner
      companies could make business decisions that are not in its best interests
      or that it does not agree with, which could impair the value of its
      partner company interests; and
  ·
              its
      business strategy may not be successful if valuations in the market
      sectors in which its partner companies participate
  decline.
  22
 Item 1B. Unresolved
Staff Comments
  None
  Item
2. Properties
  We
presently maintain our U.S. executive offices in premises of approximately 3,000
square feet at 805 Third Avenue, New York, New York 10022 under a sublease from
the Stanoff Corporation, which is controlled by Robert K. Lifton, our former
chairman and chief executive officer, and Howard Weingrow, our former deputy
chairman and chief operating officer. We pay approximately $100,000 for rent per
year.
  Our
research laboratory and technology center, and Israel-based production
facilities and executive offices and back office functions are located at leased
facilities of approximately 56,100 square feet in Lod, Israel. The lease,
covering approximately 44,800 square feet of such facilities expire on November
30, 2009 with two renewal options, each for 30 months, which, if exercised,
would extend the rental term to November 30, 2014.  The lease covering
approximately 7,500 square feet will expire in April 2010. The area that we
leased covering 3,800 square feet expired in February 28, 2009. Annual payments
for rent under such leases aggregate approximately $700,000, including deferred
leasehold incentives credits that are amortized as a credit to rental
expense.  As part of our recently initiated cost rationalization
program, we are reviewing our leased facilities and related costs in
relationship to our current and anticipated needs.
  Item
3. Legal
Proceedings
  On April
23, 2007, a putative class action was initiated against us and our then CEO,
among others, in the United States District Court for the Southern District of
New York. Thereafter, on September 10, 2007, plaintiffs filed the First Amended
Class Action Complaint (the “Amended Complaint”). The Amended Complaint
essentially alleges that defendants violated Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 by issuing a false and misleading press release
on April 13, 1007 (the “April 13 Press Release”), stating that the we had begun
“commercial sales” of “Microsoft-Branded” Power Packs to Microsoft.
  Defendants
moved to dismiss the case for failure to adequately plead scienter, i.e., a
culpable intent. After full briefing and oral argument on July 16, 2008, on
August 18, 2008, Hon. Paul A. Crotty, United States District Judge for the
Southern District of New York, granted defendants’ motion to dismiss in its
entirety, without leave to replead. The court held that plaintiffs did not
present a compelling inference that defendants acted with any fraudulent
intent.
  On
September 10, 2008, plaintiffs filed a Notice of Appeal of the District Court’s
order to the United States District Court of Appeals for the Second Circuit.
Plaintiffs-Appellants’ filed their moving brief on November 20, 2008.
Defendants-Appellee’s filed their opposition brief on January 15, 2009 and
Plaintiffs-Appellants’ filed their reply brief on February 13,
2009.
  We are
vigorously defending the appeal.
  Item
4. Submission
of Matters to a Vote of Security Holders
  A
Special Meeting of Stockholders of our common stockholders was held December 23,
2008. At the Meeting, three proposals were voted upon, as follows:
 23
  1.           The
vote with respect to the approval of an amendment to our Certificate of
Incorporation to increase the authorized shares of common stock from 57,500,000
to 75,500,000 was approved. The results were as follows:
  For:  38,603,171          Against:  1,344,890          Abstain:  264,921         
Broker Non-Votes:  0
  2.           The
vote with respect to the approval of an amendment to our Certificate of
Incorporation to increase the authorized shares of preferred stock from 10,000
to 15,000 was not approved. The results were as follows:
  For:  22,802,405          Against:  2,544,944          Abstain:  117,541         
Broker Non-Votes:  14,748,092
  3.           The
vote with respect to the approval of an amendment to our 2007 Equity Incentive
Plan to increase the number of shares of common stock authorized thereunder from
1,500,000 to 2,300,000 was not approved. The results were as
follows:
  For:  19,268,830          Against:  6,071,967          Abstain:  124,093         
Broker Non-Votes:  14,748,092
  
  PART
II
  Item
5. Market
For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
  Our
common stock has traded on The Nasdaq Global Market under the symbol “MDTL”
since October 3, 2000. The closing high and low sales prices of our common
stock, as reported by the Nasdaq Global Market, for the quarters indicated are
as follows:
  High
                    
                    
                    Low2007:First
      Quarter
                    
                    $
                    18.52
                    
                    
                    $
                    12.89Second
      Quarter
                    
                    
                    20.32
                    
                    
                    
                    11.80Third
      Quarter
                    
                    
                    14.97
                    
                    
                    
                    9.60Fourth
      Quarter
                    
                    
                    15.96
                    
                    
                    
                    11.582008:First
      Quarter
                    
                    $
                    15.15
                    
                    
                    $
                    8.73Second
      Quarter
                    
                    
                    10.29
                    
                    
                    
                    2.72Third
      Quarter
                    
                    
                    3.69
                    
                    
                    
                    1.80Fourth
      Quarter
                    
                    
                    1.84
                    
                    
                    
                    .29
 
  As of
March 27, 2009, there were approximately 370 stockholders of record of our
common stock. Such number does not include beneficial owners holding shares
through nominee names.
 24
 We have
never declared or paid any dividends on our common stock. Dividends on our 7.25%
Series A cumulative convertible perpetual preferred stock (the “Preferred
Stock”) are payable when, as
  
 Item
6. Selected
Financial Data
  The
selected consolidated statement of operations data for the years ended December
31, 2004 and 2005 and the selected consolidated balance sheet data as of
December 31, 2004, 2005 and 2006 have been derived from audited consolidated
financial statements not included in this annual report. The selected
consolidated statement of operations data for the years ended December 31, 2006,
2007, and 2008 and the selected consolidated balance sheet data as of December
31, 2007 and 2008 have been derived from our audited consolidated financial
statements included elsewhere in this annual report. Such consolidated financial
statements include the financial statements of all of our direct and indirect
subsidiaries. The data should be read in conjunction with the consolidated
financial statements and the notes to such statements and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
included elsewhere in this annual report.
          25
 Statement
of Operations Data:
  For
      the Year Ended December 31,2004
                
                
                2005
                
                
                2006
                
                
                2007
                
                
                2008Revenues
                
                $
                —
                
                
                $
                425,000
                
                
                $
                150,000
                
                
                $
                400,000
                
                
                $
                —Cost
      of revenues
                
                
                —
                
                
                
                262,000
                
                
                
                98,000
                
                
                
                249,000
                
                
                
                —Gross
      profit
                
                
                —
                
                
                
                163,000
                
                
                
                52,000
                
                
                
                151,000
                
                
                
                —Depreciation,
      production and facility costs:
                  Depreciation,
      production and facility costs
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                20,023,000Inventory
      reserves and write-offs
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                8,200,000Total
      depreciation, production and facility costs
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                28,223,000Operating
      expenses:Research
      and development costs, net
                
                
                9,799,000
                
                
                
                12,144,000
                
                
                
                18,057,000
                
                
                
                25,705,000
                
                
                
                21,527,000Selling,
      marketing, general and administrative expenses
                
                
                5,829,000
                
                
                
                5,720,000
                
                
                
                7,579,000
                
                
                
                13,541,000
                
                
                
                14,219,000Impairment
      charges on goodwill and property and equipment
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                86,501,000Amortization
      of intangible assets
                
                
                208,000
                
                
                
                208,000
                
                
                
                208,000
                
                
                
                208,000
                
                
                
                48,000Total
      operating expenses
                
                
                15,836,000
                
                
                
                18,072,000
                
                
                
                25,844,000
                
                
                
                39,454,000
                
                
                
                122,295,000Loss
      from operations
                
                
                (15,836,000
                )
                
                
                (17,909,000
                )
                
                
                (25,792,000
                )
                
                
                (39,303,000
                )
                
                
                (150,518,000
                )Other
      income (expenses):Interest
      and other income
                
                
                246,000
                
                
                
                973,000
                
                
                
                2,517,000
                
                
                
                2,331,000
                
                
                
                1,926,000Interest
      expense
                
                
                (72,000
                )
                
                
                (1,614,000
                )
                
                
                (9,772,000
                )
                
                
                (1,228,000
                )
                
                
                (322,000
                )174,000
                
                
                
                (641,000
                )
                
                
                (7,255,000
                )
                
                
                1,103,000
                
                
                
                1,604,000Minority
      interest
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                492,000Net
      loss
                
                
                (15,662,000
                )
                
                
                (18,550,000
                )
                
                
                (33,047,000
                )
                
                
                (38,200,000
                )
                
                
                (148,422,000
                )Value
      of warrants issued or extended
                
                
                (2,066,000
                )
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Dividend
      on preferred stock
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                4,128,000
                
                
                
                4,169,000Net
      loss attributable to common
                  stockholders
                
                $
                (17,728,000
                )
                
                $
                (18,550,000
                )
                
                $
                (33,047,000
                )
                
                $
                (42,328,000
                )
                
                $
                (152,591,000
                )Basic
      and diluted net loss per share
                
                $
                (0.68
                )
                
                $
                (0.68
                )
                
                $
                (1.08
                )
                
                $
                (1.26
                )
                
                $
                (3.75
                )Weighted
      average number of common shares used in computing basic and diluted net
      loss per share
                
                
                26,142,150
                
                
                
                27,423,568
                
                
                
                30,916,848
                
                
                
                33,554,298
                
                
                
                40,693,544
 
  Balance
Sheet Data:
  As
      of December 31,2004
                
                
                2005
                
                
                2006
                
                
                2007
                
                
                2008Working
      capital(1)
                
                $
                12,721,000
                
                
                $
                46,401,000
                
                
                $
                78,647,000
                
                
                $
                23,814,000
                
                
                $
                12,374,000Total
      assets
                
                
                79,773,000
                
                
                
                120,400,000
                
                
                
                177,608,000
                
                
                
                157,233,000
                
                
                
                62,760,000Accumulated
      deficit
                
                
                (125,181,000
                )
                
                
                (143,731,000
                )
                
                
                (176,778,000
                )
                
                
                (219,106,000
                )
                
                
                (371,697,000
                )Total
      stockholders’ equity (deficit)
                
                
                73,863,000
                
                
                
                65,377,000
                
                
                
                110,436,000
                
                
                
                91,751,000
                
                
                
                (4,576,000
                )
 
 (1)
              Working
      capital is total current assets less total current
      liabilities.
  26
 Item
7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
  Introduction
  We
design, develop and market an innovative fuel cell technology that provides
portable  electricity for retail, commercial and military
applications. A fuel cell is a device that converts the chemical energy of a
fuel directly into electricity.  To our knowledge we are the only company
ever to have manufactured working portable fuel cells in production
quantities.  Our intellectual property portfolio consists of 37 United
States and international patents.
  Our
technologies provide solutions for remote and off-grid power. Unlike batteries,
our products do not store power; they generate fresh power on the spot as
needed, which we believe makes our technology ideal for military applications.
It also means that we can power devices in the complete absence of electricity
from the grid – during blackouts, in battlefield conditions, in subway tunnels
or mine shafts, or at other remote or unmanned locations.
  Our fuel
cells do not generate significant heat, are DOT approved and UL listed, and
are recyclable. Most other fuel-cell developers that we are aware of use a
methane or hydrogen-based chemistry.  Our fuel cells are based on sodium
borohydride which we believe is a superior and more stable fuel.
  Our first
commercial product is our “24/7 Power Pack,” commercially introduced in late
2008. It is a recyclable hand-held power generator that can  power
advanced portable electronic devices, such as mobile handsets, smart phones, MP3
players, gaming and other devices useful in emergencies such as flashlights,
radios and GPS devices.We believe that the
24/7 Power Pack is the first commercially available, portable fuel cell ever
sold. Subsequent to the introduction of the 24/7 Power Pack, we introduced our
XtremeTM Emergency Kit, which provides light in any emergency situations where
light is needed for survival or escape. Because it generates its own power
when needed, it can provide instant light as well as energy to power portable
electronic devices on demand.
  Additionally,
through Cell Kinetics Ltd., our indirect, majority-owned subsidiary, we are also
seeking to exploit commercially what we believe to be an ever-increasing need to
study individual live cells through the development, marketing and sale of an
improved cell carrier under the CKChipTM product line. This unique CKChipTM can
accommodate up to 10,000 cells, each in individual wells, for measuring
reactions of living cells while the cells are in a static state over
time.
  Results
Of Operations
  From our
inception in April 1992 through December 31, 2008, we have generated an
accumulated deficit of approximately $371,697,000, including approximately
$44,215,000 from amortization expense and $86,501,000 from impairment charges on
goodwill and property and equipment. We expect to incur additional operating
losses during 2009 and possibly thereafter, principally in connection with our
fuel cell related operations, including production related costs, selling,
marketing, advertising, general and administrative expenses and research and
development costs.  At December 31, 2008, we had cash and cash
equivalents of $10,642,000. During the year ended December 31, 2008, we
reported cash used in operating activities of $47,515,000 and incurred a
net loss of $148,422,000, which net loss included $86,501,000 from impairment
charges on goodwill and property and equipment. These losses have significantly
weakened our financial position and available cash resources. These losses have
significantly weakened our financial position and available cash resources. As
further described below, we have relied upon external financing for our
operations, principally through the issuance and sale of our common stock,
warrants, preferred stock and convertible notes. We plan to continue to finance
our operations, as we have in the past, through the sale of our securities and
other
   27
 forms of
external financing until such time that we are able to generate sufficient funds
from the sale of our products to finance our operations. See “Liquidity and
Capital Resources” later in this
Item 7 for a discussion of our plans to raise additional capital and our cost
rationalization plan.
  Since our
inception, we have relied principally on outside sources of funding to finance
our operations, as our revenues have been minimal. During 2007 and 2008, we have
raised gross proceeds aggregating $71,500,000 through the sale of our securities
to outside investors and Cell Kinetics has raised gross proceeds of $1,048,000
through the sale of its securities in a rights offering to our
stockholders.
  Although
we have received or expect to receive purchase orders pursuant to some of our
agreements with our distributors, various factors have impacted those
agreements and purchase orders, including the recent primary focus on our newly
developed emergency kit product and our newly developed advanced power
management system to address the changing needs of potential purchasers, the
reevaluation of our pricing structures for our products and the continued
evolution of the market for our products. Accordingly, we are now working
with our existing distributors and representatives to market and sell our
products under our current pricing and cost structures, and we can give no
assurance that we will be successful in such marketing and sales
efforts.
  While our
production line located at the facilities of our contract manufacturer,
Celestica Ireland Ltd., in Galway, Ireland began production
during 2008, we have recently curtailed such production while we seek to sell
quantities of inventory that we currently have on-hand. We plan to resume our
production of our products based the depletion of our finished goods inventory,
and the level of sales of our products. We expect that as we resume
production of our products, we will incur costs and gross losses until such time
that our revenues exceed our direct and indirect production costs attributable
to such revenues, of which we can give no such assurance. Until such time, we
expect our reliance on outside sources of funding to continue. Additionally,
weak economic and market conditions could negatively impact product sales and
consumer acceptance of our products, and consequently our revenues and results
of operations.
  Our
research and development costs have increased from approximately $2,749,000 for
the year ended December 31, 1999 to approximately $21,527,000 for the year ended
December 31, 2008 as we have continued to devote greater efforts to develop and
advance the technology underlying, and to commercialize the products
incorporating, our fuel cells.  Additionally, during the year ended
December 31, 2008, we incurred depreciation, production and facility costs
aggregating $28,223,000. As described
  28
 more
fully above, we have recently initiated a comprehensive cost rationalization
plan designed to reduce operating costs and enhance operational efficiencies and
expect to see results from that plan during the ensuing months. If we are unable
to successfully commercialize our fuel cell technology we will be forced to
further curtail our spending levels and possibly take other tactical and/or
strategic actions until such time, if ever, as we generate significant revenues
or otherwise receive funds from third party sources. As described more fully
above, we have recently initiated a comprehensive cost rationalization plan
designed to reduce operating costs and enhance operational
efficiencies.
  Year
ended December 31, 2008 compared to year ended December 31, 2007
  We
sustained net losses of $148,422,000 during the year ended December 31, 2008,
compared to $38,200,000 for the year ended December 31, 2007. The increase
can be primarily attributed to impairment charges recorded during the year ended
December 31, 2008 related to the Company’s goodwill and property and equipment
aggregating $86,501,000, Depreciation, Production and Facility costs incurred in
2008 of $28,223,000, including excess production capacity (such as depreciation,
subcontractor charges and labor), materials and components and inventory
reserves and write-offs, and an increase in selling, general and administrative
expenses. These factors were partially offset by a decrease in research and
development costs, an increase in interest income, net, and by credits allocated
to the minority interest in Cell Kinetics for its share of the subsidiary loss.
Our interest in Cell Kinetics was reduced from 100% to approximately 82.5% as a
result of its rights offering that was completed in January 2008. Each of the
above mentioned factors are described more fully below. As we continue to seek
to commercialize and market our fuel cell products and develop our military
products, we expect that we will continue to devote resources in the area of
production and facility costs and research and development costs, as well as
selling, marketing, general and administrative expenses, and we will continue to
incur charges related to our production facilities, including excess production
capacity, until such time as we more fully and efficiently utilize our
production facilities through the production and sale of our fuel cell products,
of which we can give no assurance.  Our ability to devote resources to
activities that are necessary for us to continue our operations will be
constrained by available funding from outside sources and the allocation of such
resources will depend on the outcome of our marketing and sales efforts, as well
as other factors.
  In
accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,”
goodwill is subject to at least an annual assessment for impairment. For the
year ended December 31, 2008, we engaged an independent valuation firm to
perform the annual assessment of our goodwill for impairment. In general, a
write down is required if the carrying value exceeds the fair value of the
reporting unit. Upon completion of such assessment for the year ended December
31, 2008, we determined that the entire goodwill balance of $55,993,000
allocated to our fuel cell reporting unit is impaired, and,
accordingly, recorded a charge in the amount of $55,993,000, which is
included within impairment charges on goodwill and property and equipment
in the statement of operations, for the year ended December 31,
2008.
  In
accordance with SFAS No. 144, “Accounting for Impairment and Disposal of
Long-Lived Assets,” in the event that any one or combination of factors indicate
that there is an impairment of an entity’s long-lived assets, such long lived
assets are to be reviewed to determined if their carrying value exceed their
fair value.  For the year ended December 31, 2008, we engaged an
independent valuation firm to perform an assessment of our property and
equipment for impairment, since indicators of impairment were present for our
fuel cell reporting unit. In such assessment,  it was determined that
the carrying value of our fuel cell equipment exceeded its estimated fair
value by approximately $30,508,000 and, accordingly, we recorded a charge in
such amount to impairment charges on goodwill and property and equipment in the
statement of operations, for the year ended December 31, 2008.
  29
 During
the year ended December 31, 2008, we incurred costs aggregating approximately
$28,223,000, with respect to Depreciation, Production and Facility costs. Such
costs include production related depreciation, subcontractor, labor and material
and component costs, as well as $8,200,000 of charges incurred for reserves for
inventory obsolescence, lower of cost or market and other inventory reserves and
write-offs. In accordance with SFAS 151 “Inventory Costs an Amendment of ARB No.
43, Chapter 4,” we have recognized unallocated depreciation, labor and other
costs as expenses for the year ended December 31, 2008. Unless and until such
time as we are able to more fully and efficiently utilize our production
facilities through the production and sale of our fuel cell products, we will
continue to incur charges for depreciation and other production facility costs,
including excess production capacity. We have recently significantly reduced our
production activities in an effort to reduce costs and preserve our cash
resources.
  Research
and development costs amounted to approximately $21,527,000 during the year
ended December 31, 2008, compared to approximately $25,705,000 during the year
ended December 31, 2007. The decrease can be attributed to a decrease of
approximately $3,940,000 in costs related to our fuel cell technologies. The
research and development activities for the periods presented
include:
  ·
              Fuel Cell Technologies.
      We incurred costs relating to our fuel cell technologies of approximately
      $20,270,000 during the year ended December 31, 2008 , compared to
      $24,210,000 during the year ended December 31, 2007. The decrease of
      approximately $3,940,000 resulted from lower labor, subcontractor and
      depreciation costs and an increase in credits realized from a cooperation
      agreement, partially offset by an increase  in materials and
      other costs. Impacting amounts charged to R&D costs during the year
      ended December 31, 2008 are costs charged to “Depreciation, Production and
      Facility Costs,” as our operations had transitioned from primarily
      research and development to manufacturing, marketing and sales related
      activities.
  ·
              Cell Kinetics – Cell Carrier
      (CKChipTM). We incurred costs of approximately $1,240,000 during the
      year ended December 31, 2008, compared to costs of approximately
      $1,230,000 during the year ended December 31,
  2007.
  Selling,
marketing, general and administrative (“SG&A”) expenses during the year
ended December 31, 2008, amounted to $14,219,000, compared to $13,541,000 during
the year ended December 31, 2007. The net increase of $678,000, is primarily
attributable to (i) increases in labor and related costs of approximately
$1,467,000, due principally an increase in our sales and marketing staff and
general management personnel, severance and employment termination related
costs, a decline in the U.S. dollar in relationship to the New Israeli Shekel
and increases in pay rates during the year ended December 31, 2008, (ii) an
increase in insurance costs of approximately $120,000, (iii) increase in
reserves for uncollectible notes receivable of approximately $450,000, (iv)
increase in marketing and sales related expenses of approximately $335,000 (iv)
a decrease in non-cash charges relating to the issuance of stock options and
restricted stock of approximately $1,460,000, and (v) decreases in costs
relating to the issuance and maintenance of patents and legal and other
professional fees of approximately $205,000, and (vi) net decrease in various
other SG&A cost categories of approximately $29,000.
  Amortization
of intangible assets amounted to $48,000 during the year ended December 31,
2008, compared to $208,000 during the year ended December 31, 2007. The
amortization of intangible assets in both years represents the amortization of
intangible assets acquired in our March 2003 acquisition of the remaining 7% of
More Energy Ltd. that we did not already own. As of December 31, 2008 such
intangible assets have been fully amortized.
 30
 Interest
income, net during the year ended December 31, 2008 amounted to net
interest income of approximately $1,604,000, compared to interest income,
net of approximately $1,103,000 during the year ended December 31, 2007.
The increase of $501,000 is attributable to a decrease in interest expense of
approximately $906,000, partially offset by a decrease in interest income of
$405,000. The decrease in interest expense during the year ended December 31,
2008 compared to 2007 is principally due to an other than temporary impairment
loss in 2007 on a short term investment of approximately $840,000 and losses
during 2007 on the translation of balances denominated in currencies other than
the U.S. dollar of approximately $320,000, partially offset by interest expense
in 2008 on a capital lease of approximately $154,000. The decrease in interest
income is primarily due to a decrease in our average cash and cash equivalents
and short-term investments and lower interest rates on such balances, partially
offset by a realized gain on a short term investment in 2008 of $840,000 and
gains during 2008 on the translation of balances denominated in currencies other
than the U.S. dollar of approximately $346,000.
  As of
December 31, 2008, we had unrecognized compensation costs of approximately
$1,453,000, related to stock based awards accounted in accordance with FASB
Statement No. 123 (revised 2004) “Share Based Payments,” which are expected to
be recognized in future periods.
  Year
ended December 31, 2007 compared to year ended December 31, 2006
  We
sustained a net loss of $38,200,000 during the year ended December 31, 2007,
compared to $33,047,000 during the year ended December 31, 2006.  The
increase in the net loss can be primarily attributed to increases during the
year ended December 31, 2007 in research and development costs, principally due
to increased funding of our fuel cell-related efforts as we moved towards
commercialization of our fuel cell products, and increased selling, marketing,
general and administrative expenses, as more fully described below. These
factors were partially offset by a decrease in interest expense due principally
to charges aggregating $8,491,000 that we recorded during the year ended
December 31, 2006 in connection with the April and May 2006 exchanges of our
common stock for our then outstanding convertible notes. As we continue to
commercialize and market our fuel cell products and work to develop new
products, we expect that we will continue to devote significant resources in the
areas of capital expenditures and research and development costs for our fuel
cell products, as well as selling, marketing, general and administrative
expenses.
  Research
and development costs amounted to $25,705,000 during the year ended December 31,
2007 compared to $18,057,000 during the year ended December 31, 2006. The
increase in 2007 can be primarily attributed to an increase of approximately
$7,644,000 in costs related to our fuel cell technologies. The research and
development activities for the periods presented include:
  ·
              Fuel Cell Technologies.
      We incurred costs relating to our fuel cell technologies of approximately
      $24,210,000 during the year ended December 31, 2007, compared to costs of
      approximately $16,566,000 during the year ended December 31, 2006. The
      increase in our research and development costs in 2007 related to our fuel
      cell technologies of approximately $7,644,000 primarily reflects costs
      incurred in preparing our fuel cell Power Pack product for high volume
      production and results from increases in labor (including stock option
      cost pursuant to our adoption of SFAS 123(R) in January 2006), materials,
      subcontractors and consultants, depreciation and other
    costs.
  31
 ·
              Cell Kinetics –Cell Carrier
      (CKChipTM). We incurred costs of approximately $1,230,000 during the
      year ended December 31, 2007, compared to costs of approximately
      $1,125,000 during the year ended December 31, 2006. Costs incurred during
      the year ended December 31, 2007 principally related to improvement and
      modifications of our Cell Carrier design to enable its use with standard
      fluorescence microscopes, as well as development and validation of
      specific applications to be used with the Cell Carrier in order to enhance
      introduction and commercialization of our Cell Carrier - CKChipTM product
      line. Costs incurred during year ended December 31, 2006 related to the
      further refinement and assembly of the desktop CellScan, various research
      activities (including initial steps in modifying the Cell Carrier design
      to enable its use with standard fluorescence microscopes) and in obtaining
      the CE mark and moving forward with our ISO application, as well as
      clarifying other regulatory requirements needed for further
      commercialization of our products. The increases in 2007 can be primarily
      attributed to increases in labor and related costs, depreciation and other
      costs, partially offset by decreases in material costs. In July 2007, Cell
      Kinetics entered into an agreement with Scorpion Surgical Technologies,
      Ltd. to acquire a 20% aggregate interest in Scorpion for a total
      investment of $150,000, of which $50,000 was paid in July 2007. Scorpion
      is a start-up company in the field of orthopedic surgical instrumentation,
      with particular emphasis upon spinal anchoring device and stabilization
      systems.  The chief executive officer of Cell Kinetics is a
      director and a co-founder of
Scorpion.
  ·
              Other R&D
      Activities. We have been devoting more resources to developing our
      fuel cell technologies and commercializing our fuel cell-based products.
      As a result, other than as described above with respect to the Cell
      Carrier CKChipTM, we have been devoting few, if any, resources to our other
      technologies.
  SG&A
expenses during the year ended December 31, 2007 amounted to $13,541,000 ,
compared to approximately $7,579,000 during the year ended December 31, 2006.
The increases of $5,962,000 in 2007 is primarily attributable to increase in
non-cash charges relating to the issuance of stock options, warrants and
restricted stock of approximately $3,446,000, resulting principally from our
adoption of SFAS 123(R) on January 1, 2006, increases in labor and related
costs of approximately $1,276,000 due principally to an increased allocation to
SG&A as our operations transition from primarily research and development to
manufacturing, marketing and sales, as well as an increase in pay rates,
increases in costs of the issuance of and maintenance of patents and legal and
other professional fees of approximately $753,000, increases in marketing costs
of approximately $346,000 increases in insurance costs of approximately
$107,000, and net increases in various other SG&A cost categories of
approximately $34,000 during the year ended December 31, 2007 compared to the
year ended December 31, 2006.
  Amortization
of intangible assets amounted to $208,000 during both the year ended December
31, 2007 and December 31, 2006. The amortization of intangible assets in both
periods represents the amortization of intangible assets acquired in our March
2003 acquisition of the remaining 7% of More Energy Ltd. that we did not already
own.
  Net
interest income and expenses during the year ended December 31, 2007 amounted to
net interest income of approximately $1,103,000, compared to net interest
expense of approximately $7,255,000 for the year ended December 31, 2006. The
change of $8,358,000 between the years ended December 31, 2007 and 2006 is
primarily due to decreases in interest expense of $8,544,000 during the year
ended December 31, 2007, principally due to aggregate costs of approximately
$8,491,000 recorded as interest expense in 2006 in connection with the April and
May 2006 exchanges of our then outstanding convertible notes for common stock
(consisting of the value of the shares issued in lieu of future interest
payments of approximately $8,266,000, the amortization of the remaining balance
of the beneficial conversion features of approximately $220,000 and out of
pocket costs incurred in connection with the exchange transactions) and interest
incurred on the convertible notes of approximately $1,001,000 during the year
ended December 31, 2006 prior to their exchange, partially offset by an
unrealized loss on a short
 32
 term
investment of approximately $840,000 and losses on translation of balances
denominated in currencies other than the U.S. dollar of approximately $320,000.
The decrease in interest expense was partially offset by a decrease in interest
income of $186,000 during the year ended December 31, 2007, compared to the year
ended December 31, 2006.
  As of
December 31, 2007, we had unrecognized compensation costs of approximately
$3,131,000 related to stock options accounted for in accordance with FASB
Statement No. 123 (revised 2004) “Share Based Payments,” which are expected to
be recognized in future periods.
  Liquidity
And Capital Resources
  Since our
inception, we have sustained operating losses and have used cash in our
operations. During the year ended December 31, 2008, we used cash in operating
activities of $47,515,000, incurred a net loss of $148,422,000 and had a total
stockholders' deficit of $4,576,000 at December 31, 2008. These losses have
significantly weakened our financial position and available cash
resources.
  We
require additional financing in order to continue to fund our current
operations, which continues to show losses, and pay existing and future
liabilities and other obligations. We are
currently negotiating with third parties in an attempt to obtain additional
sources of funds which, in our management’s opinion, would provide adequate cash
flows to finance our operations. The satisfactory completion of these
negotiations is essential to providing sufficient cash flow to meet current
operating requirements. While we expects to raise additional funds, as described
more fully below, our limited available cash resources at March 31, 2009,
coupled with cash expected to become available in April 2009 in accordance with
our cost rationalization plan, would be sufficient to continue operations only
through the second quarter of 2009. Furthermore, we cannot give any assurance
that we will in the future be able to achieve a level of profitability from the
sale of our products to sustain our operations. These conditions raise
substantial doubt about our ability to continue as a going concern. The
accompanying financial statements do not include any adjustments to reflect the
possible future effects on recoverability and reclassification of assets or the
amounts and classification of liabilities that may result from the outcome of
this uncertainty.
  We
believe we have numerous options and avenues to raise working capital in 2009,
including:
  ·
                The
      sale of our securities, with the intention of selling $3-5 million in the
      second quarter of 2009 and up to an additional $5 million before the end
      of fiscal 2009, all subject to market
  conditions.
  ·
                The
      sale of our non-essential assets, including excess inventory and/or other
      tangible assets, either in the event we are unsuccessful in selling our
      securities, or possibly in tandem with doing
so.
  ·
                Through
      government grants from the United States, the State of Israel, or possibly
      both.
  We are
currently in discussions with potential investors regarding the sale of our
securities. Furthermore, we have engaged third party valuation experts to
appraise the liquidation value of certain of our assets and we have concluded,
based upon the value assigned to those assets, that we should be able to realize
sufficient funds from any such sale over the next 60-90 days which, together
with our cost rationalization plan discussed below, we expect will enable us to
continue our operations through the end of 2009, at which time we expect to have
commenced generating revenue. We can give no assurances that we will be
successful in raising funds through the sale of our securities, through the
divestiture of assets or through any other alternative. Any inability to so
obtain additional financing will materially adversely affect us, including
requiring us to significantly further curtail or cease business operations
altogether.
  We have
recently initiated a comprehensive cost rationalization plan designed to reduce
operating costs and enhance operational efficiencies, and we have appointed an
executive vice president of operation restructuring who is in charge of this
effort. Elements
and targets of this plan include the following:  ·
                  Reduction
      in aggregate payroll of approximately
50%;
  ·
                  Operational
      expenses reduced by approximately
50%;
  ·
                  A
      full stream product cost review;
  ·
                  Exploring
      opportunities to monetize non-essential assets;
  and
  ·
                  Transforming
      our supply chain to improve costs, customer experience and
      sustainability.
  33
 In an
effort to further reduce costs while we focuses on sales and marketing
activities, we also recently suspended production across our supply
base.
  As part
of this plan, we have undertaken a staff reduction of approximately 50 employees
from our Israeli office. These positions are directly and indirectly
related to our operations and general administration. We are also engaged in
conversations with our major suppliers of goods and services and we have
initiated restructuring of our vendor processes and agreements. We are also
seeking to restructure accounts payable and trade debt, of which we can give no
assurance of success. In connection with these efforts, we are reviewing our
current product line offerings to determine how to best commercially leverage
our fuel cell products and technology. Our restructuring and cost
rationalization plan are being carried-out in parallel with our efforts to raise
addition funds from external sources, which we require to pay existing
obligations and to continue our operations.
 We have
historically relied upon, and expect to continue to so rely upon, external
financing to finance our operations, primarily through the sale of our common
stock, warrants, preferred stock, convertible notes and other securities. As of
December 31, 2008, commitments for capital expenditures in 2008 aggregated
approximately $3,000,000, which primarily relate to our fully automated
production line and related facilities.
  Our
working capital and capital requirements at any given time depend upon numerous
factors, including, but not limited to:
  ·
              the
      progress of research and development
programs;
  ·
              the
      level of resources that we devote to the development of our technologies,
      patents, marketing and sales
capabilities;
  ·
              the
      sale of existing finished goods inventory and level of production required
      to build any additional product;
  ·
              the
      amount of resources required to complete and maintain our production
      facilities;
  ·
              variability
      of currency exchange rates in relationship to the U.S.
    dollar;
  ·
              revenues
      from the sale of our products and the margins that we are able to achieve;
      and
  ·
              the
      level of success we are able to achieve with our cost rationalization
      program.
  In June
2008, we sold an aggregate of 6,823,529 shares of our common stock, along
with warrants to purchase 2,941,176 shares of our common stock, for
aggregate gross proceeds of approximately $29,000,000, less aggregate issuance
costs of approximately $1,393,000. Furthermore, commencing in April 2008, we
sold 917,020 shares of our common stock for aggregate gross proceeds of
$7,500,000, less issuance costs of approximately $223,000.
  On
February 13, 2009, we entered into a Securities Purchase Agreement (the
“Securities Purchase Agreement”) with Ascendiant Capital Group, LLC
(“Ascendiant”) to establish a potential source of funding, in what is sometimes
termed an equity line of credit arrangement. Under the Securities Purchase
Agreement, Ascendiant has agreed to provide us with up to $6,000,000 of funding
prior to February 13, 2011. During this period, we may, in our sole discretion,
request a drawdown under the equity line of credit by selling shares of our
common stock to Ascendiant and Ascendiant will be obligated to purchase the
shares. Subject to the draw down and other conditions set forth in the
Securities Purchase Agreement, we are obligated to sell no less than $3,000,000
worth of shares of our common stock to Ascendiant prior to the one year
anniversary of the date of the Securities Purchase Agreement. Except pursuant to
this drawdown minimum, we are under no obligation to request any drawdowns under
the equity line of credit. Various factors currently limit the amounts or
preclude us from drawing against this facility, including the trading price and
average trading volume of our common stock. Furthermore, we are looking
into alternative funding sources and do not intend to draw down on this facility
until we make a decision on those alternative funding sources.
 34
 During
the year ended December 31, 2008, net cash used in operating activities was
$47,515,000 compared to $34,429,000 for the year ended December 31, 2007. The
increase was primarily attributable to increases in expenditures for production
and production facility costs, including materials and components and
subcontractor costs and an increase in expenditures for selling, marketing,
general administrative expenses, as described more fully above, partially offset
by a decrease in research and development costs.  During 2008, we
continued to devote substantial cash resources to procuring raw materials and
building components and finished goods inventory.
  During
the year ended December 31, 2008, net cash used in investing activities was
$6,349,000, which represented (i) purchases of property and equipment of
$9,049,000 (ii) investment in restricted cash and deposits of $200,000,
partially offset by redemptions of short term investments of $2,000,000 and
redemptions of restricted cash of $900,000. During the year ended December 31,
2007, net cash used in investing activities was $14,983,000, which represented
(i) purchases of property and equipment of $38,039,000, of which
approximately $37,435,000 represents costs related to building and equipping our
fully automated and semi-automated production lines and related facilities,
(ii) investments in short-term investments of $58,780,000 less redemptions
of short-term investments of $87,284,000, (iii) restricted cash and
deposits of $6,838,000 less redemptions of $1,440,000 and (iv) equity investment
in an early-stage company of $50,000.
  During
the year ended December 31, 2008, net cash aggregating $47,880,000 was provided
by financing activities, which represented: (i) net proceeds of approximately
$51,630,000 from the sale of our common stock and warrants, as described more
fully above; (ii) net proceeds of approximately $447,000 from the issuance by
Cell Kinetics of its ordinary shares pursuant to a rights offering, as described
more fully above; (iii) proceeds of approximately $17,000 from our issuance of
1,280 shares of our common stock upon exercises of stock options issued under
our 1999 stock option plan and (iv) proceeds from the exercise of warrants to
purchase ordinary shares of Cell Kinetics of approximately $3,000, partially
offset by dividend payments on our Series A Preferred Stock aggregating
approximately $4,169,000 and capital lease payments of $48,000. During the year
ended December 31, 2007, net cash aggregating $14,235,000 was provided by
financing activities, which represented: (i) net proceeds of approximately
$16,951,000 from the sale of our common stock, as described more fully above;
(ii) proceeds of approximately $1,373,000 from our issuance of 171,000
shares of our common stock  upon exercise of stock options issued
under our 1999 stock option plan (of which 125,816 shares were exercised by our
executive officers; and (iii) proceeds of approximately $65,000 from our
issuance of 4,500 shares of our common stock upon exercise of outstanding
warrants, partially offset by (iv) dividend payments on our Series A preferred
stock aggregating approximately $4,128,000 (ii) payments of approximately
$26,000 for issuance costs on our Series A preferred stock.
  From our
inception in April 1992 through December 31, 2008, we have generated an
accumulated deficit of approximately $371,697,000 including approximately
$44,215,000 from amortization expense and $86,501,000 form impairment charges on
goodwill and property, plant and equipment. We expect to incur additional
operating losses during 2009 and possibly thereafter, principally in connection
with our fuel cell related operations, including production related costs,
selling, marketing, advertising, general and administrative expenses and
research and development costs.
  As of
December 31, 2008, we had cash and cash equivalents of $10,642,000. During the
year ended December 31, 2008, we used net cash in operating activities of
$47,515,000, incurred a net loss of $148,222,000, and had a total
stockholders’
deficit of $4,576,000 at December 31, 2008, which net loss included $86,501,000
of impairment charges on goodwill and property, plant and
equipment.
   35
 In
connection with the termination in November 2008 of the employment of our then
president and our then senior vice president and chief financial officer, we
made severance related payments in 2009 aggregating approximately $700,000, for
legally required and contractual arrangements pertaining to unfunded severance,
accrued vacation,  notification and adaptation period and vehicle
benefits.  Additionally, in connection with the terminations of
employment as part of our cost rationalization plan announced in February, we
are committed to make severance related payments aggregating approximately
$430,000, for amounts that had not been previously funded for such
purpose.
  On
February 10, 2009, as part of our capital management initiatives and to preserve
capital, our Board of Directors did not declare the quarterly dividend on our
Preferred Stock for the quarterly dividend period ended February 15, 2009. Our
Board of Directors will evaluate our cash position each fiscal quarter and
determine whether or not to declare dividends on our preferred stock for that
quarter.
  As part
of our spin-off of Cell Kinetics, we committed to provide to Cell
Kinetics:
  ·
              a
      cash capital contribution of $1,500,000 over an 18 month period commencing
      January 7, 2008, on an as needed
basis;
       36
 ·
              during
      that 18 month period, with such office and laboratory facilities as it may
      reasonably require, as well as to provide it with administrative and
      professional services at cost as a contribution to its capital;
      and
  ·
              additional
      financing to carry-out its operations for at least one year commencing
      January 7, 2008, if its other resources are insufficient for such period
      of time.
  On June
30, 2008, our wholly-owned subsidiary, Medis El, provided funding to Cell
Kinetics in the amount $1,500,000, pursuant to a non-interest bearing, unsecured
promissory note, with a due date of January 1, 2010 – subject to certain other
repayment conditions that are based on Cell Kinetics receiving alternative
sources of financing for its operations or the sale of its business to or merger
with a third party. At the option of Medis El, any remaining balance on the
promissory note may be contributed to the capital of the Cell
Kinetics.
  Commitments
and Contingencies
  The
following table sets forth our contractual obligations at December 31,
2008:
  Payment
      Due By PeriodContractual
      Obligations
                
                Total
                
                
                2009
                
                
                2010
                
                
                2011
                
                
                2012
                
                
                2013
      and thereafterCapital
      Lease Obligation
                
                $
                4,135,000
                
                
                $
                80,000
                
                
                $
                2,028,000
                
                
                $
                1,014,000
                
                
                $
                1,013,000
                
                
                $
                —Operating
      Lease Obligation
                
                
                1,422,000
                
                
                
                1,057,000
                
                
                
                229,000
                
                
                
                136,000
                
                
                
                —
                
                
                
                —Purchase
      Obligations
                
                
                9,455,000
                
                
                
                9,455,000
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Total
                
                $
                15,012,000
                
                
                $
                10,592,000
                
                
                $
                2,257,000
                
                
                $
                1,150,000
                
                
                $
                1,013,000
                
                
                $
                —
 
  Tax
Matters
  As of
December 31, 2008, for U.S. federal income tax purposes, we have net operating
loss carry-forwards of approximately $30,990,000 including approximately
$7,884,000 arising from tax deductions in excess of expense recorded with
respect to grants of stock options and warrants. For Israeli income tax
purposes, we have net operating loss carry-forwards of approximately
$137,637,000. Since our inception, we have not had any taxable
income.
  The
availability of our U.S. net operating loss carry-forwards may be reduced to the
extent one or more direct or indirect holders of 5% or greater amount of our
common stock increases their equity interest in us by more than 50% in the
aggregate.
  Grants
Obtained From The State Of Israel
  Medis El,
the predecessor to Cell Kinetics in its CellScan and Cell Carrier related
business, received approximately $1,629,000 in research and development grants
related to the CellScan technology from the Office of the Chief Scientist of the
Ministry of Commerce and Industry of the State of Israel from its inception to
1997. This is based upon a policy of the government of Israel to provide grants
of between 50% and 66% of qualifying approved research and development
expenditures to promote research and development by Israeli companies. Medis El
received 50% of qualifying approved research and development expenditures.
Pursuant to the grant arrangement, Cell Kinetics as the assignee of Medis El’s
contingent obligation in connection with Cell Kinetics’ acquisition of Medis
El’s CellScan and Cell Carrier related business, including its intellectual
property rights relating to the CellScan and its Cell Carrier technology, is
required to pay 3% of its sales of CellScan related products developed with the
grant funds until the grant amounts are paid in full. There is no requirement to
repay the grants if the
   37
 products
developed with the grant funds are not sold. If Cell Kinetics wishes to sell the
underlying technology prior to repaying the grant funds, it must first seek
permission from the Israeli government for such sale. Prior to Medis El
receiving grant funds in 1992, Medis El assumed from Israel Aerospace Industries
Ltd. (formerly known as Israel Aircraft Industries Ltd.), its largest
stockholder, its obligation relating to the repayment of grants out of future
royalties, if any, of approximately $805,000, which contingent obligation Cell
Kinetics also assumed in connection with its acquisition of Medis El’s CellScan
and Cell Carrier related business. As of December 31, 2008, Cell Kinetics’ total
contingent obligation for the repayment of grants, which includes the $805,000
described above, is $2,247,000. Neither we nor any of our subsidiaries presently
receive any grants from the State of Israel.
  Approved
Enterprise
  The law
for the Encouragement of Capital Investments, 1959 (the “Investment Law”) and
the tax benefits that we may derive therefrom can be summarized as
follows:
  The
Israel based facilities of More Energy have been granted status of an “Approved
Enterprise” under the Law for an investment program approved in 2001. We applied
to the Investment Center to set 2005 as the Year of Operation According to the
provisions of the Law, More Energy has elected the “alternative benefits track”
- the waiver of grants in return for tax exemption and, accordingly, More Energy
income is tax-exempt for a period of two years commencing with the year it first
earns taxable income, and subject to corporate taxes at the reduced rate of 10%
to 25%, depending upon the level of our foreign ownership y, for an additional
period of 5-8 years from when the tax exemption ends. The period of tax
benefits, detailed above, is limited to the earlier of 12 years from the Year of
Operation, or 14 years from the approval date (except for the tax-exempt period
of two years which is unlimited). Due to reported losses for tax purposes the
tax benefit period has not yet commenced.
  The
entitlement to the above benefits is conditional upon fulfilling the conditions
stipulated by the Law, regulations published there under and the letters of
approval for the specific investments in “Approved Enterprises.” In the event of
failure to comply with these conditions, the benefits may be canceled and More
Energy may be required to refund the amount of the benefits, in whole or in
part, including interest.
  If More
Energy distributes cash dividend from retained earning which were tax exempt due
to its approved enterprise status, More Energy would be required to pay
corporate tax at a rate of 10% to 25% corporate tax on the gross amount
distributed and a further 15% withholding tax would be deducted from the amount
disturbed to the recipients.
  If
More Energy derives income from sources other than the approved enterprise
programs during the relevant period of benefits, this income would be taxable at
the regular corporate tax rate of Israel.
  On April
1, 2005, an amendment to the Law came into effect (“the Amendment”) and has
significantly changed the provisions of the Investment Law. The Amendment sets
forth the scope of enterprises which may qualify as a Privileged Enterprise
(under the Amendment, the designation is Privileged Enterprise rather than
Approved Enterprise) by setting forth criteria for qualification of a company,
such as provisions generally requiring that at least 25% of the Privileged
Enterprise’s income will be derived from export and that minimum qualifying
investments in productive assets be made. Additionally, the Amendment enacted
major changes in the manner in which tax benefits are awarded under the
Investment Law so that companies no longer require Investment Center approval in
order to qualify for tax benefits. Under the Amendment, the year in which the
company elects to commence its tax benefits is designated as the year of
election (“Year of Election”). A company may choose its Year of Election by
notifying the Israeli Tax authorities in connection with filings its annual tax
return or within 12 months
after the end of the Year of Election, whichever is earlier, or by requesting a
pre-ruling from the Israeli tax authorities no later than within 6 months after
the end of the Year of Election.
   38
 In July
2006, More Energy submitted an application to the Investment Center for approval
to manufacture abroad and still be eligible for all the benefits according the
Law. In August 2006, More Energy applied to the Israeli Tax Authorities in order
to receive approval for manufacturing in Ireland with Celestica. A decision
regarding both requests has not yet been received and is pending upon
fulfillment of certain requests. The Company cannot be certain that the
approvals will be granted.
  The Law,
as amended, also provides that any letter of approval granted prior to the
Amendment will remain subject to the terms and benefits included in such letter
of approval. Accordingly, while it is anticipated that the Investment Law, as
amended, will govern More Energy’s Privileged Enterprise terms and benefits, the
Company does not expect that the Amendment will have any impact on Medis
El.
  Critical
Accounting Policies and Estimates
  Our
discussion and analysis of our financial condition and results of operations is
based on our consolidated financial statements, which have been prepared in
accordance with U.S. generally accepted accounting principles. The preparation
of these consolidated financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent liabilities. On an on-going
basis, we evaluate past judgments and our estimates, including those related to
goodwill and intangible assets, stock options and warrants and deferred income
taxes. We base our estimates on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
  We
believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our consolidated financial
statements.
  Going
Concern
  The
accompanying financial statements do not include any adjustments to reflect the
possible future effects on recoverability and reclassification of assets or the
amounts and classification of liabilities that may result should we be unable to
continue as a going concern. If the consolidated financial statements were
prepared on a liquidation basis, the carrying value of the assets and
liabilities would be adjusted to reflect the liquidation basis of
accounting.
  Goodwill
and Property and Equipment
  Assets
acquired in connection with our historical acquisitions included significant
amounts of goodwill.
  Goodwill
represents the excess of the purchase price over the fair value of the assets
acquired. Goodwill is not amortized. However, we are required to perform
impairment reviews at least annually and more frequently in certain
circumstances.
  The
goodwill impairment test is a two-step process, which requires management to
make judgments in determining what assumptions to use in the calculation. The
first step of the process consists of estimating the fair value of our reporting
units based on a discounted cash flow model using revenue and profit forecasts
and comparing those estimated fair values with the carrying values, which
include
   39
 goodwill.
If the estimated fair value is less than the carrying value, a second step is
performed to compute the amount of the impairment by determining an “implied
fair value” of goodwill. We cannot predict the occurrence of certain future
events that might adversely affect the reported value of goodwill. Such events
include, but are not limited to, strategic decisions made in response to
economic and competitive conditions, the impact of the economic environment on
our potential client base, and material negative change in relationship with
significant clients. The “implied fair value” of our reporting units will be
determined by our management and will generally be based upon future cash flow
projections for the reporting units discounted to present value. We will use
outside valuation experts when management considers that it would be appropriate
to do so.
  Property
and equipment are initially stated at cost. Depreciation on property and
equipment is computed using the straight-line method over the estimated useful
lives of the property and equipment after consideration of historical results
and anticipated results based on our current plans. Our estimated useful lives
represent the period the asset is expected to remain in service assuming normal
routine maintenance. We will review the estimated useful lives assigned to
property and equipment when our business experience suggests that they may have
changed from our initial assessment. Factors that lead to such a conclusion may
include physical observation of asset usage, examination of realized gains and
losses on asset disposals and consideration of market trends such as
technological obsolescence or change in market demand.
  We will
perform impairment reviews of property and equipment, when events or
circumstances indicate that the value of the assets may be impaired. Indicators
include operating or cash flow losses, significant decreases in market value or
changes in the long-lived assets’ physical condition. When indicators of
impairment are present, management determines whether the sum of the
undiscounted future cash flows estimated to be generated by those assets is less
than the carrying amount of those assets. In this circumstance, the impairment
charge is determined based upon the amount by which the carrying value of the
assets exceeds their fair value. The estimates of both the undiscounted future
cash flows and the fair values of assets require the use of complex models that
require numerous highly sensitive assumptions and estimates.
  40
 Stock
Options, Warrants and Restricted Stock
  We
utilize stock options, warrants and restricted stock as an important means of
compensation for employees, directors and consultants and also warrants as an
instrument in our fund raising process. Accounting for such options, warrants
and restricted stock results in significant non-cash charges to our operations
or accumulated deficit. There are assumptions and estimates involved in
determining the value of such stock options, warrants and restricted stock and
the timing of related charges to our operations or accumulated deficit. These
estimates and assumptions include the expected term of the option, volatility of
our stock price, interest rates and expected forfeiture rates. The market price
of our stock also has a significant impact on charges we incur related to stock
options and warrants.
  Inventories
  Inventories
consist of raw materials, components and finished goods and are subject to lower
of cost or market valuation and write-downs for obsolescence and other reserves.
Application of the appropriate accounting guidance and determining the correct
valuation of our inventories involves the use of judgment and
estimates.  As such, a significant change in our estimates could have
a material impact on the carrying value of our inventories and the results of
our operations.
  Deferred
Income Taxes
  We record
a valuation allowance to reduce our deferred tax assets to zero. In the event
that we were to determine that we are likely to be able to realize all or part
of our deferred tax assets in the future, an adjustment to the deferred tax
assets would be credited to operations in the period such determination was
made.
  Effective
January 1, 2008, we adopted FASB Interpretation 48, “Accounting for Uncertainty
in Income Taxes” (“FIN 48”). FIN 48 defines the threshold for
recognizing the benefits of tax return positions in the financial statements as
“more-likely-than-not” to be sustained by the taxing authority. The recently
issued literature also provides guidance on derecognition, measurement and
classification of income tax uncertainties, along with any related interest and
penalties. FIN 48 also includes guidance concerning accounting for income
tax uncertainties in interim periods and increases the level of disclosures
associated with any income tax uncertainties. The application of FIN 48 requires
the exercise of
judgment and the use estimates and, depending on transactions and circumstances,
could potentially have a significant impact on our consolidated financial
statements.
 41
 Recent
Accounting Pronouncements
  In
December 2007, the FASB issued Statement No. 141 (revised 2007), Business
Combinations (SFAS 141R). FAS 141R establishes principles and
requirements for how an acquirer in a business combination (i) recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any no controlling interest in the acquiree,
(ii) recognizes and measures the goodwill acquired in a business
combination or a gain from a bargain purchase, and (iii) determines what
information to disclose to enable users of financial statements to evaluate the
nature and financial effects of the business combination. FAS 141R will be
applied prospectively to business combinations that have an acquisition date on
or after January 1, 2009.  The impact of SFAS 141R on the
Company’s consolidated results of operations and financial condition will depend
on the nature and size of acquisitions, if any, subsequent to the effective
date.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS
No. 160 establishes accounting and reporting standards that require that
the ownership interests in subsidiaries held by parties other than the parent be
clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parent’s equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parent’s ownership interest
while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently. SFAS No. 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after
December 15, 2008. We are currently evaluating the potential impact, if
any, of the adoption of SFAS No. 160 on its consolidated financial
statement.
  In
February 2008, the FASB issued FSP No. FAS 157-1, “Application of FASB
Statement No. 157 to FASB Statement No. 13 and Other Accounting
Pronouncements That Address Fair Value Measurements for Purposes of Lease
Classification or Measurement under Statement 13”, and FSP No. FAS 157-2,
“Effective Date of FASB Statement No. 157”. Collectively, the Staff
Positions defer the effective date of Statement 157 to fiscal years beginning
after November 15, 2008 for nonfinancial assets and nonfinancial
liabilities except for items that are recognized or disclosed at fair value on a
recurring basis at least annually, and amend the scope of Statement 157. As
described above in Note 17 of Note B, we adopted SFAS No. 157 and the
related FASB staff positions except for those items specifically deferred under
FSP No. FAS 157-2.
  In March
2008, the FASB issued Statement 161 “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS 161”) an amendment to FASB No.
133.  This statement changes the disclosure requirements for
derivative instruments and hedging activities.  Entities are required
to provide enhanced disclosures about (a) how and why and entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows.  This statement is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008.  Early application is
encouraged.  We do not expect the adoption of SFAS 161 to have a
material impact on its financial position, results of operations or cash
flows.
  In
December 2007, the FASB ratified EITF Issue No. 07-1 “Accounting for
Collaborative Arrangements” (“EITF 07-1”), which provides guidance regarding
financial statement presentation and disclosure of collaborative arrangements to
jointly develop, manufacture, distribute and market a product
   42
 whereby
the collaborators will share, based on contractually defined calculations, the
profits or losses from the associated activities. The consensus requires
collaborators in such an arrangement to present the result of activities for
which they act as the principal on a gross basis and report any payments
received from, or made to other collaborators based on other applicable GAAP or,
in the absence of other applicable GAAP, based on analogy to authoritative
accounting literature or a reasonable, rational and consistently applied
accounting policy election. EITF 07-1 is effective for fiscal years beginning
after December 31, 2008, which will be our fiscal year 2009, and will be applied
as a change in accounting principle retrospectively for all collaborative
agreements existing as of the effective date. We are in the process of
evaluating the potential impact of adopting EITF No. 07-1 on our
consolidated financial statements.
  Item 7A. Quantitative
and Qualitative Disclosures About Market Risk
  Impact
Of Inflation And Devaluation On Results Of Operations, Liabilities And
Assets
  In
connection with our currency use, we operate in a mixed environment. Payroll is
paid in the local currency of each of our subsidiaries, the New Israeli Shekel
(NIS), and our other operating expenses and capital expenditures are, for the
most part, based in U.S. Dollars, NIS, Euro and Swiss Francs. Consideration for
virtually all sales is either in dollars or dollar-linked currency. As a result,
not all monetary assets and all monetary liabilities are linked to the same base
in the same amount at all points in time, which cause currency fluctuation
related gains or losses. While our liquid funds are primarily invested in U.S.
Dollars-based assets, we also invest liquid funds in NIS, Euro and Swiss
Francs.  Furthermore, from time to time, we have purchased forward
contracts denominated in foreign currencies (see discussion of currency risk
management below).
  Currency
Risk Management
  In
September, 2005, we entered into a Capital Equipment Purchase Agreement (the
“Agreement”) with Komax Systems LCF SA (formerly known as Ismeca Europe
Automation SA) to build an automated assembly line for our fuel cell Power Pack
products, to be operated at the Galway, Ireland facility of Celestica. Under the
Agreement, as amended, we will pay Komax an aggregate of approximately
20,690,000 Swiss Francs (approximately $17,000,000) based on currency exchange
rates in effect on payment dates and on December 31, 2008) for constructing the
line. The Agreement calls for an initial payment of fifteen percent of the total
contract price with milestone payments scheduled over the life of the contract.
From the inception of the agreement through December 31, 2008, we paid an
aggregate of approximately 20,461,000 Swiss Francs (approximately $16,784,000).
All such amounts are included in property and equipment as of December 31,
2008.
  Based on
a study performed by us, we undertook in 2006 a currency risk management
strategy for payments under the Komax agreement and pursuant to which in 2006,
on a limited basis, we entered into forward contracts and participating forward
contracts for the purchase of Swiss Francs. At our option, we either took
delivery of the Swiss Francs or net settled the contracts during their term. We
also purchased in 2008, on a limited basis, foreign currencies based on
projections of up-coming payment obligations denominated in foreign currencies.
Through December 31, 2008, we have incurred net costs of approximately $600,000
on payments made to date under the Komax agreement as a result of variations in
the exchange rate between the Swiss franc and the U.S. dollar and we expect to
incur additional costs on future payments under the agreement with Komax. We had
no material open forward contracts or participating forward contracts at
December 31, 2007 or 2008.
  As
described above, a portion of our costs and expenses are denominated in foreign
currencies. The principal foreign currencies applicable to our business are the
New Israeli Shekel, the Euro and the
 43
 Swiss
Franc. As a result, we have exposure to foreign currency exchange fluctuations.
The U.S. dollar has declined in relationship to these foreign currencies from
historical levels, which has increased certain of our operating and capital
costs. Continued foreign currency fluctuations could further impact our costs,
as well as our ability to achieve and maintain profitability as we continue to
grow our business. See Part II, Item 1A, “Our results of operations and capital
costs have been and may continue to be negatively affected by potential
fluctuations in foreign currency exchange rates.”
  Impact
Of Political And Economic Conditions
  The state
of hostility which has existed in varying degrees in Israel since 1948, its
unfavorable balance of payments and its history of inflation and currency
devaluation, all represent uncertainties which may adversely affect our
business.
  Item
8. Financial
Statements and Supplementary Data
  Our
consolidated financial statements and corresponding notes thereto called for by
this item appear at the end of this document commencing on
page F-1.
  Item
9. Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
  Not
applicable
  Item 9A. Controls
and Procedures
  Under the
supervision and with the participation of management, including our Chief
Executive Officer and Chief Accounting Officer, we evaluated the effectiveness
of our disclosure controls and procedures (as defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934) as of the end of the period covered
by this report. Based upon that evaluation, our Chief Executive Officer and
Chief Accounting Officer concluded that our disclosure controls and procedures
were effective as of December 31, 2008.
  Management’s
Report on Internal Control Over Financial Reporting
  Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
participation of our management, including our Chief Executive Officer
and Chief Accounting Officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting as of December
31, 2008 based on the framework in Internal Control--Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on that evaluation, our management concluded that our internal control
over financial reporting was effective as of December 31, 2008.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
 44
 Changes
in Internal Control Over Financial Reporting
  There has
not been any change in our internal control over financial reporting (as defined
in Rule 13(a)-15(f) under the Exchange Act) during the quarter ended
December 31, 2008 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
 Report
of Independent Registered Public Accounting Firm
  The Board
of Directors and Shareholders of
 Medis
Technologies Ltd.
  We have
audited Medis Technologies Ltd.’s internal control over financial reporting as
of December 31, 2008, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (the COSO criteria). Medis Technologies Ltd.’s
management is responsible for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included
in the accompanying annual report on Form 10-K. Our responsibility is to express
an opinion on the company’s internal control over financial reporting based on
our audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
  A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  In our
opinion, Medis Technologies Ltd. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2008, based onthe COSO criteria.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Medis
Technologies Ltd. and its subsidiaries as of December 31, 2007 and 2008 and the
related consolidated statements of operations, stockholders’ equity (deficit)
and cash flows for each of the three years in the period ended December 31,
2008, and our report dated March 31, 2009 expressed an unqualified opinion
thereon.
  Tel
      Aviv, Israel
              
              KOST
      FORER GABBAY & KASIERERMarch
      31, 2009
              
              A
      MEMBER OF ERNST & YOUNG GLOBAL
 
 45
 Item 9B. Other
Information.
   
  PART
III
  Item
10. Directors,
Executive Officers and Corporate Governance
  The
information required by this Item 10 is set forth in our Proxy Statement
for the 2009 Annual Meeting of Stockholders (the “2009 Proxy Statement”), which
is incorporated herein by this reference.
  Item
11. Executive
Compensation
  The
information required by this Item 11 is set forth in the 2009 Proxy
Statement, which is incorporated herein by this reference.
  Item
12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
  The
information required by this Item 12 is set forth in the 2009 Proxy
Statement, which is incorporated herein by this reference.
  Item
13. Certain
Relationships and Related Transactions, and Director
Independence
  The
information required by this Item 13 is set forth in the 2009 Proxy
Statement, which is incorporated herein by this reference.
  Item
14. Principal
Accounting Fees and Services
  The
information required by this Item 14 is set forth in the 2009 Proxy
Statement, which is incorporated herein by this reference.
 46


PART
IV
  Item
15. Exhibits
and Financial Statement Schedules
  (a)  Financial
Statements.
  Our
financial statements as set forth in the Index to Consolidated Financial
Statements attached hereto commencing on page F-1 are hereby incorporated
by reference.
  (b)  Exhibits.
  The
following exhibits, which are numbered in accordance with Item 601 of
Regulation S-K, are filed herewith or, as noted, incorporated by reference
herein:
  3.(i)
              Restated
      Certificate of Incorporation of Medis Technologies Ltd., as amended
      (1)3.(ii)
              Restated
      By-Laws of Medis Technologies Ltd., as amended (2)4.1
              Form
      of certificate evidencing shares of common stock (2)4.2
              Certificate
      of Designation of 7.25% Series A Cumulative Convertible Perpetual
      Preferred Stock (3)10.1*
              Medis
      Technologies Ltd.’s 1999 Stock Option Plan, as amended
  (4)10.2*
              Medis
      Technologies Ltd.’s 2007 Equity Incentive Plan (5)10.3*
              Consulting
      Agreement dated December 15, 2008 between Israel Fisher and Medis
      Technologies Ltd.10.4
              Letter
      Agreement dated June 1, 1993 between Medis El Ltd. and The Industrial
      Research and Development Institute of the Chief Scientist’s Office of the
      State of Israel (6)10.5
              Agreement
      dated October 17, 1991 between Bar-Ilan University and Israel Aircraft
      Industries Ltd. (6)10.6
              Amendment
      of License dated August 8, 1992 between Bar-Ilan University and Israel
      Aircraft Industries Ltd. and Medis El (6)10.7
              Assignment
      of License Agreement between Israel Aircraft Industries between Israel
      Aircraft Industries Ltd. and Bar-Ilan University dated August 13, 1992
      between Israel Aircraft Industries Ltd. and Medis Israel Ltd.
      (6)10.8
              Letter
      Agreement dated July 18, 1996 between Medis El Ltd. and Bar-Ilan
      University (6)10.9*
              Consulting
      Agreement dated as of February 16, 2009 between Medis Technologies Ltd.
      and Robert K. Lifton10.10*
              Consulting
      Agreement dated as of February 16, 2009 between Medis Technologies Ltd.
      and Howard Weingrow10.11*
              Severance
      Agreement dated as of February 16, 2009 between Medis Technologies Ltd.
      and Robert K. Lifton10.12*
              Severance
      Agreement dated as of February 16, 2009 between Medis Technologies Ltd.
      and Howard Weingrow10.13
              Summary
      of Material Lease Terms to Lod, Israel Facility (7)10.14**
              Capital
      Equipment Purchase Agreement, dated as of September 15, 2005, between
      Medis Technologies Ltd. and Ismeca Europe Automation S.A.
    (8)10.15**
              Agreement
      for Manufacture, dated as of September 27, 2005, between More Energy Ltd.
      and Celestica Ireland Limited and guaranty by Medis Technologies Ltd.
      (8)10.16
              Registration
      Rights Agreement, dated November 15, 2006, by and between the Registrant
      and Citigroup Global Markets Inc. (9)10.17
              Securities
      Purchase Agreement dated February 13, 2009 between Medis Technologies Ltd.
      and Ascendiant Capital Group, LLC
(10)
  47
 10.18*
                  Employment
      Agreement, dated September 19, 2008, by and between Jose Mejia and Medis
      Technologies Ltd. (11)10.19*
                  Warrant
      Agreement, dated September 19, 2008, by and between Jose Mejia and Medis
      Technologies Ltd. (11)10.20*
                  Employment
      Agreement, dated December 18, 2008, by and between John Giere and Medis
      Technologies Ltd.10.21*
                  Employment
      Agreement, dated February 17, 2009, by and between Thomas Finn and Medis
      Technologies Ltd.10.22**
                  Distribution
      Agreement, dated as of August 10, 2004, between ASE International Inc. and
      Medis Technologies Ltd. (12)10.25
                  Form
      of stock option agreement (employee) (13)10.26
                  Form
      of stock option agreement (non-employee) (13)10.27
                  Form
      of restricted stock agreement (employee) (13)10.28
                  Form
      of restricted stock agreement (non-employee) (13)14.1
                  Code
      of Ethics (14)21.1
                  Subsidiaries
      of the Registrant (15)23.1
                  Consent
      of Kost Forer Gabbay & Kasierer, a Member of Ernst & Young
      Global31.1
                  Rule 13a-14(a)/15d-14(a)
      certification of Chief Executive Officer31.2
                  Rule 13a-14(a)/15d-14(a)
      certification of Chief Financial Officer32.1
                  Section 1350
      certifications
 
 *Management
      contract or compensatory plan
  **Portions
      of this document have been omitted and submitted separately with the
      Securities and Exchange Commission pursuant to a request for “Confidential
      Treatment.”
  (1)
              Filed
      as an exhibit to the Quarterly Report on Form 10-Q dated June 30,
      2006 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (2)
              Filed
      as an exhibit to the Current Report on Form 8-K dated December 18,
      2007 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (3)
              Filed
      as an exhibit to the Current Report on Form 8-K dated November 9,
      2006 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (4)
              Filed
      as an exhibit to the Quarterly Report on Form 10-Q for the quarter
      ended September 30, 2004 of Medis Technologies Ltd. and incorporated
      herein by reference.
 (5)
              Filed
      as Annex B to the Definitive Proxy Statement on Schedule 14A for the
      2007 Annual Meeting of Stockholders of Medis Technologies Ltd. and
      incorporated herein by reference.
 (6)
              Filed
      as an exhibit to the Registration Statement on Form S-1, as amended
      (File No. 333-73276), of Medis Technologies Ltd. and incorporated herein
      by reference.
 (7)
                Filed
      as an exhibit to the Annual Report on Form 10-K for the year ended
      December 31, 2004 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (8)
                  Filed
      as an exhibit to the Quarterly Report on Form 10-Q for the quarter
      ended September 30, 2005 of Medis Technologies Ltd. and incorporated
      herein by reference.
 (9)
                    Filed
      as an exhibit to the Registration Statement on Form S-3 (File No.
      333-140508) of Medis Technologies Ltd. and incorporated herein by
      reference.
 (10)
                      Filed
      as an exhibit to the Current Report on Form 8-K dated February 10,
      2009 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (11)
                          Filed
      as an exhibit to the Current Report on Form 8-K dated September 25,
      2008 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (12)
                            Filed
      as an exhibit to the Current Report on Form 8-K dated August 10, 2004
      of Medis Technologies Ltd. and incorporated herein by
      reference.
 (13)
                              Filed
      as an exhibit to the Quarterly Report on Form 10-Q dated June 30, 2007 of
      Medis Technologies Ltd. and incorporated herein by
    reference.
 (14)
                                Filed
      as an exhibit to the Annual Report on Form 10-K for the year ended
      December 31, 2003 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (15)
                                    Filed
      as an exhibit to the Annual Report on Form 10-K for the year ended
      December 31, 2006 of Medis Technologies Ltd. and incorporated herein by
      reference.
 (c)  Financial
Statement Schedules.
  None
  48
 SIGNATURES


Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
   MEDIS
      TECHNOLOGIES LTD.Dated:    March
      31, 2009
                By:
                /s/ Jose
      MejiaJose
      MejiaChairman
      and Chief Executive Officer
   
 Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
  Signature
                
                Title
                
                Date/s/
      Jose Mejia
                  Jose
      Mejia
                
                Chairman
      andPresident
      and Chief Executive Officer and Director
                  (Principal
      Executive Officer)
                
                March
      31, 2009/s/
      Michael S. Resnick
                  Michael
      S. Resnick
                
                Senior
      Vice President and Chief Accounting Officer
                  (Principal
      Accounting Officer) (Acting Principal Financial Officer)
                
                March
      31, 2009/s/
      Amos Eiran
                  Amos
      Eiran
                
                Director
                
                March
      31, 2009/s/
      Zeev Nahmoni
                  Zeev
      Nahmoni
                
                Director
                
                March
      31, 2009/s/
      Mitchell H. Freeman
                  Mitchell
      H. Freeman
                
                Director
                
                March
      31, 2009/s/
      Steve M. Barnett
                  Steve
      M. Barnett
                
                Director
                
                March
      31, 2009/s/
      Daniel Luchansky
                  Daniel
      Luchansky
                
                Director
                
                March
      31, 2009/s/ Andrew
      A. Levy
                  
                  Andrew
      A Levy
                
                Director
                
                March
      31, 2009/s/Barry Newman
                  Barry
      Newman
                
                Director
                
                March
      31, 2009


49


INDEX




PageMedis
      Technologies Ltd. Consolidated Financial StatementsReport
      of Independent Registered Public Accounting Firm
            F-2Consolidated
      Financial StatementsConsolidated
      Balance Sheets as of December 31, 2007 and 2008
            F-3Consolidated
      Statements of Operations for the years ended December 31, 2006, 2007 and
      2008
            F-4Consolidated
      Statements of Stockholders’ Equity
      (Deficit) for the years ended December 31, 2006, 2007 and
    2008
            F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2006, 2007 and
      2008
            F-6Notes
      to Consolidated Financial Statements
            F-8













































F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




Board of
Directors and Stockholders of
  Medis
Technologies Ltd.
  We have
audited the accompanying consolidated balance sheets of Medis Technologies Ltd.
and its subsidiaries (the "Company") as of December 31, 2007 and 2008 and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31,
2008.  These financial statements are the responsibility of the
Company's management.  Our responsibility is to express an opinion on
these financial statements based on our audits.
  We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
  In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company as of
December 31, 2008 and 2007, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2008, in conformity with U.S. generally accepted accounting
principles.
  The
accompanying financial statements have been prepared assuming the Company will
continue as a going concern. As shown in the financial statements, the Company
incurred net loss attributable to common stockholders of $152,591,000,
$42,328,000 and $33,047,000, for the years ended December 31, 2008, 2007 and
2006, respectively and had Stockholders' deficit of $4,576,000 as of December
31, 2008.  As more fully described in Note A, the Company needs to raise
capital, find alternative means of financial support, or both to fund its
operations and repay its existing liabilities and those arising in the normal
course of business. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. (Management's plans in regard to these
matters also are described in Note A). The 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 may result from the outcome of this uncertainty.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company's internal control over financial
reporting as of December 31, 2008, based on criteria established in
Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated March
31, 2009 expressed an unqualified opinion thereon.


Tel
      Aviv, Israel
            
            KOST
      FORER GABBAY & KASIERERMarch
      31, 2009
            
            A
      MEMBER OF ERNST & YOUNG GLOBAL





F-2


Medis
Technologies Ltd. and Subsidiaries


Consolidated
Balance Sheets


(in
U.S. dollars)


December
      31,2007
            
            
            2008ASSETSCurrent
      assetsCash
      and cash equivalents
            
            $
            16,626,000
            
            
            $
            10,642,000Short-term
      investments (Note C)
            
            
            1,160,000
            
            
            
            -Restricted
      cash and deposits (Note D)
            
            
            1,789,000
            
            
            
            1,027,000Inventories
      (Note E)
            
            
            8,809,000
            
            
            
            7,278,000Prepaid
      expenses and other current assets
            
            
            3,305,000
            
            
            
            1,245,000Total
      current assets
            
            
            31,689,000
            
            
            
            20,192,000Inventories
      (Note E)
            
            
            -
            
            
            
            2,617,000Restricted
      cash and deposits (Note D)
            
            
            3,911,000
            
            
            
            4,055,000Property
      and equipment, net (Note F)
            
            
            61,703,000
            
            
            
            32,085,000Severance
      pay fund
            
            
            1,677,000
            
            
            
            1,599,000Intangible
      assets, net (Note G)
            
            
            48,000
            
            
            
            -Goodwill
            
            
            58,205,000
            
            
            
            2,212,000Total
      assets
            
            $
            157,233,000
            
            
            $
            62,760,000LIABILITIES
      AND
              STOCKHOLDERS’
      EQUITY (DEFICIT)Current
      liabilitiesAccounts
      payable
            
            $
            4,535,000
            
            
            $
            4,701,000Accrued
      expenses and other current liabilities (Note H)
            
            
            3,340,000
            
            
            
            3,117,000Total
      current liabilities
            
            
            7,875,000
            
            
            
            7,818,000Capital
      lease and other liabilities (Note I)
            
            
            2,144,000
            
            
            
            4,067,000Accrued
      severance pay
            
            
            2,223,000
            
            
            
            2,211,000Total
      Liabilities
            
            
            12,242,000
            
            
            
            14,096,000Commitments
      and contingencies (Note L)Series
      A Preferred Stock, net, $.01 par value; $10,000 liquidation preference per
      share; 10,000 shares authorized; and 5,750 issued and outstanding at
      December 31, 2007 and December 31, 2008; Aggregated liquidation preference
      of $57,500,000 as of December 31, 2007 and 2008 (Note
      J)
            
            
            53,240,000
            
            
            
            53,240,000Stockholders’
      equity (Note K)Common
      stock, $.01 par value; 43,500,000 and 75,500,000 shares authorized at
      December 31, 2007
      and December 31, 2008, respectively; 36,367,562 and 46,082,888 shares issued and
      outstanding at December 31, 2007 and December 31, 2008, respectively
      (including 1,500,000 shares outstanding at December 31, 2007 and December
      31, 2008 loaned to be returned)
            
            
            363,000
            
            
            
            461,000Additional
      paid-in capital
            
            
            310,494,000
            
            
            
            366,660,000Accumulated
      deficit
            
            
            (219,106,000
            )
            
            
            (371,697,000
            )Total
      stockholders’ equity (deficit)
            
            
            91,751,000
            
            
            
            (4,576,000
            )Total
      liabilities and stockholders’ equity
            
            $
            157,233,000
            
            
            $
            62,760,000




The
accompanying notes are an integral part of these consolidated financial
statements.




F-3


Medis
Technologies Ltd. and Subsidiaries




Consolidated
Statements of Operations




(in
U.S. dollars)




Year
      ended December 31,2006
            
            
            2007
            
            
            2008Revenues
            
            $
            150,000
            
            
            $
            400,000
            
            
            $
            —Cost
      of Revenues
            
            
            98,000
            
            
            
            249,000
            
            
            
            —Gross
      profit
            
            
            52,000
            
            
            
            151,000
            
            
            
            —Depreciation,
      production and facility costs:Depreciation,
      production and facility costs (Note B-6)
            
            
            —
            
            
            
            —
            
            
            
            20,023,000Inventory
      reserves and write offs: (Note B-5)
            
            
            —
            
            
            
            —
            
            
            
            8,200,000Total
      depreciation, production and facility costs
            
            
            —
            
            
            
            —
            
            
            
            28,223,000Operating
      expenses:(*)Research
      and development costs, net
            
            
            18,057,000
            
            
            
            25,705,000
            
            
            
            21,527,000Selling,
      marketing, general and administrative expenses
            
            
            7,579,000
            
            
            
            13,541,000
            
            
            
            14,219,000Impairment
      charges on goodwill and property and equipment (Note A-3)
            
            
            —
            
            
            
            —
            
            
            
            86,501,000Amortization
      of intangible assets
            
            
            208,000
            
            
            
            208,000
            
            
            
            48,000Total
      operating expenses
            
            
            25,844,000
            
            
            
            39,454,000
            
            
            
            122,295,000Loss
      from operations
            
            
            (25,792,000
            )
            
            
            (39,303,000
            )
            
            
            (150,518,000
            )Interest
      income (expenses)Interest
      income
            
            
            2,517,000
            
            
            
            2,331,000
            
            
            
            1,926,000Interest
      expense
            
            
            (9,772,000
            )
            
            
            (1,228,000
            )
            
            
            (322,000
            )(7,255,000
            )
            
            
            1,103,000
            
            
            
            1,604,000Minority
      interest
            
            
            —
            
            
            
            —
            
            
            
            492,000Net
      loss
            
            
            (33,047,000
            )
            
            
            (38,200,000
            )
            
            
            (148,422,000
            )Dividend
      on preferred stock
            
            
            —
            
            
            
            (4,128,000
            )
            
            
            (4,169,000
            )Net
      loss attributable to common stockholders
            
            $
            (33,047,000
            )
            
            $
            (42,328,000
            )
            
            $
            (152,591,000
            )Basic
      and diluted net loss per share
            
            $
            (1.08
            )
            
            $
            (1.26
            )
            
            $
            (3.75
            )Weighted-average
      number of common shares used in computing basic and diluted net loss per
      share
            
            
            30,916,848
            
            
            
            33,554,298
            
            
            
            40,693,544


(*)
      Includes stock based compensation in the following items:Research
      and development
            
            $
            975,000
            
            
            $
            1,094,000
            
            
            $
            593,000Selling,
      marketing, general and administrative
            
            
            2,024,000
            
            
            
            5,470,000
            
            
            
            4,024,000Total
      stock-based compensation expenses
            
            $
            2,999,000
            
            
            $
            6,564,000
            
            
            $
            4,617,000




The
accompanying notes are an integral part of these consolidated financial
statements.




F-4


Medis
Technologies Ltd. and Subsidiaries




Consolidated
Statements of Stockholders’ Equity (Deficit)




(in
U.S. dollars)




Common
      StockShares
            
            
            Amount
            
            
            Additional
                Paid-in
                Capital
            
            
            Accumulated
                Deficit
            
            
            Total
                Stockholders’
                Equity
                (Deficit)Balance
      at December 31, 2005
            
            
            27,972,490
            
            
            $
            280,000
            
            
            $
            208,828,000
            
            
            $
            (143,731,000
            )
            
            $
            65,377,000Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (33,047,000
            )
            
            
            (33,047,000
            )Exchange
      of Senior Convertible  notes for common stocks
            
            
            3,101,874
            
            
            
            31,000
            
            
            
            54,488,000
            
            
            
            —
            
            
            
            54,519,000Exercise
      of warrants
            
            
            25,000
            
            
            
            —
            
            
            
            134,000
            
            
            
            —
            
            
            
            134,000Exercise
      of stock options
            
            
            2,335,500
            
            
            
            23,000
            
            
            
            20,416,000
            
            
            
            —
            
            
            
            20,439,000Consideration
      for share lending agreement
            
            
            1,500,000
            
            
            
            15,000
            
            
            
            —
            
            
            
            —
            
            
            
            15,000Stock–based
      compensation s to employees
            
            
            —
            
            
            
            —
            
            
            
            2,900,000
            
            
            
            —
            
            
            
            2,900,000Stock–based
      compensation to non-employees
            
            
            —
            
            
            
            —
            
            
            
            99,000
            
            
            
            —
            
            
            
            99,000Balance
      at December 31, 2006
            
            
            34,934,864
            
            
            
            349,000
            
            
            
            286,865,000
            
            
            
            (176,778,000
            )
            
            
            110,436,000Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (38,200,000
            )
            
            
            (38,200,000
            )Dividend
      on preferred stock
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (4,128,000
            )
            
            
            (4,128,000
            )Exercise
      of warrants
            
            
            4,500
            
            
            
            —
            
            
            
            65,000
            
            
            
            —
            
            
            
            65,000Exercise
      of stock options
            
            
            14,000
            
            
            
            —
            
            
            
            193,000
            
            
            
            —
            
            
            
            193,000Issuance
      of common stock pursuant to public offering, net
            
            
            1,314,198
            
            
            
            13,000
            
            
            
            16,808,000
            
            
            
            —
            
            
            
            16,821,000Restricted
      stock
            
            
            100,000
            
            
            
            1,000
            
            
            
            641,000
            
            
            
            —
            
            
            
            642,000Stock–based
      compensation to employees
            
            
            —
            
            
            
            —
            
            
            
            5,774,000
            
            
            
            —
            
            
            
            5,774,000Stock–based
      compensation to non- employees
            
            
            —
            
            
            
            —
            
            
            
            148,000
            
            
            
            —
            
            
            
            148,000Balance
      at December 31, 2007
            
            
            36,367,562
            
            
            
            363,000
            
            
            
            310,494,000
            
            
            
            (219,106,000
            )
            
            
            91,751,000Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (148,422,000
            )
            
            
            (148,422,000
            )Dividend
      on preferred stock
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (4,169,000
            )
            
            
            (4,169,000
            )Exercise
      of stock options
            
            
            1,280
            
            
            
            —
            
            
            
            17,000
            
            
            
            —
            
            
            
            17,000Issuance
      of common stock and warrants, net
            
            
            9,317,777
            
            
            
            94,000
            
            
            
            51,536,000
            
            
            
            —
            
            
            
            51,630,000Restricted
      stock
            
            
            396,269
            
            
            
            4,000
            
            
            
            1,802,000
            
            
            
            —
            
            
            
            1,806,000Stock–based
      compensation to employees
            
            
            —
            
            
            
            —
            
            
            
            2,808,000
            
            
            
            —
            
            
            
            2,808,000Stock–based
      compensation to non-employees
            
            
            —
            
            
            
            —
            
            
            
            3,000
            
            
            
            —
            
            
            
            3,000Balance
      at December 31, 2008
            
            
            46,082,888
            
            
            $
            461,000
            
            
            $
            366,660,000
            
            
            $
            (371,697,000
            )
            
            $
            (4,576,000
            )




The
accompanying notes are an integral part of these consolidated financial
statements.




F-5


Medis
Technologies Ltd. and Subsidiaries




Consolidated
Statements of Cash Flows




(in
U.S. dollars)




Year
      ended December 31,2006
            
            
            2007
            
            
            2008Cash
      flows from operating activitiesNet
      loss
            
            $
            (33,047,000
            )
            
            $
            (38,200,000
            )
            
            $
            (148,422,000
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Minority
      interest
            
            
            —
            
            
            
            —
            
            
            
            (492,000
            )Loss
      on rights offering of subsidiary
            
            
            —
            
            
            
            —
            
            
            
            42,000Depreciation
      and amortization of property and equipment
            
            
            1,539,000
            
            
            
            3,262,000
            
            
            
            10,012,000Impairment
      charges on goodwill and property and equipment
            
            
            —
            
            
            
            —
            
            
            
            86,501,000Amortization
      of intangible assets
            
            
            208,000
            
            
            
            208,000
            
            
            
            48,000Amortization
      of debt issuance costs and changes in fair value of option
            
            
            (166,000
            )
            
            
            —
            
            
            
            —Amortization
      of beneficial conversion feature on Senior
      Convertible Notes
            
            
            240,000
            
            
            
            —
            
            
            
            —Non-cash
      stock based compensation and restricted shares expense
            
            
            2,999,000
            
            
            
            6,564,000
            
            
            
            4,617,000Loss
      (gain)  on short-term investment
            
            
            —
            
            
            
            840,000
            
            
            
            (840,000
            )Value
      of shares issued as inducement in Senior Convertible Notes
      exchange
            
            
            8,266,000
            
            
            
            —
            
            
            
            —Interest
      receivable on restricted cash
            
            
            —
            
            
            
            (302,000
            )
            
            
            (82,000
            )Purchase
      of in-process research and development
            
            
            —
            
            
            
            50,000
            
            
            
            —Currency
      fluctuations on capital lease obligations
            
            
            —
            
            
            
            —
            
            
            
            (115,000
            )Changes
      in operating assets and liabilities:Inventories
      net of change in reserves
            
            
            —
            
            
            
            (8,809,000
            )
            
            
            (1,086,000
            )Prepaid
      expenses and other current assets
            
            
            (5,573,000
            )
            
            
            2,856,000
            
            
            
            2,060,000Accounts
      payable
            
            
            2,441,000
            
            
            
            (139,000
            )
            
            
            381,000Accrued
      expenses and other current liabilities
            
            
            314,000
            
            
            
            (564,000
            )
            
            
            71,000Leasehold
      incentive obligations, net
            
            
            (92,000
            )
            
            
            (276,000
            )
            
            
            (276,000
            )Accrued
      severance pay, net
            
            
            (4,000
            )
            
            
            81,000
            
            
            
            66,000Net
      cash used in operating activities
            
            
            (22,875,000
            )
            
            
            (34,429,000
            )
            
            
            (47,515,000
            )Cash
      flows from investing activities:Capital
      expenditures
            
            
            (16,724,000
            )
            
            
            (38,039,000
            )
            
            
            (9,049,000
            )Investment
      in short-term investments
            
            
            (40,419,000
            )
            
            
            (58,780,000
            )
            
            
            —Redemptions
      of short-term investments
            
            
            23,415,000
            
            
            
            87,284,000
            
            
            
            2,000,000Investment
      in restricted cash and deposits
            
            
            —
            
            
            
            (6,838,000
            )
            
            
            (200,000
            )Redemptions
      of restricted cash
            
            
            —
            
            
            
            1,440,000
            
            
            
            900,000Investment
      in early-stage company
            
            
            —
            
            
            
            (50,000
            )
            
            
            —Net
      cash used in investing activities
            
            
            (33,728,000
            )
            
            
            (14,983,000
            )
            
            
            (6,349,000
            )





(Statement
of Cash Flows continued on next page)





F-6


Medis
Technologies Ltd. and Subsidiaries




Consolidated
Statements of Cash Flows




(continued)




(in
U.S. dollars)




Year
      ended December 31,2006
            
            
            2007
            
            
            2008Cash
      flows from financing activitiesDividend
      on Series A Preferred Stock
            
            
            —
            
            
            
            (4,128,000
            )
            
            
            (4,169,000
            )Capital
      lease payment
            
            
            —
            
            
            
            —
            
            
            
            (48,000
            )Proceeds
      from issuance of common stock and warrants, net
            
            
            —
            
            
            
            16,951,000
            
            
            
            51,630,000Proceeds
      from issuance of  Series A Preferred Stock
            
            
            57,500,000
            
            
            
            —
            
            
            
            —Proceeds
      from issuance of subsidiary’s common stock, net
            
            
            —
            
            
            
            —
            
            
            
            447,000Proceeds
      from exercise of warrants in subsidiary
            
            
            —
            
            
            
            —
            
            
            
            3,000Issuance
      costs on Series A Preferred Stock
            
            
            (3,884,000
            )
            
            
            (26,000
            )
            
            
            —Proceeds
      from exercise of stock options
            
            
            19,346,000
            
            
            
            1,373,000
            
            
            
            17,000Proceeds
      from exercise of warrants
            
            
            134,000
            
            
            
            65,000
            
            
            
            —Proceeds
      from share landing agreement
            
            
            15,000
            
            
            
            —
            
            
            
            —Net
      cash provided by financing activities
            
            
            73,111,000
            
            
            
            14,235,000
            
            
            
            47,880,000Net
      increase (decrease) in cash and cash equivalents
            
            
            16,508,000
            
            
            
            (35,177,000
            )
            
            
            (5,984,000
            )Cash
      and cash equivalents at beginning of year
            
            
            35,295,000
            
            
            
            51,803,000
            
            
            
            16,626,000Cash
      and cash equivalents at end of year
            
            $
            51,803,000
            
            
            $
            16,626,000
            
            
            $
            10,642,000Supplemental
      disclosures of cash flow information:Cash
      paid during the year for:Interest
            
            $
            1,470,000
            
            
            $
            —
            
            
            $
            —Non-cash
      investing and financing activities:Capital
      expenditure included in accounts payable and
      accrued liabilities
            
            $
            4,785,000
            
            
            $
            1,092,000
            
            
            $
            877,000Capital
      lease
            
            $
            —
            
            
            $
            2,230,000
            
            
            $
            2,068,000Prepaid
      expenses charged to property, plant and equipment
            
            $
            —
            
            
            $
            1,071,000
            
            
            $
            —Option
      exercise – cash received subsequent to balance sheet date
            
            $
            1,180,000
            
            
            $
            —
            
            
            $
            —Issuance
      cost payable related to Series A Preferred Stock
            
            $
            26,000
            
            
            $
            —
            
            
            $
            —Prepaid
      expenses pursuant to a rights offering in subsidiary
            
            $
            —
            
            
            $
            155,000
            
            
            $
            —Issuance
      costs on public offering
            
            $
            —
            
            
            $
            130,000
            
            
            $
            —Exchange
      of Senior Convertible Notes for common stock:
            
            
            
            
            
            
            
            
            
            $
            —Face
      value of notes exchanged
            
            $
            49,000,000
            
            
            $
            —
            
            
            $
            —Deferred
      issuance costs on notes charged to capital
            
            $
            (2,747,000
            )
            
            $
            —
            
            
            $
            —The
      accompanying notes are an integral part of these consolidated financial
      statements.






F-7


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
A—NATURE OF BUSINESS AND GENERAL MATTERS




1.            
Medis Technologies Ltd. (“MTL”), a Delaware corporation, is a holding
company, which through its subsidiaries, Medis El Ltd., More Energy Ltd.
and Cell Kinetics Ltd. (collectively, with MTL the “Company”), designs, develops
and markets innovative liquid fuel cells for commercial and military power
solutions. A fuel cell is an electro-chemical device that through a chemical
reaction, converts the chemical energy of a fuel, such as our patented
borohydride-based fuel, hydrogen or methanol, into electrical energy. The
Company’s technology provides solutions for a wide range of applications for
remote and off grid power. The Company’s first commercial product is our “24/7
Power Pack” -
a disposable power source capable of providing direct power to many of the most
advanced portable electronic devices, such as mobile handsets, smart phones, MP3
players, gaming and other applications such as flash lights, radios, GPS, etc.
Cell Kinetics Ltd (“CKL”) is also seeking to exploit commercially an improved
cell carrier under the CKChipTM product line, which was considered to be the
nucleus of the Company’s CellScan system. This unique cell carrier can
accommodate large quantities of living cells, each in individual wells, for
measuring their reactions while in a static state over time. Upon the completion
on January 7, 2008 of CKL’s rights offering to the Company’s shareholders, MTL’s
beneficial ownership in CKL was reduced from 100% to approximately 82.5%,
representing 16,500,000 of CKL’s ordinary shares.




2. Since its
inception, the Company has sustained operating losses and has used cash in its
operations. During the year ended December 31, 2008, the Company used cash in
operating activities of $47,515,000, incurred a net loss of $148,422,000, and
had a total stockholders’ deficit of $4,576,000 at December 31, 2008. These
losses have significantly weakened the Company's financial position and
available cash resources. The
Company requires additional financing in order to continue to fund its current
operations, which continue to show losses, and pay existing and future
liabilities and other obligations. The Company is currently negotiating with
third parties in an attempt to obtain additional sources of funds which, in
management's opinion, would provide adequate cash flows to finance the Company's
operations. The satisfactory completion of these negotiations is essential to
provide sufficient cash flow to meet current operating requirements. While the
Company expects to raise additional funds, as described more fully below, its
limited available cash resources at March 31, 2009 coupled with cash expected to
become available in April 2009 in accordance with its cost rationalization plan,
would be sufficient to continue operations only through the second quarter of
2009. Furthermore, the Company cannot give any assurance that it will in the
future be able to achieve a level of profitability from the sale of its products
to sustain its operations. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. The accompanying financial
statements do not include any adjustments to reflect the possible future effects
on recoverability and reclassification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
  The
Company believes that it has numerous options and avenues to raise working
capital in 2009, including:
  ·
                The
      sale of its securities, with the intention of selling $3-5 million in the
      second quarter of 2009 and up to an additional $5 million before the end
      of fiscal 2009, all subject to market
  conditions.
  ·
                The
      sale of its non-essential assets, including excess inventory and/or other
      tangible assets, either in the event it is unsuccessful in selling its
      securities, or possibly in tandem with doing
so.
  ·
                Through
      government grants in the United States, the State of Israel, or possibly
      both.
  The
Company is currently in discussions with potential investors regarding the sale
of its securities. Furthermore, it has engaged third party valuation experts to
appraise the liquidation value of certain of its assets and it has concluded,
based upon the value assigned to those assets, that it should be able to realize
sufficient funds from any such sale over the next 60-90 days which, together
with its cost rationalization plan discussed below, it would then expect to be
able to continue its operations through the end of 2009, at which time it would
expect to have commenced generating revenue. The Company can give no assurances
that it will be successful in raising funds through the sale of its securities,
through the divestiture of assets or through any other alternative. Any
inability to so obtain additional financing will materially adversely affect the
Company, including requiring it to significantly further curtail or cease
business operations altogether.
  The
Company has recently initiated a comprehensive cost rationalization plan
designed to reduce operating costs and enhance operational efficiencies, and it
has appointed an executive vice president of operation restructuring who is in
charge of this effort. Elements and targets of this plan include the
following:
  ·
                Reduction
      in aggregate payroll salaries of approximately
  50%;
  ·
                Operational
      expenses reduced by approximately
50%;
  ·
                A
      full stream product cost review;
  ·
                Explore
      opportunities to monetize non-essential assets;
  and
  ·
                Transforming
      Medis’ supply chain to improve costs, customer experience and
      sustainability.




F-8


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




In an
effort to further reduce costs while it focuses on sales and marketing
activities, the Company also recently suspended production across its supply
base.
  As part
of this plan, the Company has undertaken a staff reduction of approximately 50
employees from its Israeli office. These positions are directly and indirectly
related to its operations and general administration. The Company has also
engaged in conversations with its major suppliers of goods and services and it
has initiated restructuring of its vendor processes and agreements. The Company
is also seeking to restructure accounts payable and trade debt, of which we can
give no assurance of success. In connection with these efforts, the Company is
reviewing its current product line offerings to determine how to best
commercially leverage its fuel cell products and technology. The Company’s
restructuring and cost rationalization plan are being carried-out in parallel
with its efforts to raise addition funds from external sources, which it
requires to pay existing obligations and to continue its
operations.
 3.            
In accordance with SFAS No. 144, “Accounting for Impairment and Disposal of
Long-Lived Assets, the Company’s management has assessed whether there has been
an impairment of the Company’s long lived assets during as of December 31, 2008.
This was undertaken due to certain indicators for its fuel cell reporting unit
of impairment such as a decline in fair value of the Company, the Company’s
recent operating results and decrease in forecasts.
 
 For the
year ended December 31, 2008, the Company engaged an independent valuation firm
to perform an assessment of its fuel cell equipment for impairment, since
indicators of impairment were present for its fuel cell reporting
unit.  This assessment was performed by comparing the sum of
undiscounted future cash flows estimated to be generated by those assets to the
carrying value of such assets.  Since such estimated undiscounted cash
flows were less than the carrying amount of those assets, the second step of the
impairment test was performed to determine the estimated fair value of the
reporting unit’s fuel cell equipment. In performing the above analyses and
tests, the Company’s management provided forecasts and related assumptions to
the third party appraiser, which applied its valuation techniques and required
economic models. These assumptions and results may differ from actual results
due to, among other things, technological change, economic conditions, changes
to its business models or changes in operating performance and an impairment
charge may be required in the future. For the year ended December 31, 2008, the
Company determined that the carrying value of the its fuel cell equipment
exceeded its estimated fair value by approximately $30,508,000 and, accordingly,
the Company recorded a charge in such amount to impairment charges on goodwill
and property and equipment in the statement of operations, for the year ended
December 31, 2008.


In
accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,”
(“SFAS No. 142”) goodwill is subject to at least an annual assessment for
impairment. In general, a write down is required if the carrying value exceeds
the fair value of the reporting unit.





For the
year ended December 31, 2008, the Company engaged an independent valuation firm
to perform its annual goodwill impairment test. The goodwill impairment test
used the two-step process set forth in SFAS No. 142. The Company’s management
has determined in accordance with SFAS 142 that it operates in two reporting
units, the fuel cell reporting unit and cell carrier reporting unit. The first
step of the process consisted of estimating the fair value of each of the
reporting units  and comparing those estimated fair values with the
carrying values, which include the assigned goodwill. The fair value is
determined using the income approach by applying discounted cash flow (“DCF”)
model. The DCF model required the Company’s management to use significant
assumptions and estimates, including but not limited to projected future
revenues and cash flows, growth rates and market share, future gross margins,
operating results including production cost, SG&A cost and research and
development cost assumptions, future working capital needs, future capital
expenditures, as well as appropriate discount rates. Since the estimated fair
value of the Company’s fuel cell reporting unit was less than its carrying
value, the second step was performed to compute the amount of the impairment by
determining an “implied fair value” of goodwill. Upon completion of such
assessment for the year ended December 31, 2008, the Company determined that the
entire goodwill balance of $55,993,000 allocated to this reporting unit is
impaired, and, accordingly, recorded a charge in the amount of $55,993,000,
which is included within impairment charges on goodwill and property and
equipment in the statement of operations, for the year ended December 31, 2008.
The goodwill of $2,212,000 on the Company’s balance sheet at
December 31, 2008 relates to its cell carrier reporting unit.









F-9


Medis Technologies Ltd. and
Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES




The
Company’s consolidated financial statements are prepared in accordance with U.S.
generally accepted accounting principles. The significant accounting policies
followed in the preparation of the consolidated financial statements, applied on
a consistent basis, are as follows:




1. 
Principles of Consolidation




The
consolidated financial statements include the accounts of MTL and its
subsidiaries. All significant intercompany transactions and balances have been
eliminated in consolidation.




2. 
Use of Estimates




In
preparing the Company’s consolidated financial statements in conformity with
U.S. generally accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ from those
estimates.




3. 
Cash Equivalents




Cash
equivalents consist of highly liquid investments with a maturity of three months
or less when purchased.




4. 
Short-term Investments




The
Company accounts for investments in marketable securities in accordance with
Statement of Financial Accounting Standard (“SFAS”) No. 115, “Accounting for
Certain Investments in Debt and Equity Securities.”




Management
determines the appropriate classification of its investments at the time of
purchase and reevaluates such determinations at each balance sheet
date.




5.  Inventories




Inventories
are stated at the lower of cost or market value.




Cost is
determined as follows:




a.
            Raw
      materials and components – average cost
basis.




b.
            Finished
      products – average production costs including raw materials, labor and
      direct manufacturing costs.






F-10


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)





The
Company reviews its inventory quantities based primarily on its estimated
forecast of product demand and production requirements. Inventory reserves are
provided to cover risks arising from slow-moving items, technological
obsolescence, excess inventories, and discontinued products and for market
prices lower than cost. During the year ended December 31, 2008, the Company
recorded charges to Depreciation, Production and Facility costs to such
inventory reserves and write offs aggregating of approximately $8,200,000.




6.  Depreciation,
Production and Facility Costs.




In
accordance with SFAS No.  151 “Inventory Costs an Amendment of ARB No.
43, Chapter 4,” the Company has recognized as expense during the  year
ended December 31, 2008 for  unallocated depreciation, subcontractor,
labor, production facility cost,  materials, components, and inventory
reserve cost. For the year ended December 31, 2008, Depreciation, Production and
Facility Costs aggregated to $28,223,000, which was comprised
of  depreciation of approximately $7,700,000, subcontractor costs of
$5,900,000, materials of $3,300,000, wages of $2,800,000, inventory reserves and
write offs of $8,200,000 and other costs of $323,000.






7. 
Translation of Foreign Currencies




The
financial statements of foreign subsidiaries have been prepared in U.S. dollars,
as the dollar is their functional currency.  A substantial portion of
the foreign subsidiaries financing and costs are incurred in
dollars.  The Company’s management believes that the dollar is the
primary currency of the economic environment in which the foreign subsidiaries
operate. Accordingly, monetary accounts maintained in currencies other than the
dollar are remeasured into U.S. dollars in accordance with SFAS No. 52
“Foreign Currency Translation”.  All transaction gains and losses of
the remeasured, monetary balance sheet items are reflected in the statement of
operations as financial income or expense, as appropriate and were immaterial to
date.







F-11


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)




8.  Property
and Equipment, net




a.
            Property
      and equipment is stated at cost, net of accumulated depreciation and
      amortization.




b.
            Materials,
      payroll and other costs that are direct incremental costs necessary to
      bring an asset to the condition of its intended use incurred during the
      construction are capitalized to the cost of such assets. Total material
      cost of $47,000 was capitalized during 2008 and $4,489,000 of material and
      $1,101,000 of labor costs were capitalized during
  2007.




c.
            Depreciation
      is provided on property and equipment on a straight-line basis over the
      estimated useful lives of such assets.  Annual rates of
      depreciation are as follows:




Useful Lives In YearsMachinery
      and equipment
            5-12
      (mainly 7)Computers
            3Furniture
      and office equipment
            15Leasehold
      improvements
            Over
      the shorter of the term of the lease or the life of the
    asset




During
the year ended December 31, 2008, the Company recorded impairment charges
related to its fuel cell property and equipment in the amount of $30,508,000.
See Note A-3 for further discussion.







9.  Derivative
Instruments and Hedging Activities




The
Company accounts for its derivative instruments and hedging activities based on
SFAS No. 133 “Accounting for Derivative Instruments and Hedging
Activities.” SFAS 133 requires companies to recognize all of its derivative
instruments on the balance sheet at fair value.  The accounting for
changes in the fair value of a derivative instrument depends on whether the
derivative instrument qualifies and has been designated as a hedging instrument
and, if it is a hedging instrument, on the type of hedging instrument for which
it qualifies.




During
2006, the Company entered into forward exchange contracts in order to hedge the
risk of variability of cash flows related to its initial payment for the
construction of its automated production line, which was denominated in Swiss
Francs.  Gains and losses from such hedging activities were immaterial
and the Company included such amounts in its consolidated statements of
operations as interest income or expense.  The Company did not have
any significant open forward exchange contracts at December 31, 2007 and
December 31, 2008.



















F-12


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)





10.
Deferred revenues




The
Company defers payments that were received in advance of the culmination of the
earnings process. Proceeds that are expected to be recognized as revenues within
the next twelve months are included in accrued expenses and other current
liabilities.




11.
Stock-based Compensation




The Company accounts for stock-based
compensation in accordance with SFAS No. 123 (revised 2004), “Share-Based
Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) requires companies to estimate the
fair value of equity-based awards on the date of grant using an option-pricing
model. The value of the portion of the award that is ultimately expected to vest
is recognized as an expense over the requisite service periods in the Company’s
consolidated statements of operations.





The Company recognizes compensation
expenses for the value of its awards granted based on the straight line method
over the requisite service period of each of the awards, net of estimated
forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates. Estimated forfeitures are based on actual
historical pre-vesting forfeitures.





The Company selected the
Black-Scholes-Merton option pricing model as the most appropriate fair value
method for its stock-options awards and values restricted stock based on the
market value of the underlying shares at the date of grant. The option-pricing
model requires a number of assumptions, of which the most significant are the
expected stock price volatility and the expected option term. Expected
volatility was calculated based upon actual historical stock price movements.
The expected term of options granted is based upon historical experience and
represents the period of time that options granted are expected to be
outstanding. The risk-free interest rate is based on the yield from U.S.
treasury bonds with an equivalent term. The Company has historically not paid
dividends on its common stock and has no foreseeable plans to pay dividends on
its common stock.





The fair value for options granted
in 2006, 2007 and 2008 is estimated at the date of grant using a
Black-Scholes-Merton options pricing model with the following weighted average
assumptions:





Year
      ended December 31,Employee
      Stock Options
            
            2006
            
            2007
            
            2008Expected
      volatility
            
            60%
            
            58%-61%
            
            62%-75%Risk-free
      interest rate
            
            4.75%
            
            4.00%-4.90%
            
            1.65%-3.45%Dividend
      yield
            
            0%
            
            0%
            
            0%Expected
      term  (years)
            
            3.20
            
            2.28-3.80
            
            2.17-3.80







The
Company applies SFAS No. 123 “Accounting for Stock Based Compensation” and No.
96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees
for Acquiring, or in Conjunction with Selling, Goods or Services” (“EITF
96-18”), with respect to options and warrants issued to non-employees. SFAS No.
123 and EITF 96-18 require the use of option valuation models to measure the
fair value of the options and warrants at the measurement date.









F-13


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)







12.  Goodwill
and Other Intangible Assets




Goodwill
and other purchased intangible assets have been recorded as a result of the
Company’s acquisitions. Goodwill is not amortized, but rather is subject to an
annual impairment test.  Other intangible assets are amortized on a
straight-line basis over the estimated lives.




SFAS
No. 142 requires goodwill to be tested for impairment at least annually or
between annual tests if certain events or indicators of impairment
occur.  Goodwill is tested for impairment at the reporting unit level
by a comparison of the fair value of a reporting unit with its carrying
amount.  During 2006 and 2007, no impairment losses were identified.
During the year ended December 31, 2008, the Company recorded an impairment loss
on its goodwill in the amount of $55,993,000. (See note A-3 for further
discussion)




13.  Long-Lived
Assets




The
Company’s long-lived assets are reviewed for impairment in accordance with SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.  Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to the
future undiscounted cash flows expected to be generated by the asset. During the
year ended December 31, 2007, the Company wrote-off the net book value of
approximately $546,000 of certain software and equipment that were no longer in
use. During the year ended December 31, 2008, the Company recorded an impairment
loss on its fuel cell property and equipment in the amount of $30,508,000. (See
note A-3 for further discussion)




14.
Research and Development Costs and Revenue Recognition




Research
and development costs are charged to operations as incurred.




During
2006 and 2007, the Company entered into contractor-related fixed price, best
efforts, research and development arrangements (hereafter, the “development
agreements”).




The
Company accounted for these contracts in accordance with the American Institute
Certified Public Accountants (“AICPA”); “Audit and Accounting Guides/Audits of
Federal Government Contracts” (the “Guide”) and AICPA Statement of Position
81-1, “Accounting for Performance of Construction-Type and Certain
Production-Type Contracts” (“SOP 81-1”).




In cases
where development agreements are in compliance with the Guide, the cost sharing
proceeds are recorded as offsets to research and development costs as
incurred.




For
development agreements that are not in compliance with the Guide, amounts earned
are recorded as revenue and are recognized in accordance with SOP
81-1.  Fixed price contract revenues are recognized using contract
accounting under the completed contract method.   The Company
believes that the use of the completed contract method is appropriate as the
Company has little past experience that enables it to have the ability to make
reasonably dependable estimates of the extent of progress toward completion,
contract revenues and contract costs.  Amounts billed and/or received
where revenue recognition criteria (delivery has occurred, persuasive evidence
of an arrangement exists, the fee is fixed or determinable, collection of the
related receivable is probable and no further obligations exist) have not been
fully met, and thus the revenue is not yet earned, are reflected as liabilities
and are offset against the related receivable.







F-14


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)







15.
Net Loss Per Share




The
Company computes net loss per share in accordance with SFAS No. 128,
“Earnings Per Share” (“SFAS No. 128”). Under the provisions of SFAS
No. 128, basic net loss per share is computed by dividing the net loss for
the period by the weighted-average number of common shares outstanding during
the period.  Diluted net loss per share is computed by dividing the
net loss for the period by the weighted-average number of common shares plus
dilutive potential common stock considered outstanding during the
period.  Since the Company generated net losses in all periods
presented, potentially diluted securities, comprised of incremental common
shares issuable upon the exercise of warrants and stock options, convertible
notes and convertible preferred stock, are not reflected in diluted net loss per
share because such shares are antidilutive.




The total
number of shares excluded from the calculation of diluted net loss per share
related to financial instruments that potentially can be converted to or
exercised for shares of the Company’s common stock aggregated approximately
4,977,028, 2,118,910 and 8,496,947 as of December 31, 2006, 2007 and 2008
respectively. The shares excluded from the calculation of diluted net loss per
share for December 31, 2007 and 2008 include shares issued pursuant to a share
lending agreement.




16.
Severance Pay




The liability of the Company’s
subsidiaries in Israel for severance pay, which comprises the Company’s entire
severance pay obligation, is calculated pursuant to Israeli severance pay law
based on the most recent salary of the employees multiplied by the number of
years of employment, as of the balance sheet date.  Employees are
entitled to one month’s salary for each year of employment or a portion
thereof.  The liability for all of its employees in Israel is fully
provided by an accrual and by monthly deposits with insurance companies and
other financial institutions.  The deposited funds include profits
(losses) accumulated up to the balance sheet date.  The deposited
funds may be withdrawn only upon the fulfillment of the obligation pursuant to
Israeli severance pay law or labor agreements.  The value of these
deposited funds is recorded as an asset in the Company’s consolidated balance
sheets.




Severance
expenses for the years ended December 31, 2006, 2007 and 2008 amounted to
approximately $340,000, $603,000 and $654,000, respectively.




17.
Income Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting
for Income Taxes” (“SFAS No. 109”). SFAS No. 109 prescribes the use of the
liability method whereby deferred tax asset and liability account balances are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse. The Company
provides a valuation allowance, if necessary, to reduce deferred tax assets to
their estimated realizable value.









F-15


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)







On
January 1, 2007, the Company adopted FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement
No. 109” (“FIN 48”). FIN 48 contains a two-step approach to
recognizing and measuring uncertain tax positions accounted for in accordance
with SFAS No. 109. The first step is to evaluate the tax position taken or
expected to be taken in a tax return by determining if the weight of available
evidence indicates that it is more likely than not that, on an evaluation of the
technical merits, the tax position will be sustained on audit, including
resolution of any related appeals or litigation processes. The second step is to
measure the tax benefit as the largest amount that is more than 50% likely to be
realized upon ultimate settlement.




The
adoption of FIN 48 on January 1, 2007 did not result in a change in the
Company’s accumulated deficit.




18.
Concentration of Credit Risk




Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash and cash equivalents and short–term
investments.  The Company’s cash and cash equivalents and short-term
investments have been invested in money market funds, commercial paper and
auction rate securities.




Such cash
and cash equivalents and short–term investments in the United States may not be
insured or may be in excess of insured limits and insurance in other
jurisdictions varies.  Management believes that the Company’s cash and
cash equivalents are financially sound and minimal credit risks
exist.




19. Fair Value
Measurement.




Effective
January 1, 2008, the Company implemented the requirements of SFAS No. 157, “Fair
Value Measurements”(“SFAS No. 157”), for its financial assets and liabilities.
SFAS No. 157 refines the definition of fair value, expands disclosure
requirements about fair value measurements and establishes specific requirements
as well as guidelines for a consistent framework to measure fair value. SFAS No.
157 defines fair value as the price that would be received to sell an asset, or
paid to transfer a liability, in an orderly transaction between market
participants. Further, SFAS No. 157 requires the Company to maximize the use of
observable market inputs, minimize the use of unobservable market inputs and
disclose in the form of an outlined hierarchy the details of such fair value
measurements.




SFAS
No. 157 specifies a hierarchy of valuation techniques based on whether the
inputs to a fair value measurement are considered to be observable or
unobservable in a marketplace. Observable inputs reflect market data obtained
from independent sources, while unobservable inputs reflect the Company’s market
assumptions. This hierarchy requires the use of observable market data when
available. These two types of inputs have created the following fair value
hierarchy:




Level 1 –
quoted prices for identical instruments in active markets;





Level 2 –
quoted prices for similar instruments in active markets; quoted prices for
identical or similar instruments in markets that are not active; and
model-derived valuations in which significant inputs and significant value
drivers are observable in active markets; and




Level 3 –
valuations derived from valuation techniques in which one or more significant
inputs or significant value drivers are unobservable







F-16


Medis Technologies Ltd. and
Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)







The
Company measures fair value using a set of standardized procedures that are
outlined herein for all financial assets and liabilities which are required to
be measured at fair value. When available, the Company utilizes quoted market
prices from an independent third party source to determine fair value and
classifies such items in Level 1. In some instances where a market price is
available, but in an inactive or over-the-counter market where significant
fluctuations in pricing can occur, the Company consistently applies the dealer
(market maker) pricing estimate and classifies the financial asset or liability
in Level 2. As of December 31, 2008, cash equivalents includes commercial paper
in the amount of $1,998,000 that is measured at fair value, such assets has been
estimates as Level 1 items.




20.
Recently Issued Accounting Pronouncements in the United States




In
December 2007, the FASB issued Statement No. 141 (revised 2007), “Business
Combinations” (“SFAS 141R”). SFAS 141R establishes principles and
requirements for how an acquirer in a business combination (i) recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any no controlling interest in the acquiree,
(ii) recognizes and measures the goodwill acquired in business
combinations or a gain from a bargain purchase, and (iii) determines what
information to disclose to enable users of financial statements to evaluate the
nature and financial effects of the business combination. SFAS 141R will be
applied prospectively to business combinations that have an acquisition date on
or after January 1, 2009.  The impact of SFAS 141R on the
Company’s consolidated results of operations and financial condition will depend
on the nature and size of acquisitions, if any, subsequent to the effective
date.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS
No. 160 establishes accounting and reporting standards that require that
the ownership interests in subsidiaries held by parties other than the parent be
clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parent’s equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parent’s ownership interest
while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently. SFAS No. 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after
December 15, 2008. The Company is currently evaluating the potential
impact, if any, of the adoption of SFAS No. 160 on its consolidated financial
statement




In
February 2008, the FASB issued FSP No. FAS 157-1, “Application of FASB
Statement No. 157 to FASB Statement No. 13 and Other Accounting
Pronouncements That Address Fair Value Measurements for Purposes of Lease
Classification or Measurement under Statement 13”, and FSP No. FAS 157-2,
“Effective Date of FASB Statement No. 157”. Collectively, the Staff
Positions defer the effective date of Statement 157 to fiscal years beginning
after November 15, 2008 for nonfinancial assets and nonfinancial
liabilities except for items that are recognized or disclosed at fair value on a
recurring basis at least annually, and amend the scope of Statement 157. As
described above in Note B-19, the Company adopted SFAS No. 157 and the
related FASB staff positions except for those items specifically deferred under
FSP No. FAS 157-2.









F-17


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
B—SIGNIFICANT ACCOUNTING POLICIES (Continued)





In March
2008, the FASB issued Statement 161 “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS 161”) an amendment to FASB No.
133.  This statement changes the disclosure requirements for
derivative instruments and hedging activities.  Entities are required
to provide enhanced disclosures about (a) how and why and entity uses derivative
instruments, (b) how derivative instruments and related hedged items are
accounted for under Statement 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows.  This statement is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008.  Early application is
encouraged.  The Company does not expect the adoption of SFAS 161 to
have a material impact on its financial position, results of operations or cash
flows.





In
December 2007, the FASB ratified EITF Issue No. 07-1 “Accounting for
Collaborative Arrangements” (“EITF 07-1”), which provides guidance regarding
financial statement presentation and disclosure of collaborative arrangements to
jointly develop, manufacture, distribute and market a product whereby the
collaborators will share, based on contractually defined calculations, the
profits or losses from the associated activities. The consensus requires
collaborators in such an arrangement to present the result of activities for
which they act as the principal on a gross basis and report any payments
received from, or made to other collaborators based on other applicable GAAP or,
in the absence of other applicable GAAP, based on analogy to authoritative
accounting literature or a reasonable, rational and consistently applied
accounting policy election. EITF 07-1 is effective for fiscal years beginning
after December 31, 2008, which will be the Company’s fiscal year 2009, and will
be applied as a change in accounting principle retrospectively for all
collaborative agreements existing as of the effective date. The Company is in
the process of evaluating the potential impact of adopting EITF No. 07-1 on its
consolidated financial statements.





21.  Reclassifications




Certain
amounts in prior years’ financial statements have been reclassified to conform
with the current year’s presentation.





NOTE
C—SHORT-TERM INVESTMENTS




As
of December 31, 2007, the Company’s short-term investments of $1,160,000
represent an AAA rated auction rate security (“ARS”) with a face value of
$2,000,000. The Company examined the value of the auction rate security in the
failed auctions and assessed it for impairment in accordance with FAS 115 and
FASB Staff Position FAS 115-1/124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments”. Since the Company
believed that the subsequent failed auctions and the continuing decline in the
bids from the ultimate debtor were reflecting an impairment of the underlying
assets securing the auction rate security at December 31, 2007, the Company has
provided, based on the most current bids available prior to the issuance of the
Company’s December 31, 2007 consolidated financial statements, a valuation
reserve of $840,000 on such auction rate security. In October 20, 2008, the
Company sold to Credit Suisse its ARS at its face value of $2,000,000 plus
accrued interest of approximately $6,700 and recorded a gain in the amount of
$840,000.





NOTE
D—RESTRICTED CASH AND DEPOSITS




Restricted
cash represents amounts held on deposit with banks as security for letters of
credit and guarantees issued by such banks primarily to Company suppliers.
Included in such amount is a one year time deposit in the amount of $4,252,000,
which was originally issued in January 2007 and renewed in January 2008 as
security for a stand by letter of credit provided by the bank to a supplier of
equipment and components in order to guaranty recovery of certain investments by
the supplier - principally in equipment to be used exclusively in the
manufacture of components for the Company 24/7 Power Pack.  Under the terms
of a purchase agreement, title to the equipment covered by the stand by letter
of credit will pass to the Company upon full recovery of the cost of such
equipment through purchases of components or draws against the letter of credit,
based on formulas set forth in the purchase agreement.  Such letter of
credit expires in March 2012 (see Note I).




F-18


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
E—INVENTORIES




Inventories
consist of the following:




December
      31,2007
            
            
            2008Raw
      materials and components
            
            $
            7,830,000
            
            
            $
            7,637,000Finished
      goods
            
            
            979,000
            
            
            
            2,258,000$
            8,809,000
            
            
            
            9,895,000Less
      non-current portion
            
            
            —
            
            
            
            2,617,000Inventory,
      current portion
            
            $
            8,809,000
            
            
            $
            7,278,000





NOTE
F—PROPERTY AND EQUIPMENT, NET




Property
and equipment consist of the following:




December
      31,2007
            
            
            2008Machinery
      and equipment
            
            $
            62,999,000
            
            
            $
            72,686,000Computers
            
            
            1,625,000
            
            
            
            1,989,000Furniture
      and office equipment
            
            
            464,000
            
            
            
            465,000Leasehold
      improvements
            
            
            3,752,000
            
            
            
            3,806,00068,840,000
            
            
            
            78,946,000Less
      Impairment loss of equipment
            
            
            —
            
            
            
            30,508,000Less
      accumulated depreciation and amortization
            
            
            7,137,000
            
            
            
            16,353,000Property
      and equipment, net
            
            $
            61,703,000
            
            
            $
            32,085,000





As of
December 31, 2007 and 2008, the machinery and equipment included $2,230,000 and
$4,135,000, respectively, that was accounted for as a capital lease obligation
(see note I). Accumulated depreciation at December 31, 2007 and 2008
includes $20,000 and $466,000, respectively, with respect to such
machinery.




Depreciation
and amortization expense on property and equipment for the years ended December
31, 2006, 2007 and 2008 amounted to $1,539,000, $3,262,000 and $10,012,000
respectively. During the year ended December 31, 2008, the Company recorded an
impairment loss on its fuel cell property and equipment in the amount of
$30,508,000. (See note A-3 for further discussion)




NOTE
G—INTANGIBLE ASSETS, NET




The
following table summarizes the cost and related accumulated amortization for
intangible assets that are subject to amortization.




December
      31,2007
            
            
            2008Cost:Fuel
      Cell technology assets
            
            $
            1,045,000
            
            
            $
            1,045,000Accumulated
      amortization
            
            
            997,000
            
            
            
            1,045,000$
            48,000
            
            
            $
            —





The
Company recorded amortization expense of $208,000 for the each of the years
ended December 31, 2006 and 2007. The amortization expense for the year
ending December 31, 2008 is $48,000.





F-19


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
H—ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES




Accrued
expenses and other current liabilities consist of the following:




December
      31,2007
            
            
            2008Employees
      and related liabilities
            
            $
            1,464,000
            
            
            $
            1,969,000Current
      portion of obligation under a capital lease
            
            
            649,000
            
            
            
            80,000Deferred
      development agreements cost
            
            
            469,000
            
            
            
            —Professional
      services
            
            
            364,000
            
            
            
            504,000Issuance
      costs
            
            
            130,000
            
            
            
            —Subcontractors
      and consultants
            
            
            120,000
            
            
            
            223,000Other
            
            
            144,000
            
            
            
            341,000$
            3,340,000
            
            
            $
            3,117,000







NOTE
I— CAPITAL LEASE AND OTHER LIABILITIES




As of December 31, 2007 and 2008 the
long-term portion of capital lease obligation amounted to $1,581,000 and
$4,055,000, respectively. On January 12, 2007, the Company and one of its
suppliers of equipment and components (the “Supplier”) entered to an agreement
pursuant to which the Company will order from the supplier and the supplier will
sell to the Company certain components for the Company’s 24/7 Power Pack.
Furthermore, under the agreement, the supplier will invest in equipment to be
used exclusively to manufacture these components. Title to such equipment will
pass to the Company upon full recovery of the cost of such equipment through
purchases of components. In order to secure the Company’s obligation to purchase
a sufficient amount of components to enable the supplier to recover its
investment, based on a formula included in the agreement, the Company has
provided a letter of credit to the supplier (see Note D). In accordance with
EITF 01-8 “Determine Whether an Arrangement Contains a Lease and SFAS 13 “Accounting for
Leases”, the Company has accounted for this arrangement as a capital lease and
has recorded the present value of future payments as equipment, with a
corresponding amount as obligation under a capital lease.




The
following summarizes the Company’s future minimum lease payments under its
capital lease obligation, as of December 31, 2008:




2009
            
            $
            80,0002010
            
            
            4,055,0004,135,000Less
      current portion
            
            
            80,000Total
      long term capital lease
            
            $
            4,055,000







F-20


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
J—SERIES A PREFERRED STOCK AND SHARE LEND




1.Series A Preferred
Stock




In
November and December 2006, MTL issued 5,750 shares of its 7.25% Series A
Cumulative Convertible Perpetual Preferred Stock (“Preferred Stock”) for
aggregate gross proceeds of $57,500,000, less issuance costs aggregating
approximately $3,910,000. The annual cash dividend on each share of Preferred
Stock is $725 and is payable quarterly, in arrears, commencing on February 15,
2007. Each share of Preferred Stock is convertible at the holder’s option at any
time into 347.2222 shares of MTL’s common stock (which is equivalent to an
initial conversion price of $28.80 per share). On or after November 20, 2009, if
the closing price of MTL’s common stock exceeds 150% of the conversion price for
20 trading days during any consecutive 30 trading day period, MTL may cause the
conversion of the Preferred Stock into common stock at the prevailing conversion
rate. The terms of the Preferred Stock preclude MTL from paying dividends or
making other distributions on its common stock if there are any accumulated and
unpaid dividends on the Preferred Stock. Of the total $57,500,000 of Preferred
Stock issued, $7,500,000 was issued pursuant to the exercise of a 75-day option
that was granted to the initial purchaser (the “Preferred Option”) in connection
with the issuance of the first $50,000,000 of Preferred Stock.
During  2008, no Preferred Stock has been converted to shares of MTL’s
common stock.




From
January 1 through December 31, 2008, MTL declared and paid quarterly cash
dividends aggregating approximately $4,169,000 on its Preferred Stock. In
February 2009, subsequent to the balance sheet date, the Company did not declare
the quarterly dividend on its Preferred Stock. As a result of not declaring the
February 2009 dividend, the Company is no longer eligible to use From S-3
registration statements and the dividend rate on the preferred stock has
increased based on an equation in the certificate of determination.
Additionally, if the Company misses dividend payments for six quarters, the
holders of the preferred stock would have the right to appoint two directors to
the Company’s Board of Directors.




2.
Share Lend




In
November 15, 2006, concurrent with the sale of the first 5,000 shares of MTL’s
Preferred Stock, it issued 1,500,000 shares of its common stock in an offering
registered under the Securities Act of 1933. The shares of common stock issued
were loaned to an affiliate of Citigroup Global Markets Limited (“CGML”) under a
5-year share lending agreement. The only consideration received by MTL was a
share lending fee of $.01 per share, or an aggregate of $15,000, which is
included in Common Stock. The loaned shares were used by CGML to promote the
sale of the Preferred Stock by facilitating hedging transactions that may be
undertaken by purchasers of the Preferred Stock. The shares that MTL lent to the
affiliate of CGML are reflected as issued and outstanding. The Company has
determined that the share lending agreement is not a derivative instrument that
would require accounting separate from the Preferred Stock and, accordingly, has
recognized net effect on stockholder’s equity of the 1,500,000 shares issued
pursuant to the share lending agreement, which includes the requirement that the
shares be returned no later than November 20, 2011, equal to the $15,000 fee
received upon lending of the shares.




SFAS 150
“Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity”  provides that entities that have issued
mandatorily redeemable shares of common stock or entered into forward contracts
that require physical settlement by repurchase of a fixed number of the issuer’s
equity shares of common stock in exchange for cash shall exclude the common
share to be redeemed or repurchased in calculating basic and diluted earnings
per share. Accordingly, the 1,500,000 shares of common stock issued pursuant to
the share lending agreement are excluded from the calculation of the Company’s
basic and diluted net loss per share.




.




F-21


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
K—STOCKHOLDERS’ EQUITY




1.
Share Capital




Each
stockholder is entitled to one vote for each share of common stock owned by that
stockholder on all matters properly submitted to the stockholders for their
vote.  Stockholders owning or controlling more than 50% of the shares
can elect all of the directors.




In June
2008, MTL completed a sale to selected institutional investors of an aggregate
of 6,823,529 shares of its common stock, along with warrants to purchase
2,941,176 shares of its common stock, for aggregate gross proceeds of
$29,000,000, less costs of approximately $1,393,000. Such sale of securities was
made pursuant to a June 19, 2008 Placement Agency Agreement and securities
purchase agreements entered into with each investor. The warrants issued to
investors have an initial exercise price of $5.50 per share, may be exercised
beginning December 2008 and expire on December 18, 2013. As part of the issuance
cost, pursuant to the placement agency agreement, the  placement agent
received as its fee $1,285,000 and warrants to purchase 294,118 shares of common
stock, which bear the same terms as those issued to the
investors.





In May
2008, MTL sold 917,020 shares of its common stock for gross proceed of
$7,500,000, less issuance costs of approximately $223,000, pursuant to a common
stock Purchase Agreement that it entered into. In April 2008, pursuant to the
Purchase Agreement, MTL obtained a committed equity line credit facility (the
“Facility”) under which it may sell up to $60 million of its registered common
stock over an 18-month period, subject to certain conditions and limitations,
including that the minimum threshold price (as defined in the Purchase
Agreement) of the Company’s common stock on any given trading day must equal or
exceed $6.00. On January 9, 2009, the Company delivered a written notice of
termination of the Purchase Agreement to the counterparty to the credit
facility, in accordance with the terms of the Purchase
Agreement.




InNovember 2007, MTL
entered into an equity distribution agreement (the “Equity Distribution
Agreement”) with a sales agent (the “Agent”) for the sale of up to $35,000,000
of MTL’s common stock. In exchange for its services as sales agent, MTL paid the
agent a commission equal to 4% of the first $15,000,000 of gross sales price of
the shares sold and 3% of any gross sales price of the shares sold in excess of
$15,000,000. From November 2007 through April 2008, MTL sold an aggregate
of 2,891,425 shares of its common stock for gross proceeds of approximately
$35,000,000 (which represents the entire amount available for sale under the
Equity Distribution Agreement), less issuance costs aggregating approximately
$1,433,000. Of such amount and shares sold, 1,577,228 shares of common stock
were sold from January 2008 through April 2008 for proceeds of approximately
$17,308,000, less issuance costs aggregating approximately
$562,000.




During
2006, the Company completed an exchange of its common stock for its outstanding
6% Senior Convertible Notes (the “Notes”) whereby holders of $49,000,000 in
principal amount of the Notes, exchanged their Notes for an aggregate of
3,101,874 shares of the Company’s common stock. In accordance with SFAS No.
84  “Induced Conversion of Convertible Debt, an amendment of APB
Opinion No. 26,” the Company recorded financing charges related to the exchange
transactions of approximately $8,491,000, which consists of the value of the
shares issued in lieu of future interest payments of approximately $8,266,000,
amortization of the remaining balance of the beneficial conversion features
of  approximately $220,000 and out of pocket costs incurred in
connection with the exchange transactions. The Company recorded the remaining
unamortized balance of the debt issuance costs as of the dates of the exchanges
of approximately $2,747,000 as a reduction to additional paid-in
capital.









F-22


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE K—STOCKHOLDERS’ EQUITY(Continued)




2.
Stock Options Plans, Stock Options, Warrants and Restricted Stock




In 1999,
the Company’s Board of Directors approved the 1999 Stock Option Plan, and
reserved 1,000,000 shares of common stock for issuance as stock options or stock
appreciation rights pursuant to the plan.  The plan provides for the
issuance of both incentive and nonqualified stock options. During the years
ended December 31, 2000 through December 31, 2006, the Company’s Board of
Directors and its stockholders at the Annual Meetings of the Stockholders
increased the number of shares of common stock reserved under the 1999 Stock
Option Plan to an aggregate of 5,000,000 shares.




In 2007,
the Company’s Board of Directors approved the Company’s 2007 Equity Incentive
Plan, and reserved 1,000,000 shares of common stock.




Grant
of stock-based awards is administered by the compensation committee of the Board
of Directors of the Company, which also establishes the terms of the
awards.





Under the
Company’s 1999 Stock Option Plan and 2007 Equity Incentive Plans (the “Plans”),
options are granted to employees, non-employees, officers and directors at an
exercise price equal to at least the market price at the date of grant and are
granted for periods not to exceed seven years. Options granted under the Plans
generally vest over a period of one to three years of employment or service. Any
options that are cancelled or forfeited before expiration become available for
future grants. The Company can also issue a variety of other equity incentives
under the 2007 Plan. In addition to granting stock options, since 2007, the
Company started to grant restricted stock.

























F-23


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
K—STOCKHOLDERS’ EQUITY (Continued)




The
following table presents the Company’s stock options and warrants activity for
employees, officers and directors of the Company for the years ended December
31, 2006 through 2008:




Number
      of Options and warrants
            
            
            Weighted
      Average Exercise PriceOutstanding
      at December 31, 2005
            
            
            3,122,500
            
            
            $
            10.29Granted
            
            
            706,500
            
            
            
            20.98Exercised
            
            
            (2,240,000
            )
            
            
            8.55Forfeited
      or expired
            
            
            (205,000
            )
            
            
            16.53Outstanding
      at December 31, 2006
            
            
            1,384,000
            
            
            
            17.62Granted
            
            
            775,000
            
            
            
            13.86Exercised
            
            
            (9,000
            )
            
            
            13.70Forfeited
      or expired
            
            
            (41,000
            )
            
            
            16.67Outstanding
      at December 31, 2007
            
            
            2,109,000
            
            
            
            16.27Granted
            
            
            904,000
            
            
            
            3.56Exercised
            
            
            (1,000
            )
            
            
            13.08Forfeited
      or expired
            
            
            (1,343,000
            )
            
            
            15.24Outstanding
      at December 31,  2008
            
            
            1,669,000
            
            
            $
            10.23Number
      of options exercisable at December 31, 2008
            
            
            929,000
            
            
            $
            15.66Number
      of options exercisable at December 31, 2007
            
            
            1,341,000
            
            
            $
            7.66Vested
      and expected to vest at December 31, 2008
            
            
            1,657,000
            
            
            $
            10.25Vested
      and expected to vest at December 31, 2007
            
            
            2,099,000
            
            
            $
            16.29








Year
      ended
              December
      31, 2008Options
            
            
            Aggregate
      intrinsic valueOutstanding
      at beginning of year
            
            
            2,109,000
            
            
            $
            2,036,000Granted
            
            
            904,000
            
            
            
            —Exercised
            
            
            (1,000
            )
            
            
            —Forfeited
            
            
            1,343,000
            
            
            
            —Outstanding
      as of December 31, 2008
            
            
            1,669,000
            
            
            $
            —
            (*)Exercisable
      as of December 31, 2008
            
            
            929,000
            
            
            $
            —
            (**)







F-24


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
K—STOCKHOLDERS’ EQUITY (Continued)




*)
            All
      outstanding options are out of the money as of December 31, 2008 and their
      intrinsic value was considered as
zero.





**)
            All
      exercisable options are out of the money as of December 31, 2008 and their
      intrinsic value was considered as
zero.







The following table summarizes
information about options and warrants to employees, officers and directors
outstanding at December 31, 2008 under the Plans:





Options
      and warrants outstanding
            
            Options
      and warrants exercisableExercise
      Price
            
            Number
      of options and warrants
            
            Remaining
      contractual life (years)
            
            Number
      of options and warrants$
      14.93
            
            128,500
            
            0.65
            
            128,50020.98
            
            248,000
            
            1.55
            
            248,00017.39
            
            10,000
            
            2.01
            
            10,00017.61
            
            6,000
            
            2.19
            
            6,00014.90
            
            60,000
            
            2.42
            
            60,00014.23
            
            302,000
            
            2.54
            
            302,00011.19
            
            165,000
            
            2.61
            
            165,00010.83
            
            5,000
            
            3.16
            
            5,00013.15
            
            4,500
            
            2.75
            
            4,50010.83
            
            12,000
            
            3.16
            
            —8.84
            
            70,000
            
            3.35
            
            —2.98
            
            183,000
            
            3.64
            
            —3.21
            
            100,000
            
            3.62
            
            —2.38
            
            125,000
            
            6.72
            
            —$ 
      2.38
            
            250,000
            
            6.72
            
            —1,669,000
            
            
            
            929,000





The
aggregated fair value at grant date of options and warrants granted for the
years ended December 31, 2006, 2007 and 2008 with an exercise price equal
to the market value at the date of grant were $6,512,000, $4,725,000 and
$1,701,000, respectively.




As of
December 31, 2007 and 2008 there were unrecognized costs of $3,131,000 and
$1,453,000, respectively, related to stock options and warrants that are
expected to be recognized in future periods.




In June,
2007, the Company entered into a Finder’s Fee agreement with The Brannock Group,
LLC (“Brannock”) (the “Agreement”), pursuant to which Brannock will advise and
assist the Company with respect to identifying, locating, selecting and entering
into manufacturing and/or distribution arrangements in China. The Agreement
provides for the Company to grant warrants to purchase 320,000 shares of the
Company’s common stock to Brannock, in three tranches, subject to the
achievement of specific milestones stipulated in the agreement and at an
exercise price equal to the last reported closing price per share on the date of
the grant of each of such respective tranche. In August, 2007, the Company
entered into memo of understanding that calls for the introduction of the
Company’s fuel cell Power Pack into the Greater China market (the
“MOU”).




F-25


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
K—STOCKHOLDERS’ EQUITY (Continued)




Pursuant
to the terms of the Agreement, the first tranche of 20,000 warrants were granted
to Brannock upon the entering into of the MOU. Such warrants are exercisable at
$11.37 (the market price of the Company’s common stock on the grant date), vest
in full upon the grant date and expire after four years. Using the Black-Scholes
option pricing model assuming a 4.59% risk free interest rate, 0% dividend
yield, expected term of 4 years and 61% volatility, the Company has estimated
the fair value of such options to be approximately $115,000.




The
following table summarizes information relating to restricted shares, as well as
changes to such awards during 2007 and 2008:





Year
      ended December 31,2007
              
              
              2008(Number
      of Shares)Outstanding
      at beginning of year
              
              
              —
              
              
              
              100,000Granted
              
              
              100,000
              
              
              
              396,269
              (*)Vested
              
              
              —
              
              
              
              (100,000
              )Forfeited
              
              
              —
              
              
              
              —Outstanding
      as of December 31,
              
              
              100,000
              
              
              
              396,269








(*)         Includes
381,269 shares of restricted stock granted in exchange for options as further
describe below.





The
aggregated fair values at grant date of restricted shares granted for the years
ended December 31, 2007 and 2008 were $1,419,000 and $2,996,000,
respectively.





In April
2008, MTL entered into agreements with certain of its executive and
non-executive officers to exchange options held by them to acquire an aggregate
of 719,500 shares of MTL’s common stock that had been issued under the Company’s
1999 Stock Option Plan for an aggregate of 287,800 restricted shares issued
under the Company’s 2007 Equity Incentive Plan (including an aggregate of
325,000 options exchanged for 130,000 restricted shares by MTL’s executive
officers). Such restricted shares vest between November 2008 and June
2009.





In
September 2008, MTL entered into agreements with certain of its independent
directors to exchange options held by them to acquire an aggregate of 124,625
shares of MTL’s common stock that had been issued under the Company’s 2007
Equity Incentive Plan for an aggregate of 93,469 shares of restricted stock
issued under the Company’s 2007 Equity Incentive Plan. Such restricted stock
vests on August 20, 2009.




In
accordance with SFAS 123(R), the Company has accounted for these exchanges as
modification to the terms of the pervious award. Accordingly, incremental
compensation costs were measured as the excess fair value of the replacement
award over the fair value of the previous award. The Company has estimated
compensation costs arising from these exchanges to be $1,459,000 and has
recorded approximately $1,014,000 as selling, marketing, general and
administrative expense during the year ended December 31, 2008, with unrecorded
compensation costs to be recorded over the remaining vesting period of the
restricted stock.





F-26


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
K—STOCKHOLDERS’ EQUITY (Continued)




During
the years ended December 31, 2006, 2007 and 2008, the Company had outstanding
warrants and options totaling 96,500, 112,000 and 97,000, respectively,
which had been granted to non-employees, and the Company recorded costs
related to such warrants and options of approximately $99,000, $148,000 and
$3,000, respectively. The Company used the Black-Scholes option pricing model to
estimate the fair value of options granted to non-employees of the Company using
the following assumptions:




Year
      ended December 31, 2006
            Year
      ended December 31, 2007
            Year
      ended December 31, 2008Expected
      Volatility
            58%
      – 59%
            61% – 65%
            75%Risk-free
      interest rate
            4.7%
      – 4.8%
            4.59%
      – 4.91%
            2.25%Dividend
      yield
            0%
            0%
            0%Expected
      term (years)
            1.8 – 3.0
            3.0 – 4.0
            4.0







NOTE
L—COMMITMENTS AND CONTINGENCIES




Commitments
and contingent liabilities




1.  CellScan License— Medis El acquired the rights to the CellScan in August 1992 by
assignment from Israel Aerospace Industries Ltd. (formerly know as Israel
Aircraft Industries) (“IAI”) of a license from Bar Ilan University (the
“University”) to IAI.  Medis El paid IAI $1,000,000 in consideration
of the assignment of the license and for certain tooling and
equipment.  The license is a perpetual worldwide license to develop,
manufacture and sell the CellScan, and to sublicense the right to manufacture
and sell the device. The license includes all rights to the University’s
CellScan patents, know-how and inventions including any subsequently acquired,
and all improvements thereto.  Medis El is obligated to pay the
University a royalty for a twenty-year period beginning in 1995.  For
the first ten years, the royalty is at the rate of 6.5% of proceeds of sales
(after deducting sales commissions and other customary charges) and 4.5% on any
fees received from granting territorial rights.  The royalty for the
second ten-year period is 3.5% on all revenues whether from sales or
fees.   In addition to such royalty payments, the Company is
required to pay $100,000 to the University during the first year that the
Company’s after-tax profits exceed $300,000. On July 26, 2007, Medis El assigned
all of its intellectual property rights to the CellScan, including the Cell
Carrier to CKL and delegated its royalty payment commitments to CKL. No
royalties were required to be paid during the three years in the period ended
December 31, 2008.




2.  Other Royalties— In consideration for grants from the State of Israel, Medis El is
obligated to pay royalties of 3% of sales of products developed with funds
provided by the State of Israel until the dollar-linked amount equal to the
grant payments received by Medis El is repaid in full. All grants received from
the State of Israel related to the CellScan and Neuritor
technologies.  Total grants received, net of royalties paid as of
December 31, 2002, aggregate $2,601,000 (of which $2,247,000 are related to
the Cellscan), which includes those received by IAI relating to such
technologies of $805,000. On July 26, 2007, in connection with its transfer to
CKL of its intellectual property rights to the CellScan, including the Cell
Carrier, Medis El delegated its royalty payment commitments to CKL. No royalties
were required to be paid during the three years in the period ended
December 31, 2008.






F-27


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
L— COMMITMENTS AND CONTINGENCIES (Continued)




3.  Lease Commitments— MTL’s office space is rented for annual rental fee of approximately
$100,000, from a company which is controlled by the company’s former chairman
and chief executive officer and by the company’s former deputy chairman and
chief operating officer.




Medis El
and More Energy are committed under leases for its facilities, which provide
aggregate space of approximately 56,100 square feet that expire between 2009 and
2010. Certain of these leases contain renewal option for up to 4
years.  Medis El has collateralized its obligations under such leases
up to an aggregate of approximately $451,000 by obtaining a bank guarantee in
favor of the lessor. Such guarantee is secured by Medis El’s cash and deposits
with the bank.




Pursuant
to the lease agreements for the facilities in Lod, Israel, the landlord agreed
to reimburse the Company for a specified amount per square foot for leasehold
improvements (the “Leasehold Incentives”). In accordance with SFAS No. 13,
“Accounting for Leases”
and FTB 88-1, “Issues Relating
to Accounting for Leases”, the leasehold improvements are recognized in
property and equipment, with the corresponding reimbursement recognized as
Leasehold Incentive obligations. The amount of the incentive totaled to
$1,292,000.




During
the years ended December 31, 2006, 2007 and 2008, the Company incurred expenses
under its facility lease commitments in Israel aggregating approximately
$387,000, $551,000 and $509,000 net of amortization of leasehold incentive
obligations in 2006, 2007 and 2008 of approximately $248,000, $276,000 and
$276,000, respectively.




In
addition, the Company is committed under vehicle leases with various termination
dates in 2009 through 2011.




Future
minimum operating lease (facility and vehicle) payments for the next three years
are as follows:




Operating
      Leases2009
            
            $
            1,057,0002010
            
            
            229,0002011
            
            
            136,000Total
      future minimum lease payments
            
            $
            1,422,000







F-28


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
L— COMMITMENTS AND CONTINGENCIES (Continued)




4. Litigations-




A. Shareholder class action-
On April 23, 2007, a putative class action was initiated against the Company and
its then CEO, among others, in the United States District Court for the Southern
District of New York. Thereafter, on September 10, 2007, plaintiffs filed the
First Amended Class Action Complaint (the “Amended Complaint”). The Amended
Complaint essentially alleges that defendants violated Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934 by issuing a false and misleading press
release on April 13, 1007 (the “April 13 Press Release”), stating that the
Company had begun “commercial sales” of “Microsoft-Branded” Power Packs to
Microsoft.




Defendants
moved to dismiss the case for failure to adequately plead scienter, i.e., a
culpable intent. After full briefing and oral argument on July 16, 2008, on
August 18, 2008, Hon. Paul A. Crotty, United States District Judge for the
Southern District of New York, granted defendants’ motion to dismiss in its
entirety, without leave to replead. The court held that plaintiffs did not
present a compelling inference that defendants acted with any fraudulent
intent.




On
September 10, 2008, plaintiffs filed a Notice of Appeal of the District Court’s
order to the United States District Court of Appeals for the Second Circuit.
Plaintiffs-Appellants’ filed their moving brief on November 20, 2008.
Defendants-Appellee’s filed their opposition brief on January 15, 2009 and
Plaintiffs-Appellants’ filed their reply brief on February 13, 2009. The
Companyis
vigorously defending the appeal.




B. Other-The Company is the
defendant in various lawsuits, including employment-related litigation claims
and other legal proceedings in the normal course of its business. The resolution
of these matters is not expected to have a significant effect on the Company’s
financial position, results of operations or cash flows.




5.  Cell
Kinetics Rights Offering — On January 7, 2008, CKL, an indirect
subsidiary of MTL, completed an over subscribed rights offering to the
shareholders of MTL, to acquire shares and warrants of CKL. Upon the
consummation of the offering, MTL continued to own, indirectly through its lower
tier subsidiaries approximately 82.5% of CKL and the participating MTL
shareholders owned the balance.  On February 11, 2008, Cell Kinetics
announced that it has received the ticker symbol of CKNTF for the quotation of
its shares on the OTC Bulletin Board maintained by Nasdaq and, on March 12,
2008, Cell Kinetics announced that it has received the ticker symbol of CKNWF
for the quotation of its four year warrants on the OTC Bulletin
Board.




In
furtherance of MTL’s plan to commercialize the Cell Carrier technology, Medis El
assigned all of its intellectual property rights to the CellScan, including the
Cell Carrier, to CKL on July 26, 2007. MTL also has agreed to provide to CKL,
over an 18 month period starting with the completion of the rights offering, an
unrestricted capital contribution of up to $1,500,000 on an as needed basis.
Furthermore, in the event that such $1,500,000 capital contribution along with
other available funds would be insufficient for CKL to carry-out its operations
for at least one year from the completion of the rights offering, MTL has agreed
to provide CKL with additional financing from time to time to ensure that CKL
will have sufficient funds to carry out its operations for at least one year
from the completion of rights offering. Additionally, MTL and Medis El have
agreed to provide office and laboratory facilities and administrative services
to CKL at cost as a contribution to capital, for a period of at least 18 months
from the completion of the rights offering. On June 30, 2008, Medis El provided
funding to CKL in the amount $1,500,000, pursuant to a non-interest bearing,
unsecured promissory note, with a due date of January 1, 2010 – subject to
certain other repayment conditions that are based on CKL’s receiving alternative
sources of financing for its operations or the sale of CKL’s business to or
merger with a third party.  At the option of Medis El, any remaining
balance on the promissory note may be contributed to the  capital of
CKL. Also on June 30, 2008, CKL entered into a second promissory note with Medis
El in the amount of $394,938, representing issuance costs related to its rights
offering that MTL and Medis El advanced on the Company’s behalf. Such promissory
note is on substantially the same terms as the promissory note described
above.






F-29


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
L— COMMITMENTS AND CONTINGENCIES (Continued)




6. Investment in Scorpion Surgical
Technologies, Ltd. — On July 16, 2007, CKL entered in to an agreement
with Scorpion Surgical Technologies, Ltd. (“Scorpion”) whereby CKL agreed to
acquire 20,000 shares which represents a 20% equity interest in Scorpion for
$150,000, with $50,000 of such amount payable upon signing of the agreement and
the remaining $100,000 payable in two equal installments subject to certain
conditions set forth in the agreement. The first 6,666 shares were acquired in
July 2007, upon the Company’s payment of the first $50,000 installment. With
certain payment milestones in contracts having not been achieved, the Company
does not believe that it is committed to move forward with the remaining of
$100,000.  CKL and Scorpion are currently considering entering into an
amendment to their agreement whereby the Company would invest significantly less
and receive a pro-rata quantity of shares based on the pricing in the July 16,
2007 agreement.   Scorpion is an early-stage company in the field
of orthopedic surgical instrumentation with particular emphasis upon spinal
stabilization systems.  The chief executive officer of CKL is a
director and co-founder of Scorpion. CKL has recorded its investment in Scorpion
as in-process research and development expense.




7. Purchase commitments – As of
December 31, 2008, the Company had purchase commitments aggregating
approximately $9,500,000.


Included
in purchase/contractual commitments at December 31, 2008 is a commitment in the
amount of approximately $2,000,000 made pursuant to an equipment design
agreement (“Design Agreement”) into which More Energy Ltd. (“More Energy”)
entered in August, 2008, with a potential second source supplier of components
for manufacture of the Company’s 24/7 Power Pack. Pursuant to the Design
Agreement, More Energy issued a purchase order in the amount of 2,468,000 Euro
for the design and construction of certain production equipment. In March
2009, More Energy issued a “stop work” order under the agreement. While the
Company is unable to estimate with a degree of certainty the total amount of
costs that it would incur should the agreement be terminated, it would not
expect to incur additional costs in excess of approximately 1,500,000 Euro or
$2,000,000.
 
 The
Company’s other purchase commitments aggregating to approximately $7,500,000 are
commitments arising in the ordinary course of business. (See note A which
relates to the Company’s going concern issue)




NOTE
M—RELATED PARTY TRANSACTIONS




1.  Consulting Agreements
—The Company had entered into consulting agreements with its former
Chairman and Chief Executive Officer (“Former CEO”) and with its former Deputy
Chairman and Executive Vice President (“Former EVP”), principal stockholders of
the Company.  Such agreements had initial terms through December 31,
2001 and both also provided for automatic extension on a year to year
basis.  Such consulting agreements were terminated on February 16,
2009.




On
February 16, 2009, the Company entere into both a Severance Agreement (the
“Severance Agreement”) and a Consulting Agreement (the “Consulting
Agreement”)
with each of the Former CEO and the Former EVP. Pursuant to the Severance
Agreements, each of the Former CEO and the Former EVP are to receive a payment
of $180,000, payable during the one year period commencing after the 6 month
anniversary of the effective date of the agreement (the “Severance Period”).
Furthermore, in the event that the Company achieves $5,000,000 in gross revenue
during each of two consecutive fiscal quarters during the Severance Period, the
Company shall pay to each of them an additional $30,000 severance payment.
Pursuant to the applicable Consulting Agreement, for a period of six months from
the Effective Date, the Former CEO shall provide services pertaining to
government and military affairs as they relate to the business of the Company
and shall endeavor to secure funding for the Company from the United States
government, and the Former EVP shall provide financial and treasury related
services as they relate to the business of the Company. In consideration of the
services to be rendered, the Company shall pay to each of them during the
six month term a monthly fee equal to $16,667.




Pursuant
to the Consulting Agreements, effective as February 16, 2008, both, the Former
CEO and the Former EVP resigned from all of their corporate offices and from the
Company’s Board of Directors.




2.  Lease Commitments— MTL’s office space is rented for annual rental fee of approximately
$100,000, from a company which is controlled by the Former CEO and Former
EVP.




F-30


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




3.  Administrative
Services —
Secretarial and bookkeeping services are provided to MTL through a costs sharing
arrangement with the Company’s Former CEO
and Former EVP.  During the years ended December 31, 2006, 2007, and
2008, fees for such services amounted to approximately $69,000, $74,000 and
$74,000, respectively. See Note L-3 regarding a lease agreement with the same
related party.




NOTE
N—INCOME TAXES




a. MTL
(which files consolidated Federal income tax returns together with
Medis Inc.) and its wholly owned subsidiaries are separately taxed under
the domestic tax laws of the state of incorporation of each entity.





b. Tax laws
applicable to the companies in Israel:





Measurement
of taxable income under the Income Tax (Inflationary Adjustments) Law,
1985:




In
accordance with the above law, results for tax purposes are measured and
reflected in real terms in accordance with the changes in the Israeli
CPI.




Commencing
with the year 2008, the Company has elected to file its tax return under the
Israeli Income Tax Regulations 1986 (Principles Regarding the Management of
Books of Account of Foreign Invested Companies and Certain Partnerships and the
Determination of Their Taxable Income). Such an elective obligates the Company
for three years. Accordingly, commencing the year 2008, results for tax purposes
will be measured in terms of earnings in dollars.




c. Tax rates
applicable to companies in Israel are as follows:





Taxable
income is subject to corporate tax rate following tax rates: 2006 – 31%, 2007 –
29%, 2008 – 27%, 2009 – 26% and 2010 and thereafter – 25%.




Beginning
January 1, 2008, the Inflationary Adjustments Law was repealed.




d. Tax  benefits
under the law for Encouragement of Capital Investments, 1959 (“the
Law”)





The
facilities of More Energy have been granted status of an “Approved Enterprise”
under the Law. According to the provisions of the Law, More Energy has elected
the “alternative benefits track” - the waiver of grants in return for tax
exemption and, accordingly, More Energy income is tax-exempt for a period of two
years commencing with the year it first earns taxable income, and subject to
corporate taxes at the reduced rate of 10% to 25%, depending upon the level of
foreign ownership of the Company, for an additional period of 5-8 years from
when the tax exemption ends. The period of tax benefits, detailed above, is
limited to the earlier of 12 years from the commencement of production, or 14
years from the approval date (except for the tax-exempt period of two years
which is unlimited). Due to reported losses for tax purposes the tax benefit
period has not yet commenced.




The
entitlement to the above benefits is conditional upon fulfilling the conditions
stipulated by the Law, regulations published there under and the letters of
approval for the specific investments in “Approved Enterprises.” In the event of
failure to comply with these conditions, the benefits may be canceled and More
Energy may be required to refund the amount of the benefits, in whole or in
part, including interest.




If More
Energy distributes cash dividend from retained earning which were tax exempt due
to its approved enterprise status, More Energy would be required to pay
corporate tax at a rate of 10% to 25% corporate tax on the gross amount
distributed and a further 15% withholding tax would be deducted from the amount
disturbed to the recipients.




F-31


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
N—INCOME TAXES (Continued)




If More
Energy derives income from sources other than the approved enterprise programs
during the relevant period of benefits, this income would be taxable at the
regular corporate tax rate of Israel.




On April
1, 2005, an amendment to the Privileged Law came into effect (“the Amendment”)
and has significantly changed the provisions of the Investment Law. The
Amendment sets forth the scope of enterprises which may qualify as a Privileged
Enterprise (under the Amendment, the designation is Privileged Enterprise rather
than Approved Enterprise) by setting forth criteria for qualification of a
company, such as provisions generally requiring that at least 25% of the
Privileged Enterprise’s income will be derived from export and that minimum
qualifying investments in productive assets be made. Additionally, the Amendment
enacted major changes in the manner in which tax benefits are awarded under the
Investment Law so that companies no longer require Investment Center approval in
order to qualify for tax benefits. Under the Amendment, the year in which the
company elects to commence its tax benefits is designated as the year of
election (“Year of Election”). A company may choose its Year of Election by
notifying the Israeli Tax authorities in connection with filings its annual tax
return or within 12 months after the end of the Year of Election, whichever is
earlier, or by requesting a pre-ruling from the Israeli tax authorities no later
than within 6 months after the end of the Year of Election.




In July
2006, More Energy had submitted an application to the Investment Center for
approval to manufacture abroad and still be eligible for all the benefits
according the Law. In August 2006, More Energy applied to the Israeli Tax
Authorities in order to receive approval for manufacturing in Ireland with
Celestica. A decision regarding both requests has not yet been received and is
pending upon fulfillment of certain requests. The Company cannot be certain that
the approvals will be granted.




The Law,
as amended, also provides that any letter of approval granted prior to the
Amendment will remain subject to the terms and benefits included in such letter
of approval. Accordingly, while it is anticipated that the Investment Law, as
amended, will govern More Energy’s Privileged Enterprise terms and benefits, the
Company does not expect that the Amendment will have any impact on Medis
El.




e. Carryforward
losses:




At
December 31, 2008 the Company had a net operating loss (“NOL”) carryforward
for United States Federal income tax purposes of approximately $31,903,000,
expiring through 2027. Such amount includes $7,884,000 of tax deductions in
excess of expense recorded with respect to grants of options and warrants.
Utilization of U.S. net operating losses may be subject to substantial
annual limitation due to the “change in ownership” within the meaning of Section
382 of the Internal Revenue Code of 1986 and similar state
provisions.




Annual
limitations may result in the expiration of net operating losses before
utilization. The Israeli subsidiaries have net operating losses, for Israeli tax
purposes, aggregating approximately $137,637,000 as of December 31, 2008, which,
pursuant to Israeli tax law, do not expire.




The
availability of MTL’s U.S. net operating loss carry-forwards may be reduced to
the extent one or more direct or indirect holders of 5% or greater amount of
MTL’s common stock increases their equity interest in us by more than 50% in the
aggregate.




F-32


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
N—INCOME TAXES (Continued)




f. Open Tax
Years:




The
Company files U.S. federal income tax returns and Israeli income tax returns, as
well as income tax returns for New York State and New York City. The Company may
be subject to examination by the U.S. Internal Revenue Service and the New York
State and New York City revenue authorities from inception of operations due to
net operation loss carry forwards generated in past years. The Company may also
be subject to examination by the Israeli tax authorities for the years 2003
through 2006.




g. Deferred
income taxes:




Deferred
income taxes reflect the net tax effect of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company’s deferred tax liabilities and assets are as follows:




December
      31,2007
            
            
            2008Net
      operating losses carry forward
            
            $
            33,562,000
            
            
            $
            48,607,000Other
      differences
            
            
            6,019,000
            
            
            
            5,347,00039,581,000
            
            
            
            53,954,000Valuation
      allowance
            
            
            (39,581,000
            )
            
            
            (53,954,000
            )Deferred
      tax assets, net of valuation allowance
            
            $
            —
            
            
            $
            —





The
entire change in valuation allowance is for the increase in net operating loss
during the year. The Company is unable to conclude that it is more likely than
not that deferred tax assets from carryforward losses will be realized in the
foreseeable future. Accordingly, a valuation allowance has been recorded for the
entire amount.




h. Loss
before income taxes is comprised as follows:




Year
      ended December 31,2006
            
            
            2007
            
            
            2008Foreign
            
            $
            (21,736,000
            )
            
            $
            (33,109,000
            )
            
            $
            (87,427,000
            )Domestic
            
            
            (11,311,000
            )
            
            
            (5,091,000
            )
            
            
            (60,995,000
            )$
            (33,047,000
            )
            
            $
            (38,200,000
            )
            
            $
            (148,422,000
            )





i. Reconciliation
of the theoretical tax benefit to the actual tax expense benefit:




In 2006,
2007 and 2008, the main reconciling items between the statutory tax rate of the
Company and the effective tax rate are carryforward tax losses, for which a full
valuation allowance was provided.




F-33


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
O—SUMMARY INFORMATION ABOUT GEOGRAPHIC AREAS




The
Company manages its business on a basis of two reportable
segments.  See Note A for a brief description of the Company’s
business. The following data is presented in accordance with SFAS No. 131,
“Disclosure about Segments of an Enterprise and Related Information”. Total
revenues are attributed to geographic areas based on the location of the
customer.




The
following data presents total revenues for the years ended December 31, 2006,
2007 and 2008 and long-lived assets as of December 31, 2007 and
2008:




December
      31,2006
            
            
            2007
            
            
            2008Total
      Revenues
            
            
            Total
      Revenues
            
            
            Long-lived
      assets
            
            
            Total
      Revenue
            
            
            Long-lived
      assetsEurope
            
            $
            —
            
            
            $
            —
            
            
            $
            43,865,000
            
            
            
            —
            
            
            $
            17,170,000Israel
            
            
            —
            
            
            
            400,000
            
            
            
            17,767,000
            
            
            
            —
            
            
            
            14,685,000United
      States
            
            
            150,000
            
            
            
            —
            
            
            
            4,000
            
            
            
            —
            
            
            
            5,000Other
            
            
            —
            
            
            
            —
            
            
            
            67,000
            
            
            
            —
            
            
            
            225,000$
            150,000
            
            
            $
            400,000
            
            
            $
            61,703,000
            
            
            
            —
            
            
            $
            32,085,000

























F-34


Medis
Technologies Ltd. and Subsidiaries




Notes
to Consolidated Financial Statements




NOTE
P —CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)




Quarter ended
            
            March
      31
            
            
            June
      30
            
            
            September
      30
            
            
            December
      31Loss
      from operations
            
            $
            (13,831,000
            )
            
            $
            (15,650,00
      0
            )
            
            $
            (14,268,000
            )
            
            $
            (106,769,000
            )Interest
      income (expenses)
            
            
            (160,000
            )
            
            
            (106,000
            )
            
            
            463,000
            
            
            
            1,407,000Net
      loss
            
            
            (13,747,000
            )
            
            
            (15,624,000
            )
            
            
            (13,676,000
            )
            
            
            (105,375,000
            )Dividend
      on preferred stock
            
            
            (1,042,000
            )
            
            
            (1,042,000
            )
            
            
            (1,042,000
            )
            
            
            (1,043,000
            )Net
      loss attributable to common stockholders
            
            
            (14,789,000
            )
            
            
            (16,666,000
            )
            
            
            (14,718,000
            )
            
            
            (106,418,000
            )Basic
      and diluted net loss per share
            
            $
            (
      .42
            )
            
            $
            (.44
            )
            
            $
            (
      .33
            )
            
            $
            (2.39
            )Weighted-average
      number of shares used in computing basic and diluted net loss per
      share
            
            
            35,556,209
            
            
            
            37,707,938
            
            
            
            44,486,347
            
            
            
            44,582,888Quarter ended
            
            March
      31
            
            
            June
      30
            
            
            September
      30
            
            
            December
      31Fiscal
      2007Revenues
            
            $
            —
            
            
            $
            —
            
            
            $
            400,000
            
            
            $
            —Gross
      profit
            
            $
            —
            
            
            $
            —
            
            
            $
            151,000
            
            
            $
            —Loss
      from operations
            
            $
            (9,235,000
            )
            
            $
            (9,540,000
            )
            
            $
            (9,124,000
            )
            
            $
            (11,404,000
            )Interest
      income (expenses)
            
            $
            901,000
            
            
            $
            800,000
            
            
            $
            441,000
            
            
            $
            (1,039,000
            )Net
      loss
            
            $
            (8,334,000
            )
            
            $
            (8,740,000
            )
            
            $
            (8,683,000
            )
            
            $
            (12,443,000
            )Dividend
      on preferred stock
            
            $
            (1,001,000
            )
            
            $
            (1,043,000
            )
            
            $
            (1,042,000
            )
            
            $
            (1,042,000
            )Net
      loss attributable to common stockholders
            
            $
            (9,335,000
            )
            
            $
            (9,783,000
            )
            
            $
            (9,725,000
            )
            
            $
            (13,485,000
            )Basic
      and diluted net loss per share
            
            $
            (.27
            )
            
            $
            (.29
            )
            
            $
            (.29
            )
            
            $
            (.40
            )Weighted-average
      number of shares used in computing basic and diluted net loss per
      share
            
            
            33,434,411
            
            
            
            33,448,397
            
            
            
            33,535,799
            
            
            
            33,794,827




********************************





F-35