POLYFUEL, INC. ANNUAL REPORT MONTHS ENDED DECEMBER...

PolyFuel2008 Annual Report

POLYFUEL, INC.

ANNUAL REPORT

12 MONTHS ENDED 31 DECEMBER 2008

PolyFucl2008 Annual Report

Table of Contents

2008 HIGHLIGHTS ........................................................................................... 1

2008 OB JECTIVESIACHIEVEMENTS .................................................................. 1

CHAIRMAN AND CHIEF EXECUTIVE'S REVIEW ........................................ 3

CORPORATE SOCIAL RESPONSIBILITY .......................................................... 6

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................................................. 8

DIRECTORS ' REPORT .......................................................................................... 13

REMUNERATION COMMIlTEE REPORT ........................................................ 16

CORPORATE GOVERNANCE REPORT ............................................................ 19

REPORT OF INDEPENDENT AUDITORS ........................................................ 2 1

FINANCIAL STATEMENTS ................................................................................ 22


2008 Highlights

Generated revenue of US$2.0 million, an increase of US$0.6 million over 2007 revenue of US$1.4 million, the majority of which was from the Company's ATP program, DOE program, and the US Army CERDEC program.

Net loss for the year was US$(7.6) million, an improvement of US$0.9 million from a US$(8.5) million loss in 2007.

Reduced overall expenditure levels to significantly lower the Company's cash bum rate; 2009 monthly cash bum rate is expected to average in the US$425,000-$450,000 range, down from an average of US$600,000 in 2008. Finished 2008 with $6.6 million in cash and cash equivalents.

Objective Status Demonstrate a "proof of concept" Completed in 2008. cell for the Company's Non-Stop Power reference design programme (Milestone 4).

Complete a working demonstration Completed in April 2009. prototype of a fuel cell power supply that achieves the small consumer acceptable form factor necessary to integrate with a notebook PC (Milestone 5 in the Company's Non-Stop Power reference design program) and surpasses its lithium-ion battery equivalent.

Secure one or more joint Two MOUs have been signed in the first 4 development agreements with months of 2009 with major consumer leading consumer electronics electronics companieslbattery manufacturers. manufacturers and provide related The MOUs call for the parties to negotiate a engineering support to accelerate joint development agreement for the transfer commercialization of their own fuel and licensing of PolyFuel's Non-Stop Power cell powered products. reference design technology in order to

accelerate commercial introduction of fuel cell powered consumer electronics products.

PolyFuel2008 Annual Rcport

2008 Objectives/Achievements (continued)

Status - Implement in-house capability to Completed in 2008. manufacture Pol yFuel ' s revolutionary new DM3 membrane technology.

Secure additional government In 2008, PolyFuel secured an extension of funding in support of PolyFue17s approximately US$260,000 to its existing U.S. commercialization objectives. Army CERDEC program in conjunction with

the University of North Florida to ruggedize its Non-Stop Power reference design technology.

In April 2009, PolyFuel was awarded a US$2.5 million program from the U.S. DOE to further miniaturize the Company's Non- Stop Power reference design technology, and to extend its durability and reduce its cost to enable commercial introduction.

In May 2009, the DOE awarded PolyFuel a further US$2.5 million program, which provides funding for the advancement of portable fuel cell technology toward meeting the goals for performance, durability, and cost that the DOE has established for wide-scale commercial adoption of DMFC technology for use in laptops and other portable electronics devices.

Raise additional capital to support The Company began a program in 2008 to the transition from development secure additional sources of capital. This into commercialization. process continues in 2009.


Chairman and Chief Executive Officer's Review 2008 was a challenging year for fuel cell technology in general, for the application of fuel cell technology to portable electronics in particular, and for PolyFuel.

The development of portable fuel cell systems technology did not progress as quickly as PolyFuel had expected. However, during the year PolyFuel continued to develop its third generation DM3 membrane and novel membrane electrode assembly (MEA), which together should enable a significant simplification in customers' fuel cell system designs and the delivery of non-stop power for end users. These breakthroughs have been developed with the assistance of a US$3 million grant from the U.S. Department of Energy.

PolyFuel solved several key challenges while successfully reaching the fifth of five milestones in its programme, which was to complete a working demonstration prototype of a fuel cell power supply that achieves the small consumer-acceptable form factor necessary to integrate with a notebook PC. Specifically, to achieve this milestone, PolyFuel increased the power output of the fuel cell, improved the thermal management of the system, improved the capacity of the fuel cartridge, and fine tuned the properties of the MEA to achieve the correct amount of water recycling.

PolyFuel's specific performance target for the fuel cell power supply was 10 hours of runtime at 15 watts average power in a 500cc integrated package, equating to an energy density of 300 watt-hours per liter. PolyFuel's prototype system was able to surpass this energy density goal easily, delivering an energy density of 313 watt- hours per liter, at a 30% weight saving compared to any of today's lithium-ion battery packs.

PolyFuel is in discussions with several major notebook PC and lithium-ion battery manufacturers to secure one or more agreements for joint development of preproduction prototype systems for consumer electronic applications. These agreements, which are expected to include a license to PolyFuel's non-membrane DM3 technology and long term supply agreement for PolyFuel's DM3 membrane, should accelerate commercialization of the partners' fuel cell powered products. Two targeted partners have each signed a Memorandum of Understanding, confirming their intentions to complete negotiations with PolyFuel on the joint development agreements.

In 2008, PolyFuel was awarded a continuation of its funded programme with the U.S. Army's Communications, Electronics Research and Development and Engineering Command (CERDEC). The CERDEC programmes are conducted in partnership with the University of North Florida and are expected to contribute approximately US$260,000 in funding to PolyFuel during 2009. The programme goal is to ruggedize Polyfuel's demonstration prototype system based on its breakthrough DM3 membrane and MEA technology.

In April 2009, PolyFuel received news from the U.S. Department of Energy that it had been awarded a US$2.5 million grant under the American Recovery and Reinvestment Act. The objectives of the programme are to advance the Company's

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Non-Stop Power technology by achieving durability targets required for commercialisation, further decrease the size of the demonstration prototype and to conduct manufacturability and assembly analyses to achieve commercial cost targets.

In May 2009, the DOE awarded PolyFuel a further US$2.5 million program, which provides funding for the advancement of portable fuel cell technology toward meeting the goals for performance, durability, and cost that the DOE has established for wide-scale commercial adoption of DMFC technology for use in laptops and other portable electronics devices.

PolyFuel encountered difficulty with the commercial introduction of its second generation DM2 membrane. The new DM2 membrane introduced in 2008 is designed to be a drop-in replacement for DuPont7s more long-established Nafion membrane for customers that had already designed their prototype systems to accommodate the Nafion material. During the development effort, customers had expressed a clear preference for the properties of PolyFuel's DM2 membrane compared to Nafion. However, the introduction of PolyFue17s DM2 membrane was delayed due to integration problems during customer qualification trials. The Company invested significant time and effort in 2008 and early 2009 to identify and correct the cause of these problems and qualification trials of the DM2 membrane have recently been resumed with selected customers.

During 2008 and into 2009 the Company implemented a number of cost saving measures. Its monthly cash bum rate is currently expected to average approximately US$425,000-$450,000 in 2009, down from an average of approximately US$600,000 in 2008.

PolyFuel finished 2008 with US$6.6 million in cash and cash equivalents. The Company has begun a programme to secure additional sources of capital to help fund the completion of the Company's technology and product development and achieve commercial introduction, a process which is continuing in 2009.

Fuel cell technology remains a challenging field, characterized by deep multidisciplinary science, significant technical hurdles, and a need for regulatory and infrastructure changes. However, 2008 saw a key step in the worldwide implementation when new transportation regulations enabled portable fuel cells to be carried on board and operated on commercial aircraft and all other forms of commercial transportation. The implementation of such regulations has been progressing strongly since before 2004, and all necessary directives related to the transport of direct methanol fuel cells and methanol fuel cartridges are now in place, enabling fuel cell powered portable electronic devices to become a commercial reality.


Despite the slow progress on the commercialisation front, the demand on behalf of consumers for longer runtime power supplies continues to grow. Major consumer electronics companies and battery manufacturers continue to invest in portable fuel cell technology development, and particuliuly in direct methanol fuel cell technology. PolyFuel continues to be recognised as one of the world leaders in this field.

Robert Jecmen Chairman

Jim Balcom President and CEO


CORPORATE SOCIAL RESPONSIBILITY

Introduction One of PolyFuel's ovemding policies is to be a good corporate citizen in all aspects of its business. The Company is an equal opportunity employer and respects the dignity and worth of each member of its staff. PolyFuel is committed to creating business growth through the development of environmentally friendly products. The Company's technology development, business development, manufacturing operations and administrative functions are conducted safely and to a high level of quality by well-trained and qualified employees. In that regard the Company was certified as ISO-9001 compliant in April 2006 by Underwriters Laboratories Inc., the culmination of a two year effort by PolyFuel. PolyFuel eliminated its externally-conducted ISO-9001 audit in 2008 as part of a corporate-wide cost saving effort. However, the Company continues to follow all ISO-9001 procedures, processes and internal audits.

Internal Policies Health and safety are very important within the workplace and PolyFuel works hard to prevent personal injury and to ensure a safe working environment. The Company strives to provide and maintain property and equipment, systems and procedures, and a working environment that is safe and without health risk. PolyFuel's future rests upon the success and growth of its employees, and the Company recognises their value. PolyFuel's training and personal development programmes, together with compensation policies designed to reward and inspire achievement, emphasises the importance of motivating, retaining and developing staff throughout the Company.

Communications are of great importance, and information is provided to all employees in regular team meetings, not only regarding individual, team and Company achievements, but also on the strategy and outlook for the business. All employees have a financial stake in the Company through an incentive stock option programme.

External Benefits of PolyFuel's Products The widespread acceptance that rising C 0 2 levels are having a detrimental impact on our global climate has increased attention on next generation clean automotive propulsion technology. The automotive industry continues to support the hydrogen fuel cell as one of the leading technologies for ensuring sustainable mobility. However, the industry has also identified that the existing fluorocarbon membrane technologies available today do not fully meet all of the requirements of the demanding fuel cell vehicle application.

As a result, the industry is looking to hydrocarbon membrane technology as a potential solution and, not surprisingly, looking to PolyFuel as one of the leaders in this field. The Company has engineered a number of promising membranes for evaluation by automotive manufacturers, and the Company believes that it can leverage its leadership position in hydrocarbon membrane technology into this important longer term and environmentally significant market.

Environmental Advantages

PolyFuel is proud to operate in the clean and renewable energy sector. Consumer electronics companies and battery manufacturers alike have been working for years to create longer-running portable power sources for laptop PCs and other applications, using "green" or environmentally- friendly fuel cell technology that can generate electricity directly from cheap, safe and widely available fuels, such as methanol.

PolyFuel has specifically developed its hydrocarbon fuel cell membrane technology as a higher performing and more environmentally-friendly alternative to existing fluorocarbon membrane


materials. Some companies have specifically identified hydrocarbon membrane technology as their preferred fuel cell membrane material because of its environmental and recycling benefits.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following review should be read in conjunction with the Company's consolidated financial statements and related notes thereto for the year ended 31 December 2008 appearing elsewhere in this Annual Report.

Executive Summary

Company Description

PolyFuel is a development stage, advanced materials science company specialising in the design, development and manufacture of hydrocarbon based fuel cell membranes primarily for portable power applications. The Company's products are currently being purchased and evaluated by developers of portable fuel cell power systems and components who are considering their performance characteristics in the context of commercial product launches. In addition to PolyFuel's primary focus in the area of portable power, it has also developed a version of its hydrocarbon membrane which has been designed for hydrogen fuel cell automotive applications.

The Company's corporate headquarters are located in Mountain View, California, where it conducts its membrane research and development, manufacturing, business development and administrative functions. The Company also has a facility in Burnaby, British Columbia focused on advanced research in portable fuel cell system technology.

Mission, Vision and Strategy

PolyFuel's mission is to become the world's leading supplier of fuel cell membranes for portable electronic and automotive applications. The Company's vision and strategy for achieving this goal incorporates the following key elements:

Establish and maintain market leadership through the continuing innovation of world leading fuel cell membrane products;

Support its customers through the development of leading edge fuel cell system reference designs aimed at optimizing the performance attributes of the PolyFuel membrane products;

Secure the protection of our technology through rigorous attention to the filing of intellectual property patents and the safeguarding of trade secrets;

Focus sales and marketing efforts on the leading developers of fuel cell systems in the portable sector;

Establish strong channel relationships with key "value added resellers" of fuel cell components; and,

Control and optimise the deployment of capital resources.

Business, Products and Markets

As an emerging developer of hydrocarbon based membranes for fuel cell applications, PolyFuel's primary focus is on the world's portable power markets, where advances in application technology (i.e. wireless networks, portable gaming, music, television, global positioning, etc.) are stimulating an ever growing demand for energy that is rapidly exceeding the ability of existing battery technologies to meet it. The Company refers to this growing divergence as the "runtime gap."

PolyFuel's membrane technology has been custom designed to enable these consumer electronics manufacturers to make portable fuel cells a realistic alternative for the market. The membrane is, in essence, the "heart" of the fuel cell; that is, it dictates the cost, size, weight. power and runtime of a portable fuel cell. PolyFuel has engineered a family of fuel cell membrane products specifically for portable direct methanol fuel cells ("DMFCs"). The PolyFuel DMFC membrane has been selected by many consumer electronics manufacturers and portable fuel cell system developers for use in their portable fuel cell research and development programmes, and is being tested at several others.


The Company believes that PolyFuel's DMFC membrane products are essentially the "next generation" in fuel cell membrane technology. Engineered using advanced "hydrocarbon chemistry," the Company believes that these products have inherently better mechanical properties, higher fuel efficiency, are more robust, and are more environmentally friendly than the existing commercial products.

Results of Operations

Comparisons of years ended 31 December 2008, 2007 and 2006

The following table sets forth for the periods indicated, our results of operations:

Year Ended 31 December

Revenues 2,O 12,402 1,39 1,247 184,600

Costs and operating expenses Research and development General and administrative

Total expenses

Loss from operations (7,876,354) (9,373,487) (10,831,932)

Other income (expense), net (26,933) (4,688) (12,865) Interest income 292,77 1 921,176 1,230,979 Interest expense (586) (635) (59,863)

Net loss (7,611,102) (8,457,634) (9,673,68 1)

Revenues

Revenues increased approximately US$0.6 million or 45% in 2008 compared to 2007, and increased approximately US$1.21 million, or 645%, in 2007 compared to 2006. In each instance, the change in revenues between years was principally attributable to increases in government programme funding. In 2008, government programme funding rose US$1.0 million, reflecting a full year of revenues from the Advanced Technology Programme (ATP) award from the U.S. National Institute of Standards and Technology (NIST) for the development of a new, ultra-low crossover membrane which accounted for US$0.7 million in revenue in 2008; the start of a new programme for the U.S. Army for the development of a ruggedized Direct Methanol Fuel Cell power supply for military laptop applications, which accounted for US$O.l million in revenue in 2008, as well as revenue associated with the Department of Energy programme ("2004 DOE Contract") awarded in August 2004 to develop a fuel cell power supply for a next generation laptop computer, which ended in October 2008 and contributed US$1.1 million in revenue in 2008. In 2008, product revenue, non-recurring engineering (NRE) and other revenue declined US$0.4 million, largely reflecting lower membrane sales and a strategic shift away from NRE programs.

In 2007, the increase in government programme revenues was principally attributable to the 2004 DOE Contract. In January 2006, the Company received formal notification from the DOE that, as a result of governmental budgetary constraints, the DOE was suspending further funding under the DOE Contract for the remainder of its fiscal year ending 30 September 2006. In May 2007, the Company received notification from the DOE indicating that funding under the DOE Contract had been reinstated, thus accounting for the 2007 government programme revenue increase over 2006.

Research and Development

Research and development expenses consist of costs associated with product research, product development, non-recurring engineering projects and government programmes. Research and development costs decreased approximately US$0.2 million, or 4.0% in 2008 compared to 2007, and increased approximately US$O.l million, or 1.5%. in 2007 compared to 2006. The decrease in 2008 was chiefly due to reductions in personnel due to the Company's cost cutting programs. The modest increase in 2007 relative to 2006 was primarily the result of increased compensation expense, including non-cash stock option expense, up US$0.3 million, and higher materials costs, up US$O.l million, related to the


development of the Company's DMFC laptop PC power module prototype, partly offset by reduced third party and miscellaneous other expenses, which fell by US$0.3 million between years.

Sales, General and Administrative General and administrative expenses consist of costs incurred in connection with sales and marketing, business development, and finance and administrative activities; including personnel costs, consulting and professional services fees, investor relations, facilities costs and other general corporate expenses. General and administrative expenses decreased US$0.6 million in 2008, or 13%, and decreased approximately US$0.3 million, or 6% in 2007 compared to 2006 The decrease in 2008 was due to Company cost saving measures, principally savings related to reductions in staff and thus lower salaries and benefits costs, which fell by US$0.6 million, supplemented by a number of lower expenses, including professional fees, facilitiesloffice expense and other expenses which netted to a reduction of US$0.4 million. The decrease in 2007 relative to 2006 was primarily the result of cost-cutting efforts which reduced expenses by US$0.4 million in third party services, lower depreciation, down US$O. 1 million, and lower other miscellaneous expenses, down US$O.l million, partly offset by increased Salaries and Benefits expense which rose US$0.3 million.

Loss From Operations As a result of the factors outlined above, the Company's overall loss from operations in 2008 decreased by US$0.8 million, or lo%, versus 2007 and decreased by approximately US$1.5 million, or 13%, in 2007 compared to 2006.

Interest Income

Interest income decreased by approximately US$0.6 million in 2008 as compared to 2007, or 68%, and declined US$0.3 million, or 25%, in 2007 compared to 2006. In both instances, the reason for the difference was primarily due to differences in levels of cash available for investment. In 2008 and 2007, the average cash available for investment declined, as cash was used to fund operating losses and make further capital investments, resulting in lower interest income.

Interest Expense Interest expense was nil in 2008 and 2007.

Income Taxes

The Company, which is considered a development stage enterprise, has incurred operating losses for every fiscal period since its inception. As a result, no income tax expense has been recognised in 2008,2007, or 2006. As of 31 December 2008, the Company had net operating loss carryforwards available to offset future taxable income of approximately US$58.1 million and US$43.8 million federal and state purposes, respectively. Management has taken the position for accounting purposes that it is more likely than not that the net operating loss will not be utilised; therefore, no income tax benefit has been recognised to date.

Stock Based Compensation

Effective 1 January 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share Based Payment ("SFAS No. 123R), using the modified prospective transition method and therefore, prior periods have not been restated. SFAS No. 123R requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on the estimated fair market value of the underlying instruments. Accordingly, stock-based compensation cost is measured at grant date, based upon the fair value of the award, and is recognized as expense, generally on a straight line basis over the requisite employee service period.

In order to determine the fair value of options granted, the Company has elected to use the Black Scholes option pricing model (the "Black Scholes Model"). While generally accepted, the Black Scholes Model is dependent upon a number of highly subjective assumptions, including the expected life of the option and stock price volatility, changes to which can have a material impact upon the level of stock compensation expense recognised. In addition, SFAS No. 123R requires the Company to estimate the expected option forfeiture rate and recognise expense only with respect to those shares expected to vest. If the actual forfeiture rate should vary materially from that estimated, the level of future expense could be significantly


impacted. See Note 3 to the Consolidated Financial Statements appearing elsewhere in this Annual Report for a further discussion on stock-based compensation.

Liquidity and Capital Resources

Since its inception and through 31 December 2008, the Company has financed its operations primarily with proceeds from the sale of private and public equity totaling approximately US$67.9 million (net of issuance costs). In July 2005, the Company completed an initial public offering of equity on the London Stock Exchange Alternative Investment Market, placing 15,686,276 new shares of common stock (each share issued together with !h Series A warrant to purchase an additional share of common stock at UK60p per share within 18 months following the placement) at a per share price of UK5 l p raising a total of £8 million (US$14 million at the effective exchange rate and before transaction costs of approximately US$2.5 million).

In January 2006, the Company placed an additional 12,500,000 new shares of common stock in a follow-on offering at a per share price of UK80p, raising a total o f £ 10 million (US$17.5 million after conversion at the effective exchange rate and before transaction costs of approximately US$0.8 million).

As of 3 1 December 2008, the Company had US$6.6 million of cash and cash equivalents available to fund future operations.

The following table sets out the Company's sources and uses of cash for the years indicated:


2008 2007 2006 U.S.$ U.S.$ U.S.$

Cash used in operating activities (6,958,921) (8,042,66 1) (8,733,875)

Cash provided by (used in) investing activities 6,36 1,374 (23,5 17) (5,738,956)

Cash provided by financing activities

Cash Used in Operating Activities

The Company, as a development stage enterprise, has consistently used cash to fund its operating activities. Net cash used in operations was approximately US$7.0 million in 2008, attributable principally to a net loss of US$7.6 million, offset by non-cash charges largely related to stock-based compensation and depreciation/amortisation. Net cash used in operations was approximately US$8.0 million in 2007 attributable primarily to a net loss of approximately US$8.5 million, offset in part by adjustments for non- cash charges related to stock based compensation of US$0.6 million which were mitigated by other non- cash items totaling US$(0.2) million, principally comprised of depreciation and amortisation expense. Net cash used in operations was US$8.7 million in 2006 attributable primarily to a net loss of US$9.7 million, offset in part by adjustments for non-cash charges related to stock based compensation of US$0.4 million and depreciation and amortisation of US$0.3 million. Net cash used in operations was US$7.1 million in 2005 and was attributable primarily to a net loss of US$7.9 million, offset in part by non-cash charges, principally depreciation and amortisation of US$0.7 million and expense related to the issuance of warrants and non-employee stock options of US$O. 1 million.

Cash Provided by (Used in) Investing Activities Net cash provided by (used in) investing activities was approximately US$6.4 million in 2008 and, US($0.02) million, US($5.7) million and US$2.7 million in 2007, 2006 and 2005, respectively. The principal source of cash in 2008 was due to net liquidation of investments which netted US$6.6 million, partly offset by US$0.2 million in equipment purchases. The principal sources (uses) of cash for investing activities during 2007 were capital equipment purchases of US($O.l) million and the net sale of short term investments of US$O.l million. The principal source (use) of cash for investing activities during 2006 and 2005 was the net sale (purchase) of short term investments.

Cash Provided by Financing Activities Net cash provided by financing activities was US$0.05 million and approximately US$0.02 million, US$16.3 million and US$10.7 million in 2008, 2007, 2006 and 2005, respectively. Cash provided in 2008


and 2007 was due to employee stock option exercise proceeds. Cash provided in 2006 was attributable primarily to US$16.8 million in net proceeds from the sale, in a follow-on placement, of 12,500,000 shares of the Company's common stock, offset in part by the repayment of lease line and finance facility obligations of US$0.5 million. Cash provided during 2005 was attributable to net proceeds of US$11.5 million from the issuance of common stock in connection with the Company's initial listing on AIM, offset in part by the repayment of lease line and finance facility obligations of US$0.8 million. Cash provided during 2005 was attributable to net proceeds of US$11.5 million from the issuance of common stock in connection with the Company's initial listing on AIM, offset in part by the repayment of lease line and finance facility obligations of US$0.8 million.

Contractual Cash Obligations

At 31 December 2008, the Company had total contractual cash obligations under non-cancelable operating leases related to the Company's headquarters in Mountain View, California, of US$657,896, for the year ending 3 1 December 2009.

Summary

Management believes that the Company's cash, cash equivalents and short-term investments at 31 December 2008 may prove insufficient to meet its anticipated cash requirements for operating and working capital purposes for at least the next 12 months. The Company has incurred losses and negative cash flow from operations for every fiscal period since its inception. The Company has been successful in completing numerous rounds of public and private equity financing, totaling approximately US$67.9 million (net of issuance costs) through 31 December 2008. However, there can be no assurance that the Company will be successful in obtaining additional financing on favorable terms, or at all. If additional funds are raised by issuing equity securities, substantial dilution to existing shareholders may occur. The Company has been seeking additional funding from various sources. Recent long time discussions with a particular interested investor were recently terminated. The Company continues to seek additional funding sources. These matters raise substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from such adverse outcomes of this uncertainty. The Company is a research and development enterprise and thus continues to face technology, industry and market risks, including, among others, the pace of commercialization of Direct Methanol Fuel Cell technology, and there can be no assurance that the Company will be able to achieve its business objectives.

PolyFuel2008 Annual Rcport

DIRECTORS' REPORT

The directors present the following annual report and the audited financial statements of the Company for the year ended 3 1 December 2008.

Principal Activities The principal activity of the Company involves the engineering, manufacture and sale of hydrocarbon based membranes for use in micro fuel cells to power portable electronic devices.

A review of the Company's business and activities can be found in the Chairman and Chief Executive's Review contained elsewhere in this Annual Report.

Results and Dividends For the year ended 31 December 2008, the Company incurred a net loss of US$7,611,102. Further details of the Company's operating results are set out in the audited Consolidated Statements of Operations as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations contained elsewhere in this Annual Report.

Given the ongoing capital requirements of the Company's business, the directors do not recommend the payment of a dividend at this time (2008: US$nil; 2007: US$ nil; 2006: US$ nil).

Research and Development During the years ended 31 December 2008, 2007, 2006 and 2005, the Company incurred research and development expenditures of US$5.4million, US$5.7 million, US$5.6 million and US$4.9 million, respectively, all of which was expensed for financial reporting purposes.

Employees Ensuring that its staff is qualified, informed and appropriately motivated is considered key to the Company's success. As such, the Company invests significant time and resources in the areas of continuing education and communications. Employees are encouraged to attend industry conferences and seminars, while the cost of relevant academic course work is reimbursed by the Company. Information on matters affecting staff, as well as issues pertaining to strategy, significant events and the performance of the Company as a whole, are regularly communicated, primarily by means of Company-wide team meetings. Motivation is achieved through the recognition and celebration of superior achievements, as well as the granting of stock options to every employee.

The Company is an equal opportunity employer and is committed to making employment decisions strictly on the basis of merit. As such, it does not discriminate on the basis of age, sex, color, race, creed, national origin or ancestry, religion, marital status, sexual orientation, veteran status, medical condition, physical or mental disability or any other basis protected by U.S. federal, state or local law.

Share Capital The Company has an authorised share capital of US$100,000 consisting of 100,000,000 shares of common stock with a par value of $0.001 per share.

On 5 July 2005, shares of the Company's common stock were admitted to the London Stock Exchange Alternative Investment Market ("AIM). The Company placed 15,686,276 new shares of common stock (each share issued together with 4i Series A warrant to purchase an additional share of common stock at UK60p per share within 18 months following the placement) at a per share price of UKSlp raising a total of £8.0 million (US$14.0 million after conversion at the effective exchange rate and before issuance costs of approximately US$2.5 million).

In January 2006, the Company placed an additional 12.5 million new shares of common stock in a follow- on offering at a per share price of UK80p, raising a total of £ 10 million (US$17.5 million after conversion at the then effective exchange rate and before transaction costs of approximately US$0.8 million).


As of 3 1 December 2008,57,886,388 shares have been issued and are outstanding. During 2008, a total of 45,000 shares were issued as a result of employee stock option exercises under the Company's 2000 Equity Incentive Plan.

Effective 4 January 2007, the subscription period pertaining to the Company's stock purchase warrants to purchase 7,843,138 shares of Series A Preferred Stock expired, thereby resulting in the cancellation of the warrants. None of the warrants were exercised prior to cancellation.

Directors and Directors' Interests

The following directors have held office continually since their original dates of appointment:

Original Date of Appointment

Robert Jecmen Non-executive Chairman 22 August 2002 Harry Fitzgibbons Non-executive Director 5 July 2005 David Berkowitz* Non-executive Director 12 March 2002 Donald MacDonald Non-executive Director 1 March 2007 James Balcom President and Chief Executive Officer 1 October 2003

* Mr. Berkowitz resigned as a company director effective April 2009.

** Mr. MacDonald was appointed as a Non-executive Director of the Company effective 1 March 2007 and was elected by the stockholders of the Company at the Annual General Meeting held on 27 June 2007.

The directors' interests in shares, warrants and options of the Company as of 31 December 2007 and 2008 are as follows:

At 31 December 2007 At 31 December 2008 Common Series A Common Series A

Stock Shares Warrants** Options

Robert Jecmen 125,000 nil 240,522 Graham Titcombe 99,020 nil 50,000 Harry Fitzgibbons 160,540 nil 65,500 David Berkowitz * nil nil 45,000 Don MacDonald nil nil 45,000 James Balcom 49,000 nil 3,121,444

Stock Shares Warrants** Options 125,000 Nil 51 1,355 99,020 Nil 25,000

160,540 Nil 273,883 nil Nil 232,500 nil Nil 232,500

49,000 Nil 3,42 1,444

* Mr. Berkowitz is a general partner in a private equity finn that beneficially owns andor controls 6,727,653 shares and options to purchase 45,000 shares of the Company's common stock at 31 December 2008. Mr. Berkowitz resigned as a Company director effective April 2009.

** Effective 4 January 2007, all subscription rights pertaining to the Series A Warrants expired by their terms. None of the Series A Warrants held by any of the Company's directors were exercised.

Payments to Creditors The Company agrees to payment terms whenever it enters into binding agreements for the purchase of goods or services. The Company's policy is to honor the payment terms at such time as it is satisfied that the supplier has provided the goods or services in accordance with the agreed upon terms and conditions. Please reference the footnotes to the Company's financial statements provided elsewhere in this report.

Statement of Directors' Responsibilities

The directors acknowledge their responsibility to oversee management's preparation of financial statements for each reporting period.

In preparing the financial statements, management is responsible for insuring that:

suitable accounting policies are adopted and that they are applied consistently; judgments and estimates are reasonable and prudent; and

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= applicable accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements.

Management is also responsible for seeing that proper accounting records are maintained which disclose, with reasonable accuracy, the financial position of the Company and which enable management to ensure that the financial statements comply with all relevant requirements. Management also takes such steps as are reasonably necessary to safeguard the assets of the Company and to prevent and detect fraud and other material irregularities.

THOMAS CALDWELL Secretary

12 June 2009


REMUNERATION COMMITTEE REPORT

The Remuneration Committee

The Remuneration Committee comprises Mr. Jecmen and Mr. MacDonald and is chaired by Mr. MacDonald. The Committee met four times during the year ended 31 December 2008 and is responsible for making recommendations to the full Board regarding all aspects of remuneration affecting executive board members, other senior executives and employees. It is also responsible for administering, reviewing and recommending appropriate stock option and other incentive programmes. In arriving at their decisions and recommendations, the Committee has retained the services of an independent compensation consultant.

Remuneration Policy The Committee's policy is to establish remuneration packages that are competitive in the market, thereby enabling the Company to attract, retain and motivate employees of appropriate caliber and experience to effectively manage the business and see to its success. Individual executive remuneration and benefits packages are designed to reward executives for their performance by way of annual cash bonus payments and the award of stock options. Together, these two elements constitute a potentially significant proportion of total targeted remuneration.

The 2008 remuneration of executive directors and other senior executives comprise the following basic elements:

Base Salary Base salaries are set to reflect the competitive market rate for each position, taking into account the experience of the individual and their value to the business. Salaries are reviewed annually on the basis of personal performance during the year and changes in overall market compensation levels.

Bonus Programme In the case of the executive team, the Company operates a performance related cash bonus programme with payouts based upon the team's level of achievement relative to pre-established corporate objectives. Targets set for the executive team in 2008 could have resulted in the following earned bonuses if the targets had been achieved: Mr. Balcom 35% and other senior executives 25%.

For above target achievement, up to 1.75 times these percentages could have been earned. Following the year-end performance review by the committee, it was established that no bonuses would be paid for 2008.

Stock Options Every employee of the Company has been granted stock options under the Company's 2000 Equity Incentive Plan. The options, which are exercisable for 10 years, generally vest ratably over a four year period with exercise prices set equal to the per share market value of the stock on the date of grant. In certain instances, vesting of options granted to executives of the Company is subject to the achievement of certain performance targets, including stock price performance. Stock options granted to executive and non-executive directors are reflected in the table below. In 2008, Non-executive directors agreed to receive ?4 of their Board fees in stock options.

Executive Director Employment Agreements In September 2003, the Company entered into an employment agreement with Mr. Balcom that provided for a starting base salary of US$240,000 per year, as well as eligibility for a cash bonus of up to 35% of base salary and the ability to participate in the Company's 2000 Equity Incentive Plan. Effective 1 December 2006, the aforementioned annual base salary was increased to US$300,000. In August 2007, Mr Balcom agreed to receive 10% of his salary in stock options in lieu of cash. Mr. Balcom, who retains his primary residence in Vancouver British Columbia, is also entitled to be reimbursed on an after-tax basis for reasonable travel and lodging expenses incurred in connection with his commute to the Company's headquarters in Mountain View, California. Other benefits include participation in the Company's health care and life insurance programmes. Should Mr. Balcom's employment be terminated by the Company without Cause or by Mr. Balcom for Good Reason within twelve months of either (i) a change of control in the voting ownership of the Company's stock, or (ii) the sale, transfer or other disposition of all or substantially all of the Company's assets in complete liquidation or dissolution of the Company, he will be


entitled to ( I ) twelve months' salary and (2) be entitled to receive continued health care coverage under the Company's existing policies for himself and his family for a period of up to twelve months. In March 2008, Mr. Balcom's contract was amended with respect to severance pay and health care benefits. Under the terms of the amendment, if Mr. Balcom's employment is terminated by the Company without cause, the Company shall pay his salary and health care benefits for six months from the time of termination and, if Mr. Balcom is not employed at the end of such six month period, the Company shall continue to pay Mr. Balcom for the lesser of ( I ) an additional six months or (2) until such time as Mr. Balcom is employed, but in no case shall the total payment period exceed twelve months. In the event Mr. Balcom's employment is terminated by the Company, he is subject to certain restrictive covenants for 12 months following the termination.

In October 2008, the Company amended Mr. Balcom's employment agreement in order to provide enhanced incentive for Mr. Balcom to remain as CEO of the Company, by providing in such amendment that if a resolution was adopted by the Board to wind down the Company's affairs and dissolve the Company, the Company would establish an irrevocable grantor trust in a form approved by the Board (the "Trust") and contribute to the Trust an amount of cash equal to the sum of (i) Executive's annual base salary (as in effect on the contribution date) and (ii) twelve (12) times the monthly COBRA premium rate that would be payable by Executive and/or the Company if Executive terminated employment on such date and elected COBRA coverage for Executive and Executive's covered dependants. The Trust is to provide for the payment of the severance benefits and continued healthcare under the Agreement, subject to the claims of the creditors of the Company in the event of the Company's insolvency. The amendment also requires that the trustee of the Trust cease payment of severance benefits to the Executive and its beneficiaries, if applicable, if the Company is or becomes insolvent and that in that case, the severance obligations revert back to the Company.

In March 2009, Mr. Balcom agreed to reduce his salary by 20% for the two month period commencing March 9,2009, from US$300,000 on an annual basis to US$240,000. In April 2009, Mr. Balcom agreed to a further reduction in his salary from US$240,000 on an annual basis to US$225,000 for the two month period May 1,2009 through June 30,2009, in exchange for a lump-sum severance payment of six months, if earned and paid under existing employment agreements, as opposed to payment under normal existing payroll procedures and the funding of 9 months into the Trust (see above), as opposed to 12 months.

Directors' Remuneration Details of the directors' remuneration for the period I January 2008 through 31 December 2008 are shown in the table below, as well as total remuneration for the period I January 2007 through 3 1 December 2007 for comparison purposes:

Taxable Base Salary* Bonus Benefits*** Fees Paid 2008 Total 2007 Total

Executive Directors James Balcom US$270,000 -- US$68,179 -- US$338,179 US$352,419 Mark Campion***** US$40,060 -- US$508 -- US$40,568 US$226,413

Non-Executive Directors** Robert Jecmen -- -. -- US$32,500 US$32,500 US$40,625 Graham Titcornbe**** -- -- -- UKf9.375 UK£9,375 UK£18,750 Hany Fitzgibbons -- -- -- UK£12,500 U K £ 2,500 UK£8,750 A. Grant Heidrich I11 -- -- -- -- -- US$22,500 Don MacDonald -- -- -- US$22,500 US$22,500 US%26,250 David Berkowitz**** -- -- -- US$22,500 US$22,500 US$33,750

Totals US$3 10,060 US$O US$68,687 * A portion of Mr. Balcom's Base Salary was paid in the form of stock options. Amounts granted were determined on the basis of

the fair market value of the options on the date of grant using the Black Scholes Option Pricing Model. See "Directors' Stock Options" below. ** In 2008 and 2007, each of the Company's Directors received a portion of their board fees in the form of stock options. Amounts granted were determined on the basis of the fair market value of the options on the date of grant using the Black Scholes Option Pricing Model. See "Directors' Stock Options" below.

*** Taxable benefits include commuting expenses (air travel, lodging and car) and excess personal life insurance. **** Messrs. Titcombe and Berkowitz resigned as Company directors effective June 2008 and April 2009, respectively. ***** Mr. Campion resigned from the Board and as Chief Financial Officer effective February 2008.


Directors' Stock Options Details of stock options held by the directors as of 3 1 December 2008 are set out in the table below:

Options Options Options Exerclse Percentage Option Held at Granted in Options Held at Price Vested at Expiration

31 Dec 2007(1) FY 2008(1) Exercised 31 Dec 2008 U.S.$ 31 Dec 2008 Date Executive Directors James Balcom (2) 24,444 -- -- 24,444 4.50 100.0% 30/09/2013

1,500,000 -- -- 1,500,000 0.10 100.0% 13/07/2014 245,000 -- -- 245.000 0.90 1 00.0% 04/07/20 15 450,000 -- -- 450,000 0.92 75.0% 20/12/2015 210,000 -- -- 210,000 1.21 25.0% 27/06/2016 360,000 -- -- 360,000 0.85 50.0% 05/12/2016 90,000 -- -- 90,000 0.68 nil 03/10/2017 59,000 -- -- 59,000 0.68 100.00% 03/10/2017

183,000 -- -- 183,000 0.55 25.0% 12/12/2017 -- 300,000 -- 300,000 0.06 nil 12/10/2018

Mark Campion (2)(3) 8,888 -- -- -- 4.50 nil 03/06/2013 450,000 -- 450,000 -- 0.10 nil 13/07/2014 75.000 -- -- - - 0.90 nil 04/07/20 15

112,000 -- -- - - 0.92 nil 20/12/2015 140,000 -. -- -- 1.21 nil 27/06/2016 90,000 . . -- -- 0.85 nil 05/12/2016 60.000 -- -- - - 0.68 nil 03/10/2017 22,500 -- -- -- 0.68 nil 03/10/2017 50.000 -- -- -- 0.55 nil 12/12/2017

Non-Executive Directors

Robert Jecmen 2,222 - - -- 2,222 4.50 100.0% 21/08/2012 110,000 -- -- 110,000 0.10 100.0% 13/07/2014 20,000 -- -- 20,000 0.90 100.02 04/07/2015 22,500 -- -- 22,500 0.93 100.0% 19/09/2015 20,800 -- -- 20,800 1.02 100.0% 20/07/2016 65,000 -- -- 65,000 0.68 100.0% 03/10/2017

-- 270,833 -- 270,833 0.10 nil 10/22/2018 Harry Fitzgibbons 15,500 -- -- 15,500 0.93 100.0% 19/09/2015

50,000 -- -- 50,000 0.68 100.0% 03/10/2017 -- 208,333 -- 208,333 0.10 nil 10/22/2018

David Berkowitz(4) 45,000 -- -- 45,000 0.68 100.0% 03/10/2017 -- 187,500 -- 187,500 0.10 nil 10/22/2018

Don MacDonald 45,000 -- 45,000 0.68 100.0% 03/10/2017 -- 187,500 -- 187,500 0.10 nil 10/22/2018

Graham Titcombe (4) 50,000 -- -- 25,000 0.68 100.0% 03/10/2017

Totals 4,575,854 1,154,166 450,000 4,696,632

(1) All options were granted at fair market value as of the date of grant.

(2) All options granted to Mr. Balcom - are subject to acceleration of vesting as to 25% of any outstanding and unvested portion in the event of a Change of Control, with such Change of Control defined as (i) a change of control in the voting ownership of the Company's stock, or (ii) the sale, transfer or other disposition of all or substantially all of the Company's assets in complete liquidation or dissolution of the Company. If within 12 months following a Change of Control, Mr. Balcom is terminated without cause, or terminates his own employment for good reason, the vesting of all remaining outstanding unvested options will accelerate.

(3) Messrs. Campion, Titcombe and Berkowitz resigned as Company directors effective February 2008, June 2008 and April 2009, respectively.

DONALDMACDONALD Chairman of the Remuneration Committee 12 June 2009


CORPORATE GOVERNANCE REPORT

Combined Code The directors are committed to the implementation and preservation of sound corporate governance principles as a means of protecting and enhancing stockholder value and improving operational performance. These principles, which are outlined in the Combined Code on Corporate Governance published July 2003, form the framework for the proper and ethical operation of the Company and are critical to obtaining and retaining the trust of our investors. It is the directors' intention, in so far as practicable and appropriate given the size and nature of the Company, to comply with all relevant provisions of the Combined Code.

The Board At 31 December 2008, the Board comprised two executive and four non-executive directors. Mr. Jecmen serves as Chairman and is a non-executive director. Mr. Titcombe resigned as a Company director effective June 2008. Mr. Berkowitz resigned as a Company director effective April 2009. Following Mr. Berkowitz's resignation, the Board is comprised of one executive and three non-executive directors.

As a group, the non-executive directors bring a wealth of commercial and professional expertise to the Board and are all considered independent. The Board met eight times during the year ended 31 December 2008, and is currently scheduled to meet four times in 2009, with additional meetings, as required.

The Board's principal responsibilities include assisting in the formulation of corporate strategy, reviewing and approving all significant corporate transactions, monitoring operational and financial performance, approving the annual budget, and generally assisting management to enhance the overall performance of the Company in order to deliver maximum value to its stockholders.

The Board has established three standing committees as follows:

The Audit Committee During 2008, the Audit Committee consisted of Mr. Fitzgibbons and Mr. Berkowitz and was chaired by Mr. Fitzgibbons. Mr. Berkowitz resigned his position as a Company director effective April 2009 and was replaced on the Audit Committee by Mr. MacDonald. The Committee met three times during the year ended 31 December 2008 in order to (i) review the annual accounts for 2007, (ii) review the interim accounts for the first six months of 2008, (iii) oversee the scope and cost of the annual independent audit and (iv) generally assess the effectiveness of the Company's internal control and risk management systems. In addition to the foregoing, the Committee is also charged with assisting the Board in ensuring that the Company's published financial statements provide a complete and accurate view of its operational activities and financial performance, and for reviewing the findings of the external auditor and reporting to the Board regarding the effectiveness of the Company's accounting and control functions. Copies of the Audit Committee's Terms of Reference can be found in their entirety on the Company's website.

The Remuneration Committee The Remuneration Committee consists of Mr. Jecmen and Mr. MacDonald and is chaired by Mr. MacDonald. A full description of the Committee and its activities can be found in the Remuneration Committee Report contained elsewhere in this Annual Report.

The Nominations Committee The Nominations Committee consists of Mr. Jecmen and Mr. Fitzgibbons and is chaired by Mr. Jecmen. The Committee, which did not meet during the year ended 31 December 2008, is responsible for evaluating the balance of skills, knowledge and experience on the Board and for making recommendations to the Board regarding any proposed changes. The Committee's Terms of Reference, which can be found in their entirety on the Company's website, include consideration and recommendations regarding the structure, size, composition and performance of the Board; the leadership needs of the organisation, both executive and non-executive; the adequacy of succession planning for directors and other senior managers; and the appointment and re-appointment of non-executive directors.

Internal Controls The directors acknowledge their responsibility for overseeing management's implementation and maintenance of the Company's system of internal controls.

19


FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2008


Report of Independent Auditors

To the Board of Directors and Stockholders of PolyFuel, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Polyfuel, Inc. and its subsidiary (a development stage enterprise) at 31 December 2008, 2007 and 2006, and the results of their operations and their cash flows for the years then ended and, cumulatively, for the period from 27 January 1999 (date of inception) to 31 December 2008 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred recurring losses from operations and has experienced negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/PricewaterhouseCoopers LLP San Jose, California 12 June, 2009


POLYFUEL, INC. (A development stage enterprise) CONSOLIDATED STATEMENTS OF OPERATIONS

Period from 27 January 1999

(Inception) to Year Ended 31 December 31 December

2008 2007 2006 2008 U.S.$ U.S.$ U.S.$ U.S.$

Revenues 2,012,402 1,391,247 184,600 5,473,457

Costs and operating expenses Research and development Sales, general and administrative

Total expenses

Loss from operations (7,876,354) (9,373,487) (10,831,932) (69,524,906)

Other income (expense), net Interest income Interest expense

Net loss (7,611,102) (8,457,634) (9,673,681) (67,772,800)

Net loss attributable to common stockholders (7,611,102) (8,457,634) (9,673,681) (55,557,688)

Net loss per share Basic and diluted

Weighted average number of shares used in net loss per share calculations

Basic and diluted 5731 1,388 57,368.049 56,154,107

The accompanying footnotes are an integral part of these Consolidated Financial Statements.


POLYFUEL, INC. (A development stage enterprise) CONSOLIDATED BALANCE SHEETS

31 December 2008 2007 2006 US.$ US.$ US.$

Assets

Current assets Cash and cash equivalents Short-term investments Accounts receivable Inventories Prepaid expenses and other current assets

Total current assets

Propeny and equipment, net Other assets

Total assets

Liabilities and Stockholders' Equity

Current liabilities Accounts payable and accrued expenses Deferred revenue

Total current liabilities

Total liabilities

Commitment and Contingencies (See Note 5)

Stockholders' equity Common stock: US$0.001 par value; 100,000,000 shares authorised at 31 December 2008, 2007 and 2006; 57,886,388, 57,436,388 and 57,282,839 shares issued and outstanding at 31 December 2008, 2007 and 2006. respectively

Additional paid-in capital Accumulated other comprehensive income Deficit accumulated during development stage

Total stockholders' equity

Total liabilities and stockholders' equity



POLYFUEL, INC. (A development stage enterprise) CONSOLIDATED STATEMENTS OF STOCKHOLDERS'EQUITY (DEFICIT)

Dclicll Not= Accumulated Accumulated Tolal

Addltlonal Rmlvnble Other Durlng the Slocklmldm' Wld-in Imm Comprrhtmlvc Ikwlopmnl EqUlr

C o m n Stack Capllal Slockholdcrs lnconv S W (Drflcit) S h a m U.S.S U.S.O U.S.S U.S.O U.S.O U.SJ

Issuance of c o m n rtock for carh ot USS25 pr sham in laovary 1999 4 100 100 Nu loss (59,926) 159.9261 Balaacw at 31 b e h e r 1999 4 100 (59,926) (59.8261

Issuance of c o m n stock for in-pmess mearch and dcvclapmnt and mtw payable in Octobw 2000 9,120 9 205.191 205.200 Net loss -- 14,316,346) (4,316,346) Balaacw at 31 k c d c r 2000 9,124 9 205,291 -- (4.376.272) 14,170,972)

Issuance of warrants with credit line and lease line in May and July 2001 93.986 93.986 Exercise of common rtock options at USS22.50 per shan for cash and n a w meivable in May and k e m b c r 2001 5,707 6 128.394 (127.116) 1.284 Slmk bard compenration c r p m e 5.954 5,954 htcrwt accrued oo nMw rscivable (4.W7) 14,907) Nu loss -- (4,839,1931 (4.839.193) Balancw at 31 b c d c r 2001 14.831 IS 433.625 1132.023) -- 19,215,465) (8,913.848)

Issuance of warrants with lcarc line in Jum 2002 45.175 45.175 Ercrcire of c o m n stock options at USS22.50 per r h m for cash 64 1.438 1.438 Stock bard compensation expense 23.207 23.207 Cancellation of nola mcivablc 44.438 44.438 lotcrcst accrued on m w meivablc (3.131) 13.1311 Reprchase of commoo rtock a1 USf4.50 per s h m for note mi-civablc 12.224) 12) 110,008) 10,010 Nu loss -- 11,017,090) (7,017,0901 Balarru at 31 December 2002 12.671 13 493.437 (80.706) -- (16,232,555) (15,819,811)

Issuance of warranu with consulting agrccmnt in August d Dccembcr 2003 44.57 1 44.57 1 lssuance of warranu with finance facility in S c p e d e r 2003 44.944 44.944 Exercise of c o m n stock options at USS22.50 d USf4.50 per sham for cash 1.467 1 7.733 7.734 Caoccllatian of mo rscivablc 34,469 34.469 lntcrwt accrued on notes rseivable 16.384) (6,364) Repurchase of c o m n stock at USf4.50 per r h m for nates mcivablc 11.067) (1) 14.799) 4.800 Nu loss -- (8,887,814) (8.887.814) Balances at 31 Deccdcr 2003 13.071 13 585.886 (47.821) -- (25,120,369) 124.582.291)

Conversion of Series Al. A2 and B dccmpble convcnible prcferrcd rtock in commoo rlock d Series AA redccmpble coovcnible pmferrcd stock upon rsapitalisauon 83.988 84 6.022.Ml 14,720,684 20.743.069 Repurchase of c o m n stock at USS22.50 per sham for mtes rscivablc (1.891) (2) (186) 47.821 47.633 Issuance of warranu wilh finance facility in May 2004 174.150 174.150 Issuance of w a m U wilh bridge loam io February and April 2004 533.957 533.957 Exercise of common stock aptiam at USSO.10 per r h m for cash 2.833 3 280 283 Nd lorr -- (8,966,989) 18,966,9891 Balances st 3 1 D e c e h r 2004 98,001 98 7,316,388 -- (19,366,674) (12,050,188)

Issuance of warran& with consulting agrccmnt in May 2005 69.618 69.618 Conversion of Series AA and BB deemablc convertible preferred stock iota c a m o stock upon admission lo AIM 28.655.645 28,656 22.608.91 1 -- 22,637.567 laruance of common slmk and Series A Warrants for cash at USS0.W per unit in connection with initial public offering in July 2005, m of issuance cash of USS2.767.027 15,686,276 15.686 11,217,281 11.232.973 Issuance of c o m n stock options to finaacial advisor in eamcction wilh AIM Listing 242.568 242.568 Stock-bawd corrpcmstion cxpemc 16.726 16.726 Excrcisc of c o m n stock optiom at USS0.90 and USSO. 10 pw sham for cash 110.171 110 11.740 11.850 Nu loss (7,943,025) (7,943,025)

Balances at 31 Dacctrdcr 2005 44.550.093 44.550 41,483,238 -- 127,309,6991 14.218.089 Issuance of c o m n rtock for cash at USS1.4052 per share in comcction with follow-on offering in January 2036, nct of issuance COSIS of USS816.653 12.500.WO 12.500 16.736.850 16,749.350 Stock-bad conpensation crpensc 373.417 373.417 Conprchcnsive incom - change in unrcaliscd gain on available-for- sale iovwtmots 857 857 Exvcise of conumo stock optiom at USSO.10 per r h m for cash 232,746 233 23,041 23.274 Nu loss (9,673,681) (9.673.681)

Balances at 31 D e c c h r 2036 57,282,839 57.283 58,616,546 857 (36.983.380) 21.691.306 Stock-bawd cd~rrpc~ation expenre 640.975 620,975 Conprehemive iacom - change in unrcalird gain on available-for- sale iovutmnts 323 323 Excrcirc of c o m n stock optiom at USSO.IO per r h m far cash 153,549 I53 15.201 15.354 Nd loss (8,457,634) (8,457,6341 Balaoca a 31 December 2007 57.436.388 57.436 59,272,722 1,180 (45,441,014) 13,890,324

Stock-bawd conpcmation cxpenrc 526.W 526.846 Conpmhcmivc iacom - change in unrcaliscd gain on availablc-for-sale invatmnu fI,I80) 11,180) Exucisc of c o m n stock options at USSO.10 per r h m for cash 450.000 450 44,550 45.000 N a lor, (7.61 1.102) 17,6l1.102) Balances at 31 December 2008 57.886.388 57.886 59,844,118 -- (53,052,116) 6.849.888



POLYFUEL. INC. (A development stage enterprise) CONSOLIDATED STATEMENTS OF CASH FLOWS

Period from 27 January 1999

(Inception) to

Cash flows from operating activities Net loss Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortisation Purchased research and development Stock-based expense - non-employees Stock-based employee compensation expense Realized gain on sale of investments Loss on inventory write-down Loss /(Gain) on sale of equipment Non-cash expense related to notes receivable from stockholders Non-cash expense related to issuance of warrants

Non-cash interest expense related to bridge loans Changes in assets and liabilities:

Accounts receivable lnventories Prepaid expenses and other current assets Other assets Accounts payable and accrued expenses Deferred revenue

Year Ended 31 December 31 ~ e c e m b e r 2008 2007 2006 2008

Net cash used in operating activities (6,958,921) (8,042,661 ) (8,733,875) (57,662,328)

Cash flows from investing activities Purchases of available for sale investments (3,701,253) (6,083,465) (8,620,502) (26,923,926) Maturities and sales of available for sale investments 10,286,151 6,162,503 3,064,404 26,933,833 Proceeds from sale of property and equipment 12,65 1 255 .- 153,631 Purchase of property and equipment (236,175) (102,810) (1 82,858) (3,760.1 21)

Net cash provided by (used in) investing activities 6,361,374 (23,517) (5,738,956) (3,596,583)

Cash flows from financing activities Proceeds from issuance of common stock 45,000 15,354 16,772,624 28,331,208 Proceeds from issuance of redeemable convertible preferred stock, net -- -- -- 37,097,656 Proceeds from lease line and finance facility -- -- -- 2,545,612 Repayment of lease line and finance facility -- -- (500,733) (2,545,612) Proceeds from issuance of notes payable and bridge loans -- -- -- 2,404,185

Net cash provided by financing activities 45,000 15,354 16,271,891 67,833,049

Net increase (decrease) in cash and cash equivalents (552,547) (8,050,824) 1,799,060 6,574,138 Cash and cash equivalents at beginning of period 7,126.685 15,177,509 13,378,449 --

Cash and cash equivalents at end of period 6,574,138 7,126,685 15,177,509 6,574.1 38

Supplemental disclosure of non-cash investing and financing activities Issuance of common and redeemable convertible preferred stock for in-process research and development and notes payable -- -- Issuance of warrants in connection with finance facilities and consulting arrangements -- -- Repurchase of common stock for notes receivable -- -- Cancellation of notes receivable -- -- Conversion of redeemable convertible preferred stock upon recapitalisation and admission to AIM -- -- Issuance of common stock options in connection with AIM Listing -- --

The accompanying footnotes are an integral part of these Consolidated Financial Statements


POLYFUEL, INC. (A development stage enterprise) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - The Company

Description of Business PolyFuel, Inc. ("PolyFuel" or the "Company"), was incorporated in Delaware on 27 January 1999. The Company is a spin-off from SRI International, Inc. (formerly the Stanford Research Institute) and was established primarily for the purpose of developing portable fuel cell technology. Since inception, the Company has been deemed to be in the development stage as it has devoted substantially all of its efforts to developing its product, raising capital and recruiting personnel. The Company is headquartered in Mountain View, California, and is publicly listed on the London Stock Exchange Alternative Investment Market ("AIM").

Principles of Consolidation The accompanying financial statements have been prepared on a consolidated basis and, accordingly, reflect the financial position and results of operations of both PolyFuel, Inc. and its wholly owned Canadian subsidiary, PolyFuel, Ltd. All intercompany account balances have been eliminated in consolidation.

Basis of Presentation and Continuance of Operations The accompanying consolidated financial statements have been prepared by the Company on a going concern basis in accordance with accounting principles generally accepted in the United States of America. As such, the statements anticipate the realisation of assets and the liquidation of liabilities in the normal course of business. Notwithstanding this fact, the Company has incurred losses and negative cash flow from operations for every fiscal period since its inception. For the year ended 31 December 2008, the Company incurred a net loss of approximately US$7.6 million and negative cash flows from operations of US$7.0 million. Management believes that the Company's cash, cash equivalents and short-term investments at 31 December 2008 may prove insufficient to meet its anticipated cash requirements for operating and working capital purposes for at least the next 12 months. The Company has been successful in completing numerous rounds of public and private equity financing, totaling approximately US$67.8 million (net of issuance costs) through 31 December 2008. However, there can be no assurance that the Company will be successful in obtaining additional financing on favorable terms, or at all. If additional funds are raised by issuing equity securities, substantial dilution to existing shareholders may occur. The Company has been seeking additional funding from various sources. Recent long time discussions with a particular interested investor were recently terminated. The Company continues to seek additional funding sources. These matters raise substantial doubt about the Company's ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from such adverse outcomes of this uncertainty.

NOTE 2 - Significant Accounting Policies

Use of Estimates The preparation of financial information in conformity with accounting principles generally accepted in the United States of America requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the financial statements and for the period then ended. Actual results could differ from these estimates.

Revenue Recognition The Company's revenue is derived primarily from government grants and the sale of products to its customers to support testing, evaluation and the development of prototype devices. With respect to product sales, the Company generally recognises revenue upon shipment if (i) a signed arrangement exists, (ii) the fee is fixed and determinable and (iii) collection of the resulting receivable is reasonably assured. Revenue from government grants is recorded as earned, generally in the period in which the underlying costs are incurred.


Cash and Cash Equivalents Cash and cash equivalents include cash on hand and cash invested in short-term securities which have remaining maturities of less than 90 days at the time of purchase. At 31 December 2008, 2007 and 2006, cash and cash equivalents included US$6,574,138, US$7,126,685 and US$15,177,509, respectively, of commercial paper, money market funds and U.S. Government Agency Securities.

Investments The Company has classified all investments as available-for-sale. Such investments are recorded at fair market value and unrealised gains and losses, if material, are recorded as a separate component of stockholders' equity (deficit) until realised. Realised gains and losses on sales of all such securities are reported in the statement of operations.

The Company's available-for-sale investments at 31 December 2007 and 2006 consisted of the following (the Company did not hold any such investments as of 31 December 2008):

Comorate notes 5.500.700 2.406.053 U.S. Government Agency Securities

The estimated fair value of available-for-sale investments at 31 December 2007 and 2006, by contractual maturity, were as follows (the Company did not hold any such investments as of 31 December 2008):

Less than one year Between one and two years

Foreign Currency Translation The functional currency of the Company's Canadian subsidiary is the U.S. dollar. Assets and liabilities are remeasured at the period-ending or historical rates, as appropriate, while revenues and expenses are remeasured at average monthly rates. Currency transaction gains and losses are recognised in current operations and have been insignificant for all periods presented.

Concentration of Credit Risk and Other Risks and Uncertainties Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable. The Company deposits its cash and cash equivalents with three financial institutions.

Property and Equipment Property and equipment are stated at cost, net of accumulated depreciation and amortisation. Depreciation is computed using the straight-line method over the shorter of the estimated useful life of the respective assets, generally three to five years, or, in the case of leasehold improvements, the shorter of the useful life of the assets or the lease term. Maintenance and repairs are charged to expense as incurred. When assets are retired or otherwise disposed of, the cost and the accumulated depreciation and amortisation are removed from the accounts and any resulting gain or loss is reflected in the consolidated statement of operations in the period realised.

Impairment of hng-Lived Assets In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company reviews long-lived assets, including property and equipment, for impairment on an annual basis and whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. In the event of impairment, the loss to be recognised would be measured based on the excess carrying value of the asset over the asset's fair value.


Income Taxes The Company accounts for income taxes in accordance with the liability method whereby deferred tax assets and liabilities are recognised for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Such deferred tax assets and liabilities are measured using current tax laws and the enacted tax rates expected to apply in the years in which these differences are expected to be recovered or settled. A valuation allowance is provided when it is more likely than not that some portion of a deferred tax asset will not be realised.

Effective 1 January 2007, the Company adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN No. 48"). FIN No. 48 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognised in the financial statements. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. See Note 9 for further details of the impact of adoption.

Fair Value of Financial Instruments In September 2006, the Financial Statement Standard Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 established a common definition for fair value, which is to be applied to U.S. generally accepted accounting principles ("GAAP) requiring use of fair value, and a framework for measuring fair value, and expanded disclosure about such fair value measurements. This pronouncement applies under the other accounting standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. SFAS No. 157 is effective for financial assets and financial liabilities for fiscal years beginning after 15 November 2007. In February 2008, the FASB released a FASB Staff Position ("FSP") 157-1, "Application of FASB Statement No. 157 to FASB Statement 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13." FSP 157-1 removed leasing transactions accounted for under FASB Statement 13 and related guidance from the scope of SFAS No. 157. FSP 157-2, "Partial Deferral of the Effective Date of Statement 157," deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those which are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after 15 November 2008.

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations. SFAS No. 141R will change the accounting for business combinations. Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS No. 141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 15 December 2008. SFAS No. 141R will have an impact on accounting for business combinations once adopted but the effect is dependent upon acquisitions at that time.

SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," became effective for the Company on 1 January, 2008. SFAS No. 159 includes an amendment of FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which permits an entity to measure certain financial assets and financial liabilities at fair value. The objective of SFAS No. 159 is to improve financial reporting by allowing entities to mitigate volatility in reported earnings caused by the measurement of related assets and liabilities using different attributes, without having to apply complex hedge accounting provisions. Under SFAS No. 159, entities that elect the fair value option (by instrument) will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option election is irrevocable, unless a new election date occurs. SFAS No. 159 establishes presentation and disclosure requirements to help financial statement users understand the effect of the entity's election on its earnings, but does not eliminate disclosure requirements of other accounting standards. Assets and liabilities that are measured at fair value must be displayed on the face of the balance sheet. The Company did not elect the fair value option for its financial assets and liabilities existing at 1 January 2008, nor for its financial assets and liabilities transacted in the twelve months ended 31 December 2008.

Comprehensive Loss


Comprehensive loss consists of net loss and other comprehensive income (loss), which includes certain changes in equity that are excluded from net loss. Specifically, u~eal ised losses on investments are included in accumulated other comprehensive loss in the stockholder's equity section of the accompanying Consolidated Financial Statements. Comprehensive loss for the periods presented consisted of the following:

Year ended 31 December 2008 2007 2006 US.$ US.$ US.$

Net loss Change in u~ealised gain on investments

As of 3 1 December 2008,2007 and 2006, accumulated other comprehensive income represented unrealised gains(1osses) on investments of US$(1,180), US$323 and US$857, respectively.

Accounting for Stock-Based Compensation Effective 1 January 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R, Share Based Payment ("SFAS No. 123R"), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on the estimated fair market value of the underlying instruments. Accordingly, stock-based compensation cost is measured at grant date, based upon the fair value of the award, and is generally recognised as expense on a straight line basis over the requisite employee service period.

The Company adopted SFAS No. 123R using the modified prospective transition method, which requires the application of the standard as of 1 January 2006. Accordingly, the Company's Consolidated Financial Statements as of and for the years ended 31 December 2006 and 2007 reflect the impact of SFAS NO. 123R. In accordance with the modified prospective transition method, the Company's Consolidated Financial Statements for prior periods have not been restated.

Prior to the adoption of SFAS No. 123R, the Company accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"), and related interpretations. Under APB No. 25, compensation expense was recorded for options issued to employees in fixed amounts and with fixed exercise prices to the extent that such exercise prices were less than the fair market value of the Company's common stock on the date of grant. The Company also followed the disclosure provisions of SFAS No. 123, Accounting for Stock Based Compensation ("SFAS No. 123"), as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.

The Company accounts for equity instruments issued to non-employees in accordance with SFAS No. 123, Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services and Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. Accordingly, as these equity instruments vest, the Company will be required to remeasure the fair value of the equity instrument at each reporting period prior to vesting and finally at the vesting date of the equity instruments.

Loss per Share Basic loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed by giving effect to all potentially dilutive common stock equivalents, including preferred stock, stock options and warrants. For the years ended 31 December 2008, 2007 and 2006, options to purchase 9,343,766, 8,891,885 and 7,847,516 shares of common stock; and warrants to purchase 501,331, 502,978 and 8,350,139 shares of common stock, respectively, were excluded from the computation of diluted loss per share as the effect would be antidilutive.

The following table sets forth the computation of basic and diluted net loss attributable to common stockholders per share:


Years Ended 31 December 2008 2007 2006

Numerator Net loss

Net loss attributable to common stockholders (7.61 1,102) (8,457,634) (9,673,68 1)

Denominator

Basic and diluted weighted average common shares 57.811.388 outstanding

57.368.049 56.154.107

Net loss per share Basic Diluted

Recent Accounting Pronouncements In September 2006, the Financial Statement Standard Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 established a framework for measuring fair value under GAAP, clarified the definition of fair value within that framework and expanded disclosure about such fair value measurements. This pronouncement applies under the other accounting standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. SFAS No. 157 is effective for financial assets and financial liabilities for fiscal years beginning after 15 November 2007. In February 2008, the FASB released a FASB Staff Position ("FSP") 157-1, "Application of FASB Statement No. 157 to FASB Statement 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13." FSP 157-1 removed leasing transactions accounted for under FASB Statement 13 and related guidance from the scope of SFAS No. 157. FSP 157-2, "Partial Deferral of the Effective Date of Statement 157," deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those which are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after 15 November 2008.

SFAS No. 159, 'The Fair Value Option for Financial Assets and Financial Liabilities," became effective for the Company on 1 January 2008. SFAS No. 159 includes an amendment of FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which permits an entity to measure certain financial assets and financial liabilities at fair value. The objective of SFAS No. 159 is to improve financial reporting by allowing entities to mitigate volatility in reported earnings caused by the measurement of related assets and liabilities using different attributes, without having to apply complex hedge accounting provisions. Under SFAS No. 159, entities that elect the fair value option (by instrument) will report unrealized gains and losses in earnings at each subsequent reporting date. 'The fair value option election is irrevocable, unless a new election date occurs. SFAS No. 159 establishes presentation and disclosure requirements to help financial statement users understand the effect of the entity's election on its earnings, but does not eliminate disclosure requirements of other accounting standards. Assets and liabilities that are measured at fair value must be displayed on the face of the balance sheet. The Company did not elect the fair value option for its financial assets and liabilities existing at 1 January 2008, nor for its financial assets and liabilities transacted in the twelve months ended 3 1 December 2008.

NOTE 3 - Fair Value Measurements

As stated in "Note 1 - Organisation, Basis of Presentation and Significant Accounting Policies," on 1 January 2008 the Company adopted SFAS 157, which established a framework for measuring fair value under GAAP and clarified the definition of fair value within that framework. SFAS 157 does not require assets and liabilities that were previously recorded at cost to be recorded at fair value. For assets and liabilities that are already required to be disclosed at fair value, SFAS 157 introduced, or reiterated, a


number of key concepts that form the foundation of the fair value measurement approach to be used for financial reporting purposes. The fair value of our financial instruments reflects the amounts that we estimate we would receive in connection with the sale of an asset or paid in connection with the transfer of a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS 157 also established a fair value hierarchy that prioritizes the inputs used in valuation techniques into the following three levels:

Level l - q u o t e d prices in active markets for identical assets and liabilities Level 2--observable inputs other than quoted prices in active markets for identical assets and liabilities Level 3-unobservable inputs

The adoption of SFAS 157 did not have an effect on our financial condition or results of operations, but SFAS 157 introduced new disclosures about how we value certain assets and liabilities. Much of the disclosure focuses on the inputs used to measure fair value, particularly in instances in which the measurement uses significant unobservable (Level 3) inputs. A substantial majority of our financial instruments are valued using quoted prices in active markets or are based on other observable inputs.

The following table sets forth the fair value of our financial assets measured on a recurring basis as of 31 December 2008. Assets and liabilities are measured on a recurring basis if they are remeasured at least annually.

Level 3 Level 1 (US$) Level 2 (US$) (US$) Total (US$)

Assets Cash equivalents

Total

NOTE 4 - Stock Based Compensation

The Company accounts for stock based compensation in accordance with the provisions of SFAS No. 123R using the modified prospective transition method, which requires the application of the standard as of 1 January 2006. Accordingly, the Company's Consolidated Financial Statements as of and for the year ended 31 December 2008 reflect the impact of SFAS No. 123R. In accordance with the modified prospective transition method, the Company's Consolidated Financial Statements for prior periods have not been restated. Stock-based compensation expense recognised under SFAS No. 123R for the year ended 31 December 2008 was as follows:


2008 2007 2006 U.S.$ U.S.$ U.S.$

Research and development General and administrative Total

Amounts include (i) amortisation related to the compensation cost for all post AIM listing share-based payments granted prior to, but not yet vested as of 1 January 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of Statement 123, and (ii) compensation expense pertaining to the share-based payment awards granted subsequent to 1 January 2006, based on the grant- date fair value estimated in accordance with SFAS No. 123R.

SFAS No. 123R permits companies to select the option pricing model that best fits their particular set of circumstances, provided such valuation model (i) is applied in a manner consistent with the fair value measurement objective required under SFAS No. 123R, (ii) is based on established principles of financial


economic theory and (iii) reflects all substantive characteristics of the underlying instrument. In

recognition of these standards and after consideration of various relevant factors, including option plan design, data availability and cost-benefit analysis, the Company has selected the Black Scholes option pricing model to value its options.

The weighted average estimated grant date fair value per share of employee stock options during the years ended 31 December 2008, 2007 and 2006 was determined to be US$0.06, US$0.64 and US$0.73, respectively using the Black Scholes model with the following underlying assumptions:

Year ended 31 December 2008 2007 2006

Expected volatility Weighted average risk-free interest rate Expected dividend yield Weighted average expected life (in years)

109% 62%-70% 70% 2.11% 4.11% 5.18%

nil nil nil 5.61 years 5.97 years 6.35 years

Pursuant to the requirements of SFAS No. 123, the Company has, for the period prior to its flotation on AIM in July 2005, estimated the fair value of its stock options by applying a present value approach that does not consider the expected volatility of the underlying stock ("minimum value method). For all subsequent periods, the Company has estimated its expected stock price volatility based on historical volatility calculations for a group of peer comparable companies. The weighted average risk free interest rate reflects the rates of U.S. government securities appropriate for the term of the Company's stock options at the time of grant. The weighted average expected term is based on the average of the vesting term and the 10 year contractual lives of all options awarded after 1 January 2006.

Stock based compensation expense recognised in the Consolidated Statement of Operations for the year ended 31 December 2008 is based on awards ultimately expected to vest; therefore, it has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of initial grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company estimates forfeitures based on its historical activity, as it believes that these forfeiture rates are indicative of its expected forfeiture rate.

As of 31 December 2008, the Company had unrecognized deferred stock-based compensation expense related to unvested stock options of approximately US$0.6 million after estimated forfeitures, which will be recognized over an estimated weighted-average remaining requisite service period of 1.91 years. During the year ended 31 December 2008, the Company granted 1,650,666 options with an estimated total fair market value at grant date of approximately US$O. 1 million, after estimated forfeitures.

Prior to the adoption of SFAS No. 123R, the Company accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25. Accounting for Stock Issued to Employees ("APB No. 25"), and related interpretations. The Company also followed the disclosure provisions of SFAS No. 123, Accounting for Stock Based Compensation ("SFAS No. 123"), as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.

Stock Option Plan In October 2000, the Company adopted the 2000 Equity Incentive Plan (the "Plan"). The Plan provides for the granting of stock options to employees, directors and service providers of the Company. Options granted under the Plan may be either incentive stock options ("ISOs") or nonqualified stock options ("NSOs"). ISOs may be granted only to Company employees (including officers and directors who are employees). NSOs may be granted to Company employees and service providers.

Options under the plan may be granted for periods of up to ten years and at prices no less than 85% of the estimated fair market value of the shares on the date of grant as determined by the Board of Directors, provided however, that (i) the exercise price of an IS0 and NSO shall not be less than 100% and 85% of the estimated fair value of the shares on the date of grant, respectively, and (ii) the exercise price of an IS0 and NSO granted to a 10% stockholder shall not be less than 110% of the estimated fair market value of the shares on the date of grant. To date, options granted generally vest over four years.

Restricted stock may be issued to employees, officers, directors, consultants, advisors and other service providers at fair value on the date of issuance. Under the term of restricted stock purchase agreements, the Company would have the right to repurchase all unvested common stock at the original issuance price upon

3 2


the termination of the applicable employee's employment. The following is a summary of stock option activity:

Options reserved at Plan inception Options granted

Balances at 31 December 2000 Additional shares reserved Options granted Options exercised Options cancelled



Balances at 31 December 2003 Additional shares reserved Options grdnted Options exercised Options cancelled

Balances at 31 December 2004 Additional shares resewed Options granted Options exercised Options cancelled


Balances at 31 December 2006 Options granted Options exercised Options cancelled

Balances at 31 December 2007

Options granted Options exercised Options cancelled

Balances at 31 December 2008

options available for

grant Outstanding

options

Weighted average exercise

Price US.$


The following table summarizes information about stock options outstanding and exercisable at 31 December 2008:

Options Outstanding Options Exercisable

Exercise price US$

22.50 4.50 0.55 - 1.77 0.06 - 0.10

Weighted average

remaining contractual

Number life outstanding (in years)

377 1.65 52,007 4.30

Weighted Average Exercise

Price US$

22.50 4.50

Aggregate Intrinsic

Value Number us$ Exercisable

-- 377 -- 52,007

Weighted average 43gregate exercise Intrinsic

price Value US$ US$

22.50 ..

4.50 --

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on options with an exercise price less than the Company's closing stock price of UK1.88~ per share (US$0.03 at the then effective exchange rate) as of 31 December 2008, which would have been received by the option holders had those option holders exercised their options as of that date. The total number of in-the-money options exercisable as of 31 December 2008 was nil. As of 31 December 2007, there were 3,589,7 17 outstanding options exercisable at a weighted average exercise price of US$0.57 per share.

The aggregate intrinsic value of options exercised during the year ended 31 December 2008 was approximately US$108,000. The total cash received from employees as a result of employee stock option exercises during this period was approximately US$45,000.

Non-Employee Stock Options During the years ended 31 December 2008, 2007 and 2006, and cumulatively for the period from 27 January 1999 (Inception) to 31 December 2008, the Company granted options to purchase nil, nil, nil and 59,714 shares, respectively, to non-employees for their services rendered to the Company. During the years ended 31 December 2008, 2007 and 2006, and cumulatively for the period from 27 January 1999 (Inception) to 31 December 2008, the Company recorded compensation expense of US$ nil, US$ nil, and US$ nil and US$45,887, respectively, related to such services.

NOTE 5 - Property and Equipment

Property and equipment consist of the following:

Year Ended 31 December 2008 2007 2006

Laboratory equipment 2,288,115 2,262,955 2,393,161 Computer equipment and software 279,735 278,473 432,148 Vehicles 24,642 24,642 24,642 Office equipment 80,236 80,236 85,176 Leasehold improvements 528,875 462,009 462,009

3,201,603 3,108,315 3,397,136 Less: accumulated depreciation and amortization (2,834,626) (2,77 1,276) (2,936,73 1)

366,977 337,039 460,405

NOTE 6 - Commitments and Contingencies

Operating Lease

The Company leases its office space under noncancelable operating leases. Total rent expense for the years ended 31 December 2008, 2007 and 2006 and cumulatively for the period from 27 January 1999 (Inception) to 31 December 2008 were US$532,043, US$514,095, US$511,698 and US$3,548,536, respective1 y.


The Company maintains a letter of credit for the benefit of its landlord in the amount of US $175,000 which is secured by a cash deposit of the same amount for the lease of its office space in Mountain View, California.

Future Minimum Payments

At 31 December 2008, the Company had total future minimum payments due under non-cancelable operating lease facilities of US$657,896 for the year ending 31 December 2009. See Note 12.

NOTE 7 - Redeemable Preferred Stock

In July 2005, in connection with the Company's initial public offering of common stock and admission to the London Stock Exchange Alternative Investment Market, all of the Company's issued and outstanding shares of preferred stock were converted into shares of common stock. See Note 7.

Recapitalisation

In May 2004, pursuant to a vote of its stockholders, the Company engaged in a recapitalisation of its various outstanding equity instruments (the "Recapitalisation"). Under the Recapitalisation, holders of common stock received one share of common stock in exchange for each 45 shares of common stock previously held. Each holder of Series A2 and Series B redeemable convertible preferred stock ("Series A2 and Series B Preferred Stock") and warrants to acquire Series A2 and Series B Preferred Stock was granted the opportunity to participate in the Company's issuance of a new Series BB redeemable convertible preferred stock ("Series BB Preferred Stock"). Holders of Series A2 and Series B Preferred Stock and warrants to acquire Series A2 and Series B Preferred Stock who chose to purchase shares of Series BB Preferred Stock at predetermined levels were thereby entitled to receive shares of a new Series AA redeemable convertible preferred stock ("Series AA Preferred Stock") in exchange for their shares of Series Al , A2 and B Preferred Stock and warrants to acquire Series A2 and B Preferred Stock. Holders of Series A2 and Series B Preferred Stock and warrants to acquire Series A2 and Series B Preferred Stock who chose not to purchase shares of Series BB Preferred Stock at the predetermined levels received shares of common stock and warrants to acquire common stock, respectively, in exchange for their preferred stock and warrants.

The difference between the fair value of the Series AA Preferred Stock issued and the carrying value of the Series Al, A2 and B Preferred Stock exchanged of US$14,720,684 has been recorded as a credit to accumulated deficit and was offset against net loss in determining the net loss attributable to common stockholders.

Following is a summary of the Company's outstanding equity instruments prior to and immediately following the recapitalisation and issuance of Series BB Preferred Stock:

Number of Number of Number of Shares of Series Shares of

Shares Prior to AA Preferred Common Stock Original Equity Instruments Recapitalisation Stock Received Received

Common Stock 588,195 13,071 Series A1 Preferred Stock 789,600 54,273 Series A2 Preferred Stock 1,200,000 242,701 27,493 Series B Preferred Stock 15,650,000 4,267,733 2,222

Redeemable Preferred Stock Warrants

In connection with certain financing arrangements and in exchange for services rendered, the Company has issued warrants to purchase shares of the Company's redeemable convertible preferred stock.

In May 2005, in connection with a consulting arrangement, the Company issued warrants to purchase 88,565 shares of the Company's Series BB Preferred Stock at an exercise price of US$1.00 per share and with expiration dates ten years from the date of issuance. The value ascribed to these warrants upon their issuance was US$69,618 and was recorded as consulting expense over the period the services were provided. The fair value of the warrants was estimated using the Black-Scholes option pricing model. The estimate was based upon the ten year contractual term of the warrants, a risk-free interest rate of 4.37% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. In July 2005, in connection with the Company's admission to the London Stock Exchange Alternative Investment Market,


the warrant became exercisable for 110,706 shares of the Company's common stock at an exercise price of US$0.80 per share. See Note 7.

In May 2004, in connection with the Finance Facility, the Company issued a warrant to purchase 247,500 shares of the Company's Series BB Preferred Stock at an exercise price of US$1.00 per share and with an expiration date in May 2011. The value ascribed to this warrant upon its issuance was US$174,150 and was recorded as interest expense over the availability term of the Finance Facility, which expired October 2004. The fair value of the warrant was estimated using the Black-Scholes option pricing model with the estimate based upon the seven year contractual term of the warrant, a risk-free interest rate of 4.57% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. In July 2005, in connection with the Company's admission to the London Stock Exchange Alternative Investment Market, the warrant became exercisable for 309,375 shares of the Company's common stock at an exercise price of US$0.80 per share. See Note 7.

In February and April 2004, in connection with two bridge loans, the Company issued warrants to purchase 1,149,990 shares of the Company's Series BB Preferred Stock at an exercise price of US$1.00 per share and with expiration dates five years from the date of issuance. The value ascribed to these warrants upon their issuance was US$533,957 and was recorded as a discount to the bridge loans. The discount was subsequently charged to interest expense upon conversion of the loans into Series BB Preferred Stock in May 2004. The fair value of the warrants was estimated using the Black-Scholes option pricing model with the estimate based upon the five year contractual term of the warrants, risk-free interest rates of 3.07%- 3.20% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. The exercise price of the warrants was subsequently amended from US$1.00 per share to US$2.00 per share. In July 2005, in connection with the recapitalisation of the Company's various equity securities pursuant to its admission to the London Stock Exchange Alternative Investment Market, the warrants were terminated. See Note 7.

From August through December 2003, in connection with a consulting arrangement, the Company issued warrants to purchase 74,250 shares of the Company's Series B Preferred Stock at an exercise price of US$1.00 per share and with expiration dates five years from the date of issuance. The value ascribed to these warrants upon their issuance was US$44,571 and was recorded as consulting expense during the year ended 31 December 2003. The fair value of the warrants was estimated using the Black-Scholes option pricing model. The estimate was based upon the five year contractual term of the warrants, risk-free interest rates of 3.26%- 3.43% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. In May 2004, in connection with the Recapitalisation, the warrants became exercisable for 1,650 shares of common stock at an exercise price of US$45.00 per share.

In September 2003, in connection with the Finance Facility, the Company issued a warrant to purchase 65,000 shares of the Company's Series B Preferred Stock at an exercise price of US$1.00 per share and with an expiration date in September 2010. The value ascribed to this warrant upon its issuance was US$44,944 and was recorded as interest expense during the year ended 31 December 2003. The fair value of the warrant was estimated using the Black-Scholes option pricing model. The estimate was based upon the seven year contractual term of the warrant, a risk-free interest rate of 3.85% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. In May 2004, in exchange for certain concessions made by the lender in connection with the bridge loans (as described above), the Company modified the terms of the warrant to allow it to be converted into 65,000 shares of Series BB Preferred Stock. In July 2005, in connection with the Company's admission to the London Stock Exchange Alternative Investment Market, the warrant became exercisable for 81,250 shares of the Company's common stock at an exercise price of US$0.80 per share. See Note 7.

In June 2002, in connection with the Lease Line, the Company issued a warrant to purchase 90,000 shares of the Company's Series B Preferred Stock at an exercise price of US$1.00 per share and with an expiration date in June 2009. The value ascribed to this warrant upon its issuance was US$45,175 and was recorded as a discount to the accompanying capital lease obligations. The fair value of the warrant was estimated using the Black-Scholes option pricing model. The estimate was based upon the seven year contractual term of the warrant, a risk-free interest rate of 3.84% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. During the years ended 31 December 2005, 2004, 2003 and cumulatively from 27 January 1999 (inception) to 31 December 2005, US$ nil, US$13,424, US$15,035, and US$45,175 was amortised to interest expense, respectively, using the effective interest rate method. In May 2004, in connection with the Recapitalisation, the warrant became exercisable for 2,000 shares of

36


common stock at an exercise price of US$45.00 per share. The warrant has expired as of 31 December 2007.

In July 2001, in connection with obtaining a line of credit, the Company issued a warrant to purchase 5,500 shares of the Company's Series A2 Preferred Stock at an exercise price of US$5.00 per share and with an expiration date in July 2006. The value ascribed to this warrant upon its issuance was US$16,935 and was recorded as interest expense during the year ended 31 December 2001. The fair value of the warrant was estimated using the Black-Scholes option pricing model. The estimate was based upon the five year contractual term of the warrant, a risk-free interest rate of 4.72% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. In May 2004, in connection with the Recapitalisation, the warrant became exercisable for 378 shares of common stock at an exercise price of US$72.74 per share. The warrant has expired as of 3 1 December 2007.

In May 2001, in connection with the Lease Line, the Company issued a warrant to purchase 29,400 shares of the Company's Series A2 Preferred Stock at an exercise price of US$5.00 per share and with an expiration date in May 2008. The value ascribed to this warrant upon its issuance was US$77,051 and was recorded as a discount to the accompanying capital lease obligations. The fair value of the warrant was estimated using the Black-Scholes option pricing model. The estimate was based upon the seven year contractual term of the warrant, a risk-free interest rate of 3.84% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. During the years ended 31 December 2005, 2004, 2003 and cumulatively from 27 January 1999 (inception) to 31 December 2005, US$ nil, US$15,110, US$23,766, and US$77,05 1 was amortised to interest expense, respectively, using the effective interest rate method. In May 2004, in connection with the Recapitalisation, the warrant became exercisable for 2,020 shares of common stock at an exercise price of US$72.74 per share. The warrant has expired as of 31 December 2007.

NOTE 8 - Stockholders' Equity

Common Stock

The Company's Certificate of Incorporation, as amended, authorises the Company to issue up to 100,000,000 shares of common stock at a par value of US$0.001 per share.

On 5 July 2005, the Company completed an equity financing and shares of the Company's common stock were admitted to trading on the London Stock Exchange Alternative Investment Market (the "AIM Listing"). The Company placed 15,686,276 new shares of common stock at a per share price of UK5lp (each share issued together with !h Series A warrant to purchase an additional share of common stock at an exercise price of UK60p per share within 18 months following the placement). The warrant has expired as of 31 December 2007. The Company raised a total of £8 million (US$14 million after conversion at the effective exchange rate and before transaction costs of approximately US$2.5 million).

Immediately prior to the admission, each of the following, which had previously been approved by the Company's Board of Directors and stockholders, became effective, based upon the terms of the AIM Listing: (i) certain amendments to the Company's Amended and Restated Certificate of Incorporation (the "Certificate of Incorporation") to (a) increase the conversion ratios for the Series AA Preferred Stock and Series BB Preferred Stock from 1: 1 to 1.25:1, and (b) clarify the Certificate of Incorporation to provide that no dividends will be paid upon such conversion and, (ii) the termination of certain warrants to purchase shares of Series BB Preferred Stock, (iii) the conversion of the Company's Series AA Preferred Stock and Series BB Preferred Stock to Common Stock pursuant to the terms of the Company's Certificate of Incorporation, (iv) an amendment to the Company's investor rights agreements, (v) an amendment to the Company's 2000 Equity Incentive Plan to increase the number of shares reserved under such plan to 9,250,000 shares and (vi) the granting of options to certain existing option holders to purchase, in total, an additional 701,000 shares of the Company's common stock under the 2000 Equity Incentive Plan, as amended.

Subsequent to the AIM Listing, an amendment and restatement of the Certificate of Incorporation, which had previously been approved by the Company's Board of Directors and stockholders, became effective, based upon the terms of the AIM Listing: to (a) provide that, following the conversion of the Series AA Preferred Stock and Series BB Preferred Stock, the Company shall only be authorised to issue 100,000,000 shares of its common stock, (b) require that stockholders provide the Company information with respect to common stock that they beneficially own, upon the Company's request, and (c) require that any person


acquiring securities representing 30% and 50% or more of the Company's voting power, respectively, make a cash offer for the remaining outstanding shares of the Company at the highest price paid by such person for shares of the Company in the preceding 12 month period; provided, however, that if such offer is not made, said person shall lose any and all voting rights attaching to the shares held by them.

In connection with the AIM Listing, the Company granted Collins Stewart Limited, its nominated advisor in the transaction, a fully vested option to purchase 444,616 shares of the Company's common stock at an initial exercise price equal to the original AIM Listing price of UKSlp per share (the "Collins Stewart Option"). The Collins Stewart Option has a term of five (5) years and its exercise price is subject to adjustment from time to time. The value ascribed to the Collins Stewart Option upon its issuance was US$242,568 and this amount was recorded as an increase in Additional Paid-in Capital. The fair value of the Collins Stewart Option was estimated using the Black-Scholes option pricing model. The estimate was based upon the five year contractual term of the option, a risk-free interest rate of 3.78% on the date of issuance, expected volatility of 70% and a zero percent annual dividend rate. As of 3 1 December 2008, no portion of the Collins Stewart Option has been exercised.

In March 2002 and May 2004, the Board of Directors of the Company approved a one-for five and one-for- forty-five reverse stock splits of the Company's common stock, respectively. The stock splits have been reflected in the accompanying financial statements, and all applicable references to the number of common shares and per share information have been restated.

In March and December 2001, the Company accepted full recourse promissory notes from two executives to finance their purchase of 5,707 shares of the Company's common stock. Interest on the notes was computed at an annual rate of 5.61% and 6.00%, respectively. In August 2003, the Company repurchased 1,067 of these shares in exchange for an aggregate amount of US$4,800 of principal and accrued interest on the notes. The Company also waived repayment of a note receivable of US$34,469 by releasing the employee's payment obligations. In September 2004, the Company repurchased 1,891 shares of common stock in exchange for the remaining note amount of US$47,821. As a result of these transactions, all future awards exercised with a recourse note shall be presumed to have been exercised with non-recourse notes and the underlying option grants may be subject to variable accounting.

NOTE 9 - Employee Benefit Plans

In January 2001, the Company established a defined contribution savings plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. The Company may contribute a discretionary percentage of the amount of the salary deferrals. Through 31 December 2008, there have been no such contributions made by the Company to the plan.

NOTE 10 - Income Taxes

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainties in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes ("FIN 48") on 1 January 2007. FIN 48 prescribes a comprehensive model for how companies should recognise, measure, present, and disclose in their financial statements, uncertain tax positions taken or expected to be taken on a tax return. Under FIN 48, tax positions must initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realised upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts.

As a result of the implementation of FIN 48, the Company did not recognise any adjustment to the liability for uncertain tax positions. As of the date of adoption, we recorded a US$1.6 million reduction to deferred tax assets, all of which was offset by a full valuation allowance and therefore did not record any adjustment to the beginning balance of retained earnings.

The Company is subject to taxation in the United States, California, and Canadian jurisdictions. The tax years from 1999 through 2008, are subject to examination by the Internal Revenue Service and California due to the net operating losses generated in those years. The Company is currently not under any federal,


state or Canadian audits. The Company does not expect any material changes in unrecognised tax benefits in the next twelve months.

The Company accounts for interest and penalties related to unrecognised tax benefits as part of its provision for federal, state, and foreign income taxes. As of the date of adoption of FIN 48, the Company did not have any accrued interest or penalties associated with any unrecognised tax benefits, nor were any interest expense recognised for the year ended 3 1 December 2008. At 3 1 December 2008, the Company had US$0.4 million of u~ecognised tax benefits which were netted against deferred tax assets with a full valuation allowance, which if recognised would have no effect on the Company's effective tax rate. A reconciliation of the beginning and ending amounts of unrecognised tax benefits is as follows:

(in US thousands) Balance as of 1 January 2008 $ 440.8 Additions for tax positions related to the current year 2.0 Additions for tax positions related to prior years Reductions for tax positions of prior years Settlements

Balance as of 3 1 December 2008 $ 442.8

At 31 December 2008, the Company had federal and state net operating loss carryforwards of approximately US$58.0 million and US $43.8 million, respectively. Additionally, the Company had federal and state research and development credits of approximately US$0.3 million and US$1.0 million, respectively. The federal net operating loss carryforwards and research and development credit will expire at various dates between the years 2019 and 2028, if not utilized. The state of California net operating loss carryforwards will expire at various dates between the years 2009 and 2028, if not utilized. The California research and development credits can be carried forward indefinitely.

On 30 September 2008, California enacted Assembly Bill 1452 which among other provisions, suspends net operating loss deductions for 2008 and 2009 and extends the carryforward period of any net operating losses not utilized due to such suspension; adopts the federal 20-year net operating loss carryforward period; phases-in the federal two-year net operating loss carryback periods beginning in 201 1 and limits the utilisation of tax credits to 50% of a taxpayer's taxable income. The Company expects to be in a loss for both 2008 and 2009 tax years and therefore will not be utilising any net operating losses.

Utilisation of the federal and state net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the "change in ownership" provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net operating losses and credits before utilisation. The Company has concluded that ownership changes occurred in 2000, 2002, and 2005, which will limit the future realisation of its net operating loss carry forwards. The Company has reduced its federal and state net operating loss carry forwards by approximately US$0.7 million, and US$14 million, respectively as they would expire unutilised. In addition, the Company has reduced its federal research tax credit carry forwards by approximately US$0.6 million as they would expire unutilised due to section 382 and 383 limitations.

Under the Housing and Economic Recovery Act of 2008 ("Act"), signed into law on July 2008, allows taxpayers to claim refundable AMT and research and development credit carryovers if they forego bonus depreciation on certain qualified fixed assets placed in service from the period between 1 April and 31 December 2008. The Company estimated and recognised the credit based on fixed assets placed into service after 31 March 2008 and has recorded a net tax benefit of US$10,425 for a U.S. federal refundable credit as provided by the Act.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets for financial reporting purposes and the amount used for income tax purposes. Significant components of the Company's deferred tax assets for federal and state income taxes are as follows:


Deferred tax assets Net operating loss carryforwards Accruals and reserves Research credits Depreciation

Subtotal Valuation allowance Net Deferred Tax Assets

Years Ended 31 December 2008 2007 U.S.$ U.S.$

NOTE 11 - Research and Development Arrangement

In August 2004, the Company received a research and development contract from the U.S. Department of Energy (the "DOE"), entitled "Direct Methanol Fuel Cell Power Supply for All-Day True Wireless Mobile Computing" (the "Contract"). Under the original terms of the Contract, the DOE was to reimburse approximately 47% of eligible contract costs (both direct and allowable indirect) up to a maximum of US$3.0 million over a three year period. In January 2006, the Company received formal notification from the DOE that as a result of governmental budgetary constraints, it was suspending further funding under the Contract for the remainder of the DOE'S fiscal year ending 30 September 2008. In May 2007, the Company received notification from the DOE indicating that funding under the DOE Contract had been reinstated. During the years ended 3 1 December 2005 and 2004, the Company recognised revenues related to the Contract of US$l.O million and US$O.l million, respectively. During the years ended 31 December 2008 and 2007 the Company recognised revenue related to the Contract of US$1.1 million and US$0.9 million, respectively.

In October 2007, the Company received a research and development contract from the U.S. Department of Commerce, National Institute of Standards and Technology Advanced Technology Program (the "ATP), entitled "Ultra-low Methanol Crossover Membranes for Higher Energy Density Direct Methanol Fuel Cells" (the "Contract"). During the years ended 31 December 2008 and 2007 the Company recognised revenue related to the Contract of US$0.7 million and US$O.l million, respectively.

NOTE 12 - Related Party Transactions

During the years ended 31 December 2008, 2007 and 2006 and cumulatively for the period from 27 January 1999 (inception) to 31 December 2008, the Company made purchases of materials, supplies and services from SRI International ("SRI"), one of the Company's stockholders, for the approximate amount of US$ nil, US$ nil, US $nil and US$2.8 million, respectively. At 31 December 2008, no amounts were due to SRI.

NOTE 13 - Subsequent Events

In April 2009, the Company announced that the U.S. Department of Energy has awarded the Company with a US$2.5 million appropriation for its portable fuel cell development programme. In May 2009, the Company announced it had been awarded an additional US$2.5 million by the DOE to further commercialization efforts for the application of fuel cell technology to consumer electronic products, including lap top computers.

The Company executed an amendment to its existing Canadian operations lease agreement on 17 April 2009, in its efforts to reduce expenses and liabilities. In exchange for the payment of CDN$0.104 million, the remainder of the lease, otherwise terminating 31 March 2013, was cancelled. However, at the Company's option, if exercised by 23 June 2009, it may pre-pay 9 months rent and extend the lease from 1 July - 31 March 2010, under the same lease rates as the original lease terms. A second option is also available, if exercised by 31 January 2010, at the Company's discretion, to extend the lease a further 9 months through a further pre-payment of rent, extending the lease through December 2010, at the same lease rates as in the original lease agreement.


DIRECTORS AND KEY CONTACTS

DIRECTORS Robert Jecmen Non-Executive Chairman Jim Balcom Executive Director Harry Fitzgibbons Non-Executive Director Don MacDonald Non-Executive Director all care of: 1245 Terra Bella Avenue Mountain View, California 94043 United States

COMPANY SECRETARY Thomas Caldwell Registered Ofice in the State of Delaware C/O Corporation Service Company 271 1 Centerville Road, Suite 400 City of Wilmington County of Newcastle, Delaware 19808 United States

AIM NOMINATED ADVISOR & BROKER KBC Peel Hunt Ltd 1 1 1 Broad Street London EC2N 1 PH United Kingdom

LEGAL ADVISORS Latham & Watkins (London) LLP 99 Bishopsgate London EC2M 3XF United Kingdom

AUDITORS Pricewaterhousecoopers LLP Ten Alameda Boulevard San Jose, California 95 1 13 United States

BANKERS Silicon Valley Bank 3003 Tasman Avenue Santa Clara, California 95054 United States

REGISTRARS Capita IRG (Offshore) Limited Victoria Chambers, Liberation Square 113 The Esplanade St. Helier, Jersey JE4 OFF United Kingdom

PRESS & INVESTOR INQUIRIES Hogarth Partnership Limited 2"* Floor, Upstream One London Bridge London SE19BG United Kingdom

Latham & Watkins LLP 140 Scott Drive Menlo Park, California 94025 United States

POLYFUEL, INC. ANNUAL REPORT MONTHS ENDED DECEMBER...

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