**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, 2006**




**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
                Registered****Common
                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
o  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
o 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
o




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. o




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange
      Act.




Large
                  accelerated filer o
              Accelerated
                  filer x
              Non-accelerated
                  filer o




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes
o  No
x




As
      of
      June 30, 2006, the aggregate market value of the registrant’s common stock held
      by non-affiliates of the registrant was approximately $423,655,426.




As
      of
      March 12,  2007,
      there were outstanding 34,939,364 shares of the registrant’s common
      stock.




**DOCUMENTS
      INCORPORATED BY REFERENCE**




Portions
      of the Registrant’s Proxy Statement for the 2007 Annual Meeting of Stockholders
      are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part
      III.










**TABLE
      OF CONTENTS**






**PART
                I**
              **1**


**Item
                1.**
            **Business**
            1


**Item
                1A.**
            **Risk
                Factors**
            **12**


**Item
                1B.**
            **Unresolved
                Staff Comments**
            **23**


**Item
                2.**
            **Properties**
            **24**


**Item
                3.**
            **Legal
                Proceedings**
            **24**


**Item
                4.**
            **Submission
                of Matters to a Vote of Security Holders**
            **24**




**PART
              II**
            **24**




**Item
                5.**
            **Market
                For Registrant’s Common Equity, Related Stockholder Matters and Issuer
                Purchases of Equity Securities**
            **24**


**Item
                6.**
            **Selected
                Financial Data**
            **25**


**Item
                7.**
            **Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations**
            **27**


**Item
                7A.**
            **Quantitative
                and Qualitative Disclosures About Market Risk**
            **40**


**Item
                8.**
            **Financial
                Statements and Supplementary Data**
            **41**


**Item
                9.**
            **Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure**
            **41**


**Item
                9A.**
            **Controls
                and Procedures**
            **41**


**Item
                9B.**
            **Other
                Information.**
            **43**




**PART
                III**
              **43**


**Item
                10.**
            **Directors,
                Executive Officers and Corporate Governance**
            **43**


**Item
                11.**
            **Executive
                Compensation**
            **44**


**Item
                12.**
            **Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters**
            **44**


**Item
                13.**
            **Certain
                Relationships and Related Transactions, and Director
                Independence**
            **44**


**Item
                14.**
            **Principal
                Accounting Fees and Services**
            **44**




**PART
                IV**
              **44**


**Item
                15.**
            **Exhibits
                and Financial Statement Schedules**
            **44**




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 portable electronics market,
      our
      general expectations concerning this industry and this market, and our position
      within this industry 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 this industry and this market, 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 ‘‘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;




·
            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 innovative liquid fuel cell products principally
      for
      the mobile handset and portable consumer electronics markets. Our first
      commercial product is our ‘‘24/7 Power Pack’’ - a small, inexpensive and
      disposable power source capable of providing direct power or multiple recharges
      to many of the most advanced portable electronic devices, such as mobile
      handsets, smart phones, MP3 players, gaming and other handheld electronic
      devices. The 24/7 Power Pack is the world’s first commercially viable portable
      fuel cell solution for the consumer market and represents a significant
      technological achievement in the advancement of the global fuel cell industry.
      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.




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.




**Commercialization**




As
      part
      of our commercialization process, in 2006 we have produced over 7,000 24/7
      Power
      Packs for testing, marketing and promotional purposes, of which we have
      distributed in excess of 1,000 to key personnel of leading mobile network
      operators, original equipment manufacturers (OEMs), software providers, retail
      customers, advertising executives, content providers and others worldwide.
      We
      have also distributed 24/7 Power Packs to our distributors - Quasar Business
      Solutions, Northwest Charging Systems, Inc., ASE International Inc., Kensington
      Technology Group and Superior Communications. Of particular focus to us are
      the
      high usage enterprise market (field service business market) customers, who
      we
      seek to access through the mobile operators, OEMs and distributors of software
      who service those customers. We have delivered and continue to deliver samples
      of our Power Pack and supporting documentation to a number of those entities
      for
      evaluation and testing of our product. Such documentation includes a
      considerable amount of material developed as part of the Underwriters
      Laboratories testing of our product. We have also delivered products to General
      Dynamics which has carried out tests on our product and is our exclusive
      distributor in the U.S. military markets.




Our
      semi-automated production line has the capacity to produce up to 30,000 units
      per month. We intend for our fully automated production line, operated by a
      third-party contract manufacturer, to be qualified for high-volume production
      in
      the second quarter of 2007, and during the second half of 2007, we plan to
      ramp
      up production of the units, from hundreds of thousands of units per month and
      increasing to 1.5 million units per month. We have received Underwriters
      Laboratories Inc. (UL) listing of our 24/7 Power Pack produced on our
      semi-automated line and we will seek UL listing of products coming off our
      fully
      automated line when that line is ready. UL is an internationally recognized,
      independent, not-for-profit product safety certification organization




-1-


involved
      in testing products and writing standards for safety. We believe this listing
      is
      important to the successful launch of the 24/7 Power Pack as it serves to
      provide customers, end-users and regulatory bodies with additional assurance
      and
      important third party certification of the durability and safety of the 24/7
      Power Pack. It also imposes on us a critical measure of quality control and
      product discipline. We expect these factors will help increase demand for our
      24/7 Power Packs during 2007.




**Market**




According
      to iSuppli Corporation, an independent market research firm, the number of
      mobile handset subscribers will grow from 2.1 billion in 2005 to 3.0 billion
      in
      2010, with reported annual sales of over 800 million new and replacement
      handsets per year. In addition, iSuppli estimates that the number of mobile
      handsets with advanced multimedia functionality, such as digital cameras, music
      playback (MP3 and other), FM Radio, GPS navigation systems, television
      reception, and office applications run by smart phones (such as Microsoft’s
      Windows Mobile 5.0) will increase from approximately 975 million in 2005
      (representing approximately 46% of total handsets) to approximately 2.5 billion
      in 2010 (representing approximately 83% of total handsets). The penetration
      of
      multimedia functionality combined with increasingly larger and higher resolution
      colored screens, advancing generation wireless protocols and dual mode handsets
      for WiFi and voice over internet protocol (‘‘VoIP’’) are creating significantly
      greater demand on power sources to keep handsets functioning. Furthermore,
      enterprise market customers are expanding their use of smart phones carrying
      sophisticated software like Windows Mobile 5.0 or Symbion. According to the
      Gartner Group, some 100 million smart phones were expected to be sold in 2006.
      This is consistent with Microsoft’s stated expectation that its software will be
      in approximately 100 million smart phones by the end of 2007. This is a market
      that we believe is most suited to our 24/7 Power Pack, to provide the power
      required to achieve the productivity desired from these devices. This conclusion
      has been borne out of meetings of our marketing staff with representatives
      of
      mobile service providers, software providers, OEMs and other companies active
      in
      that field.




It
      is
      widely believed and reported that current mobile handset battery technologies
      are approaching technological limitations. The recent large scale recalls of
      lithium ion batteries used in handsets suggests that there are limitations
      on
      the ability to expand battery power capacity. The power gap that already exists
      between ever-increasing power demands of electronic applications and battery
      capacity continues to widen. Although end users’ primary requirements for mobile
      handsets have historically been voice and text services and functionality,
      wireless industry participants, including wireless service providers, handset
      manufacturers and content providers, are increasingly relying on multimedia
      applications to drive revenues and growth. If handset batteries are rapidly
      depleted from the use of multimedia applications, limiting the handset’s primary
      voice and text functions, end users will likely be discouraged from using such
      applications on a regular basis. These factors drive wireless industry
      participants, as well as advertisers and content providers who are looking
      to
      expand their business model through handheld devices, to continually evaluate
      solutions such as portable fuel cell chargers and battery replacement devices.
      Similar power limitations are also being experienced with digital audio and
      video players such as iPods, MP3 players and other devices as well as by
      portable gaming devices. The only solutions currently offered for this growing
      power gap are portable battery based chargers, which are offered at a
      significant cost relative to their power supply and continue to pose
      environmental concerns. We believe that the proliferation of portable consumer
      devices with increasing multimedia functionality combined with the current
      technological limitations of overall battery capacity have created a strong
      demand for an alternative portable power source like our 24/7 Power
      Pack.




-2-


**Products**




In
      order
      to address the significant and growing market opportunity for higher capacity
      portable power sources, we have focused primarily on the following product
      offerings:




*24/7
      Power Pack.* Our
      24/7
      Power Pack is a disposable, portable auxiliary 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
      power (1.3 watts, up to 5.6 volts) to operate, and charge, multiple times,
      a
      wide range of the advanced portable electronic devices in the market today.
      Such
      devices include most mobile handsets (including the most advanced ‘‘3G’’ and
‘‘4G’’ cell phones with a full range of functionality), dual-mode phones for
      WiFi and VoIP, PDAs (both for personal and professional use, including wireless
      versions with e-mail and internet capability), smart phones, MP3 players,
      hand-held video games and other devices with similar power requirements. Our
      patent pending power management system provides the capability of charging
      a
      number of different devices using inexpensive connectors that access the
      particular device’s battery. When used to power a mobile handset, each
      disposable 24/7 Power Pack is expected to deliver the equivalent of
      approximately 20-30 hours of talk time (approximately 5-10 full charges), or
      approximately 60-80 hours of use time for an iPod (based on multiple charges),
      depending on the individual device’s power consumption and battery type. Before
      activation, the 24/7 Power Pack is expected to have a shelf life in excess
      of
      one and a half years. Once activated, the 24/7 Power Pack is expected to provide
      power up to twelve weeks. We are also working with General Dynamics C4 Systems
      to promote the 24/7 Power Pack for military use by the Department of Defense
      in
      GSM phones, PDAs and other uses as well as for sales to The Homeland
      Security. **




*Refuelable
      Power Pack* .
      We are
      developing a larger (8 watt) refuelable Power Pack product for military
      applications, including a power source for tablet computers, in support of
      the
      United States Department of Defense Wearable Computer Power Program. The
      Refuelable Power Pack is expected to allow the user to refuel the Power Pack
      by
      using a cartridge which transfers new fuel and electrolytes into the Power
      Pack,
      replacing any remaining fuel, electrolyte and water by-products which are
      returned to the refueling cartridge. This refueling process is expected to
      take
      a matter of seconds and the cartridge can then be discarded.




*Next
      Generation Products; Research and Development* .
      We are
      also developing other products, or exploring additional opportunities with
      respect to our fuel cell technologies, including:




·
            a
                next generation refuelable 24/7 Power
                Pack;




·
            a
                fuel cell using a gel electrolyte to increase performance relative
                to
                size;




·
            a
                more powerful, refuelable fuel cell for laptop
                computers;




·
            a
                stationary fuel cell for back-up emergency power for small office
                and home
                use; and




·
            fuel
                cells for the powering of unmanned aerial vehicles used by the
                military.




**Competitive
      Advantages**




*Leading-Edge,
      Disruptive Technology* .
      We
      believe that our products have a competitive advantage over virtually every
      other portable power source for handheld electronic devices. We believe these
      competitive advantages include:




-3-


·
            Significantly
                more hours of operation relative to cost when compared to portable
                disposable and rechargeable battery chargers currently on the
                market;




·
            The
                ability to start a mobile handset depleted of power more quickly
                than
                other portable chargers;




·
            Versatility
                to charge a variety of devices using low cost
                connectors;




·
            No
                discernible heat emission;




·
            Significantly
                less flammable or toxic than other fuel cell
                alternatives;




·
            Significantly
                lower cost of materials and greater efficiency when compared to other
                portable fuel cell products;




·
            Relative
                size - small, portable solution;
                and




·
            More
                environmentally friendly ‘‘green’’ solution relative to other battery or
                fuel cell alternatives.




*World’s
      First Commercial Portable Fuel Cell Solution* .
      We
      believe that we have the only commercially viable portable fuel cell solution,
      which we expect to launch by the second quarter of 2007. We believe that other
      portable fuel cell solutions are primarily in prototype stage 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 other
      fuel cell providers. 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.




*Inflection
      Point of Commercialization and Mass Production* .
      We
      recently announced the initiation of a testing and certification program of
      our
      24/7 Power Pack with UL. We received UL certification for 24/7 Power Packs
      coming off our semi-automated line in December 2006.




We
      have
      also entered into distribution agreements for our 24/7 Power Packs with several
      leading companies including Quasar Business Solutions, Northwest Charging
      Systems, Inc., ASE International, Kensington Technology and Superior
      Communications. We believe these relationships will facilitate greater reach
      for
      our products in enterprise and retail markets, thereby further advancing the
      commercialization process. Recent feedback from these distributors and other
      companies servicing the enterprise and retail markets indicates strong demand
      for the 24/7 Power Pack. In response to this demand, we intend for our fully
      automated production line, operated by a third-party contract manufacturer,
      to
      be qualified for high-volume production in the second quarter of 2007 and during
      the second half of 2007, we plan to ramp up production of the units, from
      hundreds of thousands of units per month and increasing to 1.5 million units
      per
      month.




*Significant
      Intellectual Property and Technological Know-how* .
      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 which we are pursuing 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 and power
      and
      management system. We




-4-


also
      have
      significant trade secrets pertaining to our fuel cell technology and production
      process which we believe create substantial barriers to market entry and protect
      us from reverse engineering.




**Strategic
      Relationships**




We
      have
      formed strategic relationships with well-established companies through
      distribution, marketing, technology, supply and product development
      arrangements. These relationships include:




·
            *ASE
                International Inc*.
                We have entered into an agreement with ASE for the distribution of
                our
                24/7 Power Packs to drug stores, convenience stores, department stores,
                airport stores and duty free shops. ASE issued to us in 2005 a purchase
                order for delivery of 200,000 24/7 Power Packs a month from the first
                year
                of availability from our production and 400,000 24/7 Power Packs
                a month
                from the second year of production.




·
            *Quasar
                Business Solutions*.
                Quasar is a Gold Level Microsoft partner, which is offering Microsoft
                Windows Mobile to their customer base. We have entered into a distribution
                agreement with Quasar to market our 24/7 Power Pack to that customer
                base,
                particularly to provide a power source to take full advantage of
                the
                Windows’ capabilities. Quasar has issued a purchase order for 1,000,000
                Power Packs.




·
            *Northwest
                Charging Systems, Inc.*(“*Northwest*”).
                We have entered into a distribution agreement for Northwest to market
                and
                sell our 24/7 Power Packs world wide. As part of that agreement,
                Northwest
                has issued an initial purchase order for 250,000 24/7 Power Packs.
                Northwest is a global resources company, manufacturer and battery
                assembler, focused on providing engineering, design, components and
                production assistance to the portable power market. Northwest provides
                Smart Battery management solutions for complex battery systems of
                up to 12
                cells in series including safety, pack management, cell balancing,
                fuel
                gauging and charging solutions.




·
            *Kensington
                Technology Group*.
                We have entered into a distribution agreement with Kensington to
                grant
                them a limited, exclusive right to market and distribute our 24/7
                Power
                Packs to their traditional customer base, including ‘‘big box’’ stores
                such as Best Buy and Circuit City, and office supply chains such
                as Office
                Max and Home Depot.




·
            *Superior
                Communications*.
                We have entered into a distribution agreement with Superior to distribute
                our 24/7 Power Packs to certain major mobile operators, including
                Cingular
                Wireless, AT&T Wireless, T-Mobile and
                Alltel.




·
            *General
                Dynamics C4 Systems*.
                We have an exclusive partnering relationship with General Dynamics
                to
                develop micro-fuel cell products for the U.S. Departments of Defense
                and
                Homeland Security, including refuelable Power Packs as power sources
                for
                tablet computers, cell phones and other
                applications.




·
            *ASPECT
                and Tenzor MA*.
                We have established a program for the commercialization of the 24/7
                Power
                Pack in Russia with ASPECT (the Association for Advanced Technologies
                of
                Russia) and Tenzor MA, two Russian business groups. The milestone-based
                program includes the certification, marketing and distribution of
                the 24/7
                Power Pack in Russia, and finally, the establishment of a full production
                assembly capability by Tenzor MA for the Russian market. Depending
                on the
                successful achievement of various commercialization milestones, the
                program contemplates the funding of capital investment by the Russian
                groups to build an automated production line in
                Russia.




-5-


·
            *Israel
                Aerospace Industries Ltd.*We
                have entered into an agreement with Israel Aerospace Industries Ltd.
                (formerly know as Israel Aircraft Industries Ltd.), Israel’s largest
                aerospace company and our largest stockholder, to develop an 800
                watt fuel
                cell to electrically power Israel Aerospace’s Unmanned Air Vehicle
                systems. The first phase, which covers a six month period, provides
                for us
                to develop a demonstration system which would pass functionality
                tests and
                which can be demonstrated to be redesignable to achieve the weight
                (6
                kilograms) goals of the final system. The first phase is funded by
                Israel
                Aerospace paying us $400,000. Upon the successful completion of the
                first
                phase as agreed upon by the parties, the second phase would require
                Israel
                Aerospace to pay us approximately $1,500,000 to complete the development
                of the fuel cell over an 18 month schedule. During the first phase
                and
                conditioned on minimum purchase requirements thereafter, Israel Aerospace
                will be granted exclusivity with respect to large fuel cells for
                unmanned
                vehicles. The agreement will be carried out by us as the prime contractor
                together with Oy Hydrocell of Finland as the main
                subcontractor.




**Target
      End Users**




Based
      on
      our studies and reviews with our distributors and potential customers, we have
      identified potential users and sources of demand for our products:




·
            *Enterprise*.
                We estimate that a large portion of our potential customer base will
                come
                from the ‘‘enterprise’’ market, principally the high-usage field service
                market. This demographic uses increasingly advanced portable electronic
                devices to access corporate applications and databases. The ability
                to
                keep field service workers’ devices charged while out on calls can have a
                significant impact on productivity.




·
            *Consumers
                of Content on Portable Devices*.
                Mobile operators, and content providers are increasing the ability
                of
                consumers to access content such as music, video, social networks,
                Google
                services and other content. Much of that content is to be underwritten
                by
                advertising, which adds to the power requirements. We expect consumers
                who
                want to fully access that content will be interested in having the
                Power
                Pack to provide the continuous power
                required.




·
            *Frequent
                Travelers*.
                We expect frequent travelers who utilize cell phones and other portable
                electronic devices to be interested in using the 24/7 Power Pack
                to keep
                their devices charged while
                traveling.




·
            *Parents*.
                We expect this demographic group to be interested in purchasing and
                frequently using a 24/7 Power Pack-type product. Uses cited for the
                24/7
                Power Pack included backup power for children with cell
                phones.




·
            *Emergency
                Users*.
                This market includes users requiring backup power during emergency
                situations such as natural disasters and
                blackouts.




·
            ‘‘*Kidults*.’’
                This market includes 13-to-24 year-olds who represent prime users
                for many
                advanced portable devices. We, and our distributors, believe that
                the 24/7
                Power Pack offers a valuable opportunity for the distributors and
                their
                customers to access this very important market early in their lives
                as a
                way of relating to this consumer group as they grow
                older.




-6-


**Strategy**




We
      intend
      to grow the demand for our fuel cell products by:




·
            Further
                strengthening strategic relationships with major mobile providers,
                OEMs,
                key enterprise clients, and other distributors to accelerate
                commercialization.




·
            Expanding
                manufacturing facilities systematically after the implementation
                of our
                first fully automated line in 2007.




·
            Continuing
                to improve performance, cost and size of our existing 24/7 Power
                Pack
                through technological improvements, optimized production processes,
                and
                improved supplier agreements.




·
            Developing
                next generation products for laptop computers, military applications,
                and
                the residential backup market.




Entering
      into arrangements with third parties, similar to the arrangement entered into
      with ASPECT and Tenzor MA, to leverage such third parties as a source of
      expertise and funding to create new manufacturing facilities and open up new
      markets for our products.




**Competition**




We
      expect
      our fuel cell products to compete against other fuel cell developers as well
      as
      against other advanced battery technologies and battery chargers. Our primary
      direct competitors are companies developing small fuel cells for the portable
      electronics market. Motorola, with technology licensed from the Los Alamos
      National Laboratory in New Mexico, has been developing a direct methanol fuel
      cell for mobile phones and now is developing a fuel cell using a reformer.
      Mechanical Technology Inc., which is working with a number of scientists
      formerly with the Los Alamos National Laboratory, has also licensed certain
      fuel
      cell technology from Los Alamos National Laboratory to further its efforts
      to
      develop direct methanol fuel cells, and has announced that it is working with
      Samsung Electronics Co., Ltd. to develop next-generation fuel cell prototypes
      for Samsung’s mobile phone business. Lawrence Livermore National Laboratory has
      also announced that it is developing small fuel cells for portable electronic
      devices. Other companies that have announced that they are developing fuel
      cells
      for portable electronic devices are NTT DoCoMo, Inc. (which has teamed with
      Aquafairy Co. to jointly develop micro fuel cells for certain 3G handsets),
      PolyFuel, Inc. (which has announced that it has developed a new membrane that
      is
      superior to others), Neah Powers Systems, Inc. and Smart Fuel Cell GmbH.
      Furthermore, a large number of corporations, national laboratories and
      universities in the United States, Canada, Europe, Japan and elsewhere are
      actively engaged in the development and manufacture of power sources, including
      batteries and fuel cells, both for portable electronic devices and other uses,
      and many more are entering the markets in which we compete. Each of these
      competitors has the potential to capture market share in various markets, which
      would have a material adverse effect on our position in the industry and our
      financial results.




We
      believe other large cell phone and portable electronic device companies are
      also
      developing fuel cells for the portable electronics market. Some of such
      companies providing public information about their fuel cell development
      programs include Toshiba Corporation, NEC




-7-


Corporation,
      Hitachi, Ltd., Casio Computer Co. Ltd., Samsung Electronics Co. Ltd. and Sony
      Corporation. Toshiba, Hitachi and other Japanese companies have announced their
      intention to unify the technical standards for micro fuel cells powered by
      methanol they are each developing, in the hope of boosting the market for such
      fuel cells. We believe that there are other companies that we may not know
      of
      that are developing fuel cells for portable electronic devices.




In
      addition, there are other fuel cell companies focusing on different markets
      than
      the portable electronic device market that we are initially targeting. These
      companies, including Plug Power Inc., Avista Systems Inc. and Fuel Cell Energy
      Inc., are not primarily targeting the portable electronics market, although
      at
      any time these companies could introduce new products in the portable electronic
      device market. Ballard Power Inc., a recognized leader in PEM fuel cell
      technology, has announced that it is developing a direct methanol fuel cell
      for
      transportation and portable applications, however, we do not know if this is
      intended for the portable electronic device market.




Additionally,
      we expect to compete with companies that develop, manufacture, and sell
      battery-operated chargers for portable electronic devices, including alkaline
      batteries, lithium battery packages and zinc-air batteries offered as chargers
      for cell phones, PDAs and other portable electronic devices that target many
      of
      the same markets we intend to target with our 24/7 Power Pack. Recently,
      Energizer has begun marketing a product called “Energi-to Go” which uses double
      A lithium batteries and charges a number of portable devices. Duracell has
      also
      announced that it is entering that market with a product. These companies have
      huge advantages of brand recognition, advertising capability and allocation
      of
      retail shelf space. Although we believe that our 24/7 Power Pack has advantages
      over these battery chargers, there is no assurance that we can compete against
      them successfully.




We
      also
      expect indirect competition from battery manufacturers who utilize existing
      battery technologies (both rechargeable and non-rechargeable). Existing battery
      technologies have the significant advantage of having commercially available
      products today, and are backed by companies who are continuously investing
      in
      marketing and further research and development to improve their existing
      products and explore alternative technologies. Chip manufactures are continuing
      efforts to develop chips for portable devices that work more efficiently and
      require less power.




Fuel
      cell
      companies working with methanol as the fuel have announced that they have made
      progress in the ability to transport those fuel cells on airplanes when
      contained inside a portable device. We have not participated in that program
      since our fuel does not contain methanol. It is our position that since our
      fuel
      is not hazardous because it is non-flammable and non-toxic that it conforms
      with
      regulations for use on an aircraft, although we can give no assurance in that
      regard.




We
      expect
      competition to intensify greatly as the need for new energy alternatives becomes
      more apparent and continues to increase. Some of our competitors are well
      established and have substantially greater managerial, technical, financial,
      marketing and product development resources. There can also be no assurance
      that
      current and future competitors will not be more successful in the markets in
      which we compete than we have been, or will be in the future. There can be
      no
      assurance that we will be successful in such a competitive
      environment.




We
      expect
      our fuel cell products to compete on the bases of size and weight, length of
      operating time, flexibility of use on different portable devices, ease of use
      and cost.




-8-


**Our
      Other Technologies**




Starting
      with our formation in 1992, we have been working to develop and commercialize
      new technologies. The first of these technologies, the CellScan, was the primary
      product of our indirect subsidiary, Medis El Ltd., through 1996. At the time
      of
      our formation, Medis El granted us distribution rights to the CellScan in the
      United States and its territories and possessions. Over ensuing years Medis
      El
      acquired other technologies, including our direct liquid fuel cell technology.
      In 2000, Medis El became our indirect, wholly-owned subsidiary. With the
      exception of our fuel cells, CellScan system and inherently conductive polymers,
      all of our technologies are in the development stage and no successful
      commercial prototypes have as yet been developed, nor can we assure you that
      any
      such prototypes will be developed or, if developed, commercialized. Furthermore,
      in allocating our limited resources of personnel and funds, at this time we
      decided to limit our development and commercialization efforts to our fuel
      cells, CellScan system and cell carrier and explosive detection
      technology.




***Cell
      Kinetics - CellScan***




The
      CellScan is a static cytometer, or an instrument for measuring fluorescence
      emanating from living cells while the cells are in a static state. A key element
      of the CellScan is its patented Cell Carrier which can accommodate up to 10,000
      cells, each in individual wells. Each well holds one living cell, such as a
      lymphocyte or a tumor cell. The CellScan can repeatedly and continuously monitor
      the fluorescence intensity and polarization emitted from stained living cells
      for purposes of cell research and disease diagnostics.




On
      January 12, 2006, we announced that our scientists had achieved a breakthrough
      in the use of the CellScan System, allowing much longer survival of cells and
      the opportunity for their measurement. We expect that this breakthrough will
      pave the way to important contributions in various areas of cancer research,
      including in the cutting edge research area of cancer stem cells, as well as
      providing a significant new tool in drug development. We have developed a new
      proprietary version of the CellScan Cell Carriers which hold up to ten thousand
      individual cells, particularly in providing new coatings of the Cell Carriers.
      The new Cell Carrier allows the cells to survive and be measured for over 48
      hours, which provides an opportunity for measuring the reaction of different
      cells and potentially separating out those cells whose reaction warrants further
      stimulation or study. To our knowledge, prior to the development of the
      CellScan, this ability to repeatedly measure the reaction of individual living
      cells by their fluorescence intensity and polarization over such an extended
      period of time has not been available to the scientific and medical communities.
      We have filed a patent application for this new Cell Carrier
      development.




Through
      Cell Kinetics Ltd. (an indirect wholly-owned subsidiary of Medis Technologies
      Ltd.), we are now concentrating on expanding the business opportunity of the
      unique abilities of our Cell Carrier technology to help satisfy the growing
      need
      for single cell analysis for various life science research and clinical
      diagnostics fields. Cell Kinetics is currently modifying the Cell Carrier design
      to enable its use with standard fluorescence microscopes. By doing so, and
      later
      by planning to design the Cell Carrier to fit light microscopy, we intend to
      substantially increase the availability of our unique Cell Carrier technology
      to
      many life science laboratories where fluorescence and light microscopes are
      installed.




We
      believe that we have identified a growing need for the simultaneous capture,
      registration, and monitoring of many adherent or non-adherent living cells.
      With
      our Cell Carrier that ability is provided by maintaining each cell in a
      registered micron-sized well for a long period of time.




-9-


We
      believe that this Cell Carrier technology can be valuable for a variety of
      research and clinical diagnostic applications such as in:




·
            cancer
                research;




·
            stem
                cells research;




·
            genetic
                engineering;




·
            drug
                discovery;




·
            drug
                toxicity assessment;




·
            immunology
                and immune function testing;




·
            hematology;




·
            cytology;
                and




·
            systems
                biology research.




During
      the last 2 years we have conducted a clinical pilot study designed to glean
      more
      about the potential of the CellScan as applied in the treatment of cancer
      patients, by enhancing individualized chemotherapy. We investigated the
      potential contribution of the CellScan in the complex decision process done
      by
      doctors while attempting to match the suitable chemotherapy treatment, in
      particular for advanced cancer stages. Based on the results of the pilot study,
      we decided to extend the laboratory research work, in order to better understand
      and define the target cases that could benefit from our proposed test. We intend
      to evaluate the benefit of such test in specific treatment resistant cases
      in
      hemato-oncology.




We
      obtained the CE mark, which indicates conformity with specified health and
      safety requirements set by European Union directives, for the CellScan in late
      2006.




We
      also
      intend to use this new platform for further development of clinical diagnostic
      applications based on the results of the basic science work done with our Cell
      Carrier. For that purpose we plan to continue the collaboration with third-party
      researchers and institutions in the development of potential applications for
      the Cell Carrier, including research of cancer stem cells and determining the
      efficacy of chemotherapeutic drugs for specific tumors.




We
      have
      decided that the best way to enhance value for our shareholders is to separate
      the CellScan and Cell Carrier technology into its own company. Therefore, we
      have established an indirect wholly-owned subsidiary, Cell Kinetics Ltd., to
      receive and, thereafter, attempt to commercially exploit this technology. At
      the
      same time, we are exploring additional financing sources, separate from Medis
      Technologies Ltd., so that it can be financially self supportive. We are also
      seeking ways to create the most value for our shareholders, which may include
      selling shares of Cell Kinetics Ltd. or spinning shares off to our shareholders
      or some other way of realizing value.




-10-


**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 per diem consultants. Most
      of
      the scientists working in the fuel cell field are from the former Soviet
      Union.  We
      are
      also working with subcontractors in developing specific components of our
      technologies.




The
      primary objective of our research and development program is to advance the
      development of our direct liquid fuel cell technology to enhance the commercial
      value of our products and technology, as well as to develop next generation
      fuel
      cell products. Another objective of our research and development program is
      to
      modify the CellScan Cell Carrier design to enable its use with standard
      fluorescence microscopes. We are also carrying on research and development
      activities related to our explosive detection technology.




We
      have
      incurred research and development costs of approximately $9,799,000, $12,144,000
      and $18,057,000 for the years ended December 31, 2004, 2005 and 2006,
      respectively.




**Government
      Regulation**




Currently,
      the only regulations we encounter are the regulations 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, to the extent applicable. We will also encounter in the future
      industry-specific government regulations that would govern our fuel cell
      products, such as transportation and environmental regulations for each region
      we seek to sell in, as well as regulations that would govern our other
      technologies, if and when developed for commercial use. 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 which we are pursuing 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.




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 five foreign countries and applications have been filed in 24 foreign
      countries (including Europe, Japan, China, Korea, Russia and India). 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.




Furthermore,
      we are 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




-11-


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 have also been issued a patent relating to our Cell Carrier
      and
      have filed and continue to file patent applications for our new Cell Carrier
      development.




We
      also
      have filed patent applications and have been granted a number of patents
      relating to our other technologies.




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 other security
      measures.




***Employees***




As
      of
      December 31, 2006, in addition to our chief executive officer and our chief
      operating officer, we had 152 full time employees, of which approximately 85
      were engineers, scientists and degreed professionals and 39 were technical,
      administrative and manufacturing support personnel and 28 were production
      employees. There are also approximately 17 engineers, scientists, degreed
      professionals and other personnel who work with us as consultants in researching
      and developing and marketing our technologies and products. All such employees
      and consultants are in Israel, except for our chief executive officer, our
      chief
      operating officer, vice president of marketing and sales and marketing
      assistant. We consider relations with our employees to be
      satisfactory.




**Item
              1A.**
            **Risk
                Factors******




**We
      have incurred losses and anticipate continued losses and negative cash
      flow.**




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 net losses of approximately $18,550,000 for the fiscal year ended
      December 31, 2005 and approximately $33,047,000 for the fiscal year ended
      December 31, 2006. Our plan is to reach the point of selling sufficient 24/7
      Power Packs coming off our automated production line in the second half of
      2007
      to achieve a rate of profitability, but we can give no assurance of that result.
      Our inability to become profitable may force us to curtail or temporarily
      discontinue our research and development programs and our 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, 2006, we had an accumulated
      deficit of approximately $176,778,000. We may continue to generate net losses
      for the foreseeable future and cannot predict when we will achieve
      profitability, if ever.




**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 based on there being a large consumer
      demand for our 24/7 Power Pack and future generations of our fuel cell products,
      as well as military




-12-


demand,
      a
      commercially acceptable market may never develop for our fuel cell products
      or
      any of our other technologies, or may develop more slowly than we anticipate.
      Our fuel cell products represent a new market product, 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 borohydrides, alkalines, glycerol, ethanol,
                or any
                other hydrogen-based fuels, the catalysts used in our fuel cell products
                or other chemicals used for powering our fuel cell products and,
                plastics
                and nickel used in the product;




·
            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 mass
      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.




**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 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.




We
      can
      give no assurance that our commercialization schedule will continue to be met
      as
      we further develop our fuel cell products, or any of our other technologies
      or
      products.




-13-


**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 product - our 24/7 Power Pack - we
      are
      developing other fuel cell products as well as future generations of our 24/7
      Power Pack, including refuelable Power Pack products 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, 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. 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 and working
      life, 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. 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 or any of our other technologies into commercially
      viable products.




**We
      have no experience manufacturing our products on a large scale commercial
      basis.**




To
      date,
      we have manufactured a limited number of our fuel cell products on our
      semi-automated production line at our facility in Israel. We intend for our
      fully automated production line, operated by a third-party contract
      manufacturer, to be qualified for high-volume production in the second quarter
      of 2007, and during the second half of 2007, we plan to ramp up production
      of
      the units, from hundreds of thousands of units per month and increasing to
      1.5
      million units per month. We have no experience in the final stages of
      manufacturing our fuel cell products on a high-volume commercial basis. We
      can
      offer no assurance that either we, our contract manufacturer or any other party
      we engage to build a fully automated line production for volume-production
      of
      our products will develop efficient, 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. Even if we or our contract manufacturer 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
      timely meet such requirements could cause us to lose customers and could have
      a
      material adverse effect on our business and financial results. Furthermore,
      our
      contemplated program for the volume production of our fuel cell products would
      require us to manufacture the electrodes, catalysts and fuel internally and
      deliver them to our proposed contract manufacturer to be part of the final
      product. Although we have established electrode and fuel production operations
      at our facility in Israel, we have not demonstrated that we are capable of
      producing any of those or any other components at a large enough scale to
      adequately supply those components in sufficient volume, or if those components
      will meet or surpass the manufacturing standards necessary for a successful
      final product.








-14-


**Customers
      will be unlikely to buy our fuel cell products or our other 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 our other technologies and 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 processes will not suffer from a reduction in
      performance, reliability and longevity. Furthermore, although we have estimated
      a pricing structure for our fuel cell products, including manufacturing costs
      and proposed sales price, we can give no assurance that these estimates will
      be
      correct in light of any manufacturing process we adopt or distribution channels
      we use.




We
      have
      developed a pricing structure for the CellScan, another product we are seeking
      to commercialize, and its related Cell Carriers and tests, that we believe
      would
      be commercially acceptable. However, we can give no assurance that potential
      CellScan customers would respond affirmatively to our pricing
      structure.




**We
      will be unable to market or sell our fuel cell products or products derived
      from
      any of our other technologies if we are unsuccessful in entering into sales
      agreements, arrangements, alliances, joint ventures or licensing agreements
      with
      third parties.**




As
      we do
      not have nor do we intend to develop our own broad based marketing or wide
      scale
      manufacturing infrastructure, our ability to market, manufacture and sell our
      fuel cell technologies or any of our other technologies 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 entering into additional
      arrangements, alliances, joint ventures or agreements or that the terms of
      which
      will be entirely beneficial to us. Failure to enter into 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.




**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.




We
      have
      entered into cooperative agreements with certain mobile operators for market
      testing and introduction of our 24/7 Power Pack. We are now in the process
      of
      providing some of these mobile operators, as well as others, with 24/7 Power
      Packs for evaluation and testing. We believe these relationships with mobile
      operators are important to the continued development and commercialization
      of
      our 24/7 Power Packs and other future fuel cell products. Generally, these
      agreements and relationships are subject to the risk of termination at the
      discretion of the mobile




-15-


operator.
      Further, the mobile operators are under no obligation to purchase any of our
      products. Termination of these agreements and relationships, or our failure
      to
      capitalize on them by selling our products to the mobile operators, could
      materially and adversely affect our commercialization plans and, therefore,
      our
      business, prospects, results of operations and financial condition. In addition,
      such mobile operators are not obligated to work exclusively with us in the
      area
      of fuel cell or battery technologies and may therefore enter into similar
      cooperation agreements, and work with and purchase products from our
      competitors. Such competition would have a material adverse effect on our
      position in the industry and our financial results.




**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.**




If
      and
      when either we or our contract manufacturers or manufacturing, strategic
      alliance or joint venture partners commence production of our fuel cells or
      fuel
      cell products, of which there can be no assurance, we will 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 impact 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.




We
      expect
      that platinum will not be a component in our commercial fuel cell products,
      however, there can be no assurance that we may not require some platinum to
      achieve the results we desire or in some future version of our fuel cell for
      larger applications. 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 a price 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




-16-


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.




**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 fuel cell products to compete against other fuel cell developers as well
      as
      against other advanced battery technologies and battery chargers. Our primary
      direct competitors are companies developing small fuel cells for the portable
      electronics market. Motorola, with technology licensed from the Los Alamos
      National Laboratory in New Mexico, has been developing a direct methanol fuel
      cell for mobile phones and now is developing a fuel cell using a reformer.
      Mechanical Technology Inc., which is working with a number of scientists
      formerly with the Los Alamos National Laboratory, has also licensed certain
      fuel
      cell technology from Los Alamos National Laboratory to further its efforts
      to
      develop direct methanol fuel cells, and has announced that it is working with
      Samsung Electronics Co., Ltd. to develop next-generation fuel cell prototypes
      for




-17-


Samsung’s
      mobile phone business. Lawrence Livermore National Laboratory has also announced
      that it is developing small fuel cells for portable electronic devices. Other
      companies that have announced that they are developing fuel cells for portable
      electronic devices are NTT DoCoMo, Inc. (which has teamed with Aquafairy Co.
      to
      jointly develop micro fuel cells for certain 3G handsets), PolyFuel, Inc. (which
      has announced that it has developed a new membrane that is superior to others),
      Neah Powers Systems, Inc. and Smart Fuel Cell GmbH. Furthermore, a large number
      of corporations, national laboratories and universities in the United States,
      Canada, Europe, Japan and elsewhere are actively engaged in the development
      and
      manufacture of power sources, including batteries and fuel cells, both for
      portable electronic devices and other uses, and many more are entering the
      markets in which we compete. Each of these competitors has the potential to
      capture market share in various markets, which would have a material adverse
      effect on our position in the industry and our financial results.




We
      believe other large cell phone and portable electronic device companies are
      also
      developing fuel cells for the portable electronics market. Some of such
      companies providing public information about their fuel cell development
      programs include Toshiba Corporation, NEC Corporation, Hitachi, Ltd., Casio
      Computer Co. Ltd., Samsung Electronics Co. Ltd. and Sony Corporation. Toshiba,
      Hitachi and other Japanese companies have announced their intention to unify
      the
      technical standards for micro fuel cells powered by methanol they are each
      developing, in the hope of boosting the market for such fuel cells. We believe
      that there are other companies that we may not know of that are developing
      fuel
      cells for portable electronic devices.




In
      addition, there are other fuel cell companies focusing on different markets
      than
      the portable electronic device market that we are initially targeting. These
      companies, including Plug Power Inc., Avista Systems Inc. and Fuel Cell Energy
      Inc., are not primarily targeting the portable electronics market, although
      at
      any time these companies could introduce new products in the portable electronic
      device market. Ballard Power Inc., a recognized leader in PEM fuel cell
      technology, has announced that it is developing a direct methanol fuel cell
      for
      transportation and portable applications, however, we do not know if this is
      intended for the portable electronic device market.




Additionally,
      we expect to compete with companies that develop, manufacture, and sell
      battery-operated chargers for portable electronic devices, including alkaline
      batteries, lithium battery packages and zinc-air batteries offered as chargers
      for cell phones, PDAs and other portable electronic devices that target many
      of
      the same markets we intend to target with our 24/7 Power Pack. Recently,
      Energizer has begun marketing a product called “Energi-to Go” which uses double
      A lithium batteries and charges a number of portable devices. Duracell has
      also
      announced that it is entering that market with a product. These companies have
      huge advantages of brand recognition, advertising capability and allocation
      of
      retail shelf space. Although we believe that our 24/7 Power Pack has advantages
      over these battery chargers, there is no assurance that we can compete against
      them successfully.




We
      also
      expect indirect competition from battery manufacturers who utilize existing
      battery technologies (both rechargeable and non-rechargeable). Existing battery
      technologies have the significant advantage of having commercially available
      products today, and are backed by companies who are continuously investing
      in
      marketing and further research and development to improve their existing
      products and explore alternative technologies. Chip manufactures are continuing
      efforts to develop chips for portable devices that work more efficiently and
      require less power.




Recently,
      fuel cell companies working with methanol as the fuel have announced that they
      have made progress in the ability to transport those fuel cells on airplanes
      when contained inside a portable device. We have not participated in that
      program since our fuel does not contain methanol. It




-18-


is
      our
      position that since our fuel is not hazardous because it is non-flammable and
      non-toxic that it conforms with regulations for use on an aircraft, although
      we
      can give no assurance in that regard.




We
      expect
      competition to intensify greatly as the need for new energy alternatives becomes
      more apparent and continues to increase. Some of our competitors are well
      established and have substantially greater managerial, technical, financial,
      marketing and product development resources. There can also be no assurance
      that
      current and future competitors will not be more successful in the markets in
      which we compete than we have been, or will be in the future. There can be
      no
      assurance that we will be successful in such a competitive
      environment.




**We
      may need additional funding in order 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 develop and market our 24/7 Power Pack or any of our other
      technologies and products, we believe this dependence will continue. We may
      need
      additional funding in order to be competitive, to establish a stronger financial
      position and to continue our operations. In addition we may need additional
      funding if cost overruns relating to the implementation of our manufacturing
      lines occur, if we do not achieve our current commercialization targets, or
      if
      we determine to expend funds on 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. 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
      complete the development of any of our other technologies or market and produce
      our fuel cell products.




**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 - New Energies, and the other
      scientists, engineers and technicians on our staff. Our success further depends
      on our highly skilled and experienced management, including Robert K. Lifton,
      our Chairman and Chief Executive Officer, and Howard Weingrow, our Deputy
      Chairman and Chief Operating Officer, and the other officers and employees
      that
      seek out, recognize and develop our technologies. The loss of the services
      of
      Mr. Finkelshtain, or any of our other technical talent or of Messrs. Lifton
      and
      Weingrow 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 and retaining executive, managerial and technical 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.




-19-


**There
      may be adverse effects on our earnings and our stock price due to the large
      amount of goodwill and intangible assets on our consolidated balance
      sheet.**




At
      December 31, 2006, our consolidated balance sheet showed approximately
      $58,205,000 of goodwill. Our goodwill balance of $58,205,000 is subject to
      a
      test for impairment at least annually, which could result in a charge to
      operations in the event impairment of the goodwill balance would be identified.
      We continue to amortize the remaining unamortized balance of our intangible
      assets of $256,000 as of December 31, 2006, with a remaining weighted average
      useful life of approximately 15 months.




**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 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 to apply for and obtain permits prior to any such
      development, production or assembly, of which we can give no assurance we 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 as limitations on transporting fuel cells on airplanes. 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 could 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




-20-


Franc.
      As
      a result, we have exposure to foreign currency exchange fluctuations. Recently,
      the U.S. dollar has been volatile relative to foreign currencies. Continued
      foreign currency fluctuations 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.




**Risks
      associated with conducting operations in Israel could materially adversely
      affect our ability to complete the development of our fuel cell technology
      or
      any of our other technologies.**




Our
      research and development facilities, our pilot manufacturing 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 our key personnel and their
      families reside 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, all male adult permanent residents of Israel under
      the age of 54, unless exempt, are obligated to perform up to 36 days 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.




**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 there is doubt as to the enforceability of civil
      liabilities under the Securities Act of 1933 and the Securities Exchange Act
      of
      1934 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:




·
            due
                service of process has been effected and the defendant was given
                a
                reasonable opportunity to defend;




·
            the
                obligation imposed by the judgment is executionable according to
                the laws
                relating to the enforceability of judgments in Israel, such judgment
                is
                not contrary to public policy, security or sovereignty of the State
                of
                Israel and such judgment is executionable in the state in which it
                was
                given;




-21-


·
            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.




**We
      do not expect to pay dividends to holders of our common
      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. No dividends may be paid
      upon our common stock unless all accumulated and unpaid dividends have been
      paid
      on the Series A preferred stock.  Other than the payment of dividends
      on our 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.




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, in connection with a fundamental change.




**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.









-22-


**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 substantial numbers of additional shares of our common or preferred stock,
      including in connection with future acquisitions, if any, or the perception
      that
      such issuances could occur, may cause prevailing market prices for our common
      stock to decline, which may negatively impact your investment. 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.




**Our
      stock price has been and could remain volatile.**




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.






**Item
              1B.**
            **Unresolved
                Staff Comments**




None














-23-


**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 chairman
      and chief executive officer, and Howard Weingrow, our deputy chairman and chief
      operating officer. We pay approximately $100,000 for rent per year. The sublease
      is on a month to month basis. In February 2007, we opened a sales office in
      Brentwood, California, with an aggregate annual rental of approximately
      $19,000.




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 leases
      covering approximately 44,800 square feet of such facilities have initial terms
      of up to five years until November 30, 2009 with two options of durations of
      30
      months each extending to November 30, 2014 and have a condition that we can
      unilaterally terminate the lease up to three years from the date of its
      inception; however, we would be required in the event of any such early
      termination to reimburse the lessor for a portion of the leasehold improvement
      costs paid by the lessor. The lease covering approximately 2,600 square feet
      has
      a term of five years until October 31, 2008. The lease covering
      approximately 4,900 square feet has a term of four years until April 10,
      2010. The lease covering 3,800 square feet has a term until February 28, 2009.
      Annual payments for rent under such leases amount to approximately $699,000,
      including landlord leasehold incentives provided to us which are recorded as
      depreciation expense rather than rent. We believe that our facilities are
      adequate for our present purposes; however, our future anticipated growth could
      require us to seek additional or new facilities.






**Item
              3.**
            **Legal
                Proceedings**




We
      are
      not party to any material litigation, and we are not aware of any threatened
      litigation that would have a material adverse effect on us or our
      business.






**Item
              4.**
            **Submission
                of Matters to a Vote of Security
                Holders**




No
      matters were submitted to a vote of securityholders during the fourth quarter
      of
      the fiscal year ended December 31, 2006.






**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:




-24-


**High**
            
            **Low****2005:**First
                Quarter
            
            $
            20.31
            
            $
            12.07Second
                Quarter
            
            
            17.40
            
            
            12.35Third
                Quarter
            
            
            18.71
            
            
            14.93Fourth
                Quarter
            
            
            19.18
            
            
            13.00







**2006:**First
                Quarter
            
            $
            25.29
            
            $
            14.70Second
                Quarter
            
            
            35.71
            
            
            18.52Third
                Quarter
            
            
            24.88
            
            
            18.60Fourth
                Quarter
            
            
            30.49
            
            
            17.39







As
      of
      March 12, 2007, there were approximately 425 stockholders of record of our
      common stock. Such number does not include beneficial owners holding shares
      through nominee names.




We
      have
      never declared or paid any dividends on our common stock. Dividends on our
      7.25%
      Series A Cumulative Convertible Perpetual Preferred Stock (“Series A preferred
      stock”) are payable when, as and if declared by our board of directors, out of
      legally available funds. The annual cash dividend on each share of our Series
      A
      preferred stock is $725 (there are 5,750 shares outstanding) and is payable
      quarterly, in arrears, commencing on February 15, 2007. Other than the payment
      of dividends on our Series A preferred stock, we currently anticipate that
      we
      will retain all of our future earnings for use in the expansion and operation
      of
      our business. Thus, we do not anticipate paying any cash dividends on our common
      stock in the foreseeable future. Our future dividend policy will be determined
      by our board of directors and will depend on various factors, including our
      results of operations, financial condition, capital requirements and investment
      opportunities. In addition, the terms of our Series A preferred stock restrict
      our ability to pay dividends on our common stock if there are any accumulated
      and unpaid dividends on our Series A preferred stock.






**Item
              6.**
            **Selected
                Financial Data**




The
      selected consolidated statement of operations data for the years ended December
      31, 2002 and 2003 and the selected consolidated balance sheet data as of
      December 31, 2002, 2003 and 2003 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,
      2004,
      2005, and 2006 and the selected consolidated balance sheet data as of December
      31, 2005 and 2006 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,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006**Revenues
            
            $
            192,000
            
            $
            131,000
            
            $
            —
            
            $
            425,000
            
            $
            150,000Cost
                of revenues
            
            
            130,000
            
            
            46,000
            
            
            —
            
            
            262,000
            
            
            98,000Gross
                profit
            
            
            62,000
            
            
            85,000
            
            
            —
            
            
            163,000
            
            
            52,000Operating
                expenses:Research
                and development costs, net
            
            
            4,054,000
            
            
            4,804,000
            
            
            9,799,000
            
            
            12,144,000
            
            
            18,057,000Selling,
                marketing, general and administrative expenses
            
            
            3,749,000
            
            
            4,197,000
            
            
            5,829,000
            
            
            5,720,000
            
            
            7,579,000Amortization
                of intangible assets
            
            
            2,633,000
            
            
            997,000
            
            
            208,000
            
            
            208,000
            
            
            208,000Total
                operating expenses
            
            
            10,436,000
            
            
            9,998,000
            
            
            15,836,000
            
            
            18,072,000
            
            
            25,844,000Loss
                from operations
            
            
            (10,374,000
            )
            
            (9,913,000
            )
            
            (15,836,000
            )
            
            (17,909,000
            )
            
            (25,792,000
            )Other
                income (expenses):Interest
                and other income
            
            
            151,000
            
            
            131,000
            
            
            246,000
            
            
            973,000
            
            
            2,517,000Interest
                expense
            
            
            (82,000
            )
            
            (55,000
            )
            
            (72,000
            )
            
            (1,614,000
            )
            
            (9,772,000
            )Net
                loss
            
            
            (10,305,000
            )
            
            (9,837,000
            )
            
            (15,662,000
            )
            
            (18,550,000
            )
            
            (33,047,000
            )Value
                of warrants issued or extended
            
            
            (2,241,000
            )
            
            (1,226,000
            )
            
            (2,066,000
            )
            
            —
            
            
            —Net
                loss attributable to commonstockholders
            
            $
            (12,546,000
            )
            $
            (11,063,000
            )
            $
            (17,728,000
            )
            $
            (18,550,000
            )
            $
            (33,047,000
            )Basic
                and diluted net loss per share
            
            $
            (0.57)(1
            )
            $
            (0.47
            )
            $
            (0.68
            )
            $
            (0.68
            )
            $
            (1.08
            )Weighted
                average number of common shares used in computing basic and diluted
                net
                loss per share
            
            
            21,897,871(1
            )
            
            23,429,829
            
            
            26,142,150
            
            
            27,423,568
            
            
            30,916,848





**Balance
        Sheet Data:**


**As
                of December 31,****2002**
            
            **2003**
            
            **2004**
            
            **2005**
            
            **2006**Working
                capital(2)
            
            $
            5,037,000
            
            $
            5,870,000
            
            $
            12,721,000
            
            $
            46,401,000
            
            $
            78,647,000Total
                assets
            
            
            67,391,000
            
            
            68,451,000
            
            
            79,773,000
            
            
            120,400,000
            
            
            177,608,000Accumulated
                deficit
            
            
            (96,390,000
            )
            
            (107,453,000
            )
            
            (125,181,000
            )
            
            (143,731,000
            )
            
            (176,778,000
            )Total
                stockholders’ equity
            
            
            65,405,000
            
            
            65,977,000
            
            
            73,863,000
            
            
            65,377,000
            
            
            110,436,000







(1)
            In
                accordance with SFAS No. 128 “Earnings Per Share,” the weighted
                average number of common shares used in computing basic and diluted
                net
                loss per share for the year ended December 31, 2002 have been
                retroactively adjusted because our March 11, 2003 rights offering
                contained a bonus element that is tantamount to a stock dividend,
                due to
                the subscription price at issuance being less than the fair market
                value
                of our common stock on such date.




(2)
            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 innovative liquid fuel cell products principally
      for
      the mobile handset and portable consumer electronics markets. We are also
      working to develop and commercialize some of the other technologies we own
      or
      own the rights to, including the CellScan, which is a static cytometer—an
      instrument for measuring reactions of living cells while the cells are in a
      static state, with particular concentration on expanding the versatility of
      and
      business opportunities for the Cell Carrier, and a device that if successfully
      developed would be able to detect certain explosive materials. Research and
      development activities for our remaining technologies have recently been
      curtailed or stopped, based upon our decision to devote more resources to
      developing our fuel cell technologies and commercializing fuel cell-based
      products. In recent years we have increased funding of our fuel cell related
      efforts (including our capital expenditures for the establishment of our
      production facilities), which we expect will continue until such time as we
      successfully commercialize our first fuel cell products, of which we can give
      no
      assurance, and perhaps thereafter.




**Results
        Of Operations**




From
      our
      inception in April 1992 through December 31, 2006, we have generated an
      accumulated deficit of approximately $176,778,000 including approximately
      $43,959,000 from amortization expense. We expect to incur additional operating
      losses during 2007 and possibly thereafter, principally as a result of our
      continuing anticipated research and development costs, increases in selling,
      marketing, general and administrative expenses related to the introduction
      of
      our products, cost related to commercialization of our fuel cell products and
      the uncertainty of bringing our fuel cell technology or any of our other
      technologies to commercial success. Since our inception, we have relied
      principally on outside sources of funding to finance our operations, as our
      revenues have been minimal. In November and December 2006, we issued an
      aggregate of 5,750 shares of our Series A preferred stock at a price of $10,000
      per share for gross proceeds of $57,500,000, less issuance costs of
      approximately $4,464,000. Additionally, in July and August 2005, we issued
      $49,000,000 aggregate principal amount of our 6% Senior Convertible Notes due
      July 2010 (“Convertible Notes”), less issuance costs of approximately
      $3,162,000, all of which was exchanged for shares of our common stock in April
      and May 2006 (see discussion below). Although we have received our first three
      purchase orders for our civilian Power Pack product which together provide
      for
      large scale delivery during our first two years of product availability, we
      will
      not derive any revenues under the purchase orders unless and until we commence
      large-scale manufacturing of our first fuel cell product. We intend for our
      fully automated production line, operated by a third-party contract
      manufacturer, to be qualified for high-volume production in the second quarter
      of 2007, and during the second half of 2007, we plan to ramp up production
      of
      the units, from hundreds of thousands of units per month and increasing to
      1.5
      million units per month. Until such time, we expect our reliance on outside
      sources of funding to continue until we are able to successfully commercialize
      our fuel cell or any of our other products or technologies, of which we can
      give
      no assurance.




Our
      research and development costs have increased from approximately $2,749,000
      for
      the year ended December 31, 1999 to approximately $18,057,000 for the year
      ended
      December 31, 2006 as we have continued to devote greater efforts to develop
      the
      technology underlying, and commercialize the products incorporating, our fuel
      cells; however, if we are unable to successfully




-27-


commercially
      develop our fuel cell technology or any of our other technologies, we will
      be
      forced to curtail our spending levels until such time, if ever, as we generate
      revenues or otherwise receive funds from third party sources.




***Year
      ended December 31, 2006 compared to year ended December 31,
      2005***




We
      sustained net losses of $33,047,000 during the year ended December 31, 2006,
      compared to $18,550,000 during the year ended December 31, 2005 . The
      increases in the net loss can primarily be attributed to charges to interest
      expense aggregating approximately $8,491,000 related to the exchanges in April
      and May 2006 of our common stock for all of our outstanding Convertible Notes
      and increases in research and development costs primarily due to increased
      funding of our fuel cell-related efforts as we move towards commercialization
      of
      our fuel cell products. Additionally, our selling, general and administrative
      expenses increased, as more fully described below. As we approach final stages
      of the anticipated commercialization of our fuel cell products, we have devoted
      and expect to continue to devote significant resources in the areas of capital
      expenditures and research and development costs for our fuel cell products.




We
      recognized revenues of $150,000 and cost of revenues of $98,000 during the
      year
      ended December 31, 2006, compared to revenues of $425,000 and cost of revenues
      of $262,000 during the year ended December 31, 2006. The revenues in both years
      are attributable to completed orders that we received from General Dynamics
      C-4
      Systems, Inc., a unit of General Dynamics Corporation relating to our fuel
      cell
      products and technology.




Research
      and development costs amounted to $18,057,000 during the year ended December
      31,
      2006, compared to $12,144,000 during the year ended December 31,
      2005 .
      The
      increase in research and development costs incurred during the year
      ended December 31, 2006 can be
      primarily attributed to an increase of approximately $5,580,000 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
                $16,566,000 during the year ended December 31, 2006, compared to
                costs of
                approximately $10,986,000 during the year ended December 31,
                2005.The
                increase in our research and development expenses related to our
                fuel cell
                technologies of approximately $5,580,000 reflects our decision to
                continue
                to devote substantial and increasing amounts of resources to the
                further
                development of our fuel cell technologies and products as we move
                towards
                commercialization and result from increases in labor, materials,
                depreciation and other costs.




·
            *Cell
                Kinetics - CellScan.*We
                incurred costs of approximately $1,125,000 during the year ended
                December
                31, 2006 relating to the further refinement and assembly of the desktop
                CellScan, on various research activities (including 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, compared to costs of approximately
                $763,000 during the year ended December 31, 2006 for further refinement
                of
                the desktop CellScan system and on various research activities. The
                increases in our CellScan related research and development costs
                during
                the year ended December 31, 2006 can be primarily attributed to increases
                materials costs for the assembly of additional desktop CellScans,
                labor
                costs - including new cell carrier design costs and cell carrier
                coating
                development - and other expenses, partially offset by a decrease
                in costs
                of subcontractors and consultants.




-28-


·
            *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 CellScan,
                we
                have been devoting few resources to many of our other technologies.
                We
                have, however, been working to develop a device to detect certain
                explosive materials. After performing preliminary testing of the
                device,
                we have made various changes in the device and continue to test different
                iterations with a view to exploiting our technology by developing
                a
                commercial product.




Selling,
      marketing, general and administrative (“SG&A”) expenses during the year
      ended December 31, 2006, amounted to approximately $7,579,000 ,
      compared to approximately $5,720,000 year
      ended December 31, 2005. The increases of $1,859,000 for the year ended December
      31, 2006, is primarily attributable  to
      increases in non-cash charges relating to the issuance of stock options of
      approximately $1,575,000, resulting principally from our adoption of SFAS 123(R)
      on January 1, 2006, increases in costs for the issuance and maintenance of
      patents and other professional fees of approximately $365,000, increases in
      insurance costs of approximately $123,000, increases in depreciation expense
      of
      approximately $106,000, increases in executive consulting costs of approximately
      $89,000, increase in selling and marketing costs of approximately $83,000,
      and
      net increases in various other SG&A cost categories of approximately
      $60,000, partially offset by decreases in labor and related costs of
      approximately $542,000.




Amortization
      of intangible assets amounted to $208,000 for each of the years ended December
      31, 2006 and December 31, 2005. 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 year ended December 31, 2006 amounted to
      net
      other expenses of approximately $7,255,000, compared to net other expense of
      approximately $641,000 during the year ended December 31, 2005. The difference
      of $6,614,000 between the years is due to an increase in interest expense of
      $8,158,000, partially offset by increases in interest income of $1,544,000.
      The
      increase in interest expense during the year ended December 31, 2006 is
      principally due to aggregate costs of approximately $8,491,000 recorded as
      interest expense in connection with the April and May 2006 exchanges of our
      common stock for our then outstanding Convertible Notes (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) partially offset by a decrease
      in
      interest incurred on our Convertible Notes prior to their exchange of
      approximately $333,000 during the year ended December 31, 2006. The increase
      in
      interest income during the year ended December 31, 2006 of $1,544,000 is
      primarily due to increases in our average cash and cash equivalents and
      short-term investment balances in 2006 compared to the same period in 2005
      resulting principally from the proceeds of our issuance of our Convertible
      Notes
      in July and August 2005 and our Series A preferred stock in November and
      December 2006, as well as increases in interest rates on cash and cash
      equivalents and short-term investments and $350,000 credited to interest income
      upon the exercise of a 75-day option to acquire up to an additional $7,500,0000
      of our Series A preferred stock that was granted to the initial purchaser in
      connection with the issuance in November 2006 of the first $50,000,000 of Series
      A preferred stock.




Effective
      January 1, 2006, we adopted FASB Statement No. 123 (revised 2004),
“Share-Based Payment” (“SFAS 123(R)”) and related Securities and Exchange
      Commission rules included in




-29-


Staff
      Accounting Bulletin No. 107, on a modified prospective basis. As a result
      of adopting SFAS 123(R), our net loss for the year ended December 31, 2006,
      is
      $2,900,000 greater than if we had continued to account for share-based
      compensation under Accounting Principles Board Opinion No. 25 (“APB
      25”).




***Year
      ended December 31, 2005 compared to year ended December 31,
      2004***




We
      sustained net losses of $18,550,000 during the year ended December 31, 2005
      compared to $15,662,000 during the year ended December 31, 2004 . The
      increase in the net loss can primarily be attributed to increases in research
      and development costs primarily due to increased funding of our fuel
      cell-related efforts as we move towards commercialization of our fuel cell
      products. Furthermore, during the year ended December 31, 2005 we incurred
      net
      increases in other expense which can be attributed to interest on our
      Convertible Notes that were issued in July and August 2005, partially offset
      by
      increased interest income earned on our cash balances and short-term
      investments. These factors were somewhat offset by a decrease in selling,
      general and administrative expenses, as more fully described below. As we get
      closer to the anticipated commercialization of our fuel cell 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.




During
      the year ended December 31, 2005, we recorded revenues of $425,000 and cost
      of
      revenues of $262,000 compared to none during the year ended December 31, 2004.
      The revenues recorded in 2005 are attributable to an August 2004 order from
      General Dynamics, pursuant to which we completed delivery of Power Packs and
      refueling cartridges to General Dynamics during the fourth quarter of
      2005.




Research
      and development costs, net amounted to $12,144,000 during the year ended
      December 31, 2005, compared to $9,799,000 during the year ended December 31,
      200 4.
      The
      increase in research and development costs incurred during 2005 compared to
      2004, can be primarily attributed to an increase of approximately $2,491,000
      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
                $10,986,000 during the year ended December 31, 2005 compared to costs
                of
                approximately $8,495,000 during the year ended December 31,
                2004.The
                increase in our research and development expenses related to our
                fuel cell
                technologies of approximately $2,491,000 reflects our decision to
                continue
                to devote substantial and increasing amounts of resources to the
                further
                development of our fuel cell technologies and products as we move
                towards
                commercialization and result from increases in labor, subcontractor,
                materials and other costs.




·
            *CellScan*.
                We incurred costs relating to the further refinement of the desktop
                CellScan system and on various research activities of approximately
                $763,000 during the year ended December 31, 2005 compared to costs
                of
                approximately $1,003,000 during the year ended December 31, 2004,
                for
                various research activities, refinement and assembly of the desktop
                CellScan. The decrease in costs can in part be attributed to our
                decision
                to devote more resources to developing our fuel cell technologies
                and
                commercializing fuel cell-based
                products.




·
            *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, we
                have
                been




-30-


devoting
                few resources to many of our other technologies. We have, however,
                been
                working to develop a device to detect certain explosive materials.
                After
                performing preliminary testing of the device in 2005, we have made
                various
                changes in the device and continue to test different iterations with
                a
                view to exploiting our technology by developing a commercial
                product.


Selling,
      marketing, general and administrative (“SG&A”) expenses during the year
      ended December 31, 2005 amounted to $5,720,000, compared
      to $5,829,000 during the year ended December 31, 2004. The decrease of $109,000
      for the year ended December 31, 2005 is primarily attributable  to
      a
      decrease in non-cash charges relating to stock options and warrants of
      approximately $999,000 and a decrease in costs related to the issuance and
      maintenance of patents of approximately $109,000, offset by an increase in
      labor
      and executive consulting costs of approximately $267,000, an increase in
      professional fees of approximately $152,000, an increase in office expenses
      of
      approximately $105,000, and increase in depreciation expense on leasehold
      improvement of approximately $101,000, an increase in a non-cash charge related
      to a reserve for a refund of land development costs of approximately $81,000,
      an
      increase in sales and marketing expense of approximately $63,000, an increase
      in
      insurance costs of approximately $52,000 and a net increase in various other
      SG&A cost categories of approximately $178,000 .




Amortization
      of intangible assets amounted to $208,000 during the each of the years ended
      December 31, 2005 and December 31, 2004. 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
      other
      income and expenses during the year ended December 31, 2005 amounted to a net
      other expenses of approximately $641,000, compared to a net other income of
      approximately $174,000 during the year ended December 31, 2004. The difference
      of $815,000 between the years ended December 31, 2005 and 2004 is primarily
      due
      to an increase in interest expense of approximately $1,542,000 during the year
      ended December 31, 2005, compared to the year ended December 31 2004, somewhat
      offset by an increase in interest income of approximately $727,000 during the
      same comparative periods. The increase in interest expense described above
      is
      principally due to our July and August 2005 issuance of $49,000,000 aggregate
      principal amount of our Convertible Notes due July 2010, related to which we
      recorded interest expense aggregating approximately $1,529,000 (comprised of
      $1,271,000 on the 6% coupon rate, $231,000 representing amortization of debt
      issuance costs and $27,000 representing amortization of beneficial conversion
      features) during 2005. The increase in interest income during the year ended
      December 31, 2005 as compared to 2004 is primarily due to an increase in our
      cash balances and short-term investments in 2005 resulting from our issuance
      of
      our Convertible Notes.




**Liquidity
        And Capital Resources**




We
      have
      historically financed our operations primarily through the proceeds of investor
      equity financing. In November and December 2006, we issued Series A preferred
      stock to qualified institutional investors in a private offering. In July and
      August 2005, we issued Convertible Notes in a private offering to qualified
      institutional buyers and in April and May 2006 exchanged our common stock for
      our outstanding Convertible Notes. We expect to continue to finance our
      operations through the sale of debt or equity until such time as we successfully
      commercialize our fuel cell products or products derived from any of our other
      technologies.




-31-


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
                status of our technologies; and




·
            the
                level of resources that we devote to the development of our technologies,
                patents, marketing and sales
                capabilities.




·
            The
                amount of resources required to complete our production facilities
                and
                product launch.




·
            Our
                anticipation, based on our current expectation that we will sell
                out the
                production capacity of our first fully automated production line,
                that we
                will undertake to build a second fully automated.




Another
      source of income or other means to affect our cash expenditures are
      collaborative arrangements with businesses and institutes for research and
      development and companies participating in the development of our technologies.
      Since January 2002, we have realized revenues of $898,000 on costs of revenues
      of $536,000, as well as credits against our research and development costs
      of
      approximately $594,000, with respect to collaborative arrangements with third
      parties relating to our fuel cell technologies. There can be no assurance that
      we will realize additional revenue or credits to our research and development
      expense from collaborative arrangements. Furthermore, there can be no assurance
      that we will raise additional funds through any financing approach implemented
      by us.




In
      July
      and August 2005, we issued $49,000,000 aggregate principal amount of our
      Convertible Notes in a private placement, less issuance costs aggregating
      approximately $3,162,000. Interest on our Convertible Notes was payable
      quarterly. The Convertible Notes were issued at par. Our Convertible Notes
      did
      not have the benefit of any sinking fund and were convertible prior to maturity
      or redemption into shares of our common stock at a conversion rate of 57.8035
      shares per $1,000 principal amount of our Convertible Notes (or an initial
      conversion price of $17.30 per share). Our Convertible Notes were callable
      by us
      after two years if the closing price of our stock for at least 20 trading days
      within a period of 30 consecutive trading days immediately prior to the
      notification date of such redemption exceeded $27.68, subject to adjustment.
      Of
      the total $49,000,000 aggregate principal amount of Convertible Notes issued,
      $7,000,000 aggregate principal amount of our Convertible Notes were issued
      pursuant to the exercise of a 30-day option that was granted to the initial
      purchaser in connection with the issuance of the first $38,000,000 aggregate
      principal amount of our Convertible Notes. The remaining $4,000,000 aggregate
      principal amount of our Convertible Notes were issued and sold directly to
      a
      group of affiliated investors in a private placement.




On
      April
      26, 2006, we completed an exchange of our common stock for our outstanding
      Convertible Notes whereby the holders of an aggregate of $46,582,000 in
      principal amount of the Convertible Notes exchanged their Convertible Notes
      for
      an aggregate of 2,948,806 shares of our common stock. Such number of shares,
      which aggregated 9.3% of our then issued and outstanding common stock after
      giving effect to this transaction, includes 256,201 shares, valued at $30 per
      share, in lieu of future interest payments had our Convertible Notes remained
      outstanding until their maturity, after giving effect to an eighteen month
      waiver of such payments.




-32-


On
      May 8,
      2006, we completed a second exchange of our common stock for our outstanding
      Convertible Notes whereby the holders of the remaining $2,418,000 in principal
      amount of the Convertible Notes exchanged their Convertible Notes for an
      aggregate of 153,068 shares of our common stock. Such number of shares includes
      13,299 shares of our common stock, valued at $30 per share, in lieu of future
      interest payments had such Convertible Notes remained outstanding until their
      maturity, after giving effect to an eighteen month waiver of such
      payments.




In
      November and December 2006, we issued 5,750 shares of our 7.25% Series A
      preferred stock in a private offering for aggregate gross proceeds of
      $57,500,000, less issuance costs aggregating approximately $4,464,000. The
      annual cash dividend on each share of our Series A preferred stock is $725
      and
      is payable quarterly, in arrears, commencing on February 15, 2007. Each share
      of
      our Series A preferred stock is convertible at the holder’s option at any time
      into 347.2222
      shares of our 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
      our
      common stock exceeds 150% of the conversion price for 20 trading days during
      any
      consecutive 30 trading day period, we may cause the conversion of our Series
      A
      preferred stock into common stock at the then prevailing conversion rate. Of
      the
      total $57,500,000 of our Series A preferred stock issued, $7,500,000 was issued
      pursuant to the exercise of a 75-day option that was granted to the initial
      purchaser in connection with the issuance of the first $50,000,000 of our Series
      A preferred stock.




On
      November 15, 2006, concurrent with our offering of our Series A preferred stock,
      we issued 1.5 million shares of our 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 that we received was a share lending
      fee of $.01 per share, or an aggregate of $15,000. The loaned shares were used
      by CGML to promote the sale of our Series A preferred stock by facilitating
      hedging transactions that may be undertaken by purchasers of our Series A
      preferred stock in the private offering described above.




During
      the year ended December 31, 2006 ,
      option
      holders exercised outstanding options issued under our 1999 Stock Option Plan,
      as amended, to acquire 2,235,000 shares of our common stock (including 1,728,500 shares exercised by our executive officers), for
      aggregate proceeds of approximately $20,439,000 (of which $1,180,000 was
      received in Subsequent to December 31, 2006).




During
      the year ended December 31, 2006, warrant holders exercised outstanding warrants
      to acquire 25,000 shares of our common stock, at an exercise price of $5.35
      per
      share, for aggregate proceeds of approximately $134,000.




Proceeds
      from our Series A preferred stock and debt-financings and other proceeds have
      been and will continue to be used for corporate expense and capital
      expenditures, including for the construction, start-up and other costs related
      to a fully-automated manufacturing line for our fuel cell products, as well
      as
      for other working capital purposes, and selling, marketing, general and
      administrative expenses. As of December 31, 2006, commitments for capital
      expenditures in 2007 aggregated approximately $28,000,000, which primarily
      relate to the completion of our fully automated production line and related
      facilities.




During
      the year ended December 31, 2006, on a limited basis, we entered into forward
      exchange contracts and participating forward exchange contracts in order to
      hedge the risk of variability of cash flows related to payments for the
      construction of our automated production line, which are denominated in Swiss
      Francs, and contractual payments denominated in Euro. As of




-33-


December
      31, 2006, we had no open forward exchange contracts or participating forward
      exchange contract.




During
      the year ended December 31, 2006, net cash used in operating activities was
      $22,875,000 compared to $16,435,000 for the year ended December 31, 2005. The
      increase was primarily attributable to an increase in research and development
      costs related to our fuel cell technologies reflecting our decision to continue
      to increase funding of such activities as we move towards commercialization
      of
      our fuel cell products, interest payments on our Convertible Notes (see above
      discussion of the exchange in April and May 2006 of our common stock for all
      of
      our outstanding Convertible Notes), an increase in selling, marketing, general
      and administrative expenses, as described above, and an increase in prepaid
      expenses and other current assets representing materials for the production
      of
      Medis Power Pack products and advance payments to suppliers, partially offset
      by
      an increase in interest income.




During
      the year ended December 31, 2006, net cash used in investing activities was
      $33,728,000, which represented (i) purchases of property and equipment of
      $16,724,000, of which approximately $14,940,000 represents costs related to
      building and equipping our fully automated and semi-automated production lines
      and related facilities, and (ii) investments in short-term investments of
      $40,419,000 less redemptions of short-term investments of $23,415,000. For
      the
      year ended December 31, 2005, net cash used in investing activities was
      $18,515,000, which represents the following (i) capital expenditures of
      $4,953,000, of which approximately $3,980,000 represents costs related to
      building and equipping our fully automated and semi-automated production lines
      and related facilities and approximately $416,000 of leasehold improvement
      and
      equipment costs related to our move to our new facility in Lod, Israel, (ii)
      investments in short-term investments of $54,000,000 less redemptions of
      short-term investments of $40,500,000 and (iii) long term loans granted in
      the
      amount of $62,000.




For
      the
      year ended December 31, 2006, cash aggregating $73,111,000 was provided by
      financing activities, compared to $54,487,000 for the year ended December 31,
      2005. The cash provided by financing activities for the year ended December
      31,
      2006 was generated from: (i) proceeds from our issuance of our Series A
      preferred stock of $57,500,000 less issuance costs of approximately $3,884,000
      paid during the year needed December 31, 2006 and less $350,000 allocated to
      the
      allocated to the over-allotment option granted to the initial purchaser, net,
      as
      described more fully above, (ii) proceeds of approximately $20,439,000 (of
      which
      $1,180,000 was received by us subsequent to December 31, 2006) from our issuance
      of 2,235,000 shares of our common stock (including 1,728,000 shares exercised
      by
      our executive officers), and (iii) proceeds of approximately $134,000 from
      our
      issuance of 25,000 shares of our common stock upon exercise of outstanding
      warrants, and (iv) $15,000 received as consideration in our share lending
      agreement, pursuant to which we lent 1,500,000 shares of our common stock to
      the
      initial purchaser of our Series A preferred stock (see discussion above). The
      cash provided by financing activities for the year ended December 31, 2005
      aggregating $54,487,000 was generated from: (i) net proceeds of approximately
      $45,841,000 from our issuance in July and August 2005 of our $49,000,000
      aggregate principal amount of Convertible Notes, (ii) net proceeds of
      approximately $700,000 from a private placement to an accredited investor in
      January 2005 of 50,000 shares of our common stock, (iii) net proceeds of
      approximately $1,000,000 from a private placement to an accredited investor
      in
      April 2005 of 83,543 shares of our common stock; (iv) proceeds of approximately
      $3,023,000 (of which $87,000 was received by us subsequent to December 31,
      2005)
      from our issuance of 399,500 shares of our common stock (including 265,000
      shares exercised by our executive officers)) upon the exercise of stock options
      issued under our stock option plan; and (v) proceeds of approximately $4,010,000
      from our issuance of 422,628 shares of our common stock upon exercise of
      outstanding warrants




-34-


(including
      129,200 shares exercised by a corporation beneficially owned by our Chief
      Executive Officer and our Deputy Chairman and Chief Operating Officer and 8,390
      shares exercised by our Chief Executive Officer and our Deputy Chairman and
      Chief Operating Officer ).




As
      of
      December 31, 2006, we had approximately $51,803,000 in cash and cash equivalents
      and $30,504,000 in short-term investments. While we expect our cash outlays
      to
      increase as we continue to pay for our fully-automated production line, we
      expect our cash and cash equivalents and short-term investments of approximately
      $82,307,000 to be sufficient for completion of our fully automated production
      line and related facilities and operating requirements during the ramp-up of
      our
      fully automated production line until we are able to finance our operations
      from
      the sales of our Power Pack product and related working capital financing if
      necessary. We intend for our fully automated production line, operated by a
      third-party contract manufacturer, to be qualified for high-volume production
      in
      the second quarter of 2007, and during the second half of 2007, we plan to
      ramp
      up production of the units, from hundreds of thousands of units per month and
      increasing to 1.5 million units per month. However, we can give no assurance
      that we will not need additional capital in completing our production capability
      and during the ramp-up of such capability.




Our
      failure to successfully commercialize or sell our fuel cell products or products
      derived from any of our other technologies would require us to seek outside
      sources of financing to raise additional funds for working capital or other
      purposes. However, such failure may materially adversely affect our ability
      to
      raise such additional funds if needed. In any event, it is not possible to
      make
      any reliable estimate of the funds required to complete the development of
      our
      fuel cell technologies or any of our other technologies or market and produce
      our fuel cell products.




**Commitments
      and Contingencies**





The
      following table sets forth our contractual obligations at December 31,
      2006.




**Payment
                Due By Period****Contractual
                Obligations**
            
            **Total**
            
            **2007**
            
            **2008**
            
            **2009**
            
            **2010**
            
            **2011
                and thereafter**Operating
                Lease Obligation
            
            $
            1,036,000
            
            $
            500,000
            
            $
            417,000
            
            $
            119,000
            
            $
            —
            
            $
            —Purchase
                Obligations
            
            
            41,463,000
            
            
            39,977,000
            
            
            892,000
            
            
            578,000
            
            
            16,000
            
            
            —Other
                Long-Term Liabilities (Note 1)
            
            
            1,730,000
            
            
            173,000
            
            
            173,000
            
            
            173,000
            
            
            173,000
            
            
            1,038,000Total
            
            $
            44,229,000
            
            $
            40,650,000
            
            $
            1,482,000
            
            $
            870,000
            
            $
            189,000
            
            $
            1,038,000





Note
                1:
            Other
                Long-Term Liabilities represents our accrued severance pay as of
                December
                31, 2006. Since we do not expect a high level of employee turnover
                giving
                rise to the payment of significant amounts of severance obligations,
                we
                have included approximately 10% of the total liability in each of
                the
                years 2007 through 2010 and the remainder in 2011 and
                thereafter.




**Tax
        Matters**


As
      of
      December 31, 2006, for U.S. federal income tax purposes, we have net operating
      loss carry-forwards of approximately $27,458,000. For Israeli income tax
      purposes, we have net operating loss carry-forwards of approximately
      $74,854,000. 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.




-35-


**Grants
        Obtained From The State Of Israel**


Medis
      El,
      our indirect wholly-owned subsidiary, received approximately $1,800,000 in
      research and development grants 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,
      with
      $1,629,000 of such funds being allotted for the CellScan and $167,000 allotted
      for the neuritor. Pursuant to the grant arrangement, Medis El is required to
      pay
      3% of its sales of CellScan and neuritor products developed with the grant
      funds
      until the grant amounts are paid in full. There is no requirement to repay
      the
      grants if the products developed with the grant funds are not sold. If Medis
      El
      sells 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.), our largest
      stockholder, its obligation relating to the repayment of grants out of future
      royalties, if any, of approximately $805,000. As of December 31, 2006, Medis
      El’s total contingent obligation for the repayment of grants, which includes the
      $805,000, is $2,601,000. Neither we nor Medis El presently receive any grants
      from the State of Israel.


**Approved
        Enterprise**


Under
      the
      Israeli Law for the Encouragement of Capital Investments, 1959, Medis El was
      issued a certificate of approval as an “Approved Enterprise.” Under the law,
      Medis El elected the “combined path,” pursuant to which Medis El had the right
      to receive a government guaranteed bank loan of 66% of the amount of the
      approved investment. In addition, Medis El had the right to receive a grant
      of
      24% of the approved investment, in which case the loan would be reduced by
      the
      amount of the grant. Medis El received investment grants of approximately
      $97,000 and loans of approximately $893,000. The investment grants were used
      to
      invest in equipment, furniture and fixtures and commercial vehicles. The loan
      proceeds were used for the above as well as to acquire know-how, leasehold
      improvements, marketing and working capital. The loans were paid-off in full
      during the year ended December 31, 2000. Additionally, through 2006 Medis El
      would have been subject to tax in respect of its income deriving from its
      Approved Enterprise activities is calculated at a rate of 20% of income for
      a
      ten-year period, with tax on dividends distributed of 15%, instead of 25%.
      These
      tax benefits expired in 2006.




In
      September 2001, More Energy, our fuel cell subsidiary, was granted Approved
      Enterprise status. The plan provides a two-year tax exemption, as well as
      reduced tax (25%-10%) for a period of 5-8 years. The benefits from the Approved
      Enterprise programs depend upon More Energy fulfilling the conditions under
      the
      letter of approval and the laws governing the grant. The commencement of the
      benefits period is determined beginning with the year in which taxable income
      is
      initially generated by the Approved Enterprise, provided that the earlier of
      14
      years have not elapsed from the year in which the approval was granted, or
      12
      years from the year in which the enterprise was initially operated. More
      Energy’s initial Approved Enterprise plan was completed during 2004 and its
      status as an entity qualifying for tax benefits will be governed by the
      provisions of the Investment Law, as amended (see below).




On
      April
      1, 2005, an amendment to the Investment 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




-36-


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.
      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 an advanced
      ruling from the Israeli tax authorities no later than within 6 months after
      the
      end of the Year of Election.




The
      Investment Law, as amended, also provides that any certificate of approval
      granted prior to the Amendment will remain subject to the terms and benefits
      included in such certificate of approval. Accordingly, while it is anticipated
      that the Investment Law, as amended, will govern More Energy’s Privileged
      Enterprise terms and benefits, we do 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.




***Goodwill
      and Intangible Assets***




We
      consider accounting policies related to our goodwill and other intangible assets
      to be critical due to the estimation processes involved and their materiality
      to
      our financial statements. As of December 31, 2006, the net book values of our
      goodwill and intangible assets were $58,205,000 and $256,000, respectively.
      Our
      goodwill and other intangible assets arose primarily as a result of three
      purchase accounting transactions: our acquisition of the minority interest
      in
      Medis Inc. in 1997, our exchange of our shares for the minority interest in
      Medis El in 2000 and our acquisition of the remaining 7% of More Energy that
      we
      did not already own in 2003. In amortizing our goodwill through December 31,
      2001 and our intangible assets through December 31, 2006, we made estimates
      and
      assumptions regarding the useful lives of such assets. If our estimates and
      assumptions change, the useful lives and resulting charges to operations for
      amortization of such assets would also change.




Additionally,
      with respect to our goodwill and intangible assets, as of January 1, 2002,
      we
      adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which was issued
      by the Financial Accounting Standards Board in June 2001. SFAS No. 142 requires
      enterprises, effective January 1, 2002, to discontinue amortizing goodwill,
      and
      instead requires that goodwill be subject to at least an




-37-


annual
      assessment for impairment. As part of our initial evaluation of our goodwill
      and
      intangible assets for any possible impairment, as of January 1, 2002, we were
      required to use estimates and assumptions with respect to markets for our
      products, future cash flows, discount rates and timing of commercialization
      of
      our technologies in determining the fair value of our reporting units. We have
      also performed annual tests for impairment of our goodwill for each of the
      years
      from 2002, through 2006. The estimates we used assume that our products will
      be
      accepted and that we will gain market share in the future and will experience
      growth in such market share. If we fail to deliver products or to achieve our
      assumed revenue growth rates or assumed gross margins, if the products fail
      to
      gain expected market acceptance, or if our estimates and/or other assumptions
      change or other circumstances change with respect to future cash flows, discount
      rates and timing of commercialization of our technologies, we may, in the
      future, be required to record charges to operations for impairment of our
      goodwill and/or our intangible assets.




***Stock
      Options and Warrants***




We
      also
      consider accounting policies related to stock options and warrants to be
      critical due to the estimation process involved. We utilize stock options and
      warrants as an important means of compensation for employees, directors and
      consultants and also warrants as an instrument in our fundraising process.
      Accounting for such options and warrants, in some circumstances, results in
      significant non-cash charges to our operations or accumulated loss. There are
      assumptions and estimates involved in determining the value of such stock
      options and warrants and the timing of related charges to our operations or
      accumulated loss. These estimates and assumptions include the expected term
      of
      the option, volatility of our stock price and interest rates. The market price
      of our stock also has a significant impact on charges we incur related to stock
      options and warrants. If these estimates and assumptions change or if our stock
      price changes, the charges to operations and/or accumulated loss could also
      change significantly.




Effective
      January 1, 2006, we adopted FASB Statement No. 123 (revised 2004),
“Share-Based Payment” (“SFAS 123(R)”) , and related Securities and Exchange
      Commission rules included in Staff Accounting Bulletin No. 107, on a
      modified prospective basis. Under this method, compensation cost recognized
      beginning January 1, 2006 include costs related to 1) all share-based
      payments (stock options and restricted stock awards) granted prior to but not
      yet vested as of January 1, 2006, based on the grant-date fair value
      estimated in accordance with the original provisions of FAS 123, “Accounting for
      Stock-Based Compensation” (“SFAS 123”), and 2) all share-based payments
      granted subsequent to December 31, 2005 based on the grant-date fair value
      estimated in accordance with the provisions of SFAS 123(R). Compensation cost
      for stock options is generally recognized ratably over the vesting period.
      During the year ended December 31 ,2006, we incurred significant non-cash
      charges to operations on grants of stock options to employees and directors
      as a
      result of our adoption of SFAS 123(R) on January 1, 2006 and we expect to
      continue to incur significant charges in the future.




***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.




-38-
 
 **Recent
          Accounting Pronouncements**


In
      February 2006, the FASB issued FASB Statement No. 155, “Accounting for Hybrid
      Financial Instruments - an amendment of FASB Statements No. 133 and 140” (“SFAS
      155”). This statement amends FASB Statements No. 133, “Accounting for Derivative
      Instruments and Hedging Activities” (“SFAS 133”), and No. 140, “Accounting for
      Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”
(“SFAS 140”). This statement allows financial instruments that have embedded
      derivatives to be accounted for as a whole (eliminating the need to bifurcate
      the derivative from its host) if the holder elects to account for the whole
      instrument on a fair value basis. It also clarifies which interest-only strips
      and principal-only strips are not subject to the requirements of SFAS 133;
      establishes a requirement to evaluate interests in securitized financial assets
      to identify interest that are freestanding derivatives or that are hybrid
      financial instruments that contain an embedded derivative requiring bifurcation;
      clarifies that concentrations of credit risk in the form of subordination are
      not embedded derivatives; and, amends SFAS 140 to eliminate the prohibition
      on a
      qualifying special-purpose entity from holding a derivative financial instrument
      that pertains to a beneficial interest other than another derivative financial
      instrument. This statement shall be effective for all financial instruments
      acquired or issued after the beginning of an entity’s first fiscal year
      beginning after September 15, 2006. The Company does not expect the adoption
      of
      SFAS 155 to have a material impact on its consolidated financial statements.




In
      July
      2006, the Financial Accounting Standards Board issued Interpretation No. 48,
      “Accounting for Uncertainty in Income Taxes”, (“FIN 48”). FIN 48 creates a
      single model to address uncertainty in tax positions. FIN 48 clarifies the
      accounting for income taxes by prescribing the minimum recognition threshold
      a
      tax position is required to meet before being recognized in the financial
      statements. FIN 48 also provides guidance on derecognition, measurement,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition. In addition, FIN 48 clearly scopes out income taxes
      from Financial Accounting Standards Board Statement No. 5, “Accounting for
      Contingencies”. FIN 48 utilizes a two-step approach for evaluating tax
      positions. Recognition (step one) occurs when an enterprise concludes that
      a tax
      position, based solely on its technical merits, is more-likely-than-not to
      be
      sustained upon examination. Measurement (step two) is only addressed if step
      one
      has been satisfied (i.e., the position is more-likely-than-not to be sustained).
      FIN 48 applies to all tax positions related to income taxes subject to Financial
      Accounting Standards Board Statement No.109, “Accounting for Income Taxes”. This
      includes tax positions considered to be “routine” as well as those with a high
      degree of uncertainty. Derecognition of a tax position that was previously
      recognized would occur when a company subsequently determines that a tax
      position no longer meets the more-likely-than-not threshold of being sustained.
      FIN 48 specifically prohibits the use of a valuation allowance as a substitute
      for derecognition of tax positions. FIN 48 is effective for fiscal years
      beginning after December 15, 2006. The Company does not expect the adoption
      of
      FIN 48 to have a material impact on its consolidated financial
      statements.




In
      September 2006, the FASB issued FASB Statement No. 157, “Fair Value
      Measurements.” (“SFAS 157”) This Standard defines fair value, establishes a
      framework for measuring fair value in generally accepted accounting principles
      and expands disclosures about fair value measurements. SFAS 157 is effective
      for
      financial statements issued for fiscal years beginning after November 15,
      2007 and interim periods within those fiscal years. The Company is currently
      evaluating the effect that the adoption of SFAS 157 will have on its
      consolidated financial statements.




In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities” (SFAS No. 159). SFAS No. 159 permits
      companies to choose to measure certain financial instruments and certain other
      items at fair value. The standard requires that




-39-


unrealized
      gains and losses on items for which the fair value option has been elected
      be
      reported in earnings. SFAS No. 159 is effective for the company beginning in
      the
      first quarter of fiscal year 2008, although earlier adoption is permitted.
      We
      are currently evaluating the impact that SFAS No. 159 will have on its
      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 and Euro-based assets.
      Furthermore, from time to time, we purchase forward contracts denominated in
      foreign currencies (see discussion of currency risk management
      below).




For
      many
      years prior to 1986, the Israeli economy was characterized by high rates of
      inflation and devaluation of the Israeli currency against the United States
      dollar and other currencies. Since the institution of the Israeli Economic
      Program in 1985, inflation, while continuing, has been significantly reduced
      and
      the rate of devaluation has been substantially diminished. However, The
      following table shows the rates of inflation (deflation) and devaluation
      (appreciation) of the NIS against the U.S. dollar for the years of 2002 through
      2006:




Rate
                of Inflation or (Deflation)
            
            Rate
                of Devaluation or (Appreciation) of the NIS against the
                Dollar2002
            
            
            6.5
            
            
            7.32003
            
            
            (1.9)
            
            
            (7.6)2004
            
            
            1.2
            
            
            (1.6)2005
            
            
            2.4
            
            
            6.92006
            
            
            (0.1)
            
            
            (8.2)







Additionally,
      in 2007, through January 31, Israel experienced deflation of 0.1% and the rate
      of devaluation of the NIS was 0.8% against the dollar.


**Currency** **Risk Management**




On
      September 28, 2005, we entered into a Capital Equipment Purchase Agreement
      (the
“Agreement”) with Ismeca Europe Automation SA (“Ismeca”) to build an automated
      assembly line for our fuel cell Power Pack products. Under the Agreement, as
      amended in October and December




-40-


2006,
      we
      will pay Ismeca an aggregate of approximately 18,973,000 Swiss Francs
      (approximately $15,562,000 at the currency exchange rate in effect on December
      31, 2006) 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. Payments totaling
      approximately 4,721,000 Swiss Francs or approximately $3,755,000 have been
      made
      since the inception of the Agreement through December 31, 2006 and additional
      payments totaling 6,192,000 Swiss Francs or approximately $4,973,000 have been
      made in January and February 2007.




Based
      on
      a study performed by us, we have undertaken a currency risk management strategy
      for payments that will be due under the Agreement and pursuant to which we
      have,
      on a limited basis, entered into forward contracts and participating forward
      contracts for the purchase of Swiss Francs in amounts aggregating approximately
      7,200,000 Swiss Francs. At our option, we either take delivery of the Swiss
      Francs or net settle the contracts during their term. As part of our strategy,
      we continue to monitor the value of the Swiss Franc in relationship to the
      U.S
      Dollar and will consider entering into new arrangements in the event that we
      recognize trends in the exchange rate of the Swiss Franc in relationship to
      the
      U.S Dollar or if we otherwise consider it beneficial to do so. Through December
      31, 2006, we have not incurred any material costs on payments made to date
      under
      the Agreement as a result of exchange rate fluctuations.




In
      July
      and August 2006, we entered into forward contract for the purchase of a total
      of
      750,000 Euro in order to hedge a portion of our future purchase obligations
      that
      are denominated in Euro. As of December 31, 2006, the Company had no open
      forward exchange contracts.






**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 Financial 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
      Financial Officer concluded that our disclosure controls and procedures were
      effective as of December 31, 2006.




-41-


**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 Financial Officer,
      we conducted an evaluation of the effectiveness of our internal control over
      financial reporting as of December 31, 2006 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, 2006.




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.




Management’s
      assessment of the effectiveness of our internal control over financial reporting
      as of December 31, 2006 has been audited by Kost Forer Gabbay & Kasierer, a
      Member of Ernst & Young Global, an independent registered public accounting
      firm, as stated in their report which is included elsewhere herein.






**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, 2006 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 Stockholders


Medis
      Technologies Ltd.




We
      have
      audited management’s assessment, included in the accompanying Management’s
      Report on Internal Control Over Financial Reporting, that Medis Technologies
      Ltd. maintained effective internal control over financial reporting as of
      December 31, 2006, 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. Our responsibility is to express an opinion on management’s
      assessment and an opinion on the effectiveness of 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, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




-42-


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, management’s assessment that Medis Technologies Ltd. maintained
      effective internal control over financial reporting as of December 31,
      2006, is fairly stated, in all material respects, based on the COSO criteria.
      Also, in our opinion, Medis Technologies Ltd. maintained, in all material
      respects, effective internal control over financial reporting as of
      December 31, 2006, based on the 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. as of December 31, 2006 and 2005, and the related
      consolidated statements of operations, stockholders’ equity and cash flows for
      each of the three years in the period ended December 31, 2006 of Medis
      Technologies Ltd. and our report dated March 14, 2006 expressed an unqualified
      opinion thereon.




KOST
                FORER GABBAY & KASIERERA
                MEMBER OF ERNST & YOUNG GLOBALTel
                Aviv, IsraelMarch
                14, 2006







**Item
              9B.**
            **Other
                Information.**




Not
      applicable.




**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
      2007 Annual Meeting of Stockholders (the “2007 Proxy Statement”), which is
      incorporated herein by this reference.




-43-


**Item
                  11.**
              **Executive
                  Compensation**




The
      information required by this Item 11 is set forth in the 2007 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 2007 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 2007 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 2007 Proxy Statement,
      which is incorporated herein by this reference.






**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.
                (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*
            Employment
                Agreement dated March 29, 2005 between Zvi Rehavi and Medis El Ltd.
                (5)10.3*
            Employment
                Agreement dated March 23, 1999 between Israel Fisher and Medis El
                Ltd.
                (6)10.4
            Strategic
                Agreement dated April 5, 2001 by and between General Dynamics Government
                Systems Corporation and Medis Technologies Ltd. (6)10.5
            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 (7)




-44-




10.6
            Agreement
                dated October 17, 1991 between Bar-Ilan University and Israel Aircraft
                Industries Ltd. (7)10.7
            Amendment
                of License dated August 8, 1992 between Bar-Ilan University and Israel
                Aircraft Industries Ltd. and Medis El (7)10.8
            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.
                (7)10.9
            Letter
                Agreement dated July 18, 1996 between Medis El Ltd. and Bar-Ilan
                University (7)10.10*
            Consultancy
                Agreement dated as of January 2, 2000 between Medis Technologies
                Ltd. and
                Robert K. Lifton (8)10.11*
            Consultancy
                Agreement dated as of January 2, 2000 between Medis Technologies
                Ltd. and
                Howard Weingrow (8)10.12**
            Distribution
                Agreement dated as of March 9, 2004 by and between ACCO Brands, Inc.
                through its Kensington Technology Group, and Medis Technologies Ltd.
                (9)10.13
            Summary
                of Material Lease Terms to Lod, Israel Facility(10)10.14**
            Product
                and Manufacturing Development Agreement, dated as of May 3, 2004,
                between
                Medis Technologies Ltd. and Flextronics International Ltd.
                (11)10.15
            Agreement
                dated May 5, 2003 between Medis Technologies Ltd. and General Dynamics
                C4
                Systems, Incorporated (12)10.16**
            Distribution
                Agreement, dated as of August 10, 2004, between ASE International
                Inc. and
                Medis Technologies Ltd. (13)10.17**
            Distribution
                Agreement, dated as of August 3, 2004, between Superior Communications
                and
                Medis Technologies Ltd. (14)10.18*
            Consultancy
                Agreement dated as of July 1, 2002 between More Energy Ltd. and JSW
                Consulting Inc. (12)10.19*
            Special
                Personal Employment Contract dated as of July 15, 2002 between Medis
                El
                Ltd. and Yaakov Weiss (12)10.20
            Purchase
                Order from ASE International, Inc. and Acceptance Letter of Medis
                Technologies Ltd. (15)10.21
            Amendment
                to Agreement dated April 5, 2001 between Medis Technologies Ltd.
                and
                General Dynamics C4 Systems, Incorporated, dated May 30, 2005
                (15)10.22**
            Letter
                of Agreement for Design Services dated as of May 6, 2005 between
                More
                Energy Limited and Celestica Ireland Limited (15)10.23**
            Capital
                Equipment Purchase Agreement, dated as of September 15, 2005, between
                Medis Technologies Ltd. and Ismeca Europe Automation S.A.
                (16)10.24**
            Agreement
                for Manufacture, dated as of September 27, 2005, between More Energy
                Ltd.
                and Celestica Ireland Limited and guaranty by Medis Technologies
                Ltd.
                (16)10.25
            Letter
                Agreement, dated January 31, 2006, between Medis Technologies Ltd.
                and
                Bank of America (17)10.27
            Consultancy
                Agreement between HT Consultants, Inc. and More Energy Ltd., dated
                as of
                January 1, 2003 (18)10.28
            Business
                cooperation and Distribution Agreement, dated as of May 1, 2006,
                between
                More Energy Ltd. and Oy Hydrocell Ltd. (19)10.29**
            Cooperation
                Agreement dated October 18, 2006 by and between More Energy, Ltd.
                and
                Israel Aircraft Industries, Ltd. (20)10.30**
            Distribution
                Agreement dated October 29, 2006 by and between Medis Technologies
                Ltd.
                and Quasar Business Solutions. (20)10.31
            Registration
                Rights Agreement, dated November 15, 2006, by and between the Registrant
                and Citigroup Global Markets Inc. (21)14.1
            Code
                of Ethics (9)




-45-




21.1
            Subsidiaries
                of the Registrant23.1
            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 by reference
                herein.




(2)
            Filed
                as an exhibit to the Registration Statement on Form S-1, as amended
                (File
                No.: 333-83945), 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 by reference
                herein.




(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 an exhibit to the Current Report on Form 8-K dated March 29, 2005
                of
                Medis Technologies Ltd. and incorporated herein by
                reference.




(6)
            Filed
                as an exhibit to the Annual Report on Form 10-K for the year ended
                December 31, 2000 of Medis Technologies Ltd. and incorporated herein
                by
                reference.




(7)
            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.




(8)
            Filed
                as an exhibit to the Annual Report on Form 10-K for the year ended
                December 31, 2001 of Medis Technologies Ltd. and incorporated herein
                by
                reference.




(9)
            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.




(10)
            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.




(11)
            Filed
                as an exhibit to the Quarterly Report on Form 10-Q for the quarter
                ended
                March 31, 2004 of Medis Technologies Ltd. and incorporated herein
                by
                reference.




(12)
            Filed
                as an exhibit to the Quarterly Report on Form 10-Q for the quarter
                ended
                March 31, 2003 of Medis Technologies Ltd. and incorporated herein
                by
                reference.




(13)
            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.




-46-


(14)
            Filed
                as an exhibit to the Current Report on Form 8-K dated August 5, 2004
                of
                Medis Technologies Ltd. and incorporated herein by
                reference.




(15)
            Filed
                as an exhibit to the Quarterly Report on Form 10-Q for the quarter
                ended
                June 30, 2005 of Medis Technologies Ltd. and incorporated herein
                by
                reference.




(16)
            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.




(17)
            Filed
                as an exhibit to the Current Report on Form 8-K dated February 2,
                2006 of
                Medis Technologies Ltd. and incorporated by reference
                herein.




(18)
            Filed
                as an exhibit to the Quarterly Report on From 10-Q dated March 31,
                2006 of
                Medis Technologies Ltd. and incorporated by reference
                herein.




(19)
            Filed
                as an exhibit to the Current Report on Form 8-K dated May 5, 2006
                of Medis
                Technologies Ltd. and incorporated by reference
                herein.




(20)
            Filed
                as an exhibit to the Quarterly Report on Form 10-Q dated September
                30,
                2006 of Medis Technologies Ltd. and incorporated by reference
                herein.




(21)
            filed
                as an exhibit to the Registration Statement on Form S-3 (File No.:
                333-140508) of Medis Technologies Ltd. and incorporated by reference
                herein.






(c)  Financial
      Statement Schedules.




None

































-47-


**INDEX**
    **Page**
 **Medis
          Technologies Ltd.** **Consolidated
          Financial Statements**
  Report
                    of Independent Registered Public Accounting Firm
                F-2Consolidated
                    Financial StatementsConsolidated
                    Balance Sheets as of December 31, 2005 and 2006
                F-3Consolidated
                    Statements of Operations for the years ended December 31, 2004,
                    2005 and
                    2006
                F-4Consolidated
                    Statements of Stockholders’ Equity for the years ended December 31, 2004,
                    2005 and 2006
                F-5Consolidated
                    Statements of Cash Flows for the years ended December 31, 2004,
                    2005 and
                    2006
                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.
        (a Delaware corporation) and its subsidiaries (the “Company”) as of
        December 31, 2005 and 2006 and the related consolidated statements of
        operations, stockholders’ equity and cash flows for each of the three years in
        the period ended December 31, 2006. 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 at the Company
        as of
        December 31, 2005 and 2006, and the consolidated results of its operations
        and its cash flows for each of the three years in the period ended
        December 31, 2006, in conformity with U.S. generally accepted accounting
        principles.
  As
        discussed in Note B-11 to the consolidated financial statements, the Company
        adopted the provisions of Statement of Financial Accounting Standards No.
        123(R), “Share Based Payment”, effective January 1, 2006.
  We
        also
        have audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the effectiveness of the Company internal
        control over financial reporting as of December 31, 2006, 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 14, 2007 expressed an unqualified opinion thereon.
  Tel
                  Aviv, Israel
              
              KOST
                  FORER GABBAY & KASIERERMarch
                  14, 2007
              
              A
                  MEMBER OF ERNST & YOUNG GLOBAL
 
 
 F-2
 **Medis
        Technologies Ltd. and Subsidiaries**
 **Consolidated
        Balance Sheets**
 **(in
        U.S. dollars)**
  **December
                  31,****2005**
              
              **2006****ASSETS**Current
                  assetsCash
                  and cash equivalents
              
              $
              35,295,000
              
              **$**
              **51,803,000**Short-term
                  investments (Note C)
              
              
              13,500,000
              
              
              **30,504,000**Prepaid
                  expenses and other current assets
              
              
              709,000
              
              
              **4,696,000**Other
                  accounts and notes receivable
              
              
              821,000
              
              
              **3,561,000**Total
                  current assets
              
              
              50,325,000
              
              
              **90,564,000**Property,
                  plant and equipment, net (Note D)
              
              
              7,475,000
              
              
              **27,318,000**Long-term
                  note
              
              
              64,000
              
              
              ***—***Severance
                  pay fund
              
              
              939,000
              
              
              **1,265,000**Debt
                  issuance costs, net (Note G)
              
              
              2,928,000
              
              
              ***—***Intangible
                  assets, net (Note E)
              
              
              464,000
              
              
              **256,000**Goodwill
              
              
              58,205,000
              
              
              **58,205,000**Total
                  assets
              
              $
              120,400,000
              
              **$**
              **177,608,000**
   **LIABILITIES
                  AND**
                **STOCKHOLDERS’
                  EQUITY**Current
                  liabilitiesAccounts
                  payable
              
              $
              1,268,000
              
              **$**
              **8,367,000**Accrued
                  expenses and other current liabilities (Note F)
              
              
              2,656,000
              
              
              **3,550,000**Total
                  current liabilities
              
              
              3,924,000
              
              
              **11,917,000**Leasehold
                  incentive obligations, net
              
              
              931,000
              
              
              **839,000**Senior
                  Convertible Notes, net (Note G)
              
              
              48,760,000
              
              
              ***—***Accrued
                  severance pay
              
              
              1,408,000
              
              
              **1,730,000**Total
                  Liabilities
              
              
              55,023,000
              
              
              **14,486,000**Commitments
                  and contingent liabilities (Note J)Series
                  A Preferred Stock, net, $.01 par value; $10,000 liquidation preference
                  per
                  share; 10,000 shares authorized; none issued and outstanding at
                  December
                  31, 2005; and 5,750 issued and outstanding at December 31, 2006
                  (Note
                  H)
              
              
              *—*
              
              
              **52,686,000**Stockholders’
                  equity (Note I)Common
                  stock, $.01 par value; 38,000,000 and 41,500,000 shares authorized
                  at
                  December 31, 2005 and 2006, respectively; 27,972,490 shares issued
                  and
                  outstanding, at December 31, 2005; and 34,934,864 shares issued and
                  outstanding at December 31, 2006 (including 1,500,000 shares loaned
                  to be
                  returned)
              
              
              280,000
              
              
              **349,000**Additional
                  paid-in capital
              
              
              208,828,000
              
              
              **286,865,000**Accumulated
                  deficit
              
              
              (143,731,000
              )
              
              **(176,778,000**
              **)**Total
                  stockholders’ equity
              
              
              65,377,000
              
              
              **110,436,000**Total
                  liabilities and stockholders’ equity
              
              $
              120,400,000
              
              **$**
              **177,608,000**
   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,****2004**
              
              **2005**
              
              **2006**Revenues
                  (Note J-4)
              
              $
              *—*
              
              $
              425,000
              
              **$**
              **150,000**Cost
                  of Revenues
              
              
              —
              
              
              262,000
              
              
              **98,000**Gross
                  profit
              
              
              —
              
              
              163,000
              
              
              **52,000**Operating
                  expenses:Research
                  and development costs, net (Note J-4)
              
              
              9,799,000
              
              
              12,144,000
              
              
              **18,057,000**Selling,
                  marketing, general and administrative expenses
              
              
              5,829,000
              
              
              5,720,000
              
              
              **7,579,000**Amortization
                  of intangible assets
              
              
              208,000
              
              
              208,000
              
              
              **208,000**Total
                  operating expenses
              
              
              15,836,000
              
              
              18,072,000
              
              
              **25,844,000**Loss
                  from operations
              
              
              (15,836,000
              )
              
              (17,909,000
              )
              
              **(25,792,000**
              **)**Interest
                  income (expenses)Interest
                  income
              
              
              246,000
              
              
              973,000
              
              
              **2,517,000**Interest
                  expense
              
              
              (72,000
              )
              
              (1,614,000
              )
              
              **(9,772,000**
              **)**174,000
              
              
              (641,000
              )
              
              **(7,255,000**
              **)**NET
                  LOSS
              
              
              (15,662,000
              )
              
              (18,550,000
              )
              
              **(33,047,000**
              **)**Value
                  of warrants issued or extended (Note I)
              
              
              (2,066,000
              )
              
              *—*
              
              
              ***—***Net
                  loss attributable to common stockholders
              
              $
              (17,728,000
              )
              $
              (18,550,000
              )
              **$**
              **(33,047,000**
              **)**Basic
                  and diluted net loss per share
              
              $
              (.68
              )
              $
              (.68
              )
              $
              (1.08
              )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**
   The
        accompanying notes are an integral part of these consolidated financial
        statements.
 F-4
 **Medis
        Technologies Ltd. and Subsidiaries**
 **Consolidated
        Statements of Stockholders’ Equity**
 **(in
        U.S. dollars)**
  **Common
                  Stock****Shares**
              
              **Amount**
              
              **Additional**
                **Paid-in
                  Capital**
              
              **Accumulated**
                **Deficit**
              
              **Total**
                **Stockholders’**
                **Equity**Balance
                  at December 31, 2003
              
              
              24,538,268
              
              
              245,000
              
              
              173,185,000
              
              
              (107,453,000
              )
              
              65,977,000Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (15,662,000
              )
              
              (15,662,000
              )Issuance
                  of common stock pursuant to private placements, net
              
              
              1,645,000
              
              
              17,000
              
              
              17,346,000
              
              
              —
              
              
              17,363,000Exercise
                  of stock warrants
              
              
              548,101
              
              
              5,000
              
              
              2,841,000
              
              
              —
              
              
              2,846,000Exercise
                  of stock options
              
              
              285,450
              
              
              3,000
              
              
              1,653,000
              
              
              —
              
              
              1,656,000Stock
                  options granted to directors
              
              
              —
              
              
              —
              
              
              147,000
              
              
              —
              
              
              147,000Stock
                  options and warrants granted to consultants
              
              
              —
              
              
              —
              
              
              572,000
              
              
              —
              
              
              572,000Extension
                  of stock options granted to employees, directors and
                  consultants
              
              
              —
              
              
              —
              
              
              964,000
              
              
              —
              
              
              964,000Extension
                  of warrants granted to stockholders
              
              
              —
              
              
              —
              
              
              2,066,000
              
              
              (2,066,000
              )
              
              —Balance
                  at December 31, 2004
              
              
              27,016,819
              
              
              270,000
              
              
              198,774,000
              
              
              (125,181,000
              )
              
              73,863,000Net
                  loss
              
              
              —
              
              
              —
              
              
              —
              
              
              (18,550,000
              )
              
              (18,550,000
              )Issuance
                  of common stock pursuant to private placements, net
              
              
              133,543
              
              
              2,000
              
              
              1,698,000
              
              
              —
              
              
              1,700,000Proceeds
                  allocated to beneficial conversion features on Senior Convertible
                  Notes
              
              
              —
              
              
              —
              
              
              267,000
              
              
              —
              
              
              267,000Exercise
                  of stock warrants
              
              
              422,628
              
              
              4,000
              
              
              4,006,000
              
              
              —
              
              
              4,010,000Exercise
                  of stock options
              
              
              399,500
              
              
              4,000
              
              
              3,019,000
              
              
              —
              
              
              3,023,000Stock
                  options granted to directors
              
              
              —
              
              
              —
              
              
              (24,000
              )
              
              —
              
              
              (24,000
              )Stock
                  options and warrants granted to consultants
              
              
              —
              
              
              —
              
              
              1,088,000
              
              
              —
              
              
              1,088,000Balance
                  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 stock 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
                  payment to employees
              
              
              —
              
              
              —
              
              
              2,900,000
              
              
              —
              
              
              2,900,000Stock-based
                  payments to non-employees
              
              
              —
              
              
              —
              
              
              99,000
              
              
              —
              
              
              99,000**Balance
                  at December 31, 2006**
              
              
              **34,934,864**
              
              
              **349,000**
              
              
              **286,865,000**
              
              
              **(176,778,000**
              **)**
              
              **110,436,000**
  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,**2004
              
              2005
              
              **2006**Cash
                  flows from operating activitiesNet
                  loss
              
              $
              (15,662,000
              )
              $
              (18,550,000
              )
              **$**
              **(33,047,000)**
              **)**Adjustments
                  to reconcile net loss to net cash used in operating
                  activitiesDepreciation
                  and amortization of property and equipment
              
              
              502,000
              
              
              871,000
              
              
              **1,539,000**Amortization
                  of intangible assets
              
              
              208,000
              
              
              208,000
              
              
              **208,000**Amortization
                  of debt issuance costs and changes in fair value of Option
              
              
              —
              
              
              231,000
              
              
              **(166,000**
              **)**Amortization
                  of beneficial conversion feature on Senior Convertible
                  Notes
              
              
              —
              
              
              27,000
              
              
              **240,000**Non-cash
                  stock based compensation expense
              
              
              1,683,000
              
              
              1,064,000
              
              
              **2,999,000**Value
                  of shares issued as inducement in Senior Convertible Notes
                  exchange
              
              
              —
              
              
              —
              
              
              **8,266,000**Changes
                  in operating assets and liabilitiesAccounts
                  receivable—trade
              
              
              74,000
              
              
              —
              
              
              —Other
                  accounts and notes receivable
              
              
              22,000
              
              
              (112,000
              )
              
              **(1,583,000**
              **)**Prepaid
                  expenses and other current assets
              
              
              (52,000
              )
              
              (438,000
              )
              
              **(3,990,000**
              **)**Accounts
                  payable
              
              
              606,000
              
              
              212,000
              
              
              **2,441,000**Accrued
                  expenses and other current liabilities
              
              
              1,410,000
              
              
              (56,000
              )
              
              **314,000**Leasehold
                  incentive obligations, net
              
              
              935,000
              
              
              (4,000
              )
              
              **(92,000**
              **)**Accrued
                  severance pay, net
              
              
              96,000
              
              
              112,000
              
              
              **(4,000**
              **)**Net
                  cash used in operating activities
              
              
              (10,178,000
              )
              
              (16,435,000
              )
              
              **(22,875,000**
              **)**Cash
                  flows from investing activitiesCapital
                  expenditures
              
              
              (2,408,000
              )
              
              (4,953,000
              )
              
              **(16,724,000**
              **)**Investment
                  in short-term investments
              
              
              (12,198,000
              )
              
              (54,000,000
              )
              
              **(40,419,000**
              **)**Redemptions
                  of short-term investments
              
              
              12,198,000
              
              
              40,500,000
              
              
              **23,415,000**Long-term
                  note
              
              
              (141,000
              )
              
              (62,000
              )
              
              —Net
                  cash used in investing activities
              
              
              (2,549,000
              )
              
              (18,515,000
              )
              
              **(33,728,000**
              **)**Cash
                  flows from financing activitiesProceeds
                  from issuance of common stock, pursuant to private
                  placement
              
              
              17,363,000
              
              
              1,700,000
              
              
              —Proceeds
                  from issuance of Series A Preferred Stock
              
              
              —
              
              
              —
              
              
              **57,500,000**Issuance
                  costs on Series A Preferred Stock
              
              
              —
              
              
              —
              
              
              **(3,884,000**
              **)**Proceeds
                  from exercise of stock options
              
              
              1,656,000
              
              
              2,936,000
              
              
              **19,346,000**Proceeds
                  from exercise of stock warrants
              
              
              2,846,000
              
              
              4,010,000
              
              
              **134,000**Proceeds
                  from share landing agreement
              
              
              —
              
              
              —
              
              
              **15,000**Proceeds
                  from issuance of Senior Convertible Notes
              
              
              —
              
              
              48,733,000
              
              
              —Proceeds
                  allocated to beneficial conversion feature on Senior Convertible
                  Notes
              
              
              —
              
              
              267,000
              
              
              —Debt
                  issuance costs on Senior Convertible Notes
              
              
              —
              
              
              (3,159,000
              )
              
              —Net
                  cash provided by financing activities
              
              
              21,865,000
              
              
              54,487,000
              
              
              **73,111,000**Net
                  increase in cash and cash equivalents
              
              
              9,138,000
              
              
              19,537,000
              
              
              **16,508,000**Cash
                  and cash equivalents at beginning of year
              
              
              6,620,000
              
              
              15,758,000
              
              
              **35,295,000**Cash
                  and cash equivalents at end of year
              
              $
              15,758,000
              
              $
              35,295,000
              
              **$**
              **51,803,000**
  F-6
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Consolidated
          Statements of Cash Flows**
 **(continued)**
 **(in
          U.S. dollars)**
 **Year
                    ended December 31,**2004
                
                2005
                
                **2006**
 Supplemental
                  disclosures of cash flow information:Cash
                  paid during the year for:Interest
              
              $
              29,000
              
              $
              651,000
              
              $
              1,470,000Non-cash
                  investing and financing activities:Capital
                  expenditure included in accounts payable and accrued
                  liabilities
              
              $
              227,000
              
              $
              127,000
              
              $
              4,785,000Option
                  exercise - cash received subsequent to balance sheet date
              
              $
              —
              
              $
              87,000
              
              $
              1,180,000Value
                  of extension of warrants granted to stockholders (see
                  Note I)
              
              $
              2,066,000
              
              $
              —
              
              $
              —Issuance
                  cost payable related to Series A Preferred Stock
              
              $
              —
              
              $
              —
              
              $
              580,000Exchange
                  of Senior Convertible Notes for common stock:Face
                  value of notes exchanged
              
              $
              —
              
              $
              —
              
              $
              49,000,000Deferred
                  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**
  Medis
        Technologies Ltd. (“MTL”), a Delaware corporation, is a holding company,
        which through its wholly-owned subsidiaries, Medis El Ltd., More Energy
        Ltd. and Cell Kinetics Ltd. (collectively, with MTL the “Company”), designs,
        develops and markets innovative liquid fuel cell solutions principally for
        the
        mobile handset and portable consumer electronics markets. The
        Company is also seeking to exploit commercially a medical diagnostic tool
        called
        the CellScan, which is a static cytometer—an instrument for measuring reactions
        of living cells while the cells are in a static state. A key element of the
        CellScan is its patented cell carrier which can accommodate up to 10,000
        cells,
        each in individual wells. Furthermore, the Company has filed patent applications
        relating to a technology for an explosive detection device and it is seeking
        to
        develop a commercial product embodying that technology. The Company also
        owns
        patents or other intellectual property rights to other proprietary technologies,
        some of which it is seeking to develop for commercial exploitation.
  Since
        inception, the Company has not recorded significant revenues from the sale
        of
        its products, has incurred operating losses and has used cash in its operations.
        Accordingly, the Company has relied on external financing, principally through
        the sale of its stock and issuance of convertible notes, to fund its research
        and development activities. The Company believes this dependence will continue
        unless it is able to successfully develop and market its technologies. In
        July
        and August, 2005, the Company issued $49,000,000 aggregate principal amount
        of
        6% Senior Convertible Notes (the “notes”) due 2010 in a private placement, less
        issuance costs aggregating approximately $3,159,000. The notes were issued
        at
        par (see Note G). In April and May 2006, the Company exchanged its common
        stock for the entire $49,000,000 aggregate principal amount of notes, whereby
        holders of the notes exchanged their notes for an aggregate of 3,101,874
        shares
        of the Company’s common stock, which includes 269,500 shares of common stock in
        lieu of future interest payments had such notes remained outstanding until
        their
        maturity (See note G). Additionally, in November and December 2006, the Company
        issued an aggregate of 5,750 shares of its Series A Cumulative Convertible
        Perpetual Preferred Stock (“Preferred Stock”) at a price of $10,000 per share
        for a gross proceeds of $57,500,000, less issuance costs of approximately
        $4,464,000 (see Note H).
  **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
        wholly-owned subsidiaries. All significant intercompany transactions and
        balances have been eliminated in consolidation.
  *2.
        Cash and Cash Equivalents*
  Cash
        and
        cash equivalents consist of cash and highly liquid investments with a maturity
        of three months or less when purchased.
  F-8
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
  **NOTE
        B—SIGNIFICANT ACCOUNTING POLICIES (Continued)**
  *3.
        Short-term Investments*
  The
        Company accounts for investments in marketable securities in accordance with
        SFAS No. 115, “Accounting for Certain Investments in Debt and Equity
        Securities.”
 
 Commercial
        paper with maturities of more than three months and less than one year are
        designated as held-to-maturity debt securities.
 
 Management
        determines the appropriate classification of its investments in auction-rate
        securities and commercial paper debt securities at the time of purchase and
        reevaluates such determinations at each balance sheet date.
 
 The
        interest rate on auction rate securities resets monthly through an auction
        process and the Company may redeem the securities at face value at any such
        interest resetting date. Accordingly, although the maturity dates of such
        securities are beyond one year from the date of purchase, the Company has
        classified its investments in auction rate securities as available for sale
        marketable securities. At December 31, 2006, the fair market value of the
        action
        rate securities is the same as the original cost.
  *4.
        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.
  *5.
        Fair Value of Financial Instruments*
  The
        carrying value of all financial instruments potentially subject to valuation
        risk (principally consisting of cash and cash equivalents, short-term
        investments, accounts receivable, accounts payable and accrued expenses and
        other current liabilities) approximates their fair value due to the short
        term
        maturities of such instruments.
  *6.
        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 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-9
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
  **NOTE
        B—SIGNIFICANT ACCOUNTING POLICIES (Continued)**
  *7.
        Property, Plant and Equipment, net*
  a.
            Property,
                plant and equipment is stated at cost, net of accumulated depreciation
                and
                amortization.  b.
            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.  c.
            Interest
                costs are capitalized in accordance with Financial Accounting Standards
                Board Statement of Financial Accounting Standards No. 34, “Capitalization
                of Interest Cost” (“SFAS 34”).  d.
            Depreciation
                is provided on property, plant and equipment on the straight-line
                basis
                over the estimated useful lives of such assets. Payments on account
                of new
                plant facility were not subject to depreciation. Annual rates of
                depreciation are as follows:  **Useful
                  Lives In Years**Machinery
                  and equipment
              7Computers
              3Furniture
                  and office equipment
              15Vehicles
              7Leasehold
                  improvements
              Over
                  the shorter of the term of the lease or the life of the
                  asset
 
 *8.
        Debt Issuance Costs*
  In
        accordance with Accounting Principles Board Opinion (“APB”) No. 21,
“Interest on Receivables and Payables” and EITF Issue No. 00-27,
“Application of Issue No. 98-5 to Certain Convertible Instruments” (“EITF
        00-27”), the Company accounted for incremental and direct costs incurred related
        to the issuance of its Senior Convertible Notes as deferred charges which
        are
        presented as long-term assets and amortizes such amounts using the effective
        interest rate method over the original life of the Senior Convertible
        Notes.
  *9.
        Senior Convertible Notes*
  Senior
        Convertible Notes are accounted for in accordance with the provisions of
        EITF
        Issue No. 98-5 “Accounting for Convertible Securities with Beneficial
        Conversion Features” (“EITF 98-5”), EITF 00-27”, EITF Issue No. 00-19,
“Accounting for Derivative Financial Instruments Indexed to, and Potentially
        Settled in, a Company’s Own Stock,” APB 14 “Accounting for Convertible Debt and
        Debt Issued With Stock Purchase Warrants” and SFAS No. 133, “ Accounting
        for Derivative Instruments and Hedging Activities *”* as
        amended (“SFAS
        No. 133”). The Company recorded a beneficial conversion feature as a
        discount on the Senior Convertible Notes and is amortizing such discount
        to
        interest expense using the effective interest rate method over the original
        life
        of the Senior Convertible Notes.
  F-10
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
  **NOTE
        B—SIGNIFICANT ACCOUNTING POLICIES (Continued)**
  The
        Company accounted for its April and May 2006 exchange of all its outstanding
        Senior Convertible Notes for its common stock in accordance with Statement
        of
        Financial Accounting Standards No. 84 “Induced Conversion of Convertible Debt,
        an amendment of APB Opinion No. 26
  *10.
        Derivative Instruments and Hedging Activities*
  The
        Company accounts for its derivative instruments and hedging activities based
        on
        SFAS No. 133. 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 is denominated in Swiss
        Francs. Gains and losses from such hedging activities for the year ended
        December 31, 2006 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 open forward exchange contracts at December
        31,
        2006.
  *11.* *Stock-based
        Compensation*
  Effective
        January 1, 2006, the Company adopted FASB Statement No. 123 (revised 2004),
“Share-Based Payment” (“SFAS 123(R)”) , and related Securities and Exchange
        Commission rules included in Staff Accounting Bulletin No. 107, on a
        modified prospective basis. Under this method, compensation cost recognized
        beginning January 1, 2006 will include costs related to 1) all
        share-based payments (stock options and restricted stock awards) granted
        prior
        to but not yet vested as of January 1, 2006, based on the grant-date fair
        value estimated in accordance with the original provisions of FAS 123,
“Accounting for Stock-Based Compensation” (“SFAS 123”), and 2) all
        share-based payments granted subsequent to December 31, 2005 based on the
        grant-date fair value estimated in accordance with the provisions of SFAS
        123(R). Compensation cost for stock options is generally recognized ratably
        over
        the vesting period.
  The
        Company applies SFAS No. 123(R) and Emerging Issues Task Force 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(R)
        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.
  Prior
        to
        the adoption of SFAS 123(R), the Company applied SFAS 123, amended by SFAS
        148,
“Accounting for Stock-Based Compensation — Transition and Disclosure,” which
        allowed companies to apply the existing accounting rules under APB 25,
“Accounting for Stock Issued to Employees,” and related Interpretations. In
        general, as the exercise price of options granted under these plans was equal
        to
        the market price of the underlying common stock on the grant date, no
        stock-based employee compensation cost was recognized in the net loss attributed
        to common stockholders for periods prior to the adoption of SFAS
        123(R).
  F-11
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
 **NOTE
        B—SIGNIFICANT ACCOUNTING POLICIES (Continued)**
  The
        following table illustrates the effect on net loss attributed to common
        stockholders and net loss per share, assuming that the Company had applied
        the
        fair value recognition provision of SFAS No. 123 on its stock-based
        employee compensation during the years ended December 31, 2004 and
        2005:
  **Year
                  ended December 31,****2004**
              
              **2005**Net
                  loss attributable to common stockholders for the year as
                  reported
              
              $
              (17,728,000
              )
              $
              (18,550,000
              )Add:
                  Stock-based employee compensation expense (income) included in
                  the
                  reported loss
              
              
              930,000
              
              
              (24,000
              )Deduct:
                  Stock-based employee compensation expense determined under fair
                  value
                  based method
              
              
              (5,192,000
              )
              
              (4,631,000
              )Pro
                  forma net loss attributable to common shareholders
              
              $
              (21,990,000
              )
              $
              (23,205,000
              )Basic
                  and diluted net loss per share as reported
              
              $
              (.68
              )
              $
              (.68
              )Pro
                  forma basic and diluted net loss per share
              
              $
              (.84
              )
              $
              (.85
              )
 
  The
        fair
        value of each option granted is estimated on the date of the grant using
        the
        Black-Scholes option pricing model with the following weighted average
        assumptions:
  **Year
                  ended December 31,****2004**
              
              **2005**Dividend
                  yield
              
              
              0%
              
              
              0%Risk-free
                  interest rate
              
              
              2.25%
              
              
              3.80%Expected
                  life in years
              
              
              1.3
              
              
              3.0Volatility
              
              
              63%
              
              
              70%
 
  The
        average fair value of each option granted in 2004 and 2005 was $4.00 and
        $7.25,
        respectively. The weighted average fair value of each option granted at or
        below
        market price (none were granted above market price) in 2004 and 2005 was
        as
        follows:
 **Year
                  ended December 31,****2004**
              
              **2005**Options
                  granted at an exercise price equal to market price
              
              $
              4.37
              
              $
              7.25Options
                  granted at an exercise price below market price
              
              $
              8.05
              
              $
              **—**
 F-12
 **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 weighted average remaining useful lives of approximately 15
        months.
  The
        Company is required to perform an impairment test of goodwill at least annually.
        The impairment test shall consist of a comparison of the fair value of an
        intangible asset with its carrying amount. If the carrying amount of an
        intangible asset exceeds its fair value, an impairment loss shall be recognized
        in an amount equal to that excess. 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 2004, 2005 and 2006, no impairment losses
        were
        identified.
  *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 2004,
        2005
        and 2006, no impairment losses have been identified.
  *14.
        Research and Development Costs and Revenue Recognition*
  Research
        and development costs are charged to operations as incurred.
  From
        time
        to time, the Company has entered into Federal Government 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 and AICPA Statement of Position 81-1, “Accounting
        for Performance of Construction-Type and Certain Production-Type Contracts”
(“SOP 81-1”).
  In
        cases
        where costs associated with a development agreement are expected to exceed
        amounts to be received, the amounts received are recorded as offsets to research
        and development costs as incurred.
  For
        development agreements where proceeds are expected to exceed costs, amounts
        earned are recorded as revenue and are recognized as services 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-13
 **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. However,
        as the
        Company generated net losses in all periods presented, potentially diluted
        securities, composed 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. For the year ended December 31, 2006, the Company applied the
        two-class method as required by EITF No. 03-6, “Participating Securities
        and the Two-Class Method” under FASB Statement No. 128, Earnings Per
        Share” (“EITF No. 03-6”). EITF No. 03-6 requires the income per share
        for each class of stock to be calculated assuming that 100% of the Company’s
        earnings are distributed as dividends to each class of stock based on their
        contractual rights. In compliance with EITF No. 03-6, the shares of
        Preferred Stock do not participate in losses, and therefore are not included
        in
        the computation of net loss per share.
  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
        4,943,053, 6,171,870 and 4,977,028 as of December 31, 2004, 2005 and 2006
        respectively. The shares excluded from the calculation of diluted net loss
        per
        share for December 31, 2006 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 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, 2004, 2005 and 2006 amounted to
        approximately $321,000, $533,000 and $340,000, respectively.
  
  
  F-14
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        B—SIGNIFICANT ACCOUNTING POLICIES (Continued)**
  *17.
        Income Taxes*
  The
        Company accounts for income taxes in accordance with Statement of Financial
        Accounting Standards 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.
  *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
        are invested in banks, on-demand insurance contracts and money market funds
        with
        major international financial institutions, 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 excess of insured limits and insurance in other jurisdictions
        varies. Management believes that the Company’s cash and cash equivalents and
        short-term investments are financially sound and, accordingly, minimal credit
        risk exists with respect to these investments. The Company only invests in
        A1-P1
        and AAA rated investments.
  In
        both
        2005 and 2006, all revenues were derived from a single customer. The Company
        recorded no revenue in 2004.
  *19
        .
        Recently Issued Accounting Pronouncements in the United States*
  In
        February 2006, the FASB issued FASB Statement No. 155, “Accounting for Hybrid
        Financial Instruments - an amendment of FASB Statements No. 133 and 140” (“SFAS
        155”). This statement amends FASB Statements No. 133, “Accounting for Derivative
        Instruments and Hedging Activities” (“SFAS 133”), and No. 140, “Accounting for
        Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”
(“SFAS 140”). This statement allows financial instruments that have embedded
        derivatives to be accounted for as a whole (eliminating the need to bifurcate
        the derivative from its host) if the holder elects to account for the whole
        instrument on a fair value basis. It also clarifies which interest-only strips
        and principal-only strips are not subject to the requirements of SFAS 133;
        establishes a requirement to evaluate interests in securitized financial
        assets
        to identify interest that are freestanding derivatives or that are hybrid
        financial instruments that contain an embedded derivative requiring bifurcation;
        clarifies that concentrations of credit risk in the form of subordination
        are
        not embedded derivatives; and, amends SFAS 140 to eliminate the prohibition
        on a
        qualifying special-purpose entity from holding a derivative financial instrument
        that pertains to a beneficial interest other than another derivative financial
        instrument. This statement shall be effective for all financial instruments
        acquired or issued after the beginning of an entity’s first fiscal year
        beginning after September 15, 2006. The Company does not expect the adoption
        of
        SFAS 155 to have a material impact on its consolidated financial
        statements. ****
  
 F-15
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        B—SIGNIFICANT ACCOUNTING POLICIES (Continued)**
  In
        July
        2006, the Financial Accounting Standards Board issued Interpretation No.
        48,
“Accounting for Uncertainty in Income Taxes”, (“FIN 48”). FIN 48 creates a
        single model to address uncertainty in tax positions. FIN 48 clarifies the
        accounting for income taxes by prescribing the minimum recognition threshold
        a
        tax position is required to meet before being recognized in the financial
        statements. FIN 48 also provides guidance on derecognition, measurement,
        classification, interest and penalties, accounting in interim periods,
        disclosure and transition. In addition, FIN 48 clearly scopes out income
        taxes
        from Financial Accounting Standards Board Statement No. 5, “Accounting for
        Contingencies”. FIN 48 utilizes a two-step approach for evaluating tax
        positions. Recognition (step one) occurs when an enterprise concludes that
        a tax
        position, based solely on its technical merits, is more-likely-than-not to
        be
        sustained upon examination. Measurement (step two) is only addressed if step
        one
        has been satisfied (i.e., the position is more-likely-than-not to be sustained).
        FIN 48 applies to all tax positions related to income taxes subject to Financial
        Accounting Standards Board Statement No.109, “Accounting for Income Taxes”. This
        includes tax positions considered to be “routine” as well as those with a high
        degree of uncertainty. Derecognition of a tax position that was previously
        recognized would occur when a company subsequently determines that a tax
        position no longer meets the more-likely-than-not threshold of being sustained.
        FIN 48 specifically prohibits the use of a valuation allowance as a substitute
        for derecognition of tax positions. FIN 48 is effective for fiscal years
        beginning after December 15, 2006. The Company does not expect the adoption
        of
        FIN 48 to have a material impact on its consolidated financial
        statements.
  In
        September 2006, the FASB issued FASB Statement No. 157, “Fair Value
        Measurements.” (“SFAS 157”) This Standard defines fair value, establishes a
        framework for measuring fair value in generally accepted accounting principles
        and expands disclosures about fair value measurements. SFAS 157 is effective
        for
        financial statements issued for fiscal years beginning after November 15,
        2007 and interim periods within those fiscal years. The Company is currently
        evaluating the effect that the adoption of SFAS 157 will have on its
        consolidated financial statements.
  In
        February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
        Financial Assets and Financial Liabilities” (SFAS No. 159). SFAS No. 159 permits
        companies to choose to measure certain financial instruments and certain
        other
        items at fair value. The standard requires that unrealized gains and losses
        on
        items for which the fair value option has been elected be reported in earnings.
        SFAS No. 159 is effective for the company beginning in the first quarter
        of
        fiscal year 2008, although earlier adoption is permitted. The Company is
        currently evaluating the impact that SFAS No. 159 will have on its consolidated
        financial statements.
  
  
 F-16
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        C—SHORT-TERM INVESTMENTS**
  Short-term
        investments at December 31, 2005 and 2006, are comprised as follow:
  **December
                  31,**2005
              
              **2006**Commercial
                  papers
              
              
              —
              
              **$**
              **16,254,000**Auction
                  rate Securities
              
              
              13,500,000
              
              
              **14,250,000**$
              13,500,000
              
              **$**
              **30,504,000**
 
 The
        average interest rate on auction rate securities and the commercial paper
        held
        on December 31, 2006 was approximately 5.3%.
   **NOTE
        D—PROPERTY, PLANT AND EQUIPMENT, NET**
  Property,
        plant and equipment consists of the following:
  **December
                  31,**2005
              
              **2006**Machinery
                  and equipment
              
              $
              6,325,000
              
              **$**
              **25,901,000**Computers
              
              
              1,281,000
              
              
              **1,739,000**Furniture
                  and office equipment
              
              
              381,000
              
              
              **432,000**Vehicles
              
              
              20,000
              
              
              **20,000**Leasehold
                  improvements
              
              
              2,273,000
              
              
              **3,570,000**10,280,000
              
              
              **31,662,000**Less
                  accumulated depreciation and amortization
              
              
              2,805,000
              
              
              **4,344,000**Property
                  and equipment, net
              
              $
              7,475,000
              
              **$**
              **27,318,000**
 
  In
        connection with the establishment of the Company’s production facilities, as of
        December 31, 2005 and 2006, the Company had recorded property, plant and
        equipment aggregating approximately $3,183,000 and $18,056,000, respectively,
        which was not subject to depreciation. These costs include capitalized labor
        of
        $232,000 and capitalized interest of $36,000 for the year ended December
        31,
        2006, and capitalized labor of $58,000 and capitalized interest of $28,000
        for
        the year ended December 31, 2005. The Company did not capitalize any labor
        or
        interest costs during the year ended December 31, 2004. See Note J-5 for a
        commitment regarding these production facilities.
  Depreciation
        and amortization expense on property and equipment for the years ended December
        31, 2004, 2005 and 2006 amounted to $502,000, $871,000 and $1,539,000,
        respectively. During the year ended December 31, 2004, the Company reduced
        its
        leasehold improvements and corresponding accumulated amortization balances
        for
        certain fully amortized leasehold improvements that are no longer in service
        in
        the amount of approximately $405,000.
  F-17
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        E—INTANGIBLE ASSETS, NET**
  As
        of
        December 31, 2005 and 2006, the Company’s intangible assets consisted of
        goodwill and fuel cell technology intangible assets.
  The
        following table summarizes the cost and related accumulated amortization
        for
        intangible assets that are subject to amortization *.*
  **December
                  31,****2005**
              
              **2006**Cost:Fuel
                  Cell technology assets
              
              $
              1,045,000
              
              **$**
              **1,045,000**Accumulated
                  amortization:Fuel
                  Cell technology assets
              
              
              581,000
              
              
              **789,000**$
              464,000
              
              **$**
              **256,000**
 
 
 The
        Company recorded amortization expense of $208,000 for the each of the years
        ended December 31, 2004, 2005 and 2006. Based on the current amount of
        intangible assets subject to amortization, the estimated amortization expense
        for each of the years ending December 31, 2007 is $208,000 and $48,000 for
        the
        year ending December 31, 2008.
  The
        Company has also reassessed the useful lives of its other intangible assets
        previously recorded in connection with earlier purchase
        acquisitions.
   **NOTE
        F— ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES**
  Accrued
        expenses and other current liabilities consist of the following:
  **December
                  31,****2005**
              
              **2006**Employees
                  and related liabilities
              
              $
              1,335,000
              
              **$**
              **2,166,000**Interest
                  payable
              
              
              637,000
              
              
              **—**Subcontractors
                  and consultants
              
              
              308,000
              
              
              **231,000**Professional
                  services
              
              
              190,000
              
              
              **227,000**Related
                  parties (Note K)
              
              
              96,000
              
              
              **—**Issuance
                  cost on Series A Preferred Stock (Note H)
              
              
              —
              
              
              **580,000**Deferred
                  income, net
              
              
              —
              
              
              **185,000**Others
              
              
              90,000
              
              
              **161,000**$
              2,656,000
              
              **$**
              **3,550,000**
 
  F-18
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        G— SENIOR CONVERTIBLE NOTES**
  *1.
        Issuance of Notes*
  In
        July
        and August 2005, the Company issued $49,000,000 aggregate principal amount
        of 6%
        Senior Convertible Notes (the “notes”) due 2010 in a private placement, less
        issuance costs aggregating approximately $3,159,000 (see below for a discussion
        of the exchange of the notes for common stock). Interest on the notes was
        payable quarterly. The notes were issued at par. The notes did not have the
        benefit of any sinking fund and were convertible prior to maturity or redemption
        into shares of the Company’s common stock at a conversion rate of 57.8035 shares
        per $1,000 principal amount of notes (or an initial conversion price of $17.30
        per share). The notes were callable by the Company after two years if the
        closing price of its stock for at least 20 trading days within a period of
        30
        consecutive trading days immediately prior to the notification date of such
        redemption exceeds $27.68, subject to adjustment. Of the total $49,000,000
        aggregate principal amount of notes issued, $7,000,000 aggregate principal
        amount of notes were issued pursuant to the exercise in July 2005 of a 30-day
        option that was granted to the initial purchaser (the “Note Option”) in
        connection with the issuance of the first $38,000,000 aggregate principal
        amount
        of notes. The remaining $4,000,000 aggregate principal amount of notes were
        issued and sold directly to a group of affiliated investors in a private
        placement.
  In
        accordance with APB No. 14, “Accounting for Convertible Debt and Debt Issued
        with Stock Purchase Warrants,” EITF 98-5, “Accounting for Convertible Securities
        with Beneficial Conversion Features or Contingently Adjustable Conversion
        Ratios,” and EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible
        Instruments” (“EITF 00-27”), $345,000 of the proceeds of the first $38,000,000
        of notes was allocated to the Note Option, based on the relative fair values
        of
        the securities at time of issuance. Amounts allocated to the Note Option
        are
        accounted for as liabilities as the Note Option is not indexed to the Company’s
        own stock in accordance with EITF 00-19, “Accounting for Derivative Financial
        Instruments Indexed to, and Potentially Settled In, a Company’s Own Stock”
(“EITF 00-19”) but instead to a debt instrument. In addition, in accordance with
        SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
the Note Option was evaluated and determined not be a derivative financial
        instrument as the Note Option does not provide for net settlement terms or
        for
        other means that could provide the holder with net settlement. The carrying
        value of the Note Option of $345,000 was credited to the proceeds of the
        $7,000,000 of notes issued upon its exercise.
  In
        accordance with EITF 00-27, the commitment date for purpose of measuring
        the
        intrinsic value of a conversion option in connection with the issuance of:
        (a)
        the $38,000,000 aggregate principal amount of notes is the date the purchase
        agreement for this amount was signed, (b) the $7,000,000 aggregate principal
        amount of notes is the date the Note Option was exercised, and (c) the
        $4,000,000 aggregate principal amount of notes, is the date the offering
        of this
        amount was completed. Beneficial conversion features aggregating approximately
        $267,000 were recorded on the $7,000,000 aggregate principal amount of notes
        and
        the $4,000,000 aggregate principal amount of notes because the effective
        conversion prices of such notes were lower than the fair value of the Company’s
        common stock on the commitment dates. There was no beneficial conversion
        feature
        on the first $38,000,000 aggregate principal amount of notes. During the
        nine
        months ended September 30, 2006, the Company recorded, prior to the exchange
        of
        the notes described below, interest expense from the amortization of the
        beneficial conversion features of approximately $20,000.
  As
        mentioned above, the Company incurred debt issuance costs totaling approximately
        $3,162,000 in connection with the issuance of the notes. In accordance with
        APB
        21, “Interest on Receivable and Payables,” the Company recorded the debt
        issuance costs as a deferred charge on its balance sheet and amortized, prior
        to
        the exchange of the notes described below, such costs based on the
  F-19
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        G— SENIOR CONVERTIBLE NOTES (Continued)**
  interest
        method over the original term of the notes. During the year ended December
        31,
        2006, the Company recorded interest expense from the amortization of the
        debt
        issuances costs of approximately $184,000.
  *2.
        Exchange of Notes*
  On
        April
        26, 2006, the Company completed an exchange of its common stock for its
        outstanding 6% Senior Convertible Notes (the “notes”) whereby holders of
        $46,582,000 in principal amount of the notes, exchanged their notes for an
        aggregate of 2,948,806 shares of the Company’s common stock. This number
        includes 256,201 shares of common stock, valued at $30 per share, in lieu
        of
        future interest payments had such notes remained outstanding until their
        maturity, after giving effect to an eighteen month waiver of such payments.
        On
        May 8, 2006, the Company completed a second exchange of its common stock
        for its outstanding notes whereby holders of the remaining $2,418,000 in
        principal amount of the notes, exchanged their notes for an aggregate of
        153,068
        shares of the Company’s common stock. This number includes 13,299 shares of
        common stock, valued at $30 per share, in lieu of future interest payments
        had
        such notes remained outstanding until their maturity, after giving effect
        to an
        eighteen month waiver of such payments. In accordance with Statement of
        Financial Accounting Standards 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.
  **NOTE
        H— SERIES A PREFERRED STOCK AND SHARE LEND**
  *1.
        Series A Preferred Stock*
  In
        November and December 2006, the Company 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 $4,464,000. 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 the Company’s common stock exceeds 150% of the conversion
        price for 20 trading days during any consecutive 30 trading day period, the
        Company may cause the conversion of the Preferred Stock into common stock
        at the
        prevailing conversion rate. The terms of the Preferred Stock preclude the
        Company 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. As of December 31, 2006, the Preferred Stock had not been
        registered for resale with the SEC. See Note H-2 for discussion of concurrent
        offering of common stock in connection with a share lending agreement.
  F-20
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        H— SERIES A PREFERRED STOCK AND SHARE LEND (Continued)**
  In
        accordance SFAS 150, “Accounting for Certain Financial Instruments with
        Characteristics of both Liabilities and Equity” (“SFAS150”) and EITF D-98
“Classification and Measurement of Redeemable Securities” (“EITF D-98”) , the
        Company has classified the net proceeds from the issuance of the Preferred
        Stock
        outside of permanent equity. Proceeds of $1,024,000 from the initial 5,000
        shares of Preferred Stock issued were allocated to the Preferred Option,
        based
        on the fair value of the Preferred Option at time of issuance. The amount
        allocated to the Preferred Option was accounted for as a liability, with
        changes
        in its fair value being charged to interest income. In respect of the Preferred
        Stock, there is no beneficial conversion feature that warrants separate
        accounting under EITF 00-27, “Application of Issue No. 98-5 to Certain
        Convertible Instruments.”
  *2.
        Share Lend*
  On
        November 15, 2006, concurrent with the Company’s offering of its Preferred Stock
        the Company issued 1.5 million 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 the Company
        was a share lending fee of $.01 per share, or an aggregate of $15,000, which
        has
        been included in Common Stock at December 31, 2006. 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 the Company has lent to the affiliate of CGML are reflected as
        issued and outstanding at December 31, 2006. 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
        the 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
        provides that entities that have issued mandatorily redeemable shares of
        common
        stock or entered into forward contracts that require physical settlement
        by
        repurchase of affixed number of the issuers 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 for the year ended December 31, 2006.
  
  
  F-21
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        I —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
        January 2004, MTL issued 1,425,000 shares of its common stock in a private
        placement to institutional investors, for gross proceeds of approximately
        $14,588,000, less related costs of approximately $309,000.
  In
        December 2004, MTL issued 220,000 shares of its common stock in a private
        placement to an accredited investor, for proceeds of approximately
        $3,080,000.
  In
        January 2005, MTL issued 50,000 shares of its common stock in a private
        placement to an accredited investor for proceeds of approximately
        $700,000.
  In
        April
        2005, MTL issued 83,543 shares of its common stock in a private placement
        to an
        accredited investor for proceeds of approximately $1,000,000.
  See
        Note H-2 for discussion of the 1,500,000 shares loaned under a 5-year share
        lending agreement.
  *2.
        Stock Options Plans, Stock Options and Warrants*
  On
        July 13, 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. As of December 31, 2006,
        there were outstanding options to purchase approximately 1,431,000 shares
        of the
        Company’s common stock and 329,0000 options were available for future grants
        pursuant the 1999 stock option plan, as amended.
  In
        August
        2004, MTL extended through December 31, 2005 the expiration dates of its
        outstanding warrants that were issued to shareholders of the Company in
        connection with the Company’s November 13, 2003 offer to exchange and exercise
        and those issued on June 6, 2004. Such warrants had original expirations
        dates
        of November 14, 2004. The Company accounted for such warrants in accordance
        with
        SFAS No. 123. Using the Black-Scholes option pricing model, the Company
        calculated the incremental fair value resulting from the extensions by
        calculating the fair value of the warrants immediately before the extension
        assuming a 1.4% risk free interest rate, 0% dividend yield, expected life
        of
        0.22 years and 62% volatility, and by calculating the fair value of the warrants
        immediately after the extension assuming a 2.0% risk free interest rate,
        0%
        dividend yield, expected life of 1.35 years and 63% volatility. The incremental
        fair value resulting from the extension of such warrants in the amount of
        $671,000 was accounted for as a preferred dividend during the year ended
        December 31, 2004.
  F-22
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        I —STOCKHOLDERS’ EQUITY (Continued)**
  In
        August
        2004, MTL extended through December 31, 2006 the expiration dates of its
        outstanding options that were scheduled to expire on December 31, 2004 and
        January 31, 2005. The Company accounted for those options issued to employees,
        officers and directors in accordance with APB No. 25 and FIN 44 and those
        issued to consultants in accordance with SFAS No. 123 and EITF
        No. 96-18 using the Black-Scholes option pricing model to estimate their
        fair value. The Company calculated the incremental intrinsic value related
        to
        the extension of options issued to employees, officers and directors to be
        approximately $784,000. Using the Black-Scholes option pricing model the
        Company
        calculated the incremental fair value of approximately $41,000 related to
        the
        extensions of options issued to consultants by calculating the fair value
        of the
        warrants immediately before and immediately after the extension and recorded
        such amount as expense during the year ended December 31, 2004.
  In
        October 2004, MTL extended through December 31, 2005 the expiration dates
        of
        certain outstanding warrants that were issued to shareholders of the Company
        and
        to members of its corporate advisory board. Such warrants were all scheduled
        to
        expire on December 31, 2004. The Company accounted for such warrants held
        by
        shareholders of the Company in accordance with SFAS No. 123 and for such
        warrants held by members of its corporate advisory board in accordance with
        SFAS
        No. 123 and EITF No. 96-18. Using the Black-Scholes option pricing
        model, the Company calculated the incremental **** fair
        value of the extensions by calculating the fair value of the warrants
        immediately before the extension assuming a 1.6% risk free interest rate,
        0%
        dividend yield, expected life of 0.21 years and 74% volatility, and by
        calculating the fair value of the warrants immediately after the extension
        assuming a 2.0% risk free interest rate, 0% dividend yield, expected life
        of
        1.21 years and 64% volatility. The Company has estimated the incremental
        fair
        value resulting from the extension of all such warrants to be approximately
        $1,534,000 and has accounted for approximately $1,395,000 related to such
        warrants held by shareholders as a preferred stock dividend and has accounted
        for approximately $139,000 related to such warrants held by advisory board
        members as expense, during the year ended December 31, 2004
  On
        July
        18, 2006, the Company issued options to purchase an aggregate of 706,500
        shares
        of its common stock to employees, officers and directors of the Company.
        Such
        options are exercisable at $20.98 (the market price of the Company’s common
        stock on the grant date), vest after one year and expire after four years.
        The
        Company accounted for those options issued to employees, officers and directors
        in accordance with SFAS 123(R). In accordance with SFAS 123(R), share based
        compensation is based on the grant-date fair value estimate and is recognized
        over the vesting term of such options, net of an estimated forfeiture rate.
        The
        Company estimated the fair value of those options, using the Black-Scholes
        option pricing model, to be approximately $6,471,000, less estimated forfeitures
        of $17,000, and has recorded compensation costs of approximately $2,900,000
        related to such options during the year ended December 31, 2006.
  During
        the year ended December 31, 2006, the Company issued 25,000 shares of its
        common
        stock pursuant to the exercise of warrants, at an exercise price of $5.35
        per
        share, for aggregate proceeds of approximately $134,000.
  During
        the year ended December 31, 2006, the Company issued 2,335,500 shares of
        its
        common stock pursuant to the exercise of stock options granted under its
        1999
        Stock Option Plan, as amended (including 1,728,500 shares exercised by MTL
        executive officers) for aggregate proceeds of approximately $20,439,000 (of
        which $1,180,000 was received subsequent to December 31, 2006 and was classified
        as Other Accounts and Notes Receivable in the December 31, 2006 condensed
        consolidated balance sheet).
  F-23
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        I —STOCKHOLDERS’ EQUITY (Continued)**
  The
        Company estimates the fair value of stock based awards, accounted for in
        accordance with SFAS 123 (R), using the Black-Scholes option pricing model
        for
        all grants made subsequent to January 1, 2006 using the following weighted
        average assumptions for the year ended December 31, 2006:
  Dividend
                  yield
              0%Expected
                  term (years)
              3.20Risk-free
                  interest rate
              4.75%Volatility
              60%Forfeiture
                  rate
              0.36%Fair
                  value at grant date
              $9.46
 
  The
        following table presents the Company’s stock option activity for employees and
        directors of the Company for the years ended December 31, 2004 through 2006:
  **Number
                  of**
                **Options**
              
              **Weighted
                  Average**
                **Exercise
                  Price**Outstanding
                  at December 31, 2003
              
              
              2,657,450
              
              
              8.19Granted
              
              
              646,000
              
              
              12.11Exercised
              
              
              (264,450
              )
              
              5.8Forfeited
                  or expired
              
              
              (13,000
              )
              
              7.64Outstanding
                  at December 31, 2004
              
              
              3,026,000
              
              
              9.24Granted
              
              
              473,500
              
              
              14.93Exercised
              
              
              (372,500
              )
              
              7.59Forfeited
                  or expired
              
              
              (4,500
              )
              
              14.09Outstanding
                  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
              
              $
              17.62Number
                  of options exercisable at December 31, 2006
              
              
              682,500
              
              $
              14.16Vested
                  and expected to vest at December 31, 2006
              
              
              1,381,792
              
              $
              17.61
 
  The
        following table summarizes information about options to employees outstanding
        at
        December 31, 2006 under the plans:
  **Options
                  Outstanding**
              
              **Options
                  Exercisable****Exercise****Price**
              
              **Number
                  outstanding at****December
                  31, 2006**
              
              **Weighted
                  average remaining contractual life****years**
              
              **Weighted
                  average**
                **exercise
                  prices**
              
              **Number
                  Exercisable at****December
                  31, 200****6**
              
              **Weighted
                  average**
                **exercise
                  prices**$  
                  10.88
              
              
              10,000
              
              
              0.67
              
              $10.88
              
              
              10,000
              
              $10.8813.08
              
              
              257,000
              
              
              1.84
              
              13.08
              
              
              257,000
              
              13.0814.93
              
              
              415,500
              
              
              2.65
              
              14.93
              
              
              415,500
              
              14.9320.98
              
              
              701,500
              
              
              3.55
              
              20.98
              
              
              —
              
              —1,384,000
              
              
              
              
              
              
              
              682,500
 
  F-24
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        I —STOCKHOLDERS’ EQUITY (Continued)**
  As
        a
        result of adopting SFAS 123(R) on January 1, 2006, the Company’s net loss for
        year ended December 31, 2006, is $2,900,000 greater than if the Company had
        continued to account for share-based compensation under Accounting Principles
        Board Opinion No. 25 (“APB 25”). Basic and diluted net loss per share for the
        year ended December 31, 2006 is $ (.09) greater than it would have been if
        the
        Company had continued to account for share-based compensation under APB
        25.
  As
        of
        December 31, 2006, there were unrecognized compensation costs of $3,571,000
        related to stock options that are expected to be recognized in future
        periods.
  The
        following table summarizes information about options and warrants granted
        to
        non-employees that were outstanding and exercisable at December 31,
        2006:
  **Options
                    and Warrants Outstanding and Exercisable****Exercise****Price**
                
                **Number
                    outstanding**
                  **at****December
                    31, 2006**
                
                **Weighted
                    average**
                  **remaining
                    contractual**
                  **life****years**
                
                **Weighted
                    average**
                  **exercise
                    prices**$13.08
                
                
                7,500
                
                1.84
                
                $13.0812.30
                
                
                20,000
                
                1.80
                
                12.3014.93
                
                
                19,500
                
                2.65
                
                14.9314.93
                
                
                30,000
                
                2.67
                
                14.9316.87
                
                
                12,000
                
                2.67
                
                16.8714.46
                
                
                7,500
                
                2.97
                
                14.4696,500
   During
        the years ended December 31, 2004, 2005, in accordance with SFAS 123 and
        EITF
        96-18, and 2006, in accordance with SFAS 123(R), the Company recorded costs
        related to the issuance of stock options to consultants of the Company of
        approximately, $572,000, $1,088,000 and $99,000, respectively, for grants
        prior
        to January 1, 2006. The Company used the Black-Scholes option pricing model
        to
        estimate the fair value of options granted to consultants of the Company
        using
        the following assumptions:
  **Year
                  ended**
                **December
                  31, 2004**
              
              **Year
                  ended**
                **December
                  31, 2005**
              
              **Year
                  ended**
                **December
                  31, 2006**Dividend
                  yield
              
              0%
              
              0%
              
              0%Risk-free
                  interest rate
              
              3.0% - 3.5%
              
              4.0%
                  - 4.4%
              
              4.7%
                  - 4.8%Expected
                  term (years)
              
              2.0
                  - 3.83
              
              2.0
                  - 4.0
              
              1.8
                  - 3.0Volatility
              
              64% - 82%
              
              41%
                  71%
              
              58%-59%
  During
        the years ended December 31, 2004, 2005 and 2006 the Chief Executive
        Officer of the Company received options to purchase 35,000, 60,000 and 80,000
        shares of the Company’s common stock, respectively.
  See
        Note B-11 for discussion of the pro forma effect of applying SFAS
        No. 123 to employee stock options.
  F-25
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        J—COMMITMENTS AND CONTINGENT LIABILITIES AND STRATEGIC AGREEMENTS**
  *Commitments
        and contingent liabilities*
  *1.
        CellScan License* —
Medis
        El acquired the rights to the CellScan in August 1992 by assignment from
        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 grant
        $100,000 to the University during the first year that the Company’s after-tax
        profits exceed $300,000. No royalties were required to be paid during the
        three
        years ended December 31, 2006.
  *2.
        Other Royalties* **—** In
        consideration of grants by 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, which
        includes those received by IAI relating to such technologies of $805,000.
        No
        royalties were required to be paid during the three years ended
        December 31, 2006.
  *3.
        Lease Commitments* **—** MTL’s
        office space is provided to MTL for an annual rental fee of approximately
        $100,000, by a company which is controlled by the chairman and chief executive
        officer and by the deputy chairman and chief operating officer of MTL. The
        sublease is on a month to month basis.
  Subsequent
        to the balance sheet date, in February 2007, MTL opened a sales office at a
        rented facility in Brentwood, California, with an aggregate annual rental
        of approximately $19,000.
  In
        December 2004, Medis El and More Energy moved their offices and technology
        center operations to an industrial compound in Lod, Israel, where More Energy
        had existing production facilities. Medis El and More Energy are committed
        under
        leases for its facilities, which provide aggregate space of approximately
        56,100
        square feet. The leases covering approximately 44,800 square feet of such
        facilities have terms of up to five years until November 30, 2009 with two
        options of duration of 30 months each extending to November 30, 2014. The
        lease
        covering approximately 2,600 square feet has a term of five years until October
        31, 2008. The lease covering approximately 4,900 square feet has a term of
        four
        years until April 10, 2010. The lease covering approximately 3,800 square
        feet
        has a term until February 28, 2009. Medis El has collateralized its obligations
        under such leases up to an aggregate of approximately $439,000 by obtaining
        a
        bank guarantee in favor of the lessor. Such guarantee is secured by Medis
        El’s
        deposits with the bank from time to time.
  F-26
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        J—COMMITMENTS AND CONTINGENT LIABILITIES AND STRATEGIC AGREEMENTS
        (Continued)**
  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 Statement of
        Financial Accounting Standards 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, which aggregates approximately $1,292,000 from the
        inception of the lease agreements through December 31, 2006, is being amortized
        on a straight-line basis over the lease term as a reduction of rental expenses.
        The leasehold improvements in property, plant and equipment are being amortized
        over the shorter of lease terms or the estimated useful life of the asset.
        The
        Leasehold Incentive Obligations, net of amortization, were reflected as an
        adjustment to reconcile net loss to net cash used in operating activities
        in the
        consolidated cash flow statement.
  During
        the years ended December 31, 2004, 2005 and 2006, the Company incurred expenses
        under its facility lease commitments in Israel aggregating approximately
        $387,000, $174,000 and $269,000, net of amortization of leasehold incentive
        obligations in 2005 and 2006 of approximately $204,000 and $248,000,
        respectively.
  In
        addition, the Company is committed under vehicle lease with various termination
        dates in 2007 through 2009.
  Future
        minimum operating lease (facility and vehicle) payments for the next five
        years
        and thereafter are as follows:
  **Operating
                  Leases**2007
              
              $
              1,199,0002008
              
              
              1,101,0002009
              
              
              697,0002010
              
              
              16,000Total
                  future minimum lease payments
              
              $
              3,013,000
  *Strategic
        Agreements*
  4. *Fuel
        Cell Technology Cooperation Agreements* —
In
        April 2001, the Company entered into a mutually exclusive agreement with
        General Dynamics C-4 Systems, Inc., a unit of General Dynamics Corporation
        (“GD”), to develop and market fuel cells and fuel cell-powered portable
        electronic devices for the United States Department of Defense (the “DOD”).
  In
        May 2003, the Company entered into a second agreement with GD to design and
        develop on a best efforts basis a pre-production prototype of its fuel cell
        Power Pack for the ruggedized personal digital assistant system that GD is
        developing for the U.S. military (the “Agreement”). The total price for the
        Company’s services provided for in the Agreement is $500,000, with an initial
        payment of $100,000 and the balance in accordance with the payment and
        performance milestones established in the Agreement through January 2005.
        At the
        outset of the agreement, the Company expected that it will benefit from the
  F-27
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        J—COMMITMENTS AND CONTINGENT LIABILITIES AND STRATEGIC AGREEMENTS
        (Continued)**
  development
        effort beyond the scope of the Agreement and the associated development costs,
        which were expected to exceed the $500,000 to be received. The Company accounted
        for the Agreement as a fixed priced, best efforts research and development
        arrangement, and, as such, amounts received were deducted from research and
        development costs. The Company received payments aggregating $500,000 from
        the
        inception of the Agreement through December 31, 2005. During the years ended
        December 31, 2004 and 2005, the Company recorded approximately $147,000 and
        $130,000, respectively, as a credit to research and development expense,
        and
        from the inception of the agreement through December 31, 2005, the Company
        recorded $500,000 as credits to research and development expense related
        to the
        Agreement.
  In
        August
        2004, the Company received an additional order from GD to deliver five prototype
        fuel cell Power Packs and associated cartridges as power sources for 10
        prototype tablet computers in support of the United States Air Force Wearable
        Computer Power Program. The order provided for 10 milestone payments of $42,500
        each through September 2005, totaling $425,000. Since the payments from GD
        exceed costs incurred in connection with this agreement, the Company accounted
        for this agreement using contract accounting on a completed contract basis.
        The
        Company made final delivery of the products under the order during the fourth
        quarter of 2005 and recorded revenues of $425,000 and cost of revenues of
        $262,000.
  In
        October 2005, the Company received a new order from GD, for further research
        and
        analysis of Company’s fuel cell Power Packs, in the amount of $150,000. Since at
        the outset of this agreement the payments from GD were expected to exceed
        costs
        incurred in connection with this agreement, the Company accounted for the
        order
        using contract accounting on a completed contract basis. The Company made
        final
        delivery of the products under the order during the third quarter of 2006
        and
        recorded revenues of $150,000 and cost of revenues of $98,000.
  In
        October 2006, the Company entered into an agreement with Israel Aerospace
        Industries Ltd. (formerly know as Israel Aircraft Industries) (“IAI”), a
        principal stockholder of the Company, to develop an 800 watt fuel cell to
        electrically power Unmanned Air Vehicle systems (UAVs). The contract provides
        for two phases of activity. The first phase, which covers a six month period,
        provides for the Company to develop a demonstration system which would pass
        functionality tests and which can be demonstrated to be redesignable to achieve
        the weight (6 kilograms) goals of the final system. The first phase is funded
        by
        IAI paying the Company $400,000. Upon the successful completion of the first
        phase, the second phase would require IAI to pay the Company approximately
        $1,500,000 to complete the development and would have an 18 month schedule.
        During the first phase of the contract and conditioned on minimum purchase
        requirements thereafter, IAI will be granted exclusivity with respect to
        large
        fuel cells for unmanned vehicles. The contract with IAI will be carried out
        by
        the Company as the prime contractor together with its strategic partner,
        Oy
        Hydrocell of Finland, as the main subcontractor. Since the Company expects
        the
        payments to exceed related costs, the Company account for the order using
        contract accounting on a completed contract basis. As of December 31, 2006,
        the
        Company has billed and received approximately $200,000 under the agreement
        and
        has incurred costs aggregating approximately $15,000, such amounts have been
        deferred as of December 31, 2006.
  
 F-28
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        J—COMMITMENTS AND CONTINGENT LIABILITIES AND STRATEGIC AGREEMENTS
        (Continued)**
  In
        October 2006, the Company entered into a Memorandum of Understanding (“MOU”)
        with two Russian business groups, defining programs for the purchase of the
        Company’s 24/7 Power Packs and ultimately for those groups to establish a
        production line for the Company’s fuel cell products in Russia. The two groups
        are: “ASPECT” - the Association for Advanced Technologies of Russia, and Tenzor
        MA, a Russian technology company primarily operating in the area of complex
        safety and fire control systems and management and control systems for major
        facilities such as nuclear power plants. The parties have established a detailed
        milestone based program for the certification of the 24/7 Power Pack in Russia,
        its marketing and distribution in Russia and finally the establishment of
        a full
        production assembly capability by Tenzor for the Russian market. The MOU
        provides that after satisfactory completion of testing on UL certified units,
        Tenzor will purchase 10,000 24/7 Power packs from the Company’s semi-automatic
        line in Israel to commence promotion and marketing of the product in Russia.
        If
        the outcome of these promotional efforts are satisfactory to both parties,
        then
        the parties will move on to the next milestone which includes sales in Russia
        of
        250,000 Power Packs per month and then the establishment of a Power Pack
        assembly and fuel facility at the Tenzor plant capable of producing 1.5 million
        Power Packs per month. The transaction contemplates an investment by the
        Russian
        groups of approximately $25 million to build the automated production line
        in
        Russia and the purchase of certain components, including framed electrodes,
        power management and others from the Company. In addition to the program
        relating to 24/7 Power Packs, the parties’ MOU contemplates their cooperation in
        the development of larger stationary fuel cells of approximately 2kW for
        development and sale in the Russian Federation. As of December 31, 2006,
        the
        Company did not record any revenue or expense related to this MOU.
  In
        October 2006, the Company entered into a worldwide distribution and commerce
        agreement with Quasar Business Solutions Inc, a provider of software solutions
        for the enterprise market, to market and sell the Company’s 24/7 Power Pack to
        the Business to Business, Business to Consumer and directly to the Enterprise
        Market. Quasar Business Solutions Inc has placed an Initial Purchase Order
        with
        the Compnay for 1,000,000 units of the Company’s 24/7 Power Packs. As of
        December 31, 2006, the Company did not record any revenue or expense related
        to
        this agreement.
  In
        November 2006, the Company entered into a worldwide distribution agreement
        with
        Northwest Charging Systems Inc (NCS), a power products supplier, to market
        and
        sell the Company’s 24/7 Power Pack. NCS has placed an initial purchase order for
        250,000 24/7 Power Packs. As of December 31, 2006, the Company did not record
        any revenue or expense related to this agreement.
  5. *Automated
        Line Production Agreement* - In
        September 2005, the Company entered into a Capital Equipment Purchase Agreement
        with Ismeca Europe Automation SA (“Ismeca”). The Ismeca, agreement calls for
        Ismeca to build an automated assembly line capable of producing up to 45
        units
        per minute of operation, or 1.5 million units per month net output, of Company’s
        fuel cell Power Pack products. The agreement, as amended in October and December
        2006, provides for the Company to pay Ismeca an aggregate of approximately
        18,973,000 Swiss Francs (approximately $15,562,000 at the currency exchange
        rate
        in effect on December 31, 2006) for constructing the line, which is planned
        to
        be operated at the Galway, Ireland facility of Celestica. This amount may
        increase if the Company requests additional capabilities in the line. From
        the
        inception of the agreement through December 31, 2006, the Company paid an
        aggregate of approximately $3,755,000 (4,721,000 Swiss Francs) under the
        agreement with Ismeca and also recoded additional amounts during December
        2006
        totaling approximately $4,700,000 of which approximately $4,600,000 was paid
        in
        January 2007. All such amounts are included in property and equipment as
        of
        December 31, 2006.
  F-29
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
 **NOTE
        J—COMMITMENTS AND CONTINGENT LIABILITIES AND STRATEGIC AGREEMENTS
        (Continued)**
  In
        September 2005, the Company entered into a contract with Celestica, an
        international electronics manufacturing services (EMS) firm, to manage its
        line
        following its installation at Celestica’s Galway, Ireland facility. This
        three-year agreement provides for Celestica to operate the line. Celestica
        will
        also operate the Company’s fuel production facility in the same
        location.
  6. *Distribution
        Agreements* —
On
        March 9, 2004, the Company entered into a distribution agreement with Kensington
        Technology Group, a leading maker of computer accessories and a division
        of ACCO
        Brands, Inc. Pursuant to the distribution agreement, among other things,
        the
        Company has granted Kensington the limited, exclusive right to market and
        distribute its Power Pack and other products using its fuel cell technology
        under the Kensington and Medis brand names.
  On
        August
        3, 2004, the Company entered into a distribution agreement with Superior
        Communications, which provides wireless accessories to major mobile operators,
        retailers and distributors across the United States, for the distribution
        of the
        Company’s fuel cell Power Pack products through outlets not otherwise covered by
        the Company’s other distribution agreements.
  On
        August
        10, 2004, the Company entered into a distribution agreement with ASE
        International Inc., which distributes a variety of consumer products to mass
        distribution outlets such as department stores, drug stores and duty free
        shops,
        for the distribution of the Company’s fuel cell Power Pack products through
        outlets not otherwise covered by the Company’s other distribution
        agreements.
  On
        July
        28, 2005, the Company announced that ASE International had issued to a purchase
        order to the Company for delivery of 200,000 Power Packs a month for the
        first
        year of availability from its production and 400,000 Power Packs a month
        from
        the second year of production. The Company will not derive any revenues under
        the purchase order unless and until it commences large-scale manufacturing
        of
        the Power Pack.
  7. *Cooperation
        Agreements with Mobile Operators -* On
        June
        7, 2005, the Company announced that it had entered into a Cooperation Agreement
        with one of the largest mobile operators in the United States, for the purposes
        of market testing and introduction to the market of the Company’s fuel cell
        Power Packs as a secondary power source for portable electronic devices offered
        by the mobile operator.
  On
        July
        5, 2005, the Company announced that it had entered into a Cooperation Agreement
        with a broadly-affiliated United Kingdom mobile telephone operator for the
        purposes of market testing and introduction to the market of Medis’ fuel cell
        Power Packs as a secondary power source for portable electronic devices offered
        by the mobile operator. This agreement is similar to the one described above
        with the U.S. mobile operator.
  
  F-30
 **Medis
          Technologies Ltd. and Subsidiaries**
 **Notes
          to Consolidated Financial Statements**
  **NOTE
        K—RELATED PARTY TRANSACTIONS**
  ** 1. *Consulting
        Agreements—* The
        Company has entered into consulting agreements with its Chairman and Chief
        Executive Officer and with its Deputy Chairman and Chief Operation Officer.
        Such
        agreements have initial terms through December 31, 2001 and provide for
        automatic extension on a year to year basis. During the years ended December
        31,
        2004, 2005 and 2006, the Company incurred fees relating to its agreement
        with
        its Chairman and Chief Executive Officer of approximately $255,000, $267,000
        and
        $295,000, respectively, as compensation for his services as an officer of
        the
        Company. During the years ended December 31, 2004, 2005 and 2006, the Company
        incurred fees relating to its agreement with its Deputy Chairman and Chief
        Operating Officer of approximately $160,000, $210,000 and $270,000,
        respectively, as compensation for his services as an officer of the
        Company.
  During
        the year ended December 31, 2002, the Company entered into a consulting
        agreement with a corporation wholly owned by its president, for selling,
        marketing and other promotional services. Such agreement has an initial term
        through December 31, 2003 and provides for automatic extension on a year
        to year
        basis. During each of the years ended December 31, 2004, 2005 and 2006, the
        Company incurred fees of approximately $144,000, as compensation for consulting
        services under such agreement.
  2. *Administrative
        Services*  *—* Secretarial and bookkeeping services are provided to MTL through a costs
        sharing
        arrangement with a company that is controlled by the Chairman and Chief
        Executive Officer and with its Deputy Chairman and Chief Operating Officer
        of
        MTL. During the years ended December 31, 2004, 2005, and 2006, fees for such
        services amounted to approximately $68,000, $66,000 and $69,000, respectively.
        See Note J-3 regarding lease agreement with the same related party.
  *3.
        Loans to Non-Executive Officers—*  On
        April
        25, 2005, the Company loaned $140,000 to its Vice President of Marketing,
        such
        loan has been paid in full. This is in addition to a $50,000 loan made by
        MTL to
        its Vice President of Marketing in January 2005, which has also been paid
        in
        full. The Vice President of Marketing is a non-executive officer of the Company.
        Such loans were evidenced by secured promissory notes (as amended, the “Notes”)
        in favor of the Company. The interest rate under the April 2005 Note was
        3.35%
        per annum, which is equal to the applicable federal rate for short-term loans
        in
        effect on such loan date, and the interest rate under the January 2005 Note
        was
        3.0% per annum, which is greater than the applicable federal rate for short-term
        loans in effect on such loan date. Interest on the loans was paid monthly,
        and
        the loans provided for a due date of September 30, 2005. Furthermore, upon
        any
        sale of stock issued pursuant to the exercise of certain warrants beneficially
        owned by Ms. Rush, the difference between the sale price of the stock and
        the
        exercise price of the warrants was to be applied to prepay the outstanding
        principal and accrued interest on the Notes. In September 2005, the Vice
        President of Marketing repaid the $50,000 due under the January 2005 loan.
        In
        September 2005, the Company and the Vice President of Marketing entered into
        an
        amendment to the April 25, 2005 note whereby the due date of that note was
        extended to November 30, 2005. On November 30, 2005, the Company and the
        Vice
        President of Marketing entered into an amendment to the April 25, 2005 note
        whereby the due date of the note was extended to February 28, 2006 and the
        interest rate was increased to 4.04%. In December 2005, the Vice President
        of
        Marketing made a principal payment on the April 25, 2005 note of $10,000
        and
        paid off the remaining principal and interest in-full pursuant to the terms
        of
        the note, on the March 1, 2006. On April 10, 2006 the Company loaned $25,000
        to
        the Vice President of Marketing, which was evidenced by a secured promissory
        note. The interest rate on this loan was 4.77% per annum, which is equal
        to the
        applicable federal rate for short-term loans in effect on such loan date.
        In
        September 2006, the Vice President of Marketing paid off the principal and
        interest in-full pursuant to the terms of the note. In December 2006, the
        Company loaned $20,000 to the Vice President of Marketing, which was evidenced
        by a secured promissory note. The interest rate on this loan was 4.97% per
        annum, which is equal to the applicable federal rate for short-term loans
        in
        effect on such loan date. All Principal and interest on this loan was paid
        in
        full in January 2007 in accordance with the terms of the note. On
  F-31
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
 **NOTE
        K—RELATED PARTY TRANSACTIONS (Continued)**
  January
        17, 2007, subsequent to the balance sheet date, the Company loaned $50,000
        to
        the Vice President of Marketing, which was evidenced by a secured promissory
        note. The interest rate for this loan is 4.88% per annum, which is equal
        to the
        applicable federal rate for short-term loans in effect on such loan date,
        interest is payable monthly and the loan is due on September 28,
        2007.
  In
        April
        2003 and May 2004, the Company loaned an aggregate of approximately $299,000,
        to
        the G eneral
        Manager of More Energy (the “Seller”) ,
        principally to enable him to pay certain tax obligations arising from the
        sale
        of his interest in More Energy to MTL in 2003. The Seller has executed a
        non-recourse, interest bearing, secured promissory note (the “Note”) in favor of
        MTL evidencing such loans. The interest rate under the Note is equal to the
        applicable federal rate for mid-term loans in effect in April 2003, which
        equals
        a rate of 2.94% per annum. Principal of, and accrued interest on, the Note
        was
        to be paid in full by December 31, 2006, the maturity date of the Note. The
        Seller has also entered into a pledge agreement with the Company under which
        he
        has pledged as collateral for the payment in full of his obligations under
        the
        Note 120,000 shares of the Company’s common stock owned by the Seller. By the
        due date of the Note of December 31, 2006, the Seller had paid off the principal
        and interest in-full in accordance with the terms of the note.
  **NOTE
        L—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.
 
 c.
            Tax
                rates applicable to the Group companies: 
 1.     The
        income of the Israeli subsidiaries (other than income from “approved
        enterprises,” see d. below) is taxed at the regular rate. Through
        December 31, 2003, the corporate tax rate was 36%. In July 2004, an
        amendment to the Israeli Income Tax Ordinance was enacted. One of the provisions
        of this amendment gradually reduces the corporate tax rate from 36% to 30%.
        The
        rates are as follows: 35% in 2004, 34% in 2005, 32% in 2006 and 30% in 2007
        and
        thereafter.
 
 2.     On
        July 25, 2005, the Israeli Income Tax Ordinance was amended to further
        reduce the corporate tax rates and to provide for a gradual reduction,
        commencing from January 1, 2006, as follows: 31% in 2006, 29% in 2007, 27%
        in 2008, 26% in 2009 and 25% in 2010 and thereafter.
 
 Since
        no
        deferred tax assets are recorded for net loss carryforwards in Israel, the
        abovementioned amendment has no effect on the financial statements.
 
 F-32
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
 **NOTE
        L—INCOME TAXES (Continued)**
  d.
            Encouragement
                Law in Israel: 
 Tax
        benefits under the law for the Encouragement of Capital Investments, 1959
        (the
“Law”):
 
 Under
        the
        Law, by virtue of the “Approved Enterprise” status granted to More Energy Ltd.
        and Medis El Ltd. are entitled to certain tax benefits. Due to reported losses
        for tax purposes, the benefit period has not yet commenced.
  Medis
        El
        is an Israeli corporation and is subject to income taxes under the relevant
        Israeli tax law. Medis El has been issued a certificate of approval as an
        “Approved Enterprise,” which allows Medis El to receive certain governments’
grants and to have lower tax rates under Israeli tax law. Such rates include
        a
        corporate tax on income derived from Approved Enterprise activities at a
        rate of
        10% to 25% and a reduced tax rate on distributed dividends of 15%. These
        benefits for tax reduced rate have expired in 2006.
  In
        September 2001, More Energy, the Company’s fuel cell subsidiary, was granted
        Approved Enterprise status. The plan provides a two-year tax exemption, as
        well
        as reduced tax (25%-10%) for a period of 5-8 years. The benefits from the
        Approved Enterprise programs depend upon More Energy fulfilling the conditions
        under the letter of approval and the laws governing the grant. The commencement
        of the benefits period is determined beginning with the year in which taxable
        income is initially generated by the Approved Enterprise, provided that the
        earlier of 14 years have not elapsed from the year in which the approval
        was
        granted, or 12 years from the year in which the enterprise was initially
        operated. More Energy’s initial Approved Enterprise plan was completed during
        2004 and its status as an entity qualifying for tax benefits will be governed
        by
        the provisions of the Investment Law, as amended (see below).
  If
        More
        Energy distributes a cash dividend from retained earning which were tax exempt
        due to its approved enterprise status, More Energy would be required to pay
        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 derive income form 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
        Investment 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. 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 an advanced ruling from the Israeli tax authorities no later than
        within 6 months after the end of the Year of Election.
  The
        Investment Law also provides that any certificate of approval granted prior
        to
        the Amendment will remain subject to the terms and benefits included in such
        certificate of approval.
  F-33
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
 **NOTE
        L—INCOME TAXES (Continued)**
  e.
            Carryforward
                losses: 
 At
        December 31, 2006, the Company had a net operating loss (“NOL”)
        carryforward for United States Federal income tax purposes of approximately
        $27,458,000, expiring through 2026. Such amount includes $7,780,000 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” provisions of the
        Internal Revenue Code of 1986 and similar state provisions. The annual
        limitation may result in the expiration of net operating losses before
        utilization. Medis El, has net operating losses, for Israeli tax purposes,
        aggregating approximately $74,854,000 as of December 31, 2006, 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.
            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,****2005**
              
              **2006**Equity
                  based compensation
              
              $
              —
              
              **$**
              **837,000**Net
                  operating loss carryforward—United States
              
              
              5,559,000
              
              
              **12,631,000**Net
                  operating loss carryforward—Israel
              
              
              14,435,000
              
              
              **18,713,000**Other
                  differences
              
              
              3,135,000
              
              
              **4,275,000**23,129,000
              
              
              **36,456,000**Valuation
                  allowance
              
              
              (23,129,000
              )
              
              **(36,456,000**
              **)**Deferred
                  tax assets, net of valuation allowance
              
              $
              —
              
              **$**
              **—**
  The
        entire change in valuation allowance is for the increase in net operating
        loss
        during the year. Management  currently
        believes that it is more likely than not that deferred tax assets from
        carryforward losses in U.S will not be realized in the foreseeable future.
        Accordingly, a valuation allowance has been recorded for the entire
        amount.
 
 g.
            Loss
                before income taxes is comprised as
                follows: 
 **Year
                  ended December 31,****2004**
              
              **2005**
              
              **2006**Foreign
              
              $
              (12,960,000
              )
              **$**
              **(15,602,000**
              **)**
              **$**
              **(21,736,000**
              **)**Domestic
              
              
              (2,702,000
              )
              
              **(2,948,000**
              **)**
              
              **(11,311,000**
              **)**$
              (15,662,000
              )
              **$**
              **(18,550,000**
              **)**
              **$**
              **(33,047,000**
              **)**
 
 h.
            Reconciliation
                of the theoretical tax benefit to the actual tax expense
                benefit:  In
        2004,
        2005 and 2006, 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-34
 **Medis
            Technologies Ltd. and Subsidiaries**
 **Notes
            to Consolidated Financial Statements**
 **NOTE
        M—SUMMARY INFORMATION ABOUT GEOGRAPHIC AREAS**
  The
        Company manages its business on a basis of one reportable segment. See
        Note A for a brief description of the Company’s business. The following
        data is presented in accordance with Statement of Financial Accounting Standards
        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, 2004,
        2005 and 2006 and long-lived assets as of December 31, 2004, 2005 and
        2006:
  **December
                  31,****2004**
              
              **2005**
              
              **2006**Total
                  Revenues
              
              Long-lived
                  assets
              
              Total
                  Revenues
              
              Long-lived
                  assets
              
              Total
                  Revenues
              
              Long-lived
                  assetsUnited
                  States
              
              $
              —
              
              $
              299,000
              
              $
              —
              
              $
              64,000
              
              $
              150,000
              
              $
              —Europe
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              12,105,000Israel
              
              
              —
              
              
              62,370,000
              
              
              425,000
              
              
              66,144,000
              
              
              —
              
              
              73,670,000$
              —
              
              $
              62,669,000
              
              $
              425,000
              
              $
              66,208,000
              
              $
              150,000
              
              $
              85,775,000
 
  **NOTE
        N —CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)**
  **Quarter
                  ended**
              
              **March
                  31**
              
              **June
                  30**
              
              **September****30**
              
              **December
                  31**Fiscal
                  2006Revenues
              
              $
              —
              
              $
              —
              
              $
              150,000
              
              $
              —Gross
                  profit
              
              $
              —
              
              $
              —
              
              $
              52,000
              
              $
              —Loss
                  from operations
              
              $
              (5,446,000
              )
              $
              (5,621,000
              )
              $
              (7,065,000
              )
              $
              (7,660,000
              )Interest
                  income (expenses)
              
              $
              (450,000
              )
              $
              (8,101,000
              )
              $
              389,000
              
              $
              907,000Net
                  loss
              
              $
              (5,896,000
              )
              $
              (13,722,000
              )
              $
              (6,676,000
              )
              $
              (6,753,000
              )Basic
                  and diluted net loss per share
              
              $
              (.21
              )
              $
              (.44
              )
              $
              (.21
              )
              $
              (.22
              )Weighted-average
                  number of shares used in computing basic and diluted net loss per
                  share
              
              
              28,229,241
              
              
              31,030,842
              
              
              32,108,884
              
              
              32,239,934Fiscal
                  2005Revenues
              
              $
              —
              
              $
              —
              
              $
              —
              
              $
              425,000Gross
                  profit
              
              $
              —
              
              $
              —
              
              $
              —
              
              $
              163,000Loss
                  from operations
              
              $
              (5,041,000
              )
              $
              (3,794,000
              )
              $
              (4,292,000
              )
              $
              (4,782,000
              )Interest
                  income (expenses)
              
              $
              73,000
              
              $
              49,000
              
              $
              (303,000
              )
              $
              (460,000
              )Net
                  loss
              
              $
              (4,968,000
              )
              $
              (3,745,000
              )
              $
              (4,595,000
              )
              $
              (5,242,000
              )Basic
                  and diluted net loss per share
              
              $
              (.18
              )
              $
              (.14
              )
              $
              (.17
              )
              $
              (.19
              )Weighted-average
                  number of shares used in computing basic and diluted net loss per
                  share
              
              
              27,087,934
              
              
              27,304,890
              
              
              27,582,802
              
              
              27,710,059
  ********************************
   F-35


**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.




Dated:   
                March 15, 2007
            **MEDIS
                TECHNOLOGIES LTD.**
              
              By:
/s/
                Robert K. LiftonRobert K. Lifton
              Chairman 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/Robert
                K. Lifton
            
            Chairman
                andChief
                Executive Officer,
            
            March
                15, 2007Robert
                K. Lifton
            
            Secretary
              and Director
              (Principal Executive Officer)/s/Howard
                Weingrow
            
            Deputy
                Chairman, Chief Operating Officer
            
            March
                15, 2007Howard
                Weingrow
            
            and Treasurer
              and
              Director/s/Israel
                  Fisher
            
            Senior
                Vice President-Finance
            
            March
                15, 2007Israel
                Fisher
            
            (Principal
                Financial Officer)/s/Jacob
                Weiss
            
            President
                and Director
            
            March
                15, 2007Jacob
                Weiss/s/Michael
                S. Resnick
            
            Senior
                Vice President and Controller
            
            March
                15, 2007Michael
                S. Resnick
            
            (Principal
                Accounting Officer)/s/Amos
                  Eiran
            
            Director
            
            March
                15, 2007Amos
                  Eiran
              /s/Zeev
                Nahmoni
            
            Director
            
            March
                15, 2007Zeev
                  Nahmoni
              /s/Jacob
                E. Goldman
            
            Director
            
            March
                15, 2007Jacob
                  E. Goldman
              /s/Philip
                Weisser
            
            Director
            
            March
                15, 2007Philip
                  Weisser
              /s/
                Mitchell H. Freeman
            
            Director
            
            March
                15, 2007Mitchell
                  H. Freeman
              /s/
                Steve
                M. Barnett
            
            Director
            
            March
                15, 2007Steve
                  M. Barnett
              /s/
                Daniel Luchansky
            
            Director
            
            March
                15, 2007Daniel
                Luchansky