While a number of factors have probably contributed to the decline in the price of MDTL we have seen over the past three and a half months, H2FC has come to the conclusion that one factor has predominated over all others: an interruption of Medis' usual program of presenting its business plan to new public market investors accompanied by a temporary shift in institutional demand for Medis securities from the public stock market to private placements. These circumstance came into play when Medis started working on the recent $57.5M preferred stock financing ("the Citigroup deal", "the deal"), a process that began in September and did not end until the middle of December.

H2FC knows from frequent contact with people at Medis over the years that meeting with brokers and institutional investors in order to present them with the investment opportunity that Medis offers has always been a high priority activity for Medis management. H2FC has often heard about such investor meetings when calling someone at the company to ask about other issues, and on occasions when H2FC specifically asked if the company knew why the share price was rising especially quickly or steadily, these investor meetings were usually cited as the most probable reason.

Up until the time that the Citigroup process began, those in attendance at these investor meetings who were sold on the company's business plan went to the public market and bought shares of Medis' common stock just like individual retail investors do, (although "the pros" typically buy stock in much larger blocks than the typical retail investor). In H2FC's view, probably more than anything else, it was this continuing demand for the stock created by the effectiveness of Medis' presentations to professional investors (based of course on the compelling nature of Medis' technology and business plan) that took the share price of MDTL to the heights we saw in 2006.

Medis CEO Robert Lifton has told H2FC that these usual investor meetings went into hiatus as soon as the decision was made to pursue the recent financing. At that time management became busy with the process of selecting and retaining an investment banker, then negotiating the deal with Citigroup, then being available to Citigroup while the bank performed its due diligence on Medis (which H2FC understands to have been extremely thorough and demanding on management's time) and then "road showing" both the preferred stock and the separate sale of the 1.5M common shares Medis loaned to Citigroup (see discussion below). Once Medis began road showing the Citigroup deal in October, the private deal was being sold rather than the idea of simply buying MDTL in the public market. The big institutional money that had previously been buying stock in the open market was now being reserved to invest in the private deal, because that deal offered these investors ways to hedge their investment, namely the 7.5% annual dividend that would be paid to holders of the preferred stock as well as the "hedging transactions" involving the 1.5M common shares Medis loaned Citigroup as part of the deal (see additional discussion below).

Another change that occurred during the period that the Citigroup deal was pending was that Medis entered a formal "quiet period". As H2FC understands it, from the time that the first prospectus for the 1.5M shares involved in the deal was filed with the SEC (10/30/06) until the time that the deal was completely finished in mid-December, SEC rules limited the company's investor communications to those related to selling the deal, and barred Medis from the more general type of communication to investors that the company had engaged in prior to the deal. In other words, under SEC rules, Medis could not have continued the general investor meetings while the Citigroup deal was pending even if management had had the time and energy to do so. (Citigroup would not have wanted Medis to be doing this then either.) So all of the effort had shifted from getting a broader group of investors to buy the stock in the public market (good for the share price) to getting a narrower group to buy the private placements involved in the deal (no direct effect on the share price, but the indirect effect of shifting the institutional demand for Medis securities away from the public market ).

Once the Citigroup deal was done we were already well into the holiday season (Lifton has told H2FC that the "over-allotment" portion of the deal was not completed until 12/16), making it impractical to try to resume the general investor meetings at that time. Besides, the Street had just bought more than $90M worth of Medis securities (see discussion below), the institutional demand for Medis stock was undoubtedly sated for the time being, and at that point Medis already had all of the cash needed to complete its commercialization program and reach positive cash flow. All of which probably made any immediate need for a resumption of the general investor meetings seem less than urgent.

So we can see that from the time that work began on the Citigroup deal, the activity by the company that up until then had been the biggest source of demand for the common stock in the public market came to a complete halt. H2FC is convinced that this shift in focus and activity from presenting the business plan with an eye toward stimulating interest in the publicly traded stock to the selling of the private placements that constituted the Citigroup deal was the single biggest factor in reducing the public market demand for common stock during this period, and that it was this decrease in demand rather than any new source of selling that has been the primary cause of the drop in share price that began in October.

(There is one obvious hole in this theory: the big run up from $20 to $30 that occurred between 9/26/06 and 10/10/06, before which the interruption in Medis' usual communications program had already begun. It seems impossible that short covering was the cause of this run up, since the short position increased by more than 1.3M shares (16.6%) between 10/15 and 11/15 (see nasdaqtrader.com). No one that H2FC has talked to has a convincing explanation for this run up. H2FC's best guess is that it was in anticipation of the the public meeting that Medis held in New York on 10/10, which set up and increased the impact of the "selling on the news" on October 11 and 12 and thereafter.)

In H2FC's view this has all been eminently worthwhile. The interruption in the general program of communicating the Medis story to the public Street was a necessary prerequisite to the selling of the private Citigroup deal and the resulting addition of more than $50M to the company's treasury. All of the effort spent on keeping the price of the common stock so high before the Citigroup period began resulted in the terms of the deal being as favorable as they are in terms of the cost of the money that Medis acquired through the deal and the relatively small dilution that will result from the deal when the preferred stock is converted to common. In other words, the favorable terms and low cost of the Citigroup deal were the payoff for the extensive communications efforts that preceded the deal, and this payoff could not have been realized without the temporary interruption in the general communications program.

H2FC has been told by that the general investor meetings have resumed during the week ending January 26. H2FC has also been told that Medis will now seek a broader audience for these meetings than it has in the past, since investors interested in sectors such as consumer goods and consumer electronics products (as opposed to just "clean energy" or development stage companies) should be much more open to a company like Medis now that the product is UL listed and additional orders are in hand. We should not not expect instantaneous results from these meetings, but in H2FC's view we can expect that this resumption will have a positive effect over time.

There have been a number of other circumstances in play during the period in question that could have contributed to the downtrend in MDTL's share price. H2FC does not believe that any of them has been a significant cause of the downtrend, but some of them may have created additional negative pressure on the stock at various times during this period when the company's usual efforts to keep the publicly quoted share price high have been in hiatus. H2FC will attempt to address each of these possible factors in turn.

• The news on 10/11/06 and 11/10/06

A "Letter to Shareholders" on October 11 disclosed delays in the availability of the high volume production line (from Q1 '07 until May) and in the expected date of completion of the UL certification process (which has since been completed). The sudden drop of $5.10 (16.72%) we saw on October 11 and 12 (from a close on 10/10 of $30.49 to a close on 10/12 of $25.39) on a total volume for those two days of over two million shares was, in H2FC's view, primarily the result of this news. Some longs must have decided to take their profits from the preceding run-up ("selling on the news", which in this case wasn't "good"), and the shorts were probably encouraged by this news to extend their positions further (the short position reported by NASDAQ rose significantly from 9/15 to 10/15 and again from 10/15 to 11/15). It seems clear to H2FC that whoever was selling on those days and whatever their reasons, October 11-12 broke the back of the preceding run up from $20 to $30 and marked the beginning of the downtrend MDTL has been in ever since.

Note that on October 10 Medis held a public meeting for investors and shareholders. MDTL has always taken a substantial hit the day after such meetings, no matter how positive the presentation or successful the meetings, and in H2FC's view these hits have always been attributable to short attacks. This time there was probably selling pressure after the meeting from both shorts (as usual) and from some of the less committed longs, since the delays in production capacity and the UL listing were disclosed at the meeting.

(In an Update published on 10/11/06 H2FC predicted that the stock would take a significant hit as a result of these delays: "I fully expect MDTL to pull back sharply from its current price over the next days and weeks, maybe even back to the high teens, for several reasons . . . I hope to be wrong, but I do fully expect MDTL's share price to go down sharply over the next few days. . ." The "hit" has obviously gone on much longer and has been much bigger than H2FC expected. But there hasn't been any negative news at all from Medis since the top on 10/10 that can explain or justify the stock's falling to the point where it is now. To the contrary, all of the substantive news from Medis since 10/11/06 has been good, especially the completion of the financing, the certification and listing of the 24/7 Power Pack by UL, and the order for a million Power Packs from Quasar.)

• The "hedging transactions" associated with the Citigroup financing

This subject has caused a great deal of confusion and concern. Lifton has recently told H2FC exactly how the Citigroup deal and its associated "hedging transactions" worked, and the following is an attempt to put this issue to bed for H2FC readers once and for all.

When Medis started working with Citigroup on the preferred stock deal, Citigroup made it clear that in order for Medis to get the terms it was seeking (a low dividend rate, no debt and no date by which Medis would have to pay back the principal), those who invested in the deal would require a "hedge" in addition to the dividend payments. Medis, in anticipation of the eventual need to raise more cash, had filed a shelf registration for 1.5M common shares on 6/7/06, and that shelf registration was still effective. So on Citigroup's suggestion the decision was made that Medis would loan those 1.5M shares to Citigroup, which would in turn sell those shares at a small discount from the then prevailing market price through a "road show" separate from but contemporaneous with the road show for the preferred shares. The cash proceeds of the sale of the 1.5M common shares would be held by Citigroup in an interest bearing account; a portion of the interest generated by that account would be paid to the buyers of the preferred as a hedge against their investment; and the 1.5M shares would be returned to Medis' treasury at the time that the preferred shares are eventually converted into common stock (or in any event at the end of five years from the date of the closing of the preferred stock deal).

This is in fact how Medis and Citigroup did the deal. The 1.5M common shares were eventually priced at $22.50 for total proceeds of $33.75M. Note that while Medis netted only ~$53-54M when the deal closed (the $57.5M proceeds from the sale of the preferred minus banking fees and legal expenses), the Street actually bought and paid cash for $91.25M ($57.5M + $33.75) worth of Medis securities in connection with this deal (which probably satisfied the institutional demand for Medis securities for awhile).

Some of the buyers of the 1.5M common shares may have been shorts with previously existing positions that took the opportunity to cover at the fixed price of $22.50. Some of the buyers of the 1.5M shares who bought because they liked the Medis story may have immediately turned around and made their shares available for borrowing by shorts. (Why not? They could get the shares back whenever they wanted and the interest they would earn on their on the loan of shares to shorts would be easy money until it was time to call the shares back and sell them for a big profit.) This may have made additional short selling by people not at all involved in the deal somewhat easier and less expensive, which may in turn may have had some (probably minimal) impact on the share price. The important point here is that whoever bought those 1.5 million shares and whatever their reasons, once they did so they were done with the deal and completely at arms length with both Citigroup and Medis. They put the shares they bought in their accounts and from that moment on they were holders of MDTL common shares just like any other such holder, and what they did with those shares from that point on was their own business and had noting to do with either Medis or Citigroup.

The confusion and concern arose because of the use of the term "hedging transactions" in the prospectus for the 1.5M shares that were loaned to Citigroup, as well as some impenetrable statements such as the following:

We have been advised by CGML ["Citigroup Global Markets Limited"] that it or its affiliates intend to use the short sales of our common stock pursuant to this offering to facilitate the establishment by the holders of our Series A preferred stock of short positions with respect to the Series A preferred stock. Concurrently with this offering of shares of common stock, CGML or its affiliates will offer investors in our Series A preferred stock the opportunity to establish short positions by entering into a swap transaction with such investor under which the investor is economically short to CGML or such affiliate.

H2FC has talked to a number of people with decades of experience in the securities industry who don't know exactly what this means. H2FC's best estimation is that some of the buyers of the preferred may have gone out on their own and shorted the common stock, knowing that they will eventually be able to cover with common shares they will get when they convert their preferred shares to common. (The parts about "swap transactions" and investors being "economically short to CGML" remain pretty much a complete mystery to H2FC.) Whatever. After much consideration and consultation with many different people, both at Medis and elsewhere, H2FC is 100% satisfied that neither Medis or any of its executives were a party to any of these shorting transactions and that they did not benefit by them in any way, except to the extent that such transactions helped sell the deal on the terms that Medis wanted. (Every Medis shareholder has benefited from these transactions in exactly the same way.) No Medis executive or employee or insider sold any shares short or otherwise established any short position for himself in connection with the Citigroup deal. No shares were provided to preexisting short sellers through the deal unless they paid $22.50 for each share. Every aspect of the deal is 100% legitimate. No conflict of interest of any kind was created between any Medis executive or employee and any other shareholder.

Still, the words "hedging" and "short" are red flags in a prospectus, especially one issued by a company that has been on the REG SHO list for over a year. These words alarmed some longs who understandably could not fathom all of the language in the prospectus. These words also drew those with an agenda against Medis (shorts and their minions) like flies. Witness Merriman Curhan Ford & Co.'s Brion Tanous, who had previously downgraded Medis to a "sell" after a very positive quarterly report, running to the Wall Street Journal and trying to "raise eyebrows" about the Citigroup deal with misleading statements that the Journal later corrected.

The fear, uncertainty and doubt ("FUD") raised by the impenetrable descriptions of the hedging and shorting transactions in the prospectus and the exploitation of that FUD by those with an agenda against the company may have caused some MDTL shareholders to sell (and/or some prospective shareholders to not buy), and therefore may have had at least some some negative effect on the share price.

• Ongoing selling and manipulation by the shorts

An attempt at a complete dissertation on all of the methods used by short sellers to keep the price of MDTL as low as they can would greatly delay the publication of this update, probably for weeks. The subject is extremely complex and multifaceted, and the part of the market in which the shorts operate is so lacking in transparency that H2FC could never prove its suspicions about everything that the shorts are doing, no matter how much time was devoted to an attempt to do so.

Suffice it to say that it is H2FC's very strong view, based on watching the pattern of the trading in the stock closely as well as frequent contact with a number of people who hold very substantial long positions in the stock, that the shorts have been by far the biggest sellers during the current downtrend, as they have been since long before this downtrend began. The shorts have probably sold many (quite possibly millions) more shares than are included in the "official" short position reported by NASDAQ, since the selling of shares by "naked" shorts (who don't even bother to borrow the shares that they are selling) are not counted in those reports.

The big irony in the history of MDTL is that the effectiveness of the company's investor communications program that preceded the Citigroup deal and that drove the share price so high is what attracted the shorts to the stock in the first place. The shorts have been plaguing MDTL since long before October 10, 2006, and they didn't cause the downtrend that began on that day. But once the demand for the stock in the public market shifted to the Citigroup deal and the private market, the ongoing activities of the short sellers became the single biggest influence on the share price. (Some additional discussion of the effects of the short sellers is included in the "Conclusion" section at the end of this report.)

• The change in ownership of Medis shares from Merrill Lynch to Blackrock

In July and August of 2005 Medis sold a total of $49M worth of notes that were convertible into shares of common stock. A registration statement filed in November 2005 disclosed that various Merrill Lynch ("ML") bond funds had bought the majority of those notes. In April and May of 2006 Medis announced that the holders of these notes, including ML, had voluntarily converted all of the notes into a total of ~3.1M new shares of common stock.

On 10/2/2006 it was announced that Merrill Lynch Investment Managers ("MLIM"), of which the Merrill bond funds that were holding the shares described above were a part, had merged with BlackRock, Inc., and that the new company would operate under the BlackRock name.

On 10/10/06 BlackRock filed a Form SC 13G with the SEC disclosing that as of that date BlackRock owned 4,840,544 common shares of Medis, or 15.08% of the outstanding common shares. (A Form SC 13G is "filed to report acquisition of beneficial ownership of 5% or more of a class of equity securities by passive investors and certain institutions" (source).)

It is not clear to H2FC how many MDTL shares BlackRock owned before its merger with MLIM or exactly how many MDTL shares BlackRock came into as a result of the merger. For the purposes of the current analysis it doesn't matter. What matters is that as a result of the merger BlackRock became the owner of more than 5% of MDTL, at which time SEC rules began treating BlackRock as a constructive Medis insider, which in turn requires BlackRock to file additional forms with the SEC any time that BlackRock acquires or disposes of any MDTL shares. The important point is that BlackRock has not filed anything pertaining to Medis since the initial 13G, which means that BlackRock has not sold any of its MDTL shares since it went over 5% on 10/10/06. Which is a pretty strong vote of confidence from one of the top investment houses in the world.

The only other way that the transfer of control of shares from Merrill to BlackRock might have effected the price of MDTL is if BlackRock made the shares available for borrowing by short sellers and Merrill had not. In that case the supply of shares available to short sellers would have gone up, the interest short sellers pay for borrowing shares would have gone down, and it would have become easier and less expensive for "legitimate" shorts (as opposed to "naked" shorts who don't even bother to borrow the shares they sell) to sell additional shares short.

H2FC has been told by people at Medis that Merrill told them that Merrill never loaned out its shares to short sellers. H2FC doesn't know whether or not BlackRock has done so. If BlackRock hasn't, then the transfer of control of shares from Merrill to BlackRock should not have had any effect on the price of MDTL. If BlackRock has loaned its shares, then some short selling may have occurred after the transfer that might not have otherwise. (H2FC has no way of quantifying the extent to which any lending of shares by BlackRock to shorts might have effected the share price.) Note though that the short position has never gone up enough to suggest that BlackRock loaned out all of its shares, and H2FC cannot imagine any rationale for BlackRock to lend out some of its shares but not others. H2FC's best guess is that BlackRock has in fact not loaned out any of its shares, and that the transfer of control of shares form Merrill to BlackRock has had no effect on the share price.

• The falling price of oil (and other H2FC stocks)

In H2FC's view there is no logical reason that fuel cell stock prices should have anything to do with oil prices. It's not like fuel cells are having any impact on the demand for oil today or that they will for decades, if ever. This is especially the case for Medis, which unlike several of the other companies covered by H2FC has never even suggested that it has technology that might ever effect the demand for oil. But if we compare the crude oil futures chart to the MDTL chart, we see that there do appear to be some correlations. There is certainly no question that oil prices have recently been hammered down especially hard to new 52-week lows at the same time that the same thing has happened to MDTL, or that other H2FC stocks have followed the same general trend as MDTL during this period of falling oil prices (chart). One possible mechanism to explain this: energy oriented mutual funds and electronic trading funds (whose holdings H2FC has not been tracking on a regular basis) may have been reducing their exposure to MDTL and other H2FC stocks during this period when oil prices have been falling.

• December's insider transactions

Medis President Jacob Weiss and two other Medis employees sold a total of 292,841 MDTL shares in December (see the Form 4s), shares that they acquired through the exercise of options that otherwise would have expired at the end of 2006. H2FC does not believe for a second that institutional investors sold in reaction to these sales (the pros understand that the entire purpose of these options was to compensate these employees for services rendered), or even that any but the weakest and most fickle retail investors might have done so. On the other hand, the AP coverage of these sales became a drumbeat of negativity at a time (the week between Christmas and and New Years) when especially few buyers were around, and so these insider sales probably did contribute to the ongoing weakness of the stock for awhile, if only by encouraging some particularly clueless shorts. It certainly is hard to imagine that anyone was especially eager to go out and buy MDTL at a time when the share price was steadily falling and there was no news except that some insiders were selling.

Medis CEO/Chairman Lifton and COO/Vice Chairman Weingrow exercised options for 843,500 shares on 12/29/06, for which they paid more than $8 million into the company treasury (see Form 4s filed 1/3/07). They have not sold any of these shares. (Israel Aircraft Industries, who owns more MDTL than any other person or entity, has never sold a single share either. Neither has BlackRock, which owns more shares than either Lifton or Weingrow.) To H2FC this is much more significant than the sales described above. But the market apparently does not agree, at least for the time being.

• Other factors

In addition to all of the factors discussed above throw in the baseless rumor mongering on and around 10/29/06 about a supposed problem with backdated options at Medis (there is no such problem); Herb ("the weasel") Greenberg's smarmy hatchet jobs on Medis on CNBC (10/11/06) and in his column on 12/4/06; the 12/12/06 announcement of an SEC lawsuit (to which Medis is not a party) against a hedge fund accused of trading improperly in MDTL (which Medis is not even alleged to have anything to do with); the certainty that margin calls have kicked in forcing additional selling at various times during the downtrend; automated selling due to stop loss orders; maybe some tax loss selling in December by people who bought the stock when it was selling for more than $25; and probably a few weak retail hands bailing in general panic. Clearly there were a wide variety factors in play since the downtrend began that Medis had no control over and had nothing to do with, but which nevertheless have hurt the stock.

Conclusions

Each of the factors discussed above, to varying degrees, may have exerted downward pressure on the share price. But the only one of these factors that involved Medis' actual business was the news of the delays in the production line and the UL listing. That news came three and a half months ago at the very beginning of the current downtrend, the UL listing has since been completed, and all of the other substantive news from the company since the beginning of the downtrend has been good, making it impossible to believe that this one piece of negative news can account for depth and duration of the downtrend we are seeing. No, the decline in the share price we have seen since early October has more than anything else been a result of the interruption in Medis' longstanding successful program of continually attracting new institutional investors who steadily bought stock in the open market, and the shift in institutional demand for Medis securities from the public market to the private Citigroup deal, where that demand no longer directly supported the price of the stock as set by the public market.

The shorts may have been taking their best shot at MDTL during the last few weeks, using every trick in their book to take the share price down as much as they can, both to make their portfolios look as good as possible at the end of 2006 and to try to make it less painful for them to cover in 2007. But the short position in MDTL reported by NASDAQ has not gone up enough since October 15 to account for very much of the downtrend in the price of MDTL, and in H2FC's view, even with the shorts doing their thing all along, the stock would probably still be priced over $20 but for the negative effects of the Citigroup deal on the public demand for the stock. (Unless naked shorts, whose positions are not included in the NASDAQ reports, have been selling to an extent far greater than anyone outside their world realizes, a possibility that H2FC suspects but can't prove one way or the other.) In other words, the temporary absence of new buyers in the public market and the resulting reduction in demand for the stock has been a much bigger factor in the decline we have seen than any increase in supply caused by the actions of sellers (short or long).

Medis shareholders need to remember that the company is still well under the radar of the average retail investor, and even of the institutional investor to whose attention the company has not yet been actively brought. The Street as a whole remains largely ignorant of the significance of Medis' technology and the strength of it's business plan, and the only widely disseminated publicity Medis has received lately has all been negative. So it is no wonder that the stock would fall from what was a very lofty valuation at the beginning of October during this period since when the company's story has not been told to any new investor not involved in the Citigroup deal.

Everyone (obviously) has to decide for themselves what they want to do in a situation like this. H2FC is holding its shares (and watching the prices of MDTL call options). The worst possible time to sell for anyone who has invested in a company based on a real understanding of its merits and potential (and risks) is when the company's stock has been beaten down so badly. H2FC cannot believe that the sophisticated longtime Medis investors who have done their due diligence and who hold most of the float have been selling at any time since early October, or that they are selling now.

MDTL is so beaten down right now that there is no reason to expect the chart to stabilize or reverse itself until it gets a strong push in the right direction (i.e. until something actually happens that causes a big uptick in demand). Until then the shorts have pretty much free reign, even though - and this is extremely important - from here on out the shorts are utterly powerless with respect to the company's operations and the execution of its business plan. H2FC's hope and expectation is that sometime in the near future we will see clear signs of a "bottom" in MDTL's chart and a resumption of steady accumulation as Medis' usual investor communications program gets back underway. Such a bottom will be the last best opportunity to buy MDTL before the company starts announcing large orders from household name customers. H2FC expects orders of that nature to take MDTL to new heights, and probably to do so very quickly once such announcements are made.

In the meantime, Medis investors (and shorts) might remind themselves that as of December 28th Chairman/CEO Lifton and Vice Chairman/COO Weingrow together owned more than 5.4M shares, that on the trip from $30 in October to $18 on December 28 they saw the value of their shares decline by almost $65M, that they have not sold a single share along the way (or at any other time in the entire history of the company), and that on December 29 they exercised options to buy an additional 843,500 shares at an out of pocket cash cost to them of over $8 million.

H2FC is with Lifton and Weingrow, who know Medis best and who didn't get where they are by betting on pipe dreams. H2FC is not with the shorts (who are really betting on the generalized odds against development stage companies, not the the specific risks or merits of Medis), and not with "longs" who are only in the stock for short term profits or who just give up when the going gets tough.