MEDIS TECHNOLOGIES LTD - 10-K Annual Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

______________

FORM 10-K

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission file number: 0-30391

MEDIS TECHNOLOGIES LTD.

(Exact name of registrant as specified in its charter)

Delaware		13-3669062
(State of incorporation)		(I.R.S. Employer Identification No.)

805 Third Avenue

New York, New York 10022

(Address of principal executive offices, including zip code)

(212) 935-8484

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

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 ý No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý No o

As of June 30, 2004, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $257,864,000.

As of March 10, 2005, there were outstanding 27,115,487 shares of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III.

TABLE OF CONTENTS

Part I		1
Item 1.	Business	1
Item 2.	Properties	15
Item 3.	Legal Proceedings	15
Item 4.	Submission of Matters to a Vote of Security Holders	15

Part II		16

Item 5.	Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	16
Item 6.	Selected Financial Data	16
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 8.	Financial Statements and Supplementary Data	35
Item 9A.	Controls and Procedures	35
Item 9B.	Other Information	37

Part III		37

Item 10.	Directors and Executive Officers of the Registrant	37
Item 11.	Executive Compensation	37
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	37
Item 13.	Certain Relationships and Related Transactions	37
Item 14.	Principal Accounting Fees and Services	37

Part IV		38

Item 15.	Exhibits and Financial Statement Schedules	38

References in this Annual Report to “we,” “us,” or “our” are to Medis Technologies Ltd. and its direct and indirect subsidiaries, unless the context specifies or requires otherwise.

PART I

Item 1.

Business

Introduction

Our primary business focus is on the development, manufacturing, marketing and distribution of direct liquid fuel cell products for portable electronic devices, for the consumer (personal and professional) and military markets. A discussion of our direct liquid fuel cell products and technology and of our other technologies, including our CellScan, inherently conductive polymers, stirling cycle system, toroidal technologies and Rankin cycle liner compressor, follows.

We are a Delaware corporation organized in April 1992. Our executive offices are located at 805 Third Avenue, New York, New York 10022. Our telephone number is (212) 935-8484. Our website is located at www.medistechnologies.com. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically filed such material with, or furnished it to, the Securities and Exchange Commission. The information on our website is not part of this Annual Report.

Fuel Cells

Introduction

Our primary business focus is on the development, manufacturing, marketing and distribution of direct liquid fuel cell products to power and charge portable electronic devices, such as most cell phones (including the most advanced “3G” cell phones with a full range of functionality), digital cameras, PDAs (both for personal and professional use, including wireless versions with e-mail capability), MP3 players, hand-held video games and other devices with similar power requirements, as well as a broad array of military devices.

Our first planned consumer fuel cell product, which we call our “Power Pack,” is a disposable, portable auxiliary power source capable of providing power to operate and charge many of the most advanced portable electronic devices. When a device’s battery is running low or is discharged, the Power Pack allows the continued use of the device while at the same time charging the battery. When the Power Pack has depleted its fuel, it can be disposed of by the consumer. By contrast, the military product we are developing and what we anticipate will be a second generation consumer product, is refuelable rather than disposable. When the fuel in those Power Packs is depleted, the user employs a removable fuel cartridge that replaces the fuel and the electrolyte in a matter of seconds.

A fuel cell is an electro-chemical device that converts the chemical energy of a fuel, such as our patented fuel, hydrogen or methanol, into electrical energy. There are a number of different types of fuel cells being developed for commercial applications, some of which are intended for large scale applications such as automobiles and stationary power generation. By contrast, our fuel cells are not derivative or a miniaturization of these larger systems; rather we have specifically designed our system for small scale applications, and in particular for use with portable electronic devices. We also believe that certain technologies used in our fuel cells, particularly our patented fuel, may be applicable in the development of larger fuel cells delivering tens of kilowatts of power. While we have no current intention to divert our resources or funds to develop or manufacture larger fuel cells, we would consider the possibility of joint activity or licensing relationship with an appropriate company in that arena.

Central to our fuel cell products is our patented highly-advanced liquid fuel. As reflected in our patents, the basic components of our fuels are borohydride - alkaline solutions combined with alcohols. These compounds are characterized by high levels of electrochemical activity which results in high levels of power density and energy capacity at a broad range of temperatures, even including room temperatures. These are important conditions for working with portable power sources. Our fuel is not flammable and the pH level of our fuel is approximately the same as that of alkaline batteries. This contrasts with methanol, the traditional fuel used in small fuel cells being developed for portable electronic devices, which has severe limitations due to its high flammability and toxicity levels.

Our Fuel Cells Compared to Rechargeable Batteries

Fuel cells for small-scale applications have many of the characteristics of rechargeable batteries and in certain applications could compete with them. A key distinguishing feature between fuel cells and rechargeable batteries is that a fuel cell transforms its fuel directly into electrical power and produces power as long as the fuel is supplied. Batteries are energy storage devices that release power until the chemical reactant stored in the battery is depleted. Once the chemical reactant is depleted, the battery must be recharged or discarded.

As portable electronic devices continue to advance and to offer greater capabilities and functionality, the power gap that already exists between those ever-increasing power demands of electronic applications and the power that is available from batteries continues to widen. We believe that mobile operators (wireless carriers/service providers) and device manufacturers will seek significantly increased and longer lasting power to satisfy consumer desires. Since we believe that batteries presently used in these devices are approaching their technological limit, we expect the Power Pack to help fill that gap.

Our Fuel Cells Compared to Other Fuel Cells

Much of the traditional fuel cell development for the portable electronic device market centers around direct methanol fuel cells using a solid polymer membrane (proton exchange membrane, or PEM), unlike our use of our patented fuel and an alkaline electrolyte. Although the proton exchange membrane, itself, has the advantage of requiring less space than a liquid electrolyte, we believe that the use of PEM technology has other disadvantages which make it more difficult to reduce the overall size of the fuel cell, and increase the power densities to an amount needed for portable electronic devices at commercially acceptable temperature levels for broad consumer use. In a direct methanol fuel cell with a PEM, the concentration of methanol used in the fuel cell stacks is usually limited to 3% to 6%, reducing the performance of the fuel cell. In order to achieve such reduced concentrations of methanol, most traditional direct methanol fuel cells are constructed with an external cartridge delivery system containing concentrations of methanol as high as 99.5 to 100 percent to feed the methanol into the fuel cell system and a regulator to control and reduce the flow of methanol. We believe that such high concentrations of methanol raise issues of consumer health and safety and would preclude bringing such a methanol fuel cell in an airplane cabin, as well as impose other restrictions on transportability. Other direct methanol fuel cell external support systems may include a water management system, a temperature control system and where fuel cells are arranged in a stack, a forced air system. Such direct methanol fuel cell support systems could result in increased size, complexity and cost. Direct methanol fuel cells generally also use platinum or other expensive noble metals on both the anode and the cathode.

Other companies have announced their use of reformers inside their fuel cells to convert methanol into hydrogen which is then used to create power. The public announcements thus far suggest the presence of heat of over 200 degrees Celsius in these products. Other announcements have suggested the planned use of nanotechnology methods to create new forms of fuel cells. We are not aware of any

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concrete evidence of successful development of fuel cells using nanotechnology. It should be noted, however, that considerable resources are being applied by many large companies to develop fuel cells using all of these, as well as other methods, and we can give no assurance that a fuel cell product will not be developed using highly concentrated methanol, reformers, nanotechnology or other approaches that would be competitive to our products.

We have developed a fuel cell that we believe has obviated many of the problems that have affected traditional PEM-based fuel cells. Our fuel cell technology enables us to use a safer patented fuel which is not flammable, avoiding methanol’s levels of toxicity and flammability. Our fuel cell is self-regulating, meaning it provides sufficient power to meet the draw-down of power as needed. It does not require an external fuel delivery or regulating system so it can be made as a disposable product or it can use a cartridge that replaces the fuel in a matter of seconds and need not constantly sit in the fuel cell. Furthermore, our fuel cell does not require a water management system, a forced air system, a heat control system, a reformer or other complex system. Instead, our fuel cell has a very simple design and architecture, consisting of an anode, a cathode, a chamber for the liquid electrolyte and a fuel chamber. We have also eliminated the use of platinum on the cathode, and while we are still using limited amounts of platinum on the anode, we are seeking to eliminate the use of any platinum on the anode, thereby eliminating all platinum and other noble metals in our fuel cells. In addition, the cost of the liquid electrolyte in our fuel cell is substantially lower than the cost of a PEM. Eliminating complex systems, using a low cost electrolyte and reducing or eliminating platinum from our fuel cells, we believe enables us to lower the component costs of our product significantly. Finally, our fuel cell technology has allowed us to improve our fuel cell’s performance in power output and operating time relative to size and weight. As a result, we are able to use a single fuel cell in making a product, such as our Power Pack, rather than stacking a number of fuel cells with the additional complexity that approach may require. Since the initial voltage created by our fuel cell is 0.35 to 1.0 volt, our system uses a DC to DC converter that we have developed to be able to increase the initial voltage from 0.35 to 5 volts.

State Of Our Fuel Cell Products

Our first two fuel cell products are our disposable Power Pack for the consumer (both personal and professional) market and our refuelable Power Pack for military use.

Disposable Power Pack

Our disposable Power Pack is a portable auxiliary power source that allows the continued use of a portable electronic device whose battery is depleted, while at the same time charging the battery. The disposable Power Pack is expected to provide sufficient power to operate and charge most of the advanced portable electronic devices on the market today, such as most cell phones (including the most advanced “3G” cell phones and those with built-in cameras), digital cameras, PDAs (both for personal and professional use, including wireless versions with e-mail capability), MP3 players, hand-held video games and other devices with similar power requirements, since our patent pending power management system provides the capability of charging a number of different devices using inexpensive connectors that access the particular device’s battery. When used to power a cell phone, each disposable Power Pack is expected to deliver the equivalent of 15 to 20 hours of talk time, or about two to five full charges of the battery, depending on the individual cell phone power consumption and battery type. When used to power a rechargeable digital camera, the disposable Power Pack is expected to deliver two to five full charges of the battery, depending on the individual camera’s power consumption and battery type. Before its use, the Power Pack is expected to have a shelf life in excess of a year. Once it is started, the disposable Power Pack is expected to be usable for four to six weeks.

The disposable Power Pack has an anticipated maximum size of 80 x 50 x 30 mm (3.2 x 2 x 1.2 inches) and anticipated weight of up to 200 to 250 grams fully fueled. The disposable Power Pack is expected to have a price of $10.00 to $15.00 when offered by mobile operators to their subscribers and a suggested retail price of $19.99 when sold through traditional retail channels. By comparison with battery-operated portable cell phone chargers in the market today, we expect our disposable Power Pack to offer many advantages, including: substantially more hours of operation relative to cost; the ability to start a cell phone depleted of power in seconds rather than minutes; the ability to power a number of different devices; the use of a built-in fuel gauge that tells the user how much fuel is still available; and the avoidance of reverse polarity which discharges the cell phone battery when the charger is left connected.

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We expect that as manufacturers of portable electronic devices continue to offer new products and add functionality to existing products which require increased battery power and battery life, batteries now on the market will not be able to operate these new devices to the consumer’s satisfaction. We expect that our Power Pack, by being able to supply power to operate continuously and charge the device repeatedly, will offer significant benefits to the mobile operators, the device manufacturers and the consumer. We anticipate that mobile operators will benefit by providing increased use time for the new products and functions, thereby increasing their average revenue per user (“ARPU”) and the mobile operators also will have the opportunity to earn a new source of revenues on the sale of Power Packs to their existing customer base. Device manufacturers will benefit by the availability of more power for operation of their new products with increased capabilities. And consumers will be able to take greater advantage of the new device capabilities and benefit from the convenience and freedom of being able to operate and charge portable devices on the go.

In June 2004, we successfully demonstrated our refuelable military Power Pack operating an advanced PDA together with General Dynamics C4 Systems at a fuel cell conference, and demonstrated both the military Power Pack and our disposable consumer Power Pack products charging and operating cell phones and digital cameras both at meetings attended by original equipment manufacturers (OEM’s) and by our shareholders and members of the investment community. Starting at the end of February of 2005 and expected to continue through mid-May 2005, we have been making available pre-mass production units of our disposable Power Packs for review by different potential customers. These pre-mass-production Power Packs are able to demonstrate the capabilities of our planned volume production products. We plan to demonstrate these units to our distributors, Kensington Technology Group, Superior Communications and ASE International Inc. and with them to demonstrate the units to some of their key customers. Furthermore, we are meeting with major mobile operators in the United States and Europe as well as large OEM’s to demonstrate our Power Pack products. We are seeking feedback from these potential customers, which we will use to prepare our final designs as well as rely on as an indication of future orders. We plan to fix the final design for the disposable Power Pack and seek firm orders from our customers by May-June of 2005, which we expect will enable us to begin volume production at the end of 2005, with the aim by the second half of 2006 of having at least one full line running capable of producing up to 1.5 million units per month. To carry out this program on this schedule will require us at that time to have sufficient orders from our customers to warrant production lines; complete the tooling for production; have run the line and solved any problems that typically occur in new production lines; have production lines in place for the electrodes, the fuel and the balance of the Power Pack products, including funding for such lines; and have contracts with one or more manufacturers to produce our Power Pack. While we are making considerable progress towards our goals, there can be no assurance that all of these requirements will be met in a timely fashion and that there will be no delays in meeting our production program. We are already engaged in discussions with potential contract manufacturers capable of producing our Power Packs.

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Refuelable Power Pack

The refuelable Power Pack, which we anticipate will be a second generation consumer product, is expected to allow the user to refuel the Power Pack by using a cartridge which transfers new fuel and electrolyte into the Power Pack, replacing any remaining fuel, electrolyte and water by-products which are returned to the refueling cartridge. This refueling process is expected to take a matter of seconds and the cartridge can then be discarded.

Pursuant to an agreement with General Dynamics, we are designing and developing a refuelable Power Pack capable of providing auxiliary power to a rugged PDA being developed by General Dynamics to meet military specifications. Under the present system, the PDA would be charged by a battery sleeve with eight lithium manganese oxide batteries. For a 72 hour mission, always on, the present system would require the military team to carry about 140 batteries costing approximately $450. Our refuelable Power Pack is expected to provide approximately 72 hours of operating time with the use of only six refueling cartridges, making it lighter and less expensive than the present system. In December 2004, we delivered sixteen fully functional prototype fuel cell Power Packs and fuel cartridges to General Dynamics for testing in connection with the rugged PDA. Each Power Pack is currently capable of delivering five watts and five volts of continuous power. Our technical team is working closely with General Dynamics to evaluate the ability of the Power Packs and cartridges to meet extended mission requirements and military environmental specifications with a view to incorporating product enhancements in future designs.

We are also progressing in the development of a more powerful Power Pack of about eight watts for a tablet computer to fulfill an order we received from General Dynamics in August 2004, pursuant to a contract awarded to General Dynamics by the USAF. Delivery of the prototypes for that product to General Dynamics is planned for the third quarter of 2005.

State of Our Fuel Cell Technology

Even as we develop completed fuel cell products like our Power Packs, we continue to work towards substantial advances in the development of our technology to enhance the commercial value of our products. These advances include: supplying increased energy while also reducing size and weight; perfecting the discharge characteristics and length of operating time (discharge characteristics determine how much power the fuel cell can deliver over a period of time); improving the engineering design; and integrating our individual fuel cells into a seamless power source. We are also working to finalize the production model of the converter used in our power pack to step up voltage together with the power management system that allows the Power Pack to respond to differing voltage requirements of different devices.

During 2004, we entered into the following two agreements to advance our fuel cell products and move towards volume production:

On May 25, 2004, we entered into a Development Agreement with Eastman Kodak Company’s Global Manufacturing Services operation for advancing the development of refueling cartridges and chemicals to be used in our fuel cell products.

On May 3, 2004, we entered into a Product and Manufacturing Development Agreement with Flextronics International Ltd. In connection with this relationship, Flextronics developed a small Application Specific Integrated Circuit (ASIC) for our proprietary DC to DC converter to increase the voltage without having to connect a number of fuel cells in a series. We have also developed an innovative proprietary power management system (patent pending) that enables our Power

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Pack to respond to the voltage requirements of different devices using only an inexpensive connector to those devices. We have integrated the power management system with the DC to DC converter and, based on a new proprietary approach we have developed, we expect to significantly reduce the size of the combined unit in our Power Pack products. We have also succeeded in designing our Power Pack to allow for operation in any orientation.

Market Opportunities

Portable Electronic Device Market

We estimate based on various reports of cell phone sales that there are currently over 2.0 billion users of portable electronic devices world wide, of which approximately 150 million are in the United States, with reported annual sales of approximately 650 million devices per year, representing new and replacement sets. In this market, device manufacturers are continuing to add more and more entertainment, communication and other features on their handsets, particularly phone manufacturers who are incorporating into the latest 3G cell phones functionality that includes digital cameras, internet access, video games, video clips, text messaging, PDA applications, MP3 players, FM radios and even television broadcasts. Thus, the cell phone which at the outset was simply a communications device has evolved into an entertainment device offering video, music, and sports and other programs. We believe that this trend is consistent with the strategies of mobile operators (service providers) worldwide who are requiring that products they make available to their subscribers have greater functionality in order to increase their income from air time usage. Published comments made by mobile operators and others suggest that they believe that the battery life of the cell phones being delivered by cell phone OEM’s fall short of satisfying the consumer and prevents the consumer from making full use of all the capabilities presently being offered and planned for the phones and other devices. We believe that this affords us a significant market opportunity if the mobile operators decide to offer our Power Pack to their subscribers both when the subscriber first signs up for a cell phone, by an offer sent together with the bill or by providing the subscriber with a phone number to dial that activates the delivery of a Power Pack to the subscriber and bills the subscriber. Such an offer could suggest that the subscriber can solve the problem of “power frustration” by signing up for a number of Power Packs a year and having the charge included in the subscriber’s monthly bill.

Based on what we have learned from company-sponsored attitude surveys and focus groups dealing with cell phone use, we expect there to be a high level of demand for the Power Pack by those cell phone/PDA users who travel frequently and who would use the Power Pack to keep their devices charged while traveling. Also discerned from these groups was a surprisingly high level of demand by stay-at-home parents, a very high percentage of whom stated in these surveys and focus groups that they would purchase and frequently use a Power Pack-type product. Stay-at-home parents also make many of the purchasing decisions for their households and a very large percentage stated that they would purchase a Power Pack for their children who had cell phones, as well. By contrast, we would expect that cell phone users who charge their phones each night and work in an office during the day are less likely to buy a Power Pack unless they contemplate a trip, and others might buy it to keep in survival kits to protect against loss of power by reason of blackouts or for emergency use in case of natural disasters.

One market that we believe has considerable potential for our Power Pack is the “kidult” market - the 13 to 24 year olds who represent prime users for many advanced portable devices. We, and our distributors believe that the Power Pack products offer a valuable opportunity for the distributors and their customers to access this very important market early in their lives as a way of relating to this consumer group as they grow older. Another growing market where we believe the Power Pack will be attractive is the “enterprise” market which focuses on the high-usage business market, which uses increasingly advanced portable devices to access corporate applications and data bases.

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At the same time, there is a fast growing market for digital cameras - expected to reach almost 100 million sold by the end of 2005, according to published reports. Yet, we have been advised by some digital camera OEM’s that the single biggest consumer complaint about the performance of the digital camera is battery life. In our company-sponsored attitude surveys and focus groups, thus far, a very large percentage of those interviewees who owned a rechargeable digital camera said they would purchase and use a Power Pack to prevent failed battery life at a crucial picture taking time or a warning of reduced battery life that would result in rationing pictures. We would also expect that customers whose initial primary motivation to purchase a Power Pack was for use in connection with their digital cameras will soon start using the same Power Pack as a matter of convenience to charge their cell phones and other portable electronic devices and quickly make it a part of their every day lives. Similarly, we expect that cell phone Power Pack users would use them for charging their digital cameras and other portable devices.

Military Applications

The U.S. Department of Defense has stated that it has a pressing need for lighter and more compact electrical power sources as the modern soldier is increasingly equipped with many new portable electronic devices. As with the latest portable electronics for consumers, these devices require significant power sources and are currently dependent on batteries that are heavy and expensive and must be recharged frequently at a central charging source. We intend that our refuelable Power Pack will satisfy these power needs. In May 2002, we received a $75,000 order from General Dynamics towards development of a fuel cell product. On May 5, 2003, we announced an agreement with General Dynamics to design and develop a pre-production prototype of our fuel cell military Power Pack product for the rugged personal digital assistant (PDA) system that they are developing for the military. In December 2004, we delivered sixteen fully functional prototype fuel cell Power Packs and fuel cartridges to General Dynamics for testing pursuant to this agreement. The total price for our services provided for in the agreement is $500,000, with an initial payment of $100,000 and the balance in accordance with the payment and performance milestones established in the agreement through 2005. Under these two agreements with General Dynamics we have already received nine payments totaling $475,000. We anticipate further payments totaling $100,000 during 2005, as we achieve the final two milestones.

In August 2004, we received an additional order from General Dynamics to deliver five prototype fuel cell power packs and associated cartridges as power sources for 10 prototype tablet computers in support of the United States Air Force (USAF) Wearable Computer Power Program. The order provides for 10 milestone payments of $42,500 each through June 2005, or a total of $425,000. The order was issued pursuant to a contract awarded to General Dynamics by the USAF and announced on August 20, 2004. We have already received six payments totaling $255,000 under this order. We expect to deliver the five prototype fuel cell Power Packs and associated cartridges in the third quarter of 2005.

Together with General Dynamics we are also evaluating other military products where our fuel cells could be valuable. General Dynamics has received the contract for the multiple department of defense instruments and applications including Joint Tactical Radio Systems (JTRS). Other military related areas that may offer potential are products carried by foot soldiers in the Land Warrior program of the U.S. Department of Defense. The Land Warrior program is designed to make each individual soldier function as a complete weapon system, integrating small arms with high-tech equipment such as special communications devices, weapons imaging systems, video, and global positioning systems.

Business Strategy

Our business strategy with respect to our fuel cell technology is to translate our advanced fuel cell technology into commercially viable products sold to

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consumers throughout the world and sold to military users both in the United States and other countries. To accomplish those goals, we have put into place and are continuing to put in place manufacturing, marketing and distributions systems capable of providing, initially, for the commercial production, distribution and sale of our disposable Power Pack to the consumer and potentially, as a second generation product, for the refuelable Power Pack and attendant cartridges, as well as for our military fuel cell products.

Manufacturing and Distribution

It is our target to begin volume production of our disposable Power Packs starting at the end of 2005 with the capability of manufacturing thousands of Power Packs units per month and increasing in volume to the point of having a full line in place during the second half of 2006 that is capable of manufacturing up to 1.5 million Power Pack units per month. We have focused much effort, human power and cost towards meeting this target. One key area for us has been the pre-production preparations for volume production. Because micro fuel cell products have never been produced in commercial volume before, we had to internally develop most of the tooling and processes for volume production. Towards this end, we have engaged the services of Eastman Kodak Company’s Global Manufacturing Services operation. Additionally, we have engaged a number of Israel-based subcontractors and highly respected scientific groups world wide - university, government and commercial - to help us develop the engineering required for volume production of our electrodes, catalysts, fuel, electronics and other elements.

Additionally, as part of the pre-production preparations for volume production, we have developed a line for electrode production and we expect to add to our electrode production capability during the coming months. We have recently exercised an option on 4,000 square feet as part of our new facility in Lod, Israel that we plan to use for our electrode production and we already have in place pilot production capability for our fuel and catalysts using machinery specifically designed by us. Our plan is to start our production program using the electrode, catalyst and fuel production lines in our own facilities. At the appropriate time in the development of the demand for our products we would consider making a technology transfer to manufacturing partners who would upscale these lines for higher rate production, while maintaining in our facility the basic capability at all times.

Our goal is to have firm orders for our Power Pack products from mobile operators, distributors and/or OEM’s sufficient to warrant constructing production line(s) capable of producing at least one million Power Packs per month. Sometime around the middle of 2005, we would look to firm up a relationship with one or more large-scale manufacturers to start tooling for producing our disposable Power Packs and later for producing our refuelable Power Packs and the cartridges. We are already in discussions with recognized international companies capable of high volume production and our goal is to finalize a transaction by the middle of 2005.

There is no assurance that we can successfully complete our production lines to meet our planned schedule, or that we will have firm orders sufficient to warrant construction of such lines or that we will be able to enter into a satisfactory production arrangement, including acceptable pricing, with a contract manufacturer.

Our initial estimate is that a construction line to make 1.5 million Power Packs a month will cost around $22 million. As part of this program, we are considering different ways of financing the production lines. These include financing from the producing party, financing from a third party based on firm orders, and equity financing from us. The approximately $5.6 million of equity funding we obtained during December 2004 and January 2005 will help provide more flexibility regarding those decisions. Preparing for volume production has been a major effort in 2004, requiring significantly increased expenditures on our part, and we expect it to continue in even greater scale during 2005 as we ready for

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production. There is no assurance that we will be able to finance the construction of our Power Packs from any of the sources described above.

During this past year we put in place key distribution relationships for our Power Pack products.

On March 9, 2004, we entered into a distribution agreement with Kensington Technology Group, a leading maker of computer accessories and a division of ACCO Brands, Inc., a subsidiary of Fortune Brands, Inc. Pursuant to the distribution agreement, among other things, we have granted Kensington a limited, exclusive right to market and distribute our Power Pack and other products using our fuel cell technology under the Kensington and Medis brand names. We anticipate that Kensington/ACCO Brands will distribute our Power Pack products to the “big box” stores like Best Buy and Circuit City as well as office supply stores such as Office Max and Office Depot, which we expect will be excellent sources for the “enterprise” market. Kensington has a full time manager devoted to working with our team and they provide valuable resources for marketing, packaging and design know how.

On August 3, 2004, we entered into a distribution agreement with Superior Communications, which provides wireless accessories to major mobile operators, retailers and distributors across the United States, for the distribution of the Company’s fuel cell Power Packs, primarily to those stores where Superior Communications has relationships, namely to the Cingular, AT&T Wireless, T Mobile and Alltel stores where they provide important services such as supply chain management, product mix management and sales training for retail associates.

On August 10, 2004, we entered into a distribution agreement with ASE International Inc., for the distribution of our fuel cell Power Pack products through various outlets not otherwise covered by our other distribution agreements. ASE has a broad outreach to various channels such as drugstores, convenience stores, department stores, airport stores and duty free shops, representing an estimated 50,000 “doors" in the United States and Canada.

Finally, we view mobile operators as potentially a very significant distribution channel for our Power Pack products. With large existing subscriber bases and existing distribution networks to reach those subscribers, we believe that mobile operators are in a uniquely advantageous position to efficiently distribute our products. We believe that the mobile operators in turn will benefit by providing increased air time for their new products and functions, thereby increasing their average revenue per user (“ARPU”) and at the same time, develop a new source of recurring revenues on the sale of Power Packs to their existing subscriber base.

During 2004, we successfully demonstrated our Power Pack products. In June 2004, in Palo Alto, California, we demonstrated disposable and refuelable working Power Packs to representatives of major Original Equipment Manufacturers (OEMs) and other potential customers and later, in New York, we demonstrated them to shareholders and members of the investment community. Presentations were made at those showings from executives of Eastman Kodak Global Manufacturing Services, Flextronics International and General Dynamics Corporation.

Competition

We expect to compete against other fuel cell developers as well as against other advanced battery technologies and battery chargers. Our primary direct competitors are companies developing small fuel cells for the portable electronics market. These include Manhattan Scientifics Inc., which has reported that it is developing a fuel cell to provide auxiliary power to cellular phones and pagers. Motorola, with technology licensed from the Los Alamos National Laboratory in New Mexico, has been developing a direct methanol fuel cell for mobile phones and now is developing a fuel cell using a reformer.

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Mechanical Technology Inc., which is working with a number of scientists formerly with the Los Alamos National Laboratory, has also licensed certain fuel cell technology from Los Alamos National Laboratory to further its efforts to develop direct methanol fuel cells. Lawrence Livermore National Laboratory has also announced that it is developing small fuel cells for portable electronic devices. Other companies that have announced that they are developing fuel cells for portable electronic devices are PolyFuel, Inc. (which has announced that it has developed a new membrane that is superior to others) and Neah Powers Systems, Inc., with respect to both of these companies it has been announced that Intel has made investments and Smart Fuel Cell GmbH.

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

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

Additionally, we expect to compete with companies that develop, manufacture, and sell battery-operated chargers for portable electronic devices, including alkaline batteries, lithium battery packages and zinc-air batteries offered as chargers for cell phones, PDAs and other portable electronic devices that target many of the same markets we intend to target with our Power Pack.

We also expect indirect competition from battery manufacturers who utilize existing battery technologies (both rechargeable and non-rechargeable). Existing battery technologies have the significant advantage of having commercially available products today, and are backed by companies who are continuously investing in marketing and further research and development to improve their existing products and explore alternative technologies.

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

Our Other Technologies

Starting with our formation in 1992, we have been working to develop and commercialize new technologies. The first of these technologies, the CellScan, was the primary product of our indirect subsidiary, Medis El Ltd., through 1996. At the time of our formation, Medis El granted us distribution rights to the CellScan in the United States and its territories and possessions. In 1994, Medis El acquired its stirling cycle linear technologies and over the ensuing years, acquired additional technologies, including our direct liquid fuel cell technology and the other technologies listed below. In 1998, we became Medis El’s exclusive agent in North America for coordinating licensing arrangements with respect to the stirling cycle and other technologies. In 2000, Medis El became our indirect, wholly-owned subsidiary. With the exception of our fuel cells, our inherently conductive polymers and our CellScan

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system, all of our technologies are in the development stage and no successful commercial prototypes have as yet been developed, nor can we assure you that any such prototypes will be developed or, if developed, commercialized.

CellScan

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

We have completed the development and have built a much smaller and less expensive version of our original CellScan system which fits on a desk top and which has improved performance characteristics, including the number of cells that can be screened and analyzed per hour and the number of individual tests that can be completed per day. In using the new version of the CellScan, we continue to improve the methodology and the efficacy of the testing. As a result of this experience, we have updated our production drawings, and have built two CellScans during 2004.

We are in the process of developing a new cell carrier specifically designed to allow the CellScan to measure cell reaction in cell configurations different from those that can currently be studied. If this program is successful, we expect that this new cell carrier will open another dimension of possible applications for the CellScan, including working with stem-like cancer cells.

Our first focus for commercialization of the product is an in vitro test for determining chemosensitivity of a patient’s cancer; that is to measure whether a patient’s cancer cell is responsive to a particular chemotherapy protocol. In that connection, we are in the process of performing testing in conjunction with hospitals in Israel and establishing the system to carry out such testing in a commercial setting. After establishing a commercial test for chemosensitivity, we may also seek to offer other commercial tests, such as for atherosclerosis and drug allergies. As part of the commercialization process, we are also reviewing the practicality of entering into distribution agreements for the CellScan with entities that have strong marketing and distribution capabilities in various parts of the world.

In the context of our program of moving towards commercialization of the CellScan, we are seeking to obtain quality certifications and regulatory authority marketing approval of the CellScan technology and its applications. Accordingly, we are in the process of seeking ISO 9001 (International Organization of Standardization) certification and CE marking (European Conformity). In addition, we are upgrading our equipment, techniques, and protocols to meet FDA pre marketing standards, with a view towards seeking FDA approval of the CellScan and eventually, our proposed test for chemosensitivity. We have retained counsel to begin working with us on this program. We cannot assure you that we will succeed in receiving FDA approval for our tests.

Our strategy for the CellScan is to seek to create a viable commercial business and based on that business model, to carry out a program that would enable us to spin-off the assets relating to the CellScan and transfer the personnel to a subsidiary that has been formed for the commercialization of the CellScan. As part of such a program, we expect to seek public investment or private venture financing for the subsidiary or seek to enter into a transaction with a company in the biotechnology field whereby that company would acquire all or part of our interest in the CellScan. We can give no assurance that such a program can be carried out successfully.

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We are also continuing to collaborate with third-party researchers and institutions in the development of potential applications for the CellScan, including determining the efficacy of chemotherapeutic drugs for specific tumors, atherosclerosis, lupus, tuberculosis and drug allergy.

Recent, on-going and planned studies for several CellScan applications include the following:

Chemosensitivity. We have on-going studies both in our laboratory in Israel and in collaboration with the Oncological Institute in Cluj, Romania, to determine whether the CellScan could be used as a tool in determining the efficacy of chemotherapy drugs for specific tumors. The first phase of a multi-patient study at the Oncological Institute was completed in 2004. We are continuing the study with more advanced stage cancer patients.

Breast Cancer. In two studies performed at Rebecca Sieff Medical Center in Israel and published in the scientific journal The Breast, the CellScan was used for both early detection of breast cancer and testing for the risk of benign tumors developing into malignant breast cancer tumors. We have established a CellScan laboratory in Tashkent, Uzbekistan and have performed a multi-patient breast cancer study in collaboration with the Uzbekistan Health Ministry, using a tetramer enhanced antigen, which is a new biological reagent. The initial phase of the study was completed in December 2003, and a subsequent phase of the study was completed in March 2004. The results of the study in Uzbekistan were consistent with those at Rebecca Sieff Medical Center in Israel.

Tuberculosis. The CellScan is taking part in a comparative multi center multidisciplinary clinical study of Tuberculosis in Tashkent, Uzbekistan during 2005 using the conventional PPD antigen in conjunction with a novel and more specific recently developed antigen.

Autoimmune diseases. In collaboration with Sheba Medical Center in Israel, we have investigated in our laboratory the potential of the CellScan in the detection of autoimmune diseases such as Systemic Lupus Erythematosus (SLE) and atherosclerosis. The results published in the scientific journal Clinical Applications of Immunology state a strong correlation between CellScan results and other tests that measure cell stimulation, suggesting that the CellScan, used in conjunction with nucleosomal antigen, may be an efficient and much easier tool in the diagnosis and monitoring of lupus patients. CellScan was also used to determine the possibility of identifying patients with severe coronary heart disease through monitoring the response of their lymphocytes to disease-associated antigens. The report from Clinical Applications of Immunology states that results to date have demonstrated that approximately 85% of patients with severe coronary heart disease manifested a significant difference in fluorescence polarization when their lymphocytes were exposed to high doses of certain antigens.