UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-Q






QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934






For
The Quarterly Period Ended


June
30, 2009






Commission
file number: 0-30391






MEDIS
TECHNOLOGIES LTD.


(Exact
Name of Registrant as Specified in its Charter)








Delaware
            13-3669062(State or other
      jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification Number)




805
Third Avenue


New
York, New York 10022


(Address
of Principal Executive Offices and Zip Code)




(212)
935-8484


(Registrant's
Telephone Number, Including Area Code)









Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405
of this chapter) during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). 
Yes  o    No 
o




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




Large
accelerated filer   o                                                    Accelerated
filer  x


Non-accelerated
filer     o                                                    Smaller
Reporting Company  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




The
number of shares of Common Stock, par value $.01 per share, outstanding as of
August 17, 2009 was 46,349,555.







MEDIS
TECHNOLOGIES LTD.




INDEX
TO FORM 10-Q




FOR
THE QUARTER ENDED JUNE 30, 2009










PART
      I.
            FINANCIAL
      INFORMATION
            Page
      NumberItem
    1.
            Financial
      Statements1Condensed
      Consolidated Balance Sheets December
      31, 2008 and June 30, 2009 (Unaudited)Condensed
      Consolidated Statements of Operations (Unaudited)Six and three
      months ended June 30, 2008 and 2009
            2Condensed
      Consolidated Statements of Cash Flows (Unaudited)Six months ended
      June 30, 2008 and 2009
            3Notes to Condensed
      Consolidated Financial Statements (Unaudited)
            5Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition
      and Results of Operations
            14Item
    3.
            Quantitative and
      Qualitative Disclosures about Market Risk
            26Item
      4.
            Controls and
      Procedures
            26PART
      II.
            OTHER
      INFORMATIONItem
    1.
            Legal
      Proceedings
            27Item
    1A.
            Risk
      Factors
            27Item
    3.
            Defaults Upon Senior
      Securities
            29Item
    5.
            Other
      Information
            30Item
      6.
            Exhibits
            32









PART
I - FINANCIAL INFORMATION




Item
1.  Financial Statements




Medis
Technologies Ltd. and Subsidiaries


Condensed
Consolidated Balance Sheets




December
      31, 2008
                
                
                June
      30, 2009ASSETS
                
                
                
                
                (unaudited)Current
      assetsCash
      and cash equivalents
                
                $
                10,642,000
                
                
                $
                762,000Restricted
      cash and deposits
                
                
                1,027,000
                
                
                
                284,000Inventories
                
                
                7,278,000
                
                
                
                7,207,000Prepaid
      expenses and other current assets
                
                
                1,245,000
                
                
                
                398,000Total
      current assets
                
                
                20,192000
                
                
                
                8,651,000Inventories
                
                
                2,617,000
                
                
                
                —Restricted
      cash and deposits
                
                
                4,055,000
                
                
                
                —Property,
      plant and equipment, net
                
                
                32,085,000
                
                
                
                11,312,000Severance
      pay fund
                
                
                1,599,000
                
                
                
                1,279,000Goodwill
                
                
                2,212,000
                
                
                
                —Total
      assets
                
                $
                62,760,000
                
                
                $
                21,242,000LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesAccounts
      payable
                
                $
                4,701,000
                
                
                $
                4,405,000Accrued
      expenses and other current liabilities
                
                
                3,037,000
                
                
                
                7,378,000Advance
      on Series B Preferred Stock and Warrants
                
                
                —
                
                
                
                1,000,000Bridge
      loan
                
                
                —
                
                
                
                550,000Short
      term loans
                
                
                —
                
                
                
                100,000Capital
      lease – current maturities
                
                
                80,000
                
                
                
                —Total
      current liabilities
                
                
                7,818,000
                
                
                
                13,433,000Capital
      lease
                
                
                4,067,000
                
                
                
                —Accrued
      severance pay
                
                
                2,211,000
                
                
                
                1,593,000Total
      Liabilities
                
                
                14,096,000
                
                
                
                15,026,000Commitments
      and contingent liabilitiesSeries
      A Preferred Stock, net, $.01 par value; $10,000 liquidation preference per
      share; 10,000 shares authorized; and 5,750 issued and outstanding at
      December 31, 2008 and June 30, 2009; aggregate liquidation preference of
      $57,500,000 as of December 31, 2008 and $59,603,000 as of June 30,
      2009
                
                
                53,240,000
                
                
                
                53,240,000Stockholders’
      equityCommon
      stock, $.01 par value; 75,500,000 shares authorized at December 31, 2008
      and June 30, 2009; 46,082,888 and 46,349,555 shares issued and outstanding
      at December 31, 2008 and June 30, 2009 (including 1,500,000 shares
      outstanding at December 31, 2008 and June 30, 2009 loaned to be
      returned)
                
                
                461,000
                
                
                
                463,000Additional
      paid-in capital
                
                
                366,660,000
                
                
                
                367,696,000Non-controlling
      interest
                
                
                —
                
                
                
                (178,000
                )Accumulated
      deficit
                
                
                (371,697,000
                )
                
                
                (415,005,000
                )Total
      stockholders’ deficit
                
                
                (4,576,000
                )
                
                
                (47,024,000
                )Total
      liabilities and stockholders’ deficit
                
                $
                62,760,000
                
                
                $
                21,242,000




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


1


Medis
Technologies Ltd. and Subsidiaries


Condensed
Consolidated Statements of Operations


(Unaudited)









Three
      Months
                  Ended
      June 30,
              
              
              Six
      Months
                  Ended
      June 30,2008
              
              
              2009
              
              
              2008
              
              
              2009Depreciation,
      production and facility costs
              
              $
              6,617,000
              
              
              $
              2,881,000
              
              
              $
              8,983,000
              
              
              $
              11,009,000Inventory
      reserves and write-offs
              
              
              —
              
              
              
              2,617,000
              
              
              
              —
              
              
              
              2,617,000Total
      depreciation, production and facility costs.
              
              $
              6,617,000
              
              
              $
              5,498,000
              
              
              $
              8,983,000
              
              
              $
              13,626,000Operating
      expensesResearch
      and development costs
              
              $
              5,239,000
              
              
              $
              1,442,000
              
              
              $
              13,287,000
              
              
              $
              3,964,000Selling,
      marketing, general and administrative expenses
              
              
              3,794,000
              
              
              
              1,644,000
              
              
              
              7,163,000
              
              
              
              5,466,000Impairment
      charges on goodwill
              
              
              —
              
              
              
              2,212,000
              
              
              
              —
              
              
              
              2,212,000Impairment
      charges on equipment
              
              
              —
              
              
              
              15,750,000
              
              
              
              —
              
              
              
              17,974,000Amortization
      of intangible assets
              
              
              —
              
              
              
              —
              
              
              
              48,000
              
              
              
              —Total
      operating expenses
              
              
              9,033,000
              
              
              
              26,546,000
              
              
              
              20,498,000
              
              
              
              43,242,000Loss
      from operations
              
              
              (15,650,000
              )
              
              
              (26,546,000
              )
              
              
              (29,481,000
              )
              
              
              (43,242,000
              )Interest
      income (expenses)Interest
      income
              
              
              137,000
              
              
              
              7,000
              
              
              
              354,000
              
              
              
              72,000Interest
      expense
              
              
              (243,000
              )
              
              
              (399,000
              )
              
              
              (620,000
              )
              
              
              (316,000
              )(106,000
              )
              
              
              (392,000
              )
              
              
              (266,000
              )
              
              
              (244,000
              )Net
      loss
              
              $
              (15,756,000
              )
              
              $
              (26,938,000
              )
              
              $
              (29,747,000
              )
              
              $
              (43,486,000
              )Net
      loss attributable to non-controlling interest
              
              
              132,000
              
              
              
              84,000
              
              
              
              376,000
              
              
              
              178,000Net
      loss attributable to controlling interest
              
              $
              (15,624,000
              )
              
              $
              (26,854,000
              )
              
              $
              (29,371,000
              )
              
              $
              (43,308,000
              )Dividend
      on preferred stock
              
              
              (1,042,000
              )
              
              
              —
              
              
              
              (2,084,000
              )
              
              
              —Net
      loss attributable to controlling interest common
    stockholders
              
              $
              (16,666,000
              )
              
              $
              (26,854,000
              )
              
              $
              (31,455,000
              )
              
              $
              (43,308,000
              )Basic
      and diluted net loss attributable to controlling interest common
      stockholders per share
              
              $
              (0.44
              )
              
              $
              (0.62
              )
              
              $
              (0.86
              )
              
              $
              (1.01
              )Weighted-average
      number of common shares used in computing basic and diluted net loss
      attributable to controlling interest common stockholders per
      share
              
              
              37,707,938
              
              
              
              44,849,555
              
              
              
              36,632,074
              
              
              
              44,777,363







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




2


Medis
Technologies Ltd. and Subsidiaries


Condensed
Consolidated Statements of Cash Flows


(Unaudited)




Six
      Months
                  Ended
      June 30,2008
              
              
              2009Cash
      flows from operating activitiesNet
      loss attributable to controlling interest
              
              $
              (29,371,000
              )
              
              $
              (43,308,000
              )Adjustments
      to reconcile net loss to net cash used in operating
    activitiesNet
      loss attributable to non-controlling interest
              
              
              (376,000
              )
              
              
              (178,000
              )Depreciation
      and amortization of property andequipment
              
              
              4,453,000
              
              
              
              2,931,000Impairment
      charge on goodwill
              
              
              —
              
              
              
              2,212,000Impairment
      charge on equipment
              
              
              —
              
              
              
              17,974,000Loss
      on sale of equipment
              
              
              —
              
              
              
              240,000Amortization
      of intangible assets
              
              
              48,000
              
              
              
              —Non-cash
      stock based compensation and restricted shares expense
              
              
              3,420,000
              
              
              
              922,000Value
      of shares issued as commitment fee
              
              
              —
              
              
              
              117,000Loss
      from a rights offering in subsidiary
              
              
              25,000
              
              
              
              —Interest
      receivable on restricted
      cash
              
              
              (199,000
              )
              
              
              —Changes
      in operating assets and liabilities:Inventories
      net of change in reserves
              
              
              (4,190,000
              )
              
              
              2,688,000Prepaid
      expenses and other current assets
              
              
              1,179,000
              
              
              
              847,000Accounts
      payable
              
              
              38,000
              
              
              
              (295,000
              )Accrued
      expenses and other current liabilities
              
              
              129,000
              
              
              
              4,469,000Leasehold
      incentive obligations,
      net
              
              
              (137,000
              )
              
              
              (139,000
              )Fx
      currency adjustments and gain on satisfaction of Capital lease
      obligation
              
              
              158,000
              
              
              
              (451,000
              )Accrued
      severance pay,
      net
              
              
              95,000
              
              
              
              (298,000
              )Net
      cash used in operating activities
              
              
              (24,728,000
              )
              
              
              (12,269,000
              )Cash
      flows from investing activitiesCapital
      expenditures
              
              
              (5,715,000
              )
              
              
              (406,000
              )Capital
      lease payments
              
              
              (16,000
              )
              
              
              (3,685,000
              )Restricted
      cash and deposits
              
              
              137,000
              
              
              
              4,798,000Proceeds
      from sale of equipment
              
              
              —
              
              
              
              32,000Net
      cash (used) provided in investing activities
              
              
              (5,594,000
              )
              
              
              739,000Cash
      flows from financing activitiesProceeds
      from issuance of common stock pursuant to a public offering,
      net
              
              
              51,759,000
              
              
              
              —Proceeds
      from issuance of subsidiary's common stock pursuant to a rights offering,
      net of issuance costs
              
              
              456,000
              
              
              
              —Proceeds
      from advance on Series B Preferred Stock
              
              
              —
              
              
              
              1,000,000Proceeds
      from Bridge loan
              
              
              —
              
              
              
              550,000Proceeds
      from Short term loans
              
              
              —
              
              
              
              100,000Proceeds
      from exercise of stock options
              
              
              17,000
              
              
              
              —Dividend
      on Series A Preferred Stock
              
              
              (2,084,000
              )
              
              
              —Net
      cash provided by financing activities
              
              
              50,148,000
              
              
              
              1,650,000Net
      increase (decrease) in cash and cash equivalents
              
              
              19,826,000
              
              
              
              (9,880,000
              )Cash
      and cash equivalents at beginning of period
              
              
              16,626,000
              
              
              
              10,642,000Cash
      and cash equivalents at end of period
              
              $
              36,452,000
              
              
              $
              762,000




(Condensed
Consolidated Statements of Cash Flows continued on next page)


3




Medis
Technologies Ltd. and Subsidiaries


Condensed
Consolidated Statements of Cash Flows (Continued)


(Unaudited)









Six
      Months
                    Ended
      June 30,2008
                  
                  
                  2009Supplemental disclosures of cash flow
      information:Cash
      paid during the period for:Interest
                  
                  $
                  99,000
                  
                  
                  $
                  49,000Non-cash
      investing and financing activities:Capital
      expenditure included in accounts payable
                  
                  $
                  1,603,000
                  
                  
                  $
                  —Accrued
      Issuance costs on a rights offering of subsidiary
                  
                  $
                  143,000
                  
                  
                  $
                  —Accrued
      Issuance costs on public offering
                  
                  $
                  141,000
                  
                  
                  $
                  —




































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


4


Medis
Technologies Ltd. and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




Note
A - Nature Of Operations And Basis Of Presentation




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




2.  Since its
inception, the Company has sustained operating losses and has used cash in its
operations. During the six months ended June 30, 2009, the Company used cash in
operating activities of $12,269,000, incurred a net loss of $43,308,000, and had
a total stockholders’ deficit of $47,024,000 at June 30, 2009.




The
Company has limited available cash resources and requires additional financing
in order to continue to fund its current operations beyond August 2009, and to
pay existing and future liabilities and other obligations, including payroll.
The Company’s executive management has agreed to defer the payment of their July
payroll and the Company is in the process of attempting to obtain deferrals for
the payment of July payroll for remaining employees. The Company is continuing
to negotiate with third parties in an attempt to obtain additional sources of
funds to finance the Company’s operations. The satisfactory completion of these
negotiations prior to the end of August 2009 is essential to provide sufficient
cash flow to meet current operating requirements. Furthermore, even if the
Company is successful in raising additional funds, the Company cannot give any
assurance that it will, in the future, be able to achieve a level of
profitability from the sale of its products to sustain its operations. These
conditions raise substantial doubt about the Company’s ability to continue as a
going concern. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on recoverability and
reclassification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.




The
Company is pursuing the following alternatives to raise working capital in the
third quarter of 2009:




·
            The
      sale of additional shares of its Series B Preferred Stock for aggregate
      proceeds of approximately $2
million;




·
            The
      sale of its debt/equity securities, with the intention of raising
      approximately $2 million before the end of the fourth quarter 2009,
      subject to board consideration and approval and the signing of definitive
      documentation;




5


·
            The
      signing of contracts for the research and development of fuel cell
      products for military applications, which may include entering into joint
      venture, licensing or other arrangements with foreign militaries, defense
      contractors or military supply and manufacturing
  companies;




·
            Through
      government grants in the United States, the State of Israel, or possibly
      both; and




·
            The
      sale of its excess production
assets.




The
Company can give no assurances that it will be successful in raising funds
through the sale of additional shares of its Series B Preferred Stock, the sale
of debt and/or equity securities, jointly developing its products for military
use, obtaining government grants or any other alternative. Any inability to so
obtain additional financing or funding will likely cause the Company to cease
business operations.




The
Company has continued to evaluate the feasibility of selling its tangible assets
and has determined that it will maintain the necessary tangible assets to
continue its research and development activities associated with its
intellectual property and to establish a low volume commercial production
line.  The Company plans to initiate a process to sell the remainder
of its productions assets.  The Company can give no assurances when,
or if, low volume commercial production will begin.




In the
first half of 2009, the Company initiated a comprehensive cost rationalization
plan designed to reduce operating costs and enhance operational efficiencies,
pursuant to which the Company:




·
            reduced
      aggregate payroll costs by approximately
50%;




·
            reduced
      operational expenses by approximately
50%;




·
            performed
      a full stream product cost review;
and




·
            explored
      opportunities to monetize non-essential
assets.




In an
effort to further reduce costs, the Company also suspended production across its
supply base. Although the Company’s new management had pursued efforts towards
the commercialization and sale of the Company’s existing product lines,
management has since then determined that it must stabilize the Company’s
finances and raise capital prior to continuing its production, sales and
marketing programs and expend additional funds towards that goal. Accordingly,
the Company has temporarily curtailed the marketing and sales efforts for its
commercial products, which it intends to recommence if and when the Company
again is adequately capitalized.




As part
of the cost rationalization plan, the Company reduced its staff by approximately
50 employees from its Israeli office. These positions are directly and
indirectly related to its operations and general administration. The Company has
also engaged in conversations with its major suppliers of goods and services and
it has initiated restructuring of its vendor processes and agreements. The
Company is also seeking to restructure accounts payable and accrued liabilities,
of which it can give no assurance of success. In connection with these efforts,
the Company is reviewing its current product line offerings to determine how to
best commercially leverage its fuel cell products and technology. The Company’s
restructuring and cost rationalization plans are being carried out in parallel
with its efforts to raise additional funds from external sources, which it
requires to pay existing obligations and to continue its
operations.


6




Our
production line is located at the facilities of our contract manufacturer,
Celestica Ireland Ltd., in Galway, Ireland. In March 2009, we
announced that we gave notice to Celestica that we were terminating our
agreement with it in September 2009. In April 2009, Celestica provided us notice
of its immediate termination of the Agreement for breach of payment obligations.
We have disputed some of Celestica’s claims and have been and continue to be in
discussions with Celestica to amicably resolve this matter, of which there can
be no assurance. We expect that if and when we resolve this matter, we will
remove the equipment from Celestica’s facilities to a new location, where the
production line would be reconfigured and revalidated to a low volume production
line, which better reflects our forecasted product demand and production
requirements, and the excess production equipment will be sold.




3.           
 Due to its financial condition, subsequent to June 30, 2009 Cell Kinetics
has taken several steps to substantially reduce its operating expenses to avoid
a situation in which it would be unable to meet its financial obligations to its
employees and suppliers. As a result, the Company has decided to dismiss all of
its employees except for the Company’s administrative assistant by the end of
September.




Following
the dismissals, the Company expects to freeze most of its activities, including
its marketing and sales and its research and development activities, but to
continue to explore a variety of strategic and financial alternatives including,
but not limited to, a transaction with another company, the adoption of a
business incubator model, or additional fundraising.




The
Company has recorded an impairment charge in the amount of $2,212,000 for the
entire goodwill balance (see note B- 17)




4.            
The accompanying unaudited condensed consolidated financial statements should be
read in conjunction with the following notes and with the consolidated financial
statements for the year ended December 31, 2008 and related notes included in
the Company’s Annual Report on Form 10-K. The condensed consolidated financial
statements as of June 30, 2009 and for the six months ended June 30, 2008 and
2009 are unaudited and have been prepared in accordance with U.S. generally
accepted accounting principles applicable to interim financial information and
the rules and regulations promulgated by the Securities and Exchange Commission.
Accordingly, such condensed consolidated financial statements do not include all
of the information and footnote disclosures required in annual financial
statements. In the opinion of the Company's management, the unaudited condensed
consolidated financial statements include all adjustments, consisting of normal
recurring adjustments necessary for a fair presentation of such condensed
consolidated financial statements. The results of operations for the six and
three months ended June 30, 2009 are not necessarily indicative of the results
to be expected for the entire year.




The
condensed consolidated balance sheet as of December 31, 2008 has been derived
from the audited financial statements at that date but does not include all of
the information and notes required by U.S. generally accepted accounting
principles for complete financial statements.




Note
B - General




1.
            Series A Preferred Stock- In February 2009, May 2009 and again in August 2009, subsequent
      to the balance sheet date, the Company did not declare the quarterly
      dividends on its Series A Preferred Stock, of approximately $1,047,000,
      $1,056,000 and $1,071,000 for the first, second and third quarters of
      2009, respectively. Upon the Company’s determination to not declare
      dividends, the dividend rate on the Series A Preferred Stock increased
      based on an equation in the Certificate of Designation relating to the
      Series A Preferred Stock, which increase shall remain in effect until such
      time as all accrued and unpaid dividends are paid in full. Additionally,
      if dividends are in arrears for the equivalent of six calendar quarters,
      the holders of the Series A Preferred Stock would be entitled to appoint
      two directors to the Company’s Board of Directors. The Series A Preferred
      Stock liquidation preference increases by the aggregate amount that the
      dividends on the Company’s Series A Preferred Stock are accumulated and
      unpaid.




7


2.
            Net Loss Per Share -The Company computes net loss per share in accordance with SFAS No.
      128, “Earnings Per Share” (“SFAS No. 128”). Under the provisions of SFAS
      No. 128, basic net loss per share is computed by dividing the net loss for
      the period by the weighted-average number of common shares outstanding
      during the period. Diluted net loss per share is computed by dividing the
      net loss for the period by the weighted average number of common shares
      plus dilutive potential common stock considered outstanding during the
      period. Since the Company generated net losses in all periods presented,
      potentially diluted securities, comprised of incremental common shares
      issuable upon the exercise of warrants and stock options, convertible
      notes and convertible preferred stock, are not reflected in diluted net
      loss per share because such shares are
  antidilutive.




The total
number of shares excluded from the calculation of diluted net loss per share
related to financial instruments that potentially can be converted to or
exercised for shares of the Company’s common stock aggregated approximately
7,973,024 and 8,324,447 as of June 30, 2008 and 2009, respectively. The shares
excluded from the calculation of diluted net loss per share as of June 30, 2008
and 2009 also include shares issued pursuant to a share lending
agreement.




3.
            Restricted Cash and Deposits -Restricted cash and deposits represents amounts held on deposit
      with banks as security for letters of credit and guarantees issued by such
      banks primarily to the Company’s suppliers and to the landlord of the
      Company’s premises in Israel. As of December 31, 2008, included in such
      amount is a one year time deposit in the amount of $4,285,000, which was
      originally issued in January 2007 and renewed in January 2008 and January
      2009, as security for a stand-by letter of credit provided by the bank to
      a supplier of equipment and components in order to guaranty recovery of
      certain investments by the supplier - principally in equipment to be used
      exclusively in the manufacture of components for the Company’s 24/7 Power
      Pack. Under the terms of a purchase agreement, title to the equipment
      covered by the stand-by letter of credit will pass to the Company upon
      full recovery of the cost of such equipment through purchases of
      components or draws against the letter of credit, based on formulas set
      forth in the purchase agreement. Such letter of credit expires in March
      2012. The Company accounted for such arrangement with the supplier as a
      capital lease. In April 2009, approximately $3,685,000 of the time deposit
      funds were used to satisfy in full the Company’s capital lease obligation,
      with the remaining approximately $600,000 becoming available to the
      Company together with the cancellation of the corresponding stand-by
      letter of credit.




In June
2009, the landlord of the Company’s premises in Israel agreed to draw
approximately $250,000 against a letter of credit for the payment of rent,
maintenance and other facility related costs. As a result, the Company’s
restricted cash and deposit balance was reduced by the same amount. As of June
30, 2009, the restricted cash and deposits relating to the landlord’s remaining
balance of the letter of credit is approximately $284,000.




4.
            Inventories -Inventories are stated at the lower of cost or market value. Cost
      is determined as follows:




8


a.
            Raw
      materials and components – average cost
basis.





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





The
Company reviews its inventory quantities based primarily on its estimated
forecast of product demand and production requirements. Those inventories which
we believe will not be put into production for over one year are classified as
long-term. Inventory reserves are provided to cover risks arising from
slow-moving items, technological obsolescence, excess inventories, and
discontinued products and for market prices lower than cost. During the six
months ended June 30, 2009, based upon updated forecasts of product demand and
production requirements, the Company recorded charges to Depreciation,
Production and Facility costs related to such inventory reserves and write offs
aggregating of approximately $2,617,000.





Inventories
consist of the following:




December
      31, 2008
                  
                  
                  June
      30, 2009(unaudited)Raw
      materials and components
                  
                  $
                  7,637,000
                  
                  
                  $
                  4,728,000Finished
      goods
                  
                  
                  2,258,000
                  
                  
                  
                  2,479,000$
                  9,895,000
                  
                  
                  $
                  7,207,000Non-current
      portion
                  
                  
                  2,617,000
                  
                  
                  
                  —Current
      portion
                  
                  $
                  7,278,000
                  
                  
                  $
                  7,207,000







5.
            Depreciation
      and Other Production Facility Costs -In
      accordance with SFAS No. 151 “Inventory Costs an Amendment of ARB No. 43,
      Chapter 4,” the Company has recognized as expense during the six and three
      months ended June 30, 2009 unallocated depreciation, subcontractor, labor,
      production facility cost, materials, components, and inventory reserve
      costs aggregated $13,626,000 and $5,498,000,
      respectively.  These costs were comprised of depreciation of
      approximately $2,465,000 and $1,194,000, non-recurring provision for
      contractual obligations of $5,364,000 and $887,000, wages of $1,472,000
      and $565,000 and material consumption and other costs of $996,000 and
      $235,000, respectively.  During the six and three months ended
      June 30, 2009, the Company incurred a non-recurring charge for inventory
      reserves and write-offs of $2,617,000 and during the six months ended June
      30, 2009, the Company  incurred subcontractor costs of $712,000.
      For the six and three months ended June 30, 2008, unallocated
      depreciation, subcontractor, labor, production facility cost, materials,
      components, and inventory reserve costs aggregated $8,983,000 and
      $6,617,000, respectively..  These costs were comprised of
      depreciation of approximately $3,110,000 and $2,230,000, subcontractor
      costs of $2,594,000 and $1,692,000, wages of $1,175,000 and $757,000 and
      material consumption and other costs of $2,104,000 and $1,938,000,
      respectively.





6.
            Property,
      and Equipment, Net


During
the six months ended June 30, 2009, the Company impaired the net book value, and
recorded an impairment charge, in the approximate amount of $17,974,000, on
certain production equipment. In first quarter of 2009, an impairment charge of
approximately $2,224,000 was recorded in connection with the Company’s agreement
to pay cash and transfer title to certain production equipment to a supplier
that had sold such equipment to the Company, in settlement of outstanding
invoices and commitments owed to the supplier. Based upon updated forecasts of
product demand


9




and
production requirements, the Company will retain certain production equipment
from the high volume production facility to assemble a low volume commercial
production line.  The Company plans to try to sell the excess
production equipment and has written down the net book value of the excess
production equipment to its estimate sale value, resulting in an impairment
charge of approximately $15,750,000.





7.
            Capital Lease- In
      April 2009, the Company satisfied in full its capital lease obligation in
      the amount of approximately $4,018,000 through the transfer of 2,802,225
      Euro (approximately $3,685,000) to the supplier of the equipment giving
      rise to the capital lease (the “Supplier”). Such funds were transferred
      from a time deposit with a bank that was included in restricted cash and
      deposits at March 31, 2009 and which served as collateral for a stand-by
      letter of credit issued in favor of the Supplier. Upon receipt of the
      funds by Supplier, the stand-by letter of credit was cancelled and the
      remaining fund in the time deposit of approximately $600,000 became
      available to the Company.




8.
            Commitments –During the
      six months ended June 30, 2009, the Company recorded an additional
      provision for contractual obligations in the aggregate amount of
      approximately $5,346,000, related to existing subcontractor and supplier
      agreements and purchase orders pursuant to which the Company does not
      expect to fully perform. As of June 30, 2009, total liabilities recorded
      for such subcontractors and suppliers amounted to approximately
      $7,374,000, which included provision for contractual obligations, accounts
      payable and other accrued
liabilities.




In March
2009, in accordance with the terms of the September 2005 Agreement for
Manufacturer between More Energy Ltd. (“More Energy”) and Celestica Ireland
Limited (“Celestica”) (the “Agreement”), the Company provided six months
advanced written notice to Celestica of its termination of the Agreement. In
April 2009, Celestica provided notice to the Company of termination of the
Agreement for breach of payment obligations. An estimate of the Company’s
commitment through the end of the Agreement has been included in the provision
for contractual obligations as of June 30, 2009.




Also
included in the provision for contractual obligations as of June 30, 2009 is an
additional cost of approximately $2,100,000 pursuant to an equipment design
agreement (“Design Agreement”) into which More Energy entered in August 2008,
with a potential second source supplier of components for manufacture of the
Company’s 24/7 Power Pack. Pursuant to the Design Agreement, More Energy issued
a purchase order in the amount of 2,468,000 Euro for the design and construction
of certain production equipment, which the Company may utilize if and when it
resumes production. In March 2009, the Company issued a “stop work” order under
the Design Agreement.




9.
            Stock-Based
      Compensation




During
the six months ended June 30, 2009, the Company did not grant any options,
warrants or other awards under its 2007 Equity Incentive Plan.




During
the six months ended June 30, 2009 and 2008, the Company recorded stock-based
compensation costs of $922,000 and $3,305,000, respectively. Such costs include
approximately $855,000 and $2,751,000, which was recorded as selling, marketing,
general and administrative expenses, and approximately $67,000 and $554,000,
which was recorded as research and development costs, respectively.




During
the three months ended June 30, 2009 and 2008, the Company recorded stock-based
compensation costs of approximately $344,000 and $1,824,000 of which
approximately $311,000


10




and
$1,533,000 was recorded as selling, marketing, general and administrative
expense and approximately $33,000 and $291,000 was recorded as research and
development costs, respectively.




As of
June 30, 2009, there were unrecognized compensation costs of approximately
$368,000 related to stock options, warrants and restricted stock that are
expected to be recognized in future periods.




10.
            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.




11.
            Shareholder
      Class Action




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




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




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




On July
22, 2009, the United States Court of Appeals for the Second Circuit affirmed the
Southern District of New York’s dismissal of the putative class action initiated
against the Company and its former CEO, among others.




12.
            Issuance of Stock - On
      February 18, 2009, the Company issued 266,667 shares of its common stock
      to a third party in connection with its entering into a Securities
      Purchase Agreement with such third party on February 13, 2009, to
      establish a potential source of funding, in what is sometimes termed an
      equity line of credit arrangement. Subsequent to that date, the Company
      determined that it could not access the facility due to various factors
      that limit the amounts or preclude the Company from drawing against this
      facility, including the trading price and average trading volume of our
      common stock. The Company recorded approximately $117,000 as the fair
      value of the shares issued to the third party and charged such amount to
      interest expense during the three months ended June 30, 2009. The equity
      line of credit was terminated in May
2009.





13.
            Claim Holder Litigation
      - On July 21, 2009, a third-party (the “Claim Holder”) sued the Company in
      Los Angeles Superior Court (the “Litigation”) for repayment of a claim
      against the Company in the amount of $377,000 (the “Claim”).  On
      July 29, 2009, the Company assumed the outstanding trade debt associated
      with the Claim from More Energy.  The debt was initially
      incurred by More Energy in




11


the
      ordinary course of its business. On July 30, 2009, the Company and the
      Claim Holder entered into a Settlement Agreement that provides for the
      extinguishment of the Claim in exchange for the issuance to the Claim
      Holder of 2,200,000 shares of the Company’s common stock (the “Settlement
      Shares”).  On July 31, 2009, the presiding judge in the
      Litigation entered an Order Approving Settlement of Claim (the “Order”),
      pursuant to which the Settlement Agreement became binding on the Company
      and the Claim Holder, and, on August 5, 2009, the Settlement Shares were
      issued to the Claim Holder.


The
number of shares to be issued under the Settlement Agreement is subject to
adjustment as follows: in the event that the number of VWAP Shares (as described
below) exceeds the number of Settlement Shares initially issued, then the
Company will issue to the Claim Holder additional shares of its common stock
equal to the sum of (i) the difference between the number of VWAP Shares and the
number of Settlement Shares initially issued, and (ii) the number of Additional
Shares (as described below). In the event that the number of VWAP Shares is less
than the number of Settlement Shares initially issued, then the Claim Holder
will return to the Company for cancellation that number of shares as equals (i)
the difference between the number of VWAP Shares and the number of Settlement
Shares initially issued, less (ii) the number of Additional Shares.




The
number of VWAP Shares is equal to 308,000 divided by 75% of the volume weighted
average price (the “VWAP”) of the Company’s common stock over the 20-day trading
period immediately following the date on which the Settlement Shares were
issued.  The number of Additional Shares is equal to the product of
(x) 3,080,000 multiplied by (y) (i) the difference between the VWAP of the
shares over such 20-day trading period minus $0.10 (ii) multiplied by
15%.




14.
            Series B Preferred Stock
      Purchase Agreement– On June 8, 2009, the Company entered into a
      Preferred Stock Purchase Agreement (the “Purchase Agreement”) with a
      third-party investor (the “Investor”), which provides that the Investor is
      committed to purchase up to $5,000,000 of the Company’s Series B Preferred
      Stock.  Under the terms of the Purchase Agreement, from time to
      time until June 7, 2010, and at the Company’s sole discretion, it may
      present the Investor with a notice to purchase such Series B Preferred
      Stock (the “Notice”).  The Investor is obligated to purchase
      such Series B Preferred Stock on the tenth trading day after the Notice
      date, subject to satisfaction of certain closing
      conditions.  The Investor will not be obligated to purchase the
      Series B Preferred Stock (i) in the event the closing price of the
      Company’s common stock during the nine trading days following delivery of
      a Notice falls below 75% of the closing price on the trading day prior to
      the date such Notice is delivered to the Investor, or (ii) to the extent
      such purchase would result in the Investor and its affiliates beneficially
      owning more than 9.99% of the Company’s common
  stock.




On the
date of delivery of each Notice under the Purchase Agreement, the Company will
also issue to the Investor five-year warrants to purchase its common stock at an
exercise price equal to the closing price of the Company’s common stock on the
trading day prior to the delivery date of the Notice.  The number of
shares issuable upon exercise of the warrant will be equal in value to 135% of
the purchase price of the Series B Preferred Stock to be issued in respect of
the related Notice.  Each warrant will be exercisable on the earlier
of (i) the date on which a registration statement registering for resale the
shares of common stock issuable upon exercise of such warrant becomes effective
and (ii) the date that is six months after the issuance date of such
warrant.




The
Series B Preferred Stock is redeemable, at the Company’s election, after the
fifth anniversary of the date of its issuance and is subject to repurchase by
the Company (i) at any time at our election, or (ii) following the consummation
of certain fundamental transactions by the Company, at the option of a majority
of the holders of the Series B Preferred Stock.


12




Holders
of Series B Preferred Stock will be entitled to receive dividends, which will
accrue in shares of Series B Preferred Stock on an annual basis at a rate equal
to 10% per annum from the issuance date.  Accrued dividends will be
payable upon redemption of the Series B Preferred Stock.  The Series B
Preferred Stock ranks, with respect to dividend rights and rights upon
liquidation, senior to the Company’s common stock and on parity with the
Company’s Series A Preferred Stock.




Shares of
the Company’s Series B Preferred Stock have a liquidation preference of $10,000
per share, plus any accrued and unpaid dividends. Upon the occurrence of a
fundamental change (as defined by the Certificate of Designations), the holders
of the Series B Preferred Stock will have the right to require the Company to
repurchase all or a portion of their shares of the Series B Preferred Stock at a
repurchase price equal to 100% of the liquidation preference of the shares of
the Series B Preferred Stock plus any accrued and unpaid dividends.





So long
as any shares of Series B Preferred Stock are outstanding, the Company shall
not, without the affirmative approval of the holders of a majority of the shares
of the Series B Preferred Stock then outstanding, (a) alter or change adversely
the powers, preferences or rights given to the Series B Preferred Stock or alter
or amend this Certificate of Designations, (b) authorize or create any class of
stock ranking as to distribution of assets upon a liquidation senior to or
otherwise pari passu
with the Series B Preferred Stock, (c) amend its Restated Certificate of
Incorporation, as amended, in breach of any of the provisions hereof, (d)
increase the authorized number of shares of Series B Preferred Stock, (e)
liquidate, dissolve or wind-up the business and affairs of the Corporation, or
(f) enter into any agreement with respect to the foregoing.





On June
24, 2009, the Company received $1,000,000 from the Investor, which amount was
agreed to be an advance on the proceeds of the first Closing.




On July
1, 2009, subsequent to the balance sheet, the Company completed the Closing
under the Purchase Agreement by issuing 242 shares of its Series B Preferred
Stock to the Investor, which resulted in net proceeds to the Company of
$2,169,000, after payment of a $250,000 commitment fee to the Investor and
grossed-up for the $550,000 Loan and the $1,000,000 that was paid in advance of
the Closing.  Warrants to purchase up to 7,780,603 shares of common
stock at $0.42 per share were also issued to an affiliate of the Investor as
part of the Closing.





15.
            Bridge Loan and Amendment to
      the Purchase Agreement– On June 16, 2009, the Company entered into
      a Loan Agreement and Promissory Note (the “Loan Agreement”) with a
      third-party lender (the “Lender”), pursuant to which, the Lender made a
      $550,000 short-term loan (the “Loan”) to enable the Company to meet
      certain immediate liquidity needs.  The Loan bore interest at a
      rate of 6% per annum until paid in full, and matured on June 25,
      2009, and was subject to acceleration in the event the Company defaulted
      in its obligations under the Loan
Agreement.




Under the
terms of the Loan Agreement, the Company and the Lender also agreed to amend the
terms of the Purchase Agreement.  The agreed amendments applied solely
with respect to the first Notice delivered by the Company pursuant to the terms
of the Purchase Agreement and the related closing of the first Series B
Preferred Stock issuance thereunder (the “Closing”), and related to the timing
for delivery of the first Notice and consummation of the related Closing as well
as the method for setting the exercise price for the five-year warrant to
purchase our common stock (the “Warrant”) to be issued by us in connection with
the delivery of the first Notice.  Pursuant to the terms of the Loan
Agreement, the Company and the Lender agreed that (i) the Company would set the
exercise price of the Warrant based on the average of the daily closing prices
of the Company’s common stock on (A) the date immediately preceding the date
upon which we delivered the first Notice to the Lender, and (B) the date upon
which the Notice was so delivered, (ii) the Closing would be


13




accelerated
in contrast to those called for by the Purchase Agreement, and (iii) the gross
proceeds that the Company would derive from this funding would be reduced by the
principal amount of the Loan, and by accrued but unpaid interest
thereon.  The Lender’s obligation to accept the Notice and consummate
the Closing on the amended terms described herein was conditioned upon the
Lender’s having borrowed at least 6,500,000 freely tradable shares of our common
stock from the Company’s stockholders who were not affiliates of the
Company.




On July
1, 2009, subsequent to the balance sheet, the Company paid off the Loan in
conjunction with the Closing.




16.
            Short Term Loans– On
      May 20, 2009, the “Company” entered into a Secured Promissory Note (the
      “Knickerbocker Note”) and Pledge Agreement (the “Pledge Agreement”) with
      Knickerbocker Fine Arts Ltd. (“Knickerbocker”). Pursuant to the
      Knickerbocker Note and Pledge Agreement, Knickebocker loaned $50,000 to
      the Company at a yearly interest rate of 6%.  The loan is
      secured by 500,000 ordinary shares of Cell Kinetics Ltd. The maturity
      date of the loan and all accrued interest is August 18, 2009, and may
      be prepaid in whole or in part by the Company. The Knickerbocker Note
      contains other customary provisions found in loans of this type, including
      relating default provisions.




On May
17, 2009, the Company entered into a Promissory Note (the “Finkelshtain Note”)
with Gennadi Finkelshtain, the General Manager of More Energy Ltd. Pursuant to
the Finkelshtain Note, Mr. Finkelshtain loaned $50,000 to the Company at a
yearly interest rate of 7%.  The maturity date of the loan and all
accrued interest is September 17, 2009, and may be prepaid in whole or in part
by the Company.  The Finkelshtain Note contains other customary provisions
found in loans of this type, including relating default provisions.




17.
            Goodwill Impairment–
      As of June 30, 2009, based on Cell Kinetics Ltd's significant decline in
      its share value, and its recent decision to freeze its operation and
      dismiss its employees, management determined, in accordance with SFAS
      142that the
      estimated fair value of the cell carrier reporting unit was less than its
      carrying value, and determined that there was no value representing the
      “implied fair value” of goodwill. As such,the Company
      recorded impairment for the total balance of the goodwill in the amount of
      approximately $2,212,000.




18.
            Effect of Recent Accounting
      Pronouncements.




In May
2009, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 165, Subsequent Events (SFAS 165),
which establishes general standards of accounting for and disclosure of events
that occur after the balance sheet date but before financial statements are
issued or are available to be issued. SFAS 165 also requires the disclosure of
the date through which an entity has evaluated subsequent events and whether
that evaluation date represents the date the financial statements were issued or
were available to be issued. We adopted SFAS 165 in the second quarter of 2009
and the adoption did not have any impact on our consolidated financial
statements.




Item
2. Management's
Discussion And Analysis Of Financial Condition And Results Of
Operations




Forward
Looking Statements




You
should carefully review the information contained in this quarterly report and
in other reports or documents that we file from time to time with the Securities
and Exchange Commission. In this quarterly report, we state our beliefs of
future events and of our future financial performance. In some cases, you can
identify those so-called “forward-looking statements” by words such as “may,”
“will,”


14


“should,”
“expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,”
“potential,” “likely,” or “continue” or the negative of those words and other
comparable words. These forward-looking statements are subject to risks and
uncertainties that could cause actual results to differ materially from
historical results or those we anticipate. Factors that could cause actual
results to differ from those contained in the forward-looking statements are
discussed in this quarterly report and in our annual report on Form 10-K for the
year ended December 31, 2008. Statements included in this quarterly report are
based upon information known to us as of the date that this quarterly report is
filed with the SEC. We assume no obligation to update or alter our
forward-looking statements made in this quarterly report, whether as a result of
new information, future events or otherwise, except as otherwise required by
applicable federal securities laws.




Introduction




We
design, develop and market an innovative fuel cell technology that provides
portable electricity for retail, commercial and military applications. A fuel
cell is a device that converts the chemical energy of a fuel directly into
electricity. To our knowledge we are the only company ever to have manufactured
working portable fuel cells in production quantities. Our intellectual property
portfolio consists of 37 United States and international patents.




Our
technologies provide solutions for remote and off-grid power. Unlike batteries,
our products do not store power; they generate fresh power on the spot as
needed, which we believe makes our technology ideal for military applications.
It also means that we can power devices in the complete absence of electricity
from the grid – during blackouts, in battlefield conditions, in subway tunnels
or mine shafts, or at other remote or unmanned locations.




Our fuel
cells do not generate significant heat, are DOT approved and UL listed, and are
recyclable. Most other fuel-cell developers that we are aware of use a
methane or hydrogen-based chemistry. Our fuel cells are based on sodium
borohydride, which we believe is a superior and more stable fuel.




Our first
commercial product is our “24/7 Power Pack,” commercially introduced in late
2008. It is a recyclable hand-held power generator that can power advanced
portable electronic devices, such as mobile handsets, smart phones, MP3 players,
gaming and other devices useful in emergencies such as flashlights, radios and
GPS devices. We believe that the 24/7 Power Pack is the first commercially
available, portable fuel cell ever sold. Subsequent to the introduction of the
24/7 Power Pack, we introduced our XtremeTM Emergency Kit, which provides light
in any emergency situations where light is needed for survival or
escape. Because it generates its own power when needed, it can provide
instant light as well as energy to power portable electronic devices on
demand.




Additionally,
through Cell Kinetics Ltd., our indirect, majority-owned subsidiary, we are also
seeking to exploit commercially what we believe to be an ever-increasing need to
study individual live cells through the development, marketing and sale of an
improved cell carrier under the CKChipTM product line. This unique CKChipTM can
accommodate up to 10,000 cells, each in individual wells, for measuring
reactions of living cells while the cells are in a static state over
time.




Results
of Operations




From our
inception in April 1992 through June 30, 2009, we have generated an accumulated
deficit of approximately $415,005,000 including approximately $44,215,000 from
amortization expense and $106,689,000 from impairment charges on goodwill and
property and equipment. At June 30, 2009, we had cash and cash equivalents of
$762,000. During the six months ended June 30, 2009, we reported


15


cash used
in operating activities of $12,269,000 and incurred a net loss of $43,308,000,
which includes additional provision for contractual obligations of approximately
$5,364,000 related to subcontractor and supplier agreements and purchase orders
pursuant to which we do not expect to fully perform and impairment charges on
goodwill and equipment of $2,212,000 and $17,974,000, respectively. We expect to
incur additional operating losses during the remainder of 2009 and possibly
thereafter, principally in connection with our fuel cell related operations,
including production related costs, selling, marketing, advertising, general and
administrative expenses and research and development costs.




Historically,
we have relied upon external financing for our operations, principally through
the issuance and sale of our common stock, warrants, preferred stock and
convertible notes. We will need to continue to pay or satisfy existing
obligations and commitments and finance our operations, as we have in the past,
through the sale of our securities and other forms of external financing, until
such time that we are able to generate sufficient funds from the sale of our
products to finance our operations, of which we can give no assurance of
success. We may also be forced to sell or license a portion or all of our
material assets if we are unsuccessful in raising cash through the sale of our
securities. We can give no assurance that we will be successful in financing our
operations to provide us with liquidity beyond the end of August 2009, or that
we will successfully sell our securities, enter into another form of external
financing or sell or license our assets. See “Liquidity and Capital Resources”
later in this Item 2 for a discussion of our plans to raise additional capital
and of our comprehensive cost rationalization plan.




Since our
inception, we have relied principally on outside sources of funding to finance
our operations, as our revenues have been minimal. During 2007 and 2008, we
raised gross proceeds aggregating $71,500,000 through the sale of our securities
to outside investors and Cell Kinetics has raised gross proceeds of $1,048,000
through the sale of its securities in a rights offering to our stockholders. We
did not raise any proceeds through the sale of our securities during the three
months ended March 30, 2009, in part due to weaknesses in the capital markets.
During the three months ended June 30, 2009, we raised approximately $1,650,000
which was comprised of $100,000 of short-term loans, the $550,000 Loan and
$1,000,000 as an advance on the proceeds of the Closing of the sale of the
Company’s Series B Preferred Stock. On July 1, 2009, subsequent to the balance
sheet, the Company completed the Closing under the Purchase Agreement by issuing
242 shares of its Series B Preferred Stock to the Investor, which resulted in
net proceeds to the Company of $2,169,000, after payment of a $250,000
commitment fee to the Investor and grossed-up for the $550,000 Loan and the
$1,000,000 that was paid in advance of the Closing.  Warrants to
purchase up to 7,780,603 shares of common stock at $0.42 per share were also
issued to an affiliate of the Investor as part of the Closing.




As
described more fully below, in the first quarter of 2009 and into the second
quarter of 2009, we greatly curtailed our operations due to a lack of cash
resources and initiated a comprehensive cost rationalization plan designed to
reduce operating costs and enhance operational efficiencies. If we are unable to
successfully commercialize our fuel cell technology and cannot otherwise obtain
funds from third party sources, we will be forced to take other tactical and/or
strategic actions such as the sale or merger of our business or discontinuance
of operations.




Although
we have received purchase orders pursuant to some of our agreements with our
distributors, we believe various factors have impacted those agreements and
purchase orders, including changing needs of potential purchasers, the
reevaluation of our pricing structures for our products, the continued evolution
of the market for our products and the general economic slowdown. Furthermore,
although we have commenced selling our products on a limited number of online
e-commerce sites and are looking to sell off our existing inventory of products,
due to our lack of capital, we have temporarily curtailed the marketing and
distribution efforts for our commercial products, which we intend to recommence
if and when we again are adequately capitalized.






16




As part
of our ongoing cost rationalization plan, in an effort to reduce costs and
preserve our limited cash resources, we shut down our assembly line and ceased
the production of our products. We believe we have enough finished goods in
inventory to satisfy any sales of our products in the near term and intend to
resume production if and when we raise funds to continue our operations, as
discussed above and in “Liquidity and Capital Resources”. We can give no
assurance that we will raise sufficient capital to continue production and our
operations. Furthermore, even if we have the capital to resume production, we
must first re-evaluate our pricing and production costs, as well as our proposed
markets and sales efforts, if we are to achieve profitability on the commercial
sale of our products. Additionally, weak economic and market conditions could
negatively impact product sales and consumer acceptance of our products, and
consequently our revenues and results of operations.




Our
production line is located at the facilities of our contract manufacturer,
Celestica Ireland Ltd., in Galway, Ireland. In March 2009, we
announced that we gave notice to Celestica that we were terminating our
agreement with it in September 2009. In April 2009, Celestica provided us notice
of its immediate termination of the Agreement for breach of payment obligations.
We have disputed some of Celestica’s claims and have been and continue to be in
discussions with Celestica to amicably resolve this matter, of which there can
be no assurance. We expect that if and when we resolve this matter, we will
remove the equipment from Celestica’s facilities to a new location, where the
production line would be reconfigured and revalidated to a low volume production
line, which better reflects our forecasted product demand and production
requirements, and the excess production equipment will be sold.




Our
research and development costs were approximately $21,527,000 for the year ended
December 31, 2008 and $3,964,000 for the six months ended June 30, 2009. Until
recently, we continued to devote greater efforts to develop and advance the
technology underlying, and to commercialize the products incorporating, our fuel
cells. During the first half of 2009, however, we significantly curtailed our
research and development as part of our cost rationalization plan. Additionally,
during the six months ended June 30, 2009, we incurred depreciation, production
and facility costs aggregating $13,626,000 which amount includes non-recurring
charges for provision for contractual obligations related to subcontractor and
supplier contracts and purchase orders of approximately of $5,364,000 and
inventory reserves and write-offs of $2,617,000.




Six
Months Ended June 30, 2009 Compared To Six Months Ended June 30, 2008 And Three
Months Ended June 30, 2009 Compared To Three Months Ended June 30,
2008





We
incurred net losses of $43,308,000 and $26,854,000 during the six and three
months ended June 30, 2009, respectively, compared to $29,371,000 and
$15,624,000 during the six and three months ended June 30, 2008, respectively.
The increases can be primarily attributed to non-recurring charges incurred
partially offset by cost reductions associated with our cost rationalization
plan. During the six and three months ended June 30, 2009 we incurred impairment
charges on equipment of $17,974,000 and $15,750,000,
respectively.  For both the six and three months ended June 30, 2009
we incurred inventory reserves and write-offs of $2,617,000 and impairment
charges on goodwill of $2,212,000. During the six months ended June 30, 2009,
depreciation, production and facility costs included a non-recurring provision
for contractual obligations in the amount of approximately $5,364,000, for
estimated costs associated with subcontractor and supplier agreements and
purchase orders pursuant to which we do not expect to fully perform. During the
six and three months ended June 30, 2009,these non-recurring charges were
partially offset by decreases in research and development costs of $9,323,000
and $3,797,000 and sales, marketing, general and administrative expenses of
$1,697,000 and $2,150,000, respectively. Each of the above mentioned factors are
described more fully below.




During
the six and three months ended June 30, 2009, we incurred costs aggregating
approximately $13,626,000 and $5,548,000, respectively, with respect to
depreciation, production and






17


facility
costs (including excess production capacity such as depreciation, subcontractor
charges and labor and materials and components and inventory reserves and
write-offs), compared to $8,983,000 and $6,617,000 during the six and three
months ended June 30, 2008, respectively. For the six months ended June 30,
2009, the increase in these costs can be attributed to non-recurring charges of
provision for contractual obligations in the amount of approximately $5,364,000,
incurred for estimated costs associated with subcontractor and supplier
agreements and purchase orders pursuant to which we do not expect to fully
perform and inventory reserves and write-offs of $2,617,000. For the three
months ended June 30, 2009, the decrease in these costs can be attributed to the
shutting down of our high volume production line and also includes a
non-recurring charge of inventory reserves and write-offs of $2,617,000. In
accordance with SFAS 151 “Inventory Costs an Amendment of ARB No. 43, Chapter
4,” we have recognized unallocated depreciation, labor and other costs as
expenses for the six and three months ended June 30, 2008 and 2009. Unless and
until such time as we are able to more fully and efficiently utilize our
production facilities through the production and sale of our fuel cell products,
we will continue to incur charges for depreciation and other production facility
costs, including excess production capacity.




Research
and development costs amounted to approximately $3,964,000 and $1,442,000 during
the six and three months ended June 30, 2009, respectively, compared to
approximately $13,287,000 and $5,239,000 during the six and three months ended
June 30, 2008, respectively. The decrease can be attributed to a decrease of
approximately $9,323,000 and $3,797,000, respectively, in costs related to our
fuel cell technologies and is impacted by costs charged to depreciation,
production and facility costs. The research and development activities for the
periods presented include:




·
            Fuel Cell Technologies.
      We incurred costs relating to our fuel cell technologies of approximately
      $3,501,000 and $1,222,000 during the six and three months ended June 30,
      2009, respectively, compared to $12,600,000 and $4,910,000 during the six
      and three months ended June 30, 2008, respectively. The decreases of were
      a result of lower materials, labor, subcontractor, depreciation and other
      costs.




·
            Cell Kinetics – Cell Carrier
      (CKChipTM). We incurred costs of approximately $463,000 and $220,000
      during the six and three months ended June 30, 2009, respectively,
      compared to $663,000 and $316,000 during the six and three months ended
      June 30, 2008, respectively.




Selling,
marketing, general and administrative (“SG&A”) expenses during the six and
three months ended June 30, 2009 amounted to $5,466,000 and $1,644,000,
respectively, compared to $7,163,000 and $3,794,000 during the six and three
months ended June 30, 2008, respectively. The net decreases are primarily
attributable to the curtailing of the marketing and sales efforts for its
commercial products.




During
the six months eneded June 30, 2009, the Company recorded impairment for
the total balance of the goodwill in the amount of approximately $2,212,000.
Based on Cell Kinetics Ltd's significant decline in its share value, and its
recent decision to freeze its operation and dismiss its employees, management
determined, in accordance with SFAS 142that the estimated fair
value of the cell carrier reporting unit was less than its carrying value, and
determined that there was no value representing the “implied fair value” of
goodwill.




Impairment
charges on property and equipment recorded during the six and three months ended
June 30, 2009 amounted to approximately $17,974,000 and $15,750,000,
respectively. During the six and three months ended June 30, 2009 and based upon
updated forecasts of product demand and production requirements, we will retain
certain production equipment from the high volume production facility to
assemble a low volume commercial production line.  We plan to sell the
excess production equipment and




18


have
written down the net book value of the excess production equipment to its
estimate sale value, resulting in an impairment charge of approximately
$15,750,000. During the six months ended June 30, 2009 and in connection with
our recording of a provision for contractual obligations, we determined that
certain equipment was fully impaired and recorded impairment charges for their
book value of $2,224,000.




Interest
expense, net, during the six and three months ended June 30, 2009 amounted to
approximately $244,000 and $392,000, respectively, compared to interest expense,
net, of approximately $266,000 and $106,000 during the six and three months
ended June 30, 2008, respectively.




As of
June 30, 2009, we had unrecognized compensation costs of approximately $368,000,
related to stock-based awards accounted for in accordance with FASB Statement
No. 123 (revised 2004) “Share Based Payments,” which are expected to be
recognized in future periods.




Liquidity
And Capital Resources




Since our
inception, we have sustained operating losses and have used cash in our
operations. During the six months ended June 30, 2009, we used cash in operating
activities of $12,269,000, incurred a net loss of $43,308,000 and had a total
stockholders’ deficit of $47,024,000 at June 30, 2009.




The
Company has limited available cash resources and requires additional financing
in order to to fund its current operations beyond August 2009, and to pay
existing and future liabilities and other obligations, including payroll. The
Company’s executive management has agreed to defer the payment of their July
payroll and the Company is in the process of attempting to obtain deferrals for
the payment of July payroll for remaining employees. The Company is continuing
to negotiate with third parties in an attempt to obtain additional sources of
funds to finance the Company’s operations. The satisfactory completion of these
negotiations prior to the end of August 2009 is essential to provide sufficient
cash flow to meet current operating requirements. Furthermore, even if the
Company is successful in raising additional funds, the Company cannot give any
assurance that it will, in the future, be able to achieve a level of
profitability from the sale of its products to sustain its operations. These
conditions raise substantial doubt about the Company’s ability to continue as a
going concern. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on recoverability and
reclassification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.




The
Company is pursuing the following alternatives to raise working capital in the
third quarter of 2009:




·
            The
      sale of additional shares of its Series B Preferred Stock for aggregate
      proceeds of approximately $2
million;




·
            The
      sale of its debt/equity securities, with the intention of raising
      approximately $2 million before the end of the fourth quarter 2009,
      subject to board consideration and approval and the signing of definitive
      documentation;




·
            The
      signing of contracts for the research and development of fuel cell
      products for military applications, which may include entering into joint
      venture, licensing or other arrangements with foreign militaries, defense
      contractors or military supply and manufacturing
  companies;




19


·
            Through
      government grants in the United States, the State of Israel, or possibly
      both; and




·
            The
      sale of its excess production
assets.




The
Company can give no assurances that it will be successful in raising funds
through the sale of additional shares of its Series B Preferred Stock, the sale
of debt and/or equity securities, jointly developing its products for military
use, obtaining government grants or any other alternative. Any inability to so
obtain additional financing or funding will likely cause the Company to cease
business operations.




The
Company has continued to evaluate the feasibility of selling its tangible assets
and has determined that it will maintain the necessary tangible assets to
continue its research and development activities associated with its
intellectual property and to establish a low volume commercial production
line.  The Company plans to initiate a process to sell the remainder
of its productions assets.  The Company can give no assurances when,
or if, low volume commercial production will begin.




In the
first half of 2009, the Company initiated a comprehensive cost rationalization
plan designed to reduce operating costs and enhance operational efficiencies,
pursuant to which the Company:




·
            reduced
      aggregate payroll costs by approximately
50%;




·
            reduced
      operational expenses by approximately
50%;




·
            performed
      a full stream product cost review;
and




·
            explored
      opportunities to monetize non-essential
assets.




In an
effort to further reduce costs, the Company also suspended production across its
supply base. Although the Company’s new management had pursued efforts towards
the commercialization and sale of the Company’s existing product lines,
management has since then determined that it must stabilize the Company’s
finances and raise capital prior to continuing its production, sales and
marketing programs and expend additional funds towards that goal. Accordingly,
the Company has temporarily curtailed the marketing and sales efforts for its
commercial products, which it intends to recommence if and when the Company
again is adequately capitalized.




As part
of the cost rationalization plan, the Company reduced its staff by approximately
50 employees from its Israeli office. These positions are directly and
indirectly related to its operations and general administration. The Company has
also engaged in conversations with its major suppliers of goods and services and
it has initiated restructuring of its vendor processes and agreements. The
Company is also seeking to restructure accounts payable and accrued liabilities,
of which it can give no assurance of success. In connection with these efforts,
the Company is reviewing its current product line offerings to determine how to
best commercially leverage its fuel cell products and technology. The Company’s
restructuring and cost rationalization plans are being carried out in parallel
with its efforts to raise additional funds from external sources, which it
requires to pay existing obligations and to continue its
operations.




Our
working capital and capital requirements at any given time depend upon numerous
factors, including, but not limited to:




·
            the
      level of our existing liabilities and
  obligations;




20


·
            the
      progress of research and development
programs;




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




·
            the
      sale of existing finished goods inventory and level of production required
      to build any additional product;




·
            the
      amount of resources required to complete and maintain our production
      facilities;




·
            variability
      of currency exchange rates in relationship to the U.S.
    dollar;




·
            revenues
      from the sale of our products and the margins that we are able to achieve;
      and




·
            the
      level of success we are able to achieve with our cost rationalization
      program.




On July
21, 2009, a third-party (the “Claim Holder”) sued the Company in Los Angeles
Superior Court (the “Litigation”) for repayment of a claim against the Company
in the amount of $377,000 (the “Claim”).  On July 29, 2009, the
Company assumed the outstanding trade debt associated with the Claim from More
Energy.  The debt was initially incurred by More Energyin the ordinary course of
its business. On July 30, 2009, the Company and the Claim Holder entered into a
Settlement Agreement that provides for the extinguishment of the Claim in
exchange for the issuance to the Claim Holder of 2,200,000 shares of the
Company’s common stock (the “Settlement Shares”).  On July 31, 2009,
the presiding judge in the Litigation entered an Order Approving Settlement of
Claim (the “Order”), pursuant to which the Settlement Agreement became binding
on the Company and the Claim Holder, and, on August 5, 2009, the Settlement
Shares were issued to the Claim Holder.





The
number of shares to be issued under the Settlement Agreement is subject to
adjustment as follows: in the event that the number of VWAP Shares (as described
below) exceeds the number of Settlement Shares initially issued, then the
Company will issue to the Claim Holder additional shares of its common stock
equal to the sum of (i) the difference between the number of VWAP Shares and the
number of Settlement Shares initially issued, and (ii) the number of Additional
Shares (as described below). In the event that the number of VWAP Shares is less
than the number of Settlement Shares initially issued, then the Claim Holder
will return to the Company for cancellation that number of shares as equals (i)
the difference between the number of VWAP Shares and the number of Settlement
Shares initially issued, less (ii) the number of Additional Shares.




The
number of VWAP Shares is equal to 308,000 divided by 75% of the volume weighted
average price (the “VWAP”) of the Company’s common stock over the 20-day trading
period immediately following the date on which the Settlement Shares were
issued.  The number of Additional Shares is equal to the product of
(x) 3,080,000 multiplied by (y) (i) the difference between the VWAP of the
shares over such 20-day trading period minus $0.10 (ii) multiplied by
15%.





On June
8, 2009, the Company entered into a Preferred Stock Purchase Agreement (the
“Purchase Agreement”) with a third-party investor (the “Investor”), which
provides that the Investor is committed to purchase up to $5,000,000 of the
Company’s Series B Preferred Stock.  Under the terms of the Purchase
Agreement, from time to time until June 7, 2010, and at the Company’s sole
discretion, it may present the Investor with a notice to purchase such Series B
Preferred Stock (the “Notice”).  The Investor is obligated to purchase
such Series B Preferred Stock on the tenth trading day after the Notice date,
subject to satisfaction of certain closing conditions.  The Investor
will not be obligated to purchase the Series B Preferred Stock (i) in the event
the closing price of the Company’s common stock during the nine trading days
following delivery of a Notice falls below 75% of the closing price on the
trading day prior to the


21




date such
Notice is delivered to the Investor, or (ii) to the extent such purchase would
result in the Investor and its affiliates beneficially owning more than 9.99% of
the Company’s common stock.




On the
date of delivery of each Notice under the Purchase Agreement, the Company will
also issue to the Investor five-year warrants to purchase its common stock at an
exercise price equal to the closing price of the Company’s common stock on the
trading day prior to the delivery date of the Notice.  The number of
shares issuable upon exercise of the warrant will be equal in value to 135% of
the purchase price of the Series B Preferred Stock to be issued in respect of
the related Notice.  Each warrant will be exercisable on the earlier
of (i) the date on which a registration statement registering for resale the
shares of common stock issuable upon exercise of such warrant becomes effective
and (ii) the date that is six months after the issuance date of such
warrant.




The
Series B Preferred Stock is redeemable after the fifth anniversary of the date
of its issuance and is subject to repurchase by the Company (i) at any time at
our election, or (ii) following the consummation of certain fundamental
transactions by the Company, at the option of a majority of the holders of the
Series B Preferred Stock.




Holders
of Series B Preferred Stock will be entitled to receive dividends, which will
accrue in shares of Series B Preferred Stock on an annual basis at a rate equal
to 10% per annum from the issuance date.  Accrued dividends will be
payable upon redemption of the Series B Preferred Stock.  The Series B
Preferred Stock ranks, with respect to dividend rights and rights upon
liquidation, senior to the Company’s common stock and on parity with the
Company’s Series A Preferred Stock.




On June
16, 2009, the Company entered into a Loan Agreement and Promissory Note (the
“Loan Agreement”) with a third-party lender (the “Lender”), pursuant to which,
the Lender made a $550,000 short-term loan (the “Loan”) to enable the Company to
meet certain immediate liquidity needs.  The Loan bore interest at a
rate of 6% per annum until paid in full, and matured on June 25, 2009, and
was subject to acceleration in the event the Company defaulted in its
obligations under the Loan Agreement.




Under the
terms of the Loan Agreement, the Company and the Lender also agreed to amend the
terms of the Purchase Agreement.  The agreed amendments applied solely
with respect to the first Notice delivered by the Company pursuant to the terms
of the Purchase Agreement and the related closing of the first Series B
Preferred Stock issuance thereunder (the “Closing”), and related to the timing
for delivery of the first Notice and consummation of the related Closing as well
as the method for setting the exercise price for the five-year warrant to
purchase our common stock (the “Warrant”) to be issued by us in connection with
the delivery of the first Notice.  Pursuant to the terms of the Loan
Agreement, the Company and the Lender agreed that (i) the Company would set the
exercise price of the Warrant based on the average of the daily closing prices
of the Company’s common stock on (A) the date immediately preceding the date
upon which we delivered the first Notice to the Lender, and (B) the date upon
which the Notice was so delivered, (ii) the Closing would be accelerated in
contrast to those called for by the Loan Agreement, and (iii) the gross proceeds
that the Company would derive from this funding would be reduced by the
principal amount of the Loan, and by accrued but unpaid interest
thereon.  The Lender’s obligation to accept the Notice and consummate
the Closing on the amended terms described herein was conditioned upon the
Lender’s having borrowed at least 6,500,000 freely tradable shares of our common
stock from the Company’s stockholders.




On June
24, 2009, the Company received $1,000,000 from the Investor, which amount was
agreed to be an advance on the proceeds of the first Closing.




On July
1, 2009, subsequent to the balance sheet, the Company completed the Closing
under the Purchase Agreement by issuing 242 shares of its Series B Preferred
Stock, which resulted in net proceeds




22


to the
Company of $2,169,000, after payment of a $250,000 commitment fee to the
Investor and grossed-up for a $550,000 Loan and the $1,000,000 that was paid in
advance of the Closing.  Warrants to purchase up to 7,780,603 shares
of common stock at $0.42 per share were also issued to an affiliate of the
Investor as part of the Closing.




On May
20, 2009, the “Company” entered into a Secured Promissory Note (the
“Knickerbocker Note”) and Pledge Agreement (the “Pledge Agreement”) with
Knickerbocker Fine Arts Ltd. (“Knickerbocker”). Pursuant to the Knickerbocker
Note and Pledge Agreement, Knickebocker loaned $50,000 to the Company at a
yearly interest rate of 6%.  The loan is secured by 500,000 ordinary
shares of Cell Kinetics Ltd. The maturity date of the loan and all accrued
interest is August 18, 2009, and may be prepaid in whole or in part by the
Company. The Knickerbocker Note contains other customary provisions found
in loans of this type, including default provisions.




On May
17, 2009, the Company entered into a Promissory Note (the “Finkelshtain Note”)
with Gennadi Finkelshtain, the General Manager of More Energy Ltd. Pursuant to
the Finkelshtain Note, Mr. Finkelshtain loaned $50,000 to the Company at a
yearly interest rate of 7%.  The maturity date of the loan and all
accrued interest is September 17, 2009, and may be prepaid in whole or in part
by the Company.  The Finkelshtain Note contains other customary provisions
found in loans of this type, including default provisions.





On April
2, 2009, we received a letter from the NASDAQ Stock Market (“Nasdaq”) informing
us that based on our stockholders’ deficit, as reported in our Annual Report on
Form 10-K for the period ended December 31, 2008, we do not comply with the
minimum $10 million stockholders’ equity requirement for continued listing on
the Nasdaq Global Market under Nasdaq Marketplace Rule 4450(a)(3) (the “Rule”).
In addition, we do not meet the $2.5 million stockholders’ equity requirement
for listing on the Nasdaq Capital Market. On April 17, 2009 we responded to
Nasdaq with certain actions that may allow us to achieve the $2.5 million
shareholders’ equity retirements for inclusion on the Nasdaq Capital Market.
Thus, we submitted a transfer application for trading of our common stock to be
moved from the Nasdaq Global Market to the Nasdaq Capital Market and requested a
90-day waiver of this equity requirement. On June 17, 2009, we received a letter
from Nasdaq informing us that, based on Nasdaq’s further review and the
materials that we submitted to Nasdaq on April 17, 2009 and May 13, 2009, Nasdaq
determined to grant us an extension until July 16, 2009 to regain compliance
with the Rule. On July 17, 2009, we received a notice from Nasdaq informing us
that we are still not in compliance with the minimum stockholders’ equity for
continued listing on the Nasdaq Global Market and that unless we appeal this
determination, trading of our common stock would be suspended at the opening of
the market on July 28, 2009. We requested a hearing before a Nasdaq Hearing
Panel to present our plan for listing on the Nasdaq Capital Market, as
contemplated in our July 15, 2009 request to have trading in our common stock
transferred to the Nasdaq Capital Market in accordance with the application
submitted by us on April 17, 2009.  The hearing is scheduled for
August 20, 2009 and will stay the delisting of our common stock pending the
panel’s decision.





On
February 18, 2009, we issued 266,667 shares of our common stock to a third party
in connection with our entering into a Securities Purchase Agreement with such
third party on February 13, 2009, to establish a potential source of funding, in
what is sometimes termed an equity line of credit arrangement. Subsequent to
that date, we determined that we could not access this equity line of credit
facility due to various factors that limit the amounts or preclude us from
drawing against this facility, including the trading price and average trading
volume of our common stock. The equity line of credit facility was terminated in
May 2009.




During
the six months ended June 30, 2009, net cash used in operating activities was
$12,269,000 compared to $24,728,000 for the six months ended June 30, 2008. The
decrease was primarily attributable






23
 to a
decrease in research and development costs, decrease in the inventory purchases
and an increase in accrued expenses and other current liabilities during the six
months ended June 30, 2009 compared to the same period in 2008. In the first
half of 2009, we greatly curtailed our operations due to a lack of cash
resources.




During
the six months ended June 30, 2009, net cash provided in investing activities
was $739,000 which represented restricted cash received of $4,798,000 to
extinguish in full a capital lease payment of $3,685,000. We also purchased of
equipment of $406,000 and realized proceeds from the sales of equipment of
$32,000. During the six months ended June 30, 2008, net cash used in investing
activities was $5,594,000, which represented (i) purchases of equipment of
$5,715,000 (which includes costs related to building and equipping our fully
automated and related facilities), (ii) restricted cash and deposits of
$100,000 and (iii) payment on capital lease of $16,000, partially offset by
redemptions of restricted cash of $237,000.




During
the six months ended June 30, 2009, net cash aggregating $1,650,000 was provided
by financing activities, which represents: (i) net proceeds of $100,000 from
short-term loans, (ii) net proceeds of $550,000 from the Loan and (iii) net
proceeds of $1,000,000 as an advance on the proceeds of the Closing of the sale
of the Company’s Series B Preferred Stock. During the six months ended June 30,
2008, net cash aggregating $50,148,000 was provided by financing activities,
which represented: (i) net proceeds of approximately $51,759,000 from the sale
of our common stock and warrants, as described more fully above; (ii) net
proceeds of approximately $456,000 from the issuance by Cell Kinetics of its
ordinary shares pursuant to a rights offering, as described more fully above;
and (iii) proceeds of approximately $17,000 from our issuance of 1,280 shares of
our common stock upon exercises of stock options issued under our 1999 stock
option plan, partially offset by dividend payments on our Series A Preferred
Stock aggregating approximately $2,084,000.





From our
inception in April 1992 through June 30, 2009, we have generated an accumulated
deficit of approximately $415,005,000, including approximately $44,215,000 from
amortization expense and $106,687,000 from impairment charges on goodwill and
equipment. Assuming we raise additional funds and continue operations beyond the
third quarter of 2009 (of which we can give no assurance), we expect to incur
additional operating losses during the remainder of 2009 and possibly
thereafter, principally in connection with our fuel cell related operations,
including production related costs, selling, marketing, advertising, general and
administrative expenses and research and development costs. We plan to continue
to pay or satisfy existing obligation and commitments and finance our
operations, as we have in the past, through the sale of our securities and other
forms of external financing until such time that we are able to generate
sufficient funds from the sale of our products to finance our operations, of
which we can give no assurance.





In
connection with the termination in November 2008 of the employment of our then
president and our then senior vice president and chief financial officer, we
made severance related payments during the first quarter of 2009 aggregating
approximately $700,000, for legally required and contractual arrangements
pertaining to unfunded severance, accrued vacation, notification and adaptation
period and vehicle benefits. Additionally, in connection with the terminations
of employment as part of our cost rationalization plan announced in February and
with the termination of the employment of a non-executive officer, we made
severance related payments in April 2009 aggregating approximately $460,000, for
amounts that had not been previously funded for such purpose.





Our Board
of Directors did not declare the quarterly dividend on our Preferred Stock for
the quarterly dividend periods ended February 15, 2009, May 15, 2009 and August
15, 2009. Our Board of Directors will evaluate our cash position each fiscal
quarter and determine whether or not to declare dividends on our preferred stock
for that quarter.






24





On June
30, 2008, our wholly-owned subsidiary, Medis El, provided funding to Cell
Kinetics in the amount $1,500,000, pursuant to a non-interest bearing, unsecured
promissory note, with a due date of January 1, 2010 – subject to certain other
repayment conditions that are based on Cell Kinetics receiving alternative
sources of financing for its operations or the sale of its business to or merger
with a third party. At the option of Medis El, any remaining balance on the
promissory note may be contributed to the capital of Cell Kinetics.




The
following table sets forth our contractual obligations at June 30,
2009:




Payment
      Due By PeriodContractual
      Obligations
              
              Total
              
              
              2009
              
              
              2010
              
              
              2011
              
              
              2012
      and
                  thereafterOperating
      Lease Obligation
              
              
              325,000
              
              
              
              298,000
              
              
              
              27,000
              
              
              
              —
              
              
              
              —Purchase
      Obligations*
              
              
              7,374,000
              
              
              
              7,374,000
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
              
              $
              7,699,000, 00
              
              
              $
              7,672,000
              
              
              $
              27,000
              
              
              $
              —
              
              
              $
              —




*
Includes provision for contractual obligations in the aggregate amount of
approximately $5,346,000, related to existing subcontractor and supplier
agreements and purchase orders pursuant to which the Company does not expect to
fully perform, which we recorded during the six months ended June 30,
2009.




In March,
2009, in accordance with the terms of the September 2005 Agreement for
Manufacturer between More Energy Ltd. (“More Energy”) and Celestica Ireland
Limited (“Celestica”) (the “Agreement”), we provided six month advanced written
notice to Celestica of our termination of the Agreement. In April 2009,
Celestica provided notice to us of termination of the Agreement for breach of
payment obligations. An estimate of the Company’s commitment through the end of
the Agreement has been included in the provision for contractual obligations for
the three months ended June 30, 2009.




Also
included in the provision for contractual obligations for the six months ended
June 30, 2009, is an additional cost of approximately $2,100,000 pursuant to an
equipment design agreement (“Design Agreement”) into which More Energy entered
in August, 2008, with a potential second source supplier of components for
manufacture of our 24/7 Power Pack. Pursuant to the Design Agreement, More
Energy issued a purchase order in the amount of 2,468,000 Euro for the design
and construction of certain production equipment, which we may utilize if and
when we resume production. In March 2009, More Energy issued a “stop work” order
under the agreement.




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 property and equipment, stock options and warrants, deferred income
taxes, provision for contractual obligations and our ability to continue as a
going concern. 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


25




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.




Our
Management’s Discussion and Analysis of Financial Condition and Results of
Operations, and Note B to the consolidated financial statements, presented in
our Annual Report on Form 10-K for the fiscal year ended December 31, 2008,
filed with the SEC on June 30, 2009, describe the significant accounting
estimates and policies used in preparation of our consolidated financial
statements. Except for the following, there were no significant changes in our
critical accounting estimates during the three months ended June 30,
2009:




Provision
for Contractual Obligations - We evaluate our contractual obligations and
estimate the amount of provisions that would be required to be recorded related
to such contractual obligations. Making such estimates involves the use of
judgment and assumptions. As such, a significant change in our assumptions and
estimates could have a material impact in the amount of provision for
contractual obligations that should be recorded.




Item
3.   Quantitative And Qualitative Disclosures About Market
Risk




Disclosure
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 by MTL in U.S. Dollars by each of our subsidiaries in the local currency of
the New Israeli Shekel (NIS). Our other operating expenses and capital
expenditures are, for the most part, based in U.S. Dollars, NIS, Euro and Swiss
Francs. As a result, not all monetary assets and all monetary liabilities are
linked to the same base in the same amount at all points in time, which cause
currency fluctuation related gains or losses. While our liquid funds are
primarily invested in U.S. Dollars-based assets, we also invest liquid funds in
NIS, Euro and Swiss Francs. Furthermore, from time to time, we have purchased
forward contracts denominated in foreign currencies (see discussion of currency
risk management below).




Currency
Risk Management




We have
not entered into forward contracts to hedge currency risk during the first
quarter of 2009, nor have we any currency hedges in place as of June 30,
2009.




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 and the
Euro. As a result, we have exposure to foreign currency exchange fluctuations.
Continued foreign currency fluctuations could further impact our costs, as well
as our ability to achieve and maintain profitability.




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
4. 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









26


procedures
(as defined in Rule 13a-15(e) under the Exchange Act) as of June 30, 2009.
Based on that evaluation, our management, including our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of June 30, 2009.





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 June
30, 2009 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.






PART
II - OTHER INFORMATION




Item
1.   Legal Proceedings




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




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




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




On July
22, 2009, the United States Court of Appeals for the Second Circuit affirmed the
Southern District of New York’s dismissal of the putative class action initiated
against the Company and its former CEO, among others.




The
Company has been named as defendant in lawsuits filed by suppliers for the past
due invoices, of which three of the plantiffs have been granted attachments on
the bank accounts, totaling less than $80,000, of Medis El in Israel. In
addition, the Company continues to receive claims, both oral and in writing, by
suppliers threatening legal action for payment of past due
invoices.




Item
1A.  Risk Factors




There
have been no material changes in our risk factors from those disclosed in our
annual report on Form 10-K for the year ended December 31, 2008, other than as
set forth below.




We
require additional funding in order to continue our operations.




We have
limited available cash resources and requires additional financing in order to
continue to fund our current operations beyond August 2009, and to pay existing
and future liabilities and other


27


obligations,
including payroll. We may drawdown a second tranche of Series B Preferred Stock
subject to terms and conditions of the Purchase Agreement and are continuing to
negotiate with third parties in an attempt to obtain additional sources of funds
to finance our operations. The satisfactory completion of these negotiations
prior to the end of August 2009 is essential to provide sufficient cash flow to
meet current operating requirements.




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, or that a third
party will be willing to make such funds available.




Our
failure to raise additional funds will force us to cease business operations
entirely. Additionally, even if we raise funds in the near term, our failure to
successfully develop or market our fuel cell products 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 successfully market,
produce and sell our fuel cell products.




Our
vendor and supplier relationships are not certain or are being terminated due to
our cash position, and some of our vendors and suppliers have brought legal
action against us claiming non-payment or breach of contract.




We have
entered into agreements with third party vendors and suppliers to provide
requisite materials and components.




Recently,
primarily due to our cash position, we have ceased payments under, renegotiated
terms of, or terminated many of these existing agreements. In some cases, we
have outstanding invoices or are required to make substantial cash payments. Our
failure to make all such payments could cause some of our vendors and suppliers
to bring legal action against us under a claim for non-payment or breach of
contract, or cause a bankruptcy event.




The
Company has been named as defendant in lawsuits filed by suppliers for the past
due invoices, of which three of the plantiffs have been granted attachments on
the bank accounts, totaling less than $80,000, of Medis El in Israel. In
addition, the Company continues to receive claims, both oral and in writing, by
suppliers threatening legal action for payment of past due
invoices.




We
continue to communicate with vendors for payment of past due invoices, so that
the obligations will be settled in an amicable manner. Although many vendors
have been willing to communicate in good faith discussions, the Company cannot
provide assurance that additional litigation will not be brought against the
Company.




While we
believe that we will be able to adequately replace our suppliers or other
partners if and when we recommence production, our inability to do so in a
timely manner and on an cost-effective basis, could adversely affect our ability
to again manufacture our products and, consequently, our ability to bring our
products to market.




Our
relationships with our distributors are not certain or are being
terminated.




Although
we have received purchase orders pursuant to some of our distribution
agreements, we believe various factors have impacted those agreements and
purchase orders. Furthermore, although we have commenced selling our products on
a limited basis, we have temporarily curtailed the marketing and distribution of
our commercial products. We were recently notified by one of our distributors
that it has determined not to proceed with distributing our products.
Furthermore, our remaining distributors may


28




decide
not to continue with our arrangements with them. Generally, we can give no
assurance that any of our distributors or representatives will continue to
cooperate with us on the terms and based on the pricing schedules we believe are
appropriate. Any such failure to cooperate could adversely affect our ability to
distribute our 24/7 Power Pack and emergency kit to the marketplace and,
therefore, our business, prospects, results of operations and financial
condition.




We
may be delisted from trading on the Nasdaq Global Market.




On
April 2, 2009, we received a letter from the NASDAQ Stock Market (“Nasdaq”)
informing us that based on our stockholders’ deficit, as reported in our Annual
Report on Form 10-K for the period ended December 31, 2008, we do not comply
with the minimum $10 million stockholders’ equity requirement for continued
listing on the Nasdaq Global Market under Nasdaq Marketplace Rule 4450(a)(3)
(the “Rule”). In addition, we do not meet the $2.5 million stockholders’ equity
requirement for listing on the Nasdaq Capital Market. On April 17, 2009 we
responded to Nasdaq with certain actions that may allow us to achieve the $2.5
million shareholders’ equity retirements for inclusion on the Nasdaq Capital
Market. Thus, we submitted a transfer application for trading of our common
stock to be moved from the Nasdaq Global Market to the Nasdaq Capital Market and
requested a 90-day waiver of this equity requirement. On June 17, 2009, we
received a letter from Nasdaq informing us that, based on Nasdaq’s further
review and the materials that we submitted to Nasdaq on April 17, 2009 and May
13, 2009, Nasdaq determined to grant us an extension until July 16, 2009 to
regain compliance with the Rule. On July 17, 2009, we received a notice from
Nasdaq informing us that we are still not in compliance with the minimum
stockholders’ equity for continued listing on the Nasdaq Global Market and that
unless we appeal this determination, trading of our common stock would be
suspended at the opening of the market on July 28, 2009. We requested a hearing
before a Nasdaq Hearing Panel to present our plan for listing on the Nasdaq
Capital Market, as contemplated in our July 15, 2009 request to have trading in
our common stock transferred to the Nasdaq Capital Market in accordance with the
application submitted by us on April 17, 2009.  The hearing is
scheduled for August 20, 2009 and will stay the delisting of our common stock
pending the panel’s decision.





We cannot
predict how the market for our common stock will be effected if we are delisted
from the Nasdaq Global Market. Furthermore, we can give no assurance that we
will be successful in transferring onto the Nasdaq Capital Market. The delisting
of our common stock from Nasdaq could adversely affect the liquidity and trading
of our common stock, which may result in a decline to our stock
price.





Item
3.   Defaults Upon Senior Securities





In
February 2009, May 2009 and again in August 2009, we did not declare the
quarterly dividends on our Series A Preferred Stock, of approximately $1,050,000
per quarter. Upon our determination to not declare dividends, the dividend rate
on the Series A Preferred Stock increased based on an equation in the
Certificate of Designation relating to the Series A Preferred Stock, which
increase shall remain in effect until such time as all accrued and unpaid
dividends are paid in full. Additionally, if dividends are in arrears for the
equivalent of six calendar quarters, the holders of the Series A Preferred Stock
would be entitled to appoint two directors to the Company’s Board of Directors.
Through August 17, 2009, we are in arrears in the payment of dividends on our
Series A Preferred Stock of approximately $3,174,000.







29


Item
5.   Other Information
 None
   Item
6. Exhibits





Exhibit Number
              Exhibit Description10.1
              Letter,
      dated as of April 23, 2009, to Jose Mejia regarding retention bonus
      (1)10.2
              Letter,
      dated as of April 23, 2009, to Stephen Crea regarding retention bonus
      (1)10.3
              Form
      of Letter, dated as of April 23, 2009, to officers of Medis Technologies
      Ltd. regarding retention bonuses (1)10.4
              Warrant
      to Purchase Common Stock, dated July 1, 2009, issued to Ovation Alpha
      Capital, Ltd. (2)10.5
              Preferred
      Stock Purchase Agreement between Medis Technologies Ltd. and Volation
      Capital Partners, LLC (2)10.6
              Loan
      Agreement and Promissory Note between Medis Technologies Ltd. and Volation
      Capital Partners, LLC (2)10.7
              Stipulation
      Agreement for Settlement of IO Claims between Volation Capital Partners,
      LLC and Medis Technologies Ltd. (2)10.8
              Assignment
      Agreement between Medis Technologies Ltd. and More Energy Ltd.
      (2)31.1
              Rule
      13a-14(a)/15d-14(a) Certification31.2
              Rule
      13a-14(a)/15d-14(a) Certification32
              Section
      1350 Certifications


________________




(1)
            Filed
      as an exhibit to the Quarterly Report on Form 10-Q dated March 31, 2009 of
      Medis Technologies Ltd. and incorporated herein by
    reference.




(2)
            Filed
      as an exhibit to the Registration Statement on Form S-1 (File No.
      333-160484) of Medis Technologies Ltd. and incorporated herein by
      reference.




30


SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this Report to be signed on its behalf by the undersigned thereunto
duly authorized.








MEDIS TECHNOLOGIES
      LTD.By:
                /s/ Jose MejiaJose
      MejiaPresident
      and Chief Executive Officer(Principal
      Executive Officer)


By:
                        /s/ Steve
      CreaSteve
      CreaChief
      Financial Officer(Principal
      Financial and Accounting Officer)


Date:  August
18, 2009












31